Unintended consequences of carbon credit trades

Consider the parable of a child who is prone to occasional misbehavior. To encourage him to change this bad habit, every time he misbehaves the parents offer a small cash reward if the child behaves well for a week afterwards. The child soon realizes the benefit from misbehaving as frequently as possible so as to maximize his reward payouts. The net result is that, far from reducing bad behavior, the cash reward actually ends up worsening the child's behavior.

In a similar context, Times has an interesting story that highlights how carbon trading to mitigate ozone-depleting greenhouse gas emissions (used in refrigeration and air conditioning) has had the unintended effect of actually increasing emissions. It shows how this has distorted the incentives of manufacturers of such gases

The more dangerous the gas, the more that manufacturers in developing nations would be compensated as they reduced their emissions... they could earn one carbon credit by eliminating one ton of carbon dioxide, but could earn more than 11,000 credits by simply destroying a ton of an obscure waste gas normally released in the manufacturing of a widely used coolant gas...That incentive has driven plants in the developing world not only to increase production of the coolant gas but also to keep it high...

Since 2005 the 19 plants receiving the waste gas payments have profited handsomely from an unlikely business: churning out more harmful coolant gas so they can be paid to destroy its waste byproduct. The high output keeps the prices of the coolant gas irresistibly low, discouraging air-conditioning companies from switching to less-damaging alternative gases. That means, critics say, that United Nations subsidies intended to improve the environment are instead creating their own damage...

The production of coolants was so driven by the lure of carbon credits for waste gas that in the first few years more than half of the plants operated only until they had produced the maximum amount of gas eligible for the carbon credit subsidy, then shut down until the next year... The manufacturers have grown accustomed to an income stream that in some years accounted for half their profits... Some Chinese producers have said that if the payments were to end, they would vent gas skyward.

In fact, these 19 plants producing HFC-23 have taken 46% of all carbon credits issued by the United Nations Environment Program.

This is yet another example of the challenge associated with effective enforcement of any emissions trading scheme. I have blogged earlier here, here, and here, about how carbon tax, being very simple, is a more realistic and therefore implementable strategy to reduce carbon emissions.