Carbon Trading

Carbon emissions trading is a form of emissions trading that specifically targets carbon dioxide (calculated in tonnes of carbon dioxide equivalent or (tCO2e) and it currently constitutes the bulk of emissions trading.

This form of permit trading is a common method countries utilize in order to meet their obligations specified by the Kyoto Protocol; namely the reduction of carbon emissions in an attempt to reduce (mitigate) future climate change.

Emissions trading works by setting a quantitative limit on the emissions produced by emitters. The economic basis for emissions trading is linked to the concept of property rights. 

Costs and valuation

The economic problem with climate change is that the emitters of greenhouse gases (GHGs) do not face the full cost implications of their actions. There are costs that emitters do face, e.g., the costs of the fuel being used, but there are other costs that are not necessarily included in the price of a good or service. These other costs are called external costs. They are "external" because they are costs that the emitter does not face. 

External costs may affect the welfare of others. In the case of climate change, GHG emissions affect the welfare of people living in the future, as well as affecting the natural environment. These external costs can be estimated and converted in a common (monetary) unit. The argument for doing this is that these external costs can then be added to the private costs that the emitter faces. In doing this, the emitter faces the full (social) costs of their actions. 

Ethics and fairness

The way of dealing with climate change has particular ethical issues and other issues related to the fairness of the problem. To actually calculate social costs requires value judgements about the value of future climate impacts. There is no consensus among economists over how to value the fairness (economists use the term equity to mean fairness) of a particular climate policy, e.g., how to share the burden of costs for mitigating future climate change. Nor do economists have any professional expertise in making ethical decisions, e.g., over the value assigned to the welfare of future generations. Typically all the impacts of policy, both the costs and benefits, are added together (aggregation), with different impacts on different individuals assigned particular "weightings," i.e., relative levels of importance. These valuations are decided by the economist doing the study. Valuations can be difficult since not all goods have a market price.

Taxes versus caps

A large number of papers in the economics literature suggest that carbon taxes should be preferred to carbon trading. Counter-arguments to this are usually based on the possible preference that politicians may have for emissions trading compared with taxes. One of these is that emission permits can be freely distributed to polluting industries, rather than the revenues going to the government. In comparison, industries may successfully lobby to exempt themselves from a carbon tax. It is therefore argued that with emissions trading, polluters have an incentive to cut emissions, but if they are exempted from a carbon tax, they have no incentive to cut emissions. On the other hand, freely distributing emission permits could potentially lead to corrupt behaviour. 

A pure carbon tax fixes the price of carbon, but allows the amount of carbon emissions to vary; and a pure carbon cap places a limit on carbon emissions, letting the market price of tradable carbon allowances vary. Proponents argue that a carbon tax is more easy and simple to enforce on a broad-base scale than cap-and-trade programs. The simplicity and immediacy of a carbon tax has been proven effective in British Columbia, Canada - enacted and implemented in five months. Taxing can provide the right incentives for polluters, inventors, and engineers to develop cleaner technologies, in addition to creating revenue for the government. 

Criticisms

One criticism of carbon trading is that it is a form of colonialism, where rich countries maintain their levels of consumption while getting credit for carbon savings in inefficient industrial projects. Nations that have fewer financial resources may find that they cannot afford the permits necessary for developing an industrial infrastructure, thus inhibiting these countries economic development. Other criticisms include the questionable level of sustainable development promoted by the Kyoto Protocol's Clean Development Mechanism.

Critics of carbon trading, such as Carbon Trade Watch, argue that it places disproportionate emphasis on individual lifestyles and carbon footprints, distracting attention from the wider, systemic changes and collective political action that needs to be taken to tackle climate change.

Structuring issues

Corporate and governmental Carbon emission trading schemes (a trading system devised by economists to reduce CO2 emissions, the goal being to reduce global warming) have been modified in ways that have been attributed to permitting money laundering to take place. The principal point here is that financial system innovations (outside banking) open up the possibility for unregulated (non-banking) transactions to take place in relativity unsupervised markets. The principle being that poorly supervised markets open up the possibility of structuring to take place.