Cap and Trade: Using Markets as a Tool
Quick: What are the basic outlines of a cap-and-trade approach? Or, more generally, what is cap-and-trade supposed to affect?
If you, my readers, are typical, about 75% of you don’t really know. The other 25% can correctly say that it is intended to control carbon emissions. The Rasmussen Reports gives this statistic about people in the US at least.
More generally cap-and-trade systems are used to control pollutants. The idea is that there’s a legal cap on what the total pollutant can be emitted into the environment. That total gets divided up by the companies in that industry that emit that pollutant somehow more or less equitably. (Or based on who spent the most on lobbyists.) Then this cap is lowered over time.
That’s the “cap” part. The “trade” part is that a company that wants to emit more pollutant can buy the right to emit that amount from another company that isn’t using its full allocation. A new market is created for the “right to emit” the pollutant. Then, Adam Smith’s invisible hand of the market that the free market enthusiasts are so vocal about comes into play.
The problem with dumping pollutants into the air, rivers, and lakes is that this doesn’t really cost the companies that do the dumping. It affects all of us and costs us in health and cleanup costs, but isn’t captured in the market price of what the companies produce. Therefore there is no incentive to stop pollution. This is one of those “market externalities” I’ve written about before.
A cap-and-trade system neatly takes that market externality and internalizes it. This is a wonderful use of market economics and human nature.
In some circles there is currently criticism of capitalism, or market economies. The idea of an economic market is just a tool. The tool isn’t at fault, instead it is our fault for not using the tool correctly. Cap-and-trade can be (depending on its implementation) a good use of this tool.
I think of this general approach as an engineering design approach to economics. Thus neatly putting together an vocation and avocation.