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Don't Cry For The Failure Of Cap And Trade, You Wouldn't Have Liked How It Turned Out

Looking at the carbon markets in Europe gives a glimpse of what can go wrong with a carbon market. Imagine if we had tried one with the U.S. Congress involved.

Last week, the Harvard political scientist Theda Skocpol published a readable 140-page account of why President Obama’s cap-and-trade proposal failed to become law. She concludes that political players failed to prepare the ground for a deal, that outside environmental groups didn’t push hard enough, and that there was a faulty assumption that Republicans would follow business interests in backing the plan.

The paper is interesting, and led to a some good comment from people who follow environmental politics (see here and here, for example). And the general tone is one of regret: regret that Obama’s main effort to do something about climate change (and spur clean tech investment) failed, and regret that the opportunity to pass something comprehensive may not arise again soon.

But what if the failure was a good thing?

Look across the Atlantic, and the glow from cap-and-trade doesn’t look so rosy. The E.U.'s scheme is once again hitting the headlines for the wrong reasons, as traders complain about too many pollution permits in the system, and environmentalists bemoan a carbon price that isn’t meaningful enough to incentivize movement away from carbon-creating activities. The speculation is that the E.U. will have to step in to goose up the market, or else see the scheme—known as E.U.E.T.S.—fall by the wayside.

Europe’s "flagship program" has been in trouble before. In fact, its eight year history has been marked by recurrent controversy over issues like windfall gains for emitters, gaming by market participants, and thefts at registries supposed to keep permits safe. Most seriously, there has been a continual oversupply of permits (thus keeping carbon prices low), and emissions haven’t fallen as expected. In fact, coal—by far the dirtiest fuel—has become more cost-competitive.

So, it’s somewhat strange to read of nostalgia for a bill that aimed to emulate the E.U.'s "achievement," and in fact would probably have taken even longer to establish a decent carbon price. The bill, as passed in the House, planned to give away millions of credits to emitters, as a way of gaining their inclusion. Who’s to say they wouldn’t simply have banked those permits, as European emitters have done, weakening trade on the open market?

Backers of cap and trade often say that while carbon taxes are off the table, a market in carbon dioxide is better than nothing. They argue that, once you establish a carbon price, you can move forward by amplifying the signal (by reducing the number of permits), thereby encouraging actors to seek cleaner, less expensive, alternatives.

But the E.U. hasn’t created a stable price, and officials haven’t been able to draw out credits in a systematic way. The recession has intervened to decrease emissions naturally (and leave permits in the system). And, the E.U.E.T.S. has been beset by endless lobbying from emitters wanting dispensation, and governments not wanting to set national carbon budgets too tightly.

Carbon trading, in other words, is an invitation for all sorts of behind-the-scenes chicanery that Congress already excels at. If the Obama’s plan had been enacted, it would surely have led to yet more special pleading (if that’s possible). And the likely headlines of the last four years wouldn’t have been about waning carbon intensity, but more complaints about giveaways to big business. Cap and trade would have made boondoggles like Solyndra look insignificant.

The E.U. may trumpet the E.U.E.T.S. as an example of where Europe’s leads the world, where it takes the tough decisions others won’t (take that, America!). But the record of its eight year trading experiment says something different. America is better off without of it.