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the discussion today is the European emission trading system which is the I would say by far and away the most important cap-and-trade system that exists in the world there are two ways to look at the EU ETS the first we can look at it as just a cap-and-trade system as if it were in a unitary state and something could be implemented in the United States and many people have looked at it in this respect and it is quite often criticized or viewed from that standpoint but a second I would say less appreciated and equally if not important more important aspect of the EU TS is that it is a multinational system and it is the world's first multinational cap-and-trade system and I will talk about that as we go through the discussion this morning the latter aspect is what evokes the subtitle of my talk which is path to the future or dead end and that dichotomy describes and not so much the fate of the EU ETS all of that - but more importantly the prospects for an effective global climate regime for the EU ETS promises an eventual global system but that whole prospect has been called into question by the developments in the US with respect to cap and trade so let's proceed with the just I'll provide an assessment of the six plus years now that the European system was operated and then wrap up with some comments on the past of the future of the dead end and we'll have some time for Q&A at the end so let me describe just very briefly the main features of the EU ETS it is a classic cap-and-trade system in that emissions there's a cap and absolute limit foot on emissions over the regulated sources over some geographic area in this case the 27 member states of the European Union allowances or rights to emit are issued in some matter and you know spend by mostly free allocation and the European system and then a requirement is imposed upon the regulated sources that they must monitor and report emissions and surrender those allowances equal to their emissions it is different from the type of cap and trade programs that we know in the United States in having a highly decentralized implementation that of course reflects its multinational character so although there are certain coordinating features about how the system was set up every member state is responsible for enforcement the reporting many of the rules are are implemented individually by the Member States and at least as currently and when the system started out even the absolute cap was really the sum of 27 caps rather than an eu-wide cap which it will be as starting in 2013 the coverage of the system is for what we would call large stationary sources that is electric utilities and large industry iron and steel cement refineries glass and ceramics pulp and paper anything that is would qualify as a large source quite significantly Aviation is mean added aviation emissions are being added in 2012 not only for aviation or flights within the European Union but for all flights originating or ending in the European Union so when you fly to Europe or you go to Paris for your next vacation you know start after 2012 and the emissions from that flight from New York or Los Angeles will indeed be covered by the European emission trading system the system is set up in a series of multi year periods sequential multi-year periods for which the cap is declining in each period and the legislation with the directive establishing the system was originally set up for two periods from 2005 to 2007 what was characterized as a trial period it was sort of get things the institutions worked out and the kinks worked out of the system and that was to lead to what you could call at least the initial real trading period 2008 2012 which correspond to the first commitment period of the Kyoto Protocol and for which the European emission trading system was on the primary instruments and the central instrument in the European Union for meeting the obligations of the Member States under the Kyoto Protocol last year two years ago the initial directive was amended to establish a third trading period which will be an eight-year period starting in 2013 running through 2020 and it further specified that after 2020 although the presumption is there I'd be further amendments and changes that at least the intent and the the law as it reads now is that that cap will decline but 1.74 percent per annum from 2020 on and if you work that out it will lead to a level of missions in 2050 that will be approximately 50 percent below 2005 emissions which are roughly speaking business as usual emissions and of course assuming growth would be a larger reduction what one might predict to be emissions in 2050 without the system this is the first cap-and-trade program which allows significant amount of offsets into the system and by that means it is allowing the effect of the price created in Europe to be extended beyond Europe and to justify economically emission reductions outside of the European Union that could given the nature of the problem here are as effective as as or in terms of the global warming effect as reductions made in Europe there are two limits on the use of offsets the first is that they can be no more than 13 percent of total emissions so in some sense you could say the cap is perhaps been increased by that but then that depends upon the supply and the actual use of that and it's also limited only the trading mechanism set up by the Kyoto Protocol namely the Clean Development Mechanism and the joint implementation mechanisms that were set up under that so it's not any offset it would not include for instance a sort of offsets if in your air travel you neutralize your your you know or a carbon neutral meeting those sort of offsets are not accepted because of their more dubious nature finally allocation of the allocation of the allowances which is what makes these systems work or the currency about which they operate was free allocation to the emitting sources initially as have been all other cap-and-trade systems however the European system has really established the principle in evolving to full auctioning which is due to occur by 2026 and will start in a major way will be phased out completely for electric utilities in 2013 for industrial sources slower but by 2027 in theory everything will be fully optioned let's look at emissions or what has been the effect of this the black line here reflects the black the solid black line reflects emission since 1990 and through 2009 of the sectors of the installations that are included within the European emission trading system and you can see the huge decline in 1990 these red lines are the three caps that's the first three year period this is the current five year period which they're in this is the cap that starts in 2000 and 2013 now there are several features the nose first is that the reductions are quite modest this incidentally this this dash line is an estimate of what emissions would have been what economists would call counterfactual emissions are what the emissions would have been without the price on carbon and the distance between the solid line which is measured observed missions and this estimate of what would have been constitutes the reduction that we can attribute to the price apartment into the system and you can see that's quite modest in the early years in this very the cap was set but pretty much what emissions would have been and were largely expected to be and you see a large reduction that took place in 2009 a good part of that was of course due to the recession but you notice emissions would have reduced anyway and what you see is a much bigger reduction took place in effect which reflects the coming on line of investments in the delayed effect of investments that were made during started during the first period but of course those investments take time to take effect and that is a further effect of the price that even though you did not see that in the first period you're seeing larger reductions now the emissions data for 2010 will be released the day after tomorrow so we don't know what that is we might see a bounce out but there can be no question about the direction of what emissions in Europe and these regulated sectors are going to be in the future they will they're coming down and they will continue to go down as you see here and I would argue this will be typical of greenhouse gas emission limitation programs or cap and trade programs the u.s. proposals that failed last year in Congress had very much the same characteristic though the cap starts out pretty much at or little below current emissions and then gets tighter over time of course the whole purpose is to create the price and then to give the price which will provide drive the innovation investment in innovation here's what the price of allowances is looked like over this period of time there are two price lines here the first one the red is the price for the first period the trial period and the blue line represents the second period prices now these prices of the next futures contract the main sort of market development in the European system has been that the futures the main market is and futures that settle in December of every year prior to when allowances have to be surrendered in Marchant and April the first period this first period price you will see ended up being zero and this reflects it started out fairly modest you see the evolution but this reflects the fact that the way the system was designed which was that the first period was to be completely walled off from anything else this was a trial period it was outside of the Kyoto Protocol and the intent was and the fear was when things were set up and the reason for the trial period is if anything went wrong there was an excess of emissions or allowances and rather than had to pull them back and so on that they would simply wall off so that the real period would of course start in the second period now futures were sold this is zero price has drawn a lot of attention but notice that during all of this period through here the second period price never went to zero at God as low as a little under fourteen during that period of time but was generally around about 20 euros which was signalling what people expect to be the price in the second period and of course at midnight December 31st 2007 the price flipped the current price for emissions went from zero to something like as you can see around 20 euros a ton that involves some net efficiencies but still the long-term effect was what you see the second thing you'll see is that this price changes and it reflects largely speaking most of the occurrences and the big shifts you can see here reflect changes of expectation with respect to the conditions that will affect emissions so most notably you can see at the end of 2008 now the European Union allowance price was not the only price that fell during this period all of you if you had any portfolio holdings value of houses whatever you'll have experienced much the same sort of thing and all asset many prices went down during that Kurt and that simply reflect the fact of economic growth was not going to be as much and with the fixed cap then there'd be less demand for permits and a lower price which you can see prevailing over this period compared to there and we could look at other periods this is the tightening as the phase 2 cap was determined or the second phase cap was determined you saw a general tightening there was tremendous uncertainty about the level of emissions in Europe the inventories were very poor saying see prices started out sort of what people predicted but where it quickly became high when the first reporting of emissions took place here you had in a one-week period literal halving of the price that showed that in fact emissions were much lower than what people had expected and of course for the first period it went on to zero because there was a small surplus of allowances in the end but the second period price started separating at that point because everyone knew that that cap was going to be different tighter and would not be slack in the same sense and beyond this period in the future periods banking as is allowed so that will not be a problem the price is volatile but their measures and degrees of volatility all prices are volatile if you want to make a comparison the price of European Union allowances is comparable to that for crude oil it's more volatile than the price of coal but it's less volatile than the price of natural gas or electricity if you use the technical measures for volatility here's a picture of what trading volumes have been in this market so it started off fairly low level and you see a steady increase in the amount of trades that took place these are quarterly figures - where in 2009 it had stabilized at a level of about 4 billion tons or 4 billion allowances traded annually and has been there for the last two years now by comparison say the annual cap is about two billion tonnes so you can see that you're having in what looks like sort of a stabilization of the amount of trading you're seeing a number of allowances roughly two times the level of the cap being traded and of course any given allowance may trade several times these are futures so they're not all just trades pertaining to allowances in 2009 but you can see anyway the growth of the market there and also in terms of composition this green are the exchanges these are allowances traded through over-the-counter markets and this is through exchanges which started out very small most everything traded through over the counter as allowances are traded in the United States exchanges are more sophisticated deeper sort of financial market which is developed in Europe for allowances we haven't seen those in the United States I said also that this was the first system which has a major reliance on offsets which is extended the influence of the European price worldwide anyone who wished to reduce emissions under the Clean Development Mechanism the Kyoto Protocol we have only two years of observation this really got started in 2008 but there have been some surprises so the greatest has been you recall if you've ever worked in offsets they're always these fears about we've got to limit the amount of offsets because they'll collapse a system and people will buy them these offsets are several euros cheaper than European Union allowances yet what we've observed in these two years that only four percent of the emissions have been covered one third of the amount that's actually permitted legally under the system the 13 percent so - you know this has been somewhat of a conundrum the puzzle as to why we don't see greater use of these offsets which are perfectly substitutable for Union European Union allowances and which are cheaper about 20 percent of the installations have actually used offsets surprisingly the highest use of offsets has been a Hmong the industrial sources and not the electric utilities who tend to be the most active participants in the market and who had been expected to be the ones who would principally use it in these two years approximately 42% of the CDM credits that were available on the market were surrendered in the European Union system the rest of these you remember there are other there's other demand for CDM credits and namely government's meeting their obligations under the Kyoto Protocol such as Japan notably but others including within the European Union those that are that are above such as Spain and some others and the composition of supply in other words the the credits surrendered in Europe pretty look pretty much the same as the supply these credits which are coming most importantly from China about 40% from China and a total another 30% from the combination of India South Korea and Brazil now one of the things that most interesting aspects of the European system has been what I would call the absence of economic effects and the introduction of cap-and-trade systems are always accompanied by enormous fears expressed concerning the akram macroeconomic effects and the trade or a leakage effects of putting a price on carbon when other countries don't have it in the US we've heard terms such as the more heated rhetoric you know co2 price would wreck the American economy in Europe extreme formulations where this system would start the deindustrialization of Europe and these effects were hostile expected in fact we have not seen much effect at all the first three years of the program are up through night 2008 were relatively robust years of economic growth in Europe and of course they suffered in the Great Recession just like everyone else but no one has attributed that recession some three to four years after the carbon prices imposed on the carbon price in Europe equal effects if not greater effects occurred in the United States where there was no carbon price and the ugly truth is of course that subprime mortgages in the US had a greater effect on European macroeconomic performance than a carbon price in Europe and that it's hard to argue I find it hard to argue with that but no one was concerned about subprime mortgages in Europe in Europe least of all but there was a great concern of carbon price which simply was not there the trade effects have also been imperceptible so when you look when we wrote the book on the first three years the pricing carbon that Charlie referred to we looked a lot at these sort of trade effects and particularly at the net import figures so if there's going to be leakage or the carbon price has an effect you would expect that okay you'd see an increase of imports and perhaps fewer exports because the exports are carrying the carbon price would cause imports an increase in exports to decrease and in some of these areas and some for some products the carbon price isn't important but others like cement it is quite important and steel as well and what you see when you look at that is a continuation of past trends whatever the trend and that imports had been before 2005 that's what it became that's what it was in the years immediately the years that we looked at after 2005 and in fact these were years of increasing production in Europe notwithstanding a carbon price until of course the Great Recession hit and the question would be why do we not see these effects when you would think that a carbon price would in my explanation for this as a carbon price is just one price among many and so that the industrial location the industrial activity in its location and its level of production or its the level of activity are determined by probably hundreds of prices if you want it in various considerations that determined what it would be as of 2005 and all of those other prices remain is valid after 2005 as they were before and as determining and influential if not more influential in terms of location and production as the price of carbon which is just one more price and it also points out but what we say so we don't see these economic effects now I don't want to say that it didn't have any effect because as you saw before emissions have been limited and they're being reduced and they've been reached and they were reduced even from the beginning so what we see here and what we're discovering is that the emissions involved in production are increasing and not the production there's not a fixed relationship between carbon emissions for energy use for that matter of fact and output and the effect of the carbon the primary effect of the carbon is in fact to change and cause people to seek more carbon efficient ways or less carbon using ways to produce and of course that has cost affects how those get passed on it is a complex issue in terms you'll ask these all sorts of other things but what we observe is it doesn't have the employment it doesn't have the trade effects or the macroeconomic effects that are oftentime experience and in fact if you've been to Europe since 2005 and you were there before 2005 I daresay you didn't observe any difference in terms of the of how Europe looked and how people were behaving but emissions were lower modestly so as you can see so let's summarize here on what are the achievements of let me just wrap this part of it up with what are the achievements of the EU ETS and I would characterize these I think if we pull back up to the largest of the biggest picture is 3 there is a price on carbon over roughly 10 percent of global emissions the reductions have been modest so far as I have said but what has been established is pervasive signal and in a position of cost that enters into production decisions and consumption decisions but importantly is this signal for investment in innovation which will have the effects in the future and that as with the declining cap one could reasonably anticipate what will be a higher price although the level of that price is of course not known that depends upon the level the economic activity what happens these areas more importantly than this price price I would as an economist I would place great importance on that but what you see is a mechanism in place for affecting further greenhouse gas emissions as desired this is something that no other nation or no other set of nations has in place an effective mechanism that is of course there will be further political decisions on what level of emissions where will we establish the cap but that system is in place it's been institutionalize its established and of course the path that it's set up is quite clear it may be changed but still it is there and most importantly it has demonstrated the feasibility of a multinational system very much as was anticipated in the Kyoto Protocol now that raises the question can we consider the EU ETS a model for the world for the globe with all of its disparities and differences and I would say yes I think we should at least consider that and think about that and I would make that argument based upon some two observations in particular first of all the the European Union is not a strong federal state and it would be I would say the fount as the European Union exists today and the various founding treaties it would really if you want to seek a US analogy it would be more like the Articles of Confederation than the post-civil war US Constitution as we have evolved it were we all those states enjoy a fair degree of autonomy and we are a federal state the grandest state in the United States be that California Texas New York could not pretend to the sort of sovereignty and discretion that the smallest state and the least important of the European member states enjoys and although the legislation that what we would consider legislation that operates at the European level are called directives and appear to be like federal legislation these I would suggests functionally should be regarded more as multinational agreements for although there's a European Parliament which has a role to play there's the Commission and various officers of the European Union a directive can pass only if there is a supermajority of the participating governments and in many instances such as in fiscal matters that must be the unanimous agreement of the the Member States with under a sort of a weighting scheme but it requires a supermajority of that waiting so really when these government's decide then that becomes a directive which would be transposed and so on so it is a type of multinational agreement and although it may be convenient for Americans and others to speak of Europe as an entity and regarding it as somewhat homogeneous I would submit that it is not particularly in this area the economic disparities are large if you look at per capita income levels what's a purchasing power parity basis they differ by a factor of five between the lowest income nations which are Romania Bulgaria and the highest income nation which is Ireland that has a per capita income comparable to that of the US average now the comparable spread in the United States between the richest and the least you know wealthy or at least their highest income one with the lowest gross state product is a factor of two so we're looking at disparity which is considerably larger than we observe in the United States and that span comes pretty close to the range spans almost the global average the per capita income levels again on purchasing power parity basis of Bulgarian Romania is only 50% higher than that of China as I said before Ireland is comparable to the u.s. average different parts of Europe have had quite different historical experience with markets we might have thought before 1990 in terms of well southern Europe is not quite as market oriented as the Netherlands the UK Scandinavia and so that you could imagine a market-based system operating in Northern Europe learn the northern part of Western Europe but it was less possible to see that in the south but then after the adhesion of the new member states of Eastern Europe that came into the European Union we're now talking about countries that until 20 years ago had literally no experience with market based in fact had economic systems that for some 40 years had been based on a denial of the role of markets and you and so we do have the same sort of differences that we might think of institutional differences with the respect to markets that we might think of existing on a global level and I would be quick to note that the commitment to climate policy varies widely among the European nations so in Eastern Europe the emphasis is on what we would call conventional pollutants sulphur dioxide particulate NOx emissions yes they're concerned about climate but the imperative environmental need is really to deal with the conventional pollutants which they're doing and climate is somewhat a little bit later whereas of course in Western Europe for the most part these of all banned the conventional pollutants that were very well under control have been dealt with and they can be much more and tend to be much more concerned with climate policy so in many ways the east-west divide although it's not identical and is perhaps not as great it resembles the global north-south differences and yet the remarkable feature of the European emission trading system this first multinational cap-and-trade system is that all 27 member states belong despite these many differences among them on a global level we don't require that all hundred and 80 nations of the United Nations belong we certainly need the major emitters but constructing a system that will have those all of those major emitters is going to require dealing with the problems that they've had to deal with in Europe so the question is what really made it work in Europe so what lessons can we draw in terms of a future global system bate that would be a multinational system that what can we draw from one of course is the will to act that goes without saying but I think equally importantly is the favorable political moment it seems to be questionable one could question whether the European Union would have enacted the system if it were today when the preeminent European institution the euro is under attack and has absorbed everybody's attention this system is sort of off on the sides and so on but it was created I mean it was formally adopted in 2003 first proposed in 2001 at a time of growing optimism in Europe and confidence in their ability to act together and of course environmental is given a tremendous impetus by the u.s. rejection of the Kyoto Protocol ironically which then moved them towards trading so there was a favorable political moment of course all political achievements require a favorable political moment almost by definition a second feature that made it work is great initial deference to the Member States there were particular checks that were put in place and as the system got going there was increasing centralization later on in some ways because some of the things that member states had insisted upon initially such as allocating allowances they found to be a thankless task and we're happy to have it done in a number and by some other means but initially it was very much so as I said before the initial cap in the current cap is the sum of 27 individually nationally determined caps that are subject to some review and sort of coordination of criteria and so forth that are laid out in the International the directive or international agreement that sets up the system but it is very decentralized in its implementation as well as in the fundamental features at the beginning of what's the size of the cap it benefitted enormous Lee from the pre-existing coordinating mechanisms that existed in the European Union the Commission the whole jungle of committees and other institutions that are set up to encourage cooperation and to work out issues among the Member States none of these were set up for a cap-and-trade system in Europe but they played the role brilliantly and I think quite quite well but those mechanisms were in place so they didn't have to be created obviously in a global system you're going to have to create those we're gonna have to find the mechanisms that would allow that those sort of coordinating functions to take place equally important were the the pre assisting Club what I would call the club benefits of the European Union so anyone familiar with the system will know that the East European member states are not necessarily enthusiastically happy about the European emission trading system many of them a common complaint was okay so something built for the rich EU 15 it wasn't constructed for us we had to put it on as a part of joining the European Union one observer characterized it as an ill-fitting suit for Eastern Europe and so all the dissatisfaction about allocation what the cap levels were there's a whole history of all of this yet whenever these sources of unhappiness rose to anywhere near a high political level in these countries they simply were not going to be taken up because whatever the unhappiness about how they were treated in the allocation or in the caps or various other things that the whatever the cost or whatever the inconvenience of this system was nothing compared to the benefits of the free movement of capital labor and goods that was represented by joining the European Union as another student server said the EU ETS was just another obligation on the long march to the European Union for us this was a person from Hungary that that and that's very much the way but it was those other benefits they didn't join they didn't participate because they were convinced of the imperative nature of climate change although they would readily agree that yes it's a problem and something would be done but we have other priorities but when coupled with these other benefits the benefits of being parties to the club called the European Union it was worth accepting this and there again on a global level something more will likely be needed than simply being convinced of the importance of climate change and of doing something about it to persuade nations to come into it and then last we see in Europe their business an effective differentiation of burdens among the participating member states as the stringency of the program has increased initially everyone had a cap that was pretty much at businesses usual emissions therefore not very demanding but as the cap has increased it has been it is moving towards increasing differentiation this has been accomplished that I said before starting 2013 there's an eu-wide cap so there no national caps but it was also coupled with moving to auctioning and that created what we're called auctioning rights and so now the question is who has the right to auction the allowances that are part of the system and of course those then get allocated at the governmental level where this is being negotiated to various governments and if you think that all the member states of the European Union receive an equal allocation that's equal to their missions in some period during this time you're totally wrong that the lower income countries Romania Bulgaria the Baltic states receive anywhere from 40% to twice as many auction rights related 2005 emissions as the richer states of northwestern Europe and there are a number of states that fall in between now this is sort of well hidden and a bunch of technical formula and the directive but effectively that people knew what was going on who negotiated the treaty so let me come now to the past of the future the one of the one side of the dichotomy that I opposed that I have posed the EU EGS represents bodies the vision and hopes of the Kyoto Protocol and yet there's a curious feature about the European emission trading system which is although it isn't clearly inspired by the Kyoto Protocol it is independent of it it's embedded in European law when it was enacted it was not clear that the Kyoto Protocol would enter into force and it was quite independent and clearly I think very few people expect the protocol to extend beyond 2012 and yet we know for sure that the system will it's become quite independent it's a bottom-up construction that within some way and it is embraced of trading ironically if you have the history of the Kyoto Protocol and European opposition to trading initially but it got what the Kyoto Protocol got right there are many things to criticize about is the vision of the trading regime as being the most promising way forward towards a global climate regime and essentially because not only is it efficient and for a problem of the magnitude that global warming promises to be in terms of dealing with emissions you need efficient instruments but also its ability to differentiate burdens inconspicuously you can think of this you know carbon tax would have the same efficiency attributes if it were uniform but usually the way you make allowances for equity and different you know you differentiate ing to circumstances and a tax is somebody gets a lower tax or exemption from the tax think of your personal income tax and that of course destroys the efficiency or you could have the uniform tax but then you'd have intergovernmental transfers so imagine and think of China and United States or Indian United States would China agree to an equal carbon tax with the United States maybe with an intergovernmental transfer of the revenues what would the u.s. take some of its revenues and transfer it explicitly in an intergovernmental transfer to China as a part of awkward and sharing and differentiated responsibilities to use the jargon of the Framework Convention but they might agree to uniform price created by a linked system in which China received more allowances are perhaps more auction rights much as we've seen in Europe which don't have the same sort of explicitness they're inconspicuous they're hidden anyone who they're an intergovernmental transfer in the same manner but they're much less evident and therefore much more politically salient and the next step of course in creating the system was that the the European Union would link up with the United with what was expected to be a u.s. system and that brings me to the final the other side of this daikon which is a dead end we've had a curious development in the US which it's fallen cap-and-trade and American regulatory innovation has fallen into some disrepute and I would pose the issue has it become a cultural issue like abortion gun control stem cells I mean how could a wonky or AB economist idea take on this stature I'm not sure that it really has taken on that stature although here some of the rhetoric of opponents you would think so although I think many of the advocates are what I would call half-hearted as I'd say those other cultural issues have full throat supporters on both sides of the issue and this sort of disrepute is not limited to the federal greenhouse gas proposal that failed in Congress last year we see it in the demise of the classic canonical so2 system the system that inspired all of us the NOx budget program is dying two states and regi the first mandatory co2 emissions trading program in the United States the regional the northeastern two of the states are talking about pulling out of that in the Western climate initiative of which California is a part of course in New Mexico is trying now how to extricate themselves due to an electoral change and a new governor and even in California we find any of you have been following the legislation there are the litigation now called into question whether it can be implemented on schedule or perhaps at all but anyway with due to legal issues that have erosion have arisen now this half heartedness I mean there's a reflection in Europe in some way of what I would argue this sort of half-hearted Nisour sort of discontent in a way Europeans are very proud of their system but if you're been to Europe and you talk to people you'll find very very critical of the system also and they're sort of a you know and when you try to get to has it been effective in limiting emission you know that work they agree that it works but it's not doing enough I mean that would become basically it hasn't produced the changes that we had anticipated from a price on carbon and never mind that it's reduce the emissions and so on but it just has our it will in the future but it hasn't reproduced the explicit changes that sort of preconceived ideas of change that we expected and so you end up and what we're facing on both sides of the Atlantic I fear is the alluring promise of mandates to deliver preconceived results for the fact is the cap-and-trade is hard to love except for economists who can appreciate that yes all the subtle influences look pervasive price that stimulates innovation different ways to produce and things to make the same good so it really doesn't have the same economic effects but if you have the notion that know what is required is that we must kill coal or we must move to dramatically different ways of energy use and of leading our lives and you'll be very disappointed with cap-and-trade and you might place your hopes and mandates for doing that because and essentially what this is saying is that limiting and reducing emissions isn't enough and so we're heading the question that is raised by this is can old-time command and control do better I think our hopes rest in that will face a long detour rather than a dead-end and that detour that long detour would consist of the EU persevering with their system despite no one following and it not extending although there are some very interesting discussions underway with China between the European Union and China who is actually talking about on a provincial or sectoral level trading systems that are actually are looking to the European Union on what has been the experiences no one else has the experience with actual co2 system but it requires that Europe persevere and this half Harden half heartedness and they didn't do not yield to the lure of the mandates meanwhile in the hope of that detour would the US would return to cap and trade after finding that all of the alternatives are even worse thank you very much for your attention he said that if you went to Europe before and after 2005 you wouldn't have noticed much of a difference in right I could say that so I'm wondering where where are these incentives showing up in terms of innovation I mean what are what is driving the reduction in emissions or is this such a small blip that you can't really project okay they've been several you know I'd say there are three things I point to one you've seen in the electric utility system you've definitely seen more utilization of gas than you've seen then you would have had of coal so that's you've got gas plants and coal plants competing and the difference of price and you know what gets dispatched on electrical system as a matter of Mills per kilowatt hour so you know this and that effect is palpable has been measured you've also seen in terms of the investment I'd say the primary investments have been made are curiously the investments in improving the efficiency of coal-fired power plants so the heat rate is we would call it what the Europeans call the efficiency the power plants is not god-given I mean it varies widely it depends on how well do you maintain the plants and companies like awesome and Siemens have been busy in Europe with and with this price it makes it worthwhile to improve the heat rate or improve the efficiency of these plants now the reduction is only 10 maybe 15 percent you know in this but it's still being done in the UK I mean the the largest plant there quite prominently talked about how they're changing out their turbines putting in new turbines rebleeding the turbines that would improve the efficiency about 10 percent in their plant so that's a that's not an insignificant reduction of emissions again it's not 50 percent and it's not going to be that but that's starting off and we've seen in steel industry in cement industry changes in terms of how basically changes in the manner of producing it that have come about because there are alternatives of how to produce the same quality cement or the same steel with fairly slight changes in the production process what we really don't know is how much you know I think the cost affects they weren't done before because it was too costly but the cost effects I think probably get drowned out again because it's just you know one single price but those would be three examples I would say have about a year ago there was a publication about the comparing carbon tax versus emission trading they used the agent based model and simulate you know which trajectory would result in a bit better outcome and their conclusion was their current tax generally result in a better outcome despite the you know general findings in other of the in environment economics the reasoning is that well carbon tax give very clear idea for business right how much of the you know additional cost involved in their business will be so that they can readjust theirs themselves to their profit maximizing practice whereas emission trading sort of led the business speculate where will be the price trajectory in the future so that some of them will under capacitate and some of them will over capacity so that there will be some sub optimality and in their behaviors that the overall outcome will be less favorable so what is your reflection in this discussion okay I guess the it is a point that's commonly made and so the argument is here that we want a fixed price that a fixed price all else being equal will let's say cause more investment than a you know let's say an equivalent expected price that we might see we expect some variation around that perhaps I mean we see all around us investments made I mean huge investments you think of offshore platforms and things on a price that is a fixed and there are a variety of ways in financial markets to hedge to deal with that and then you know the structure of corporations is to deal with those sort of uncertainties so whether you know is there some edge greater you know for if you absolutely fix price you're also coming in the issue of the ability governments to commit in the long future so we may say you know our goal is 80 percent reduction but 20 50 but does anybody really believe that that issue would never be revisited that Congress today for instance could commit to what the emissions will be in 2050 I don't think so and and what we've seen one of the features the European system has been that they have actually adapted and changed their system in response to events which is quite encouraging so it doesn't just you know nobody will touch it and it sort of goes off off the road and in some manner so I think the the problem you know attacks would be wonderful and I think the real issues here become the much perhaps overdone political feasibility of the tax but I think also to my mind it's fundamentally the issue how do you differentiate in a multinational context so we're talking about a global system so how do you differentiate globally are those intergovernmental transfers we need all the efficiency we can get but to differentiate if you're gonna have a global tax you need to have intergovernmental transfers that are explicit that's going to be a lot harder to arrange than surreptitiously if I may use that word but prefers a inconspicuously to arrange the transfer in some way that very few people recognize as being that is actually a function of the market just like we transfer lots of money to you know China or India or other countries to purchase whatever goods that they can produce more cheaply than we can so this just becomes one more and it's the result of decentralized agents looking for the cheapest sort of thing and it seems all very plausible and in effect it gets set up the transfer get set up by agreement among governments who know what they're doing but it doesn't have the same political savings and I think that's where the superiority to cap-and-trade and the promise and if we could do those trance if you deal with differentiation or let's say countries like India and China don't care about differentiation and they would feel the equitable for the Japan the US Europe for them to send the same burdens as as us then okay fine you could go with it but I just don't think that's the world we live in with the question of offsets the two limitations were a 13% limitation and then CDM ji do you think that more could be accomplished if the offsets were opened up to anywhere and particularly within the countries themselves because here in California for example we have the environmental justice you know Lobby saying we want the reductions near the facilities so that limitation seems to be unnecessary to me because if CDM is really the least cost the market would find it anyway I I would quite agree I mean I quite agree with you that you you presumably the the idea for an offset regime would be you have tough criteria that have to be met and no restrictions particularly for climate I mean you don't care where the emissions are in the European system in fact joint implementation does occur within the European system outside of the sector I mean it's a very controversial but in theory it's allowed and there are several the countries are indeed exploring where they're doing a reduction in the residential sector or to get J I credits they could then be used in the European system this is a number of baseline problems because of the Kyoto limits and so on but that that could be done I I mean I I think the political realities I mean we have this fear of offsets swamping the system and it come in all the US legislation that's the way it's set up you know I wish we could get away from that and just say look it's the integrity that counts and so we don't care where they come from what they are just so they're real and they're additional and so on but that seems to be the way the more that we can widen that up so much the better the European choice of the Kyoto mechanisms because they were part of the Kyoto Protocol and it had the beneficial effect of making the European price the world price so I mean that if you go out and see DMR everything I mean the CDM would be a pale shadow of what it is today if the European system had not created a price of 20 euros it'd be very much weaker much less not viewed as a success you know whatever so so I think the morning widen it up the better and I think the interesting feature what were observed in Europe is you know that the limit is not fully subscribed despite the fact that from a rational economic standpoint everybody would do that even if you had more allowances than you need it for your emissions you'd swap them out I mean sell the EU A's itself for 3 euros more than CDM credits and use the CDM credits up to your full 13 percent but you know clearly that's not being done and I don't have a good explanation for that's one of the research topics I'm working on but I think it shows that perhaps these fears of the offsets whomping the system are really overblown it doesn't occur and in fact for most other cap-and-trade systems have offset provisions but they're very little utilized because the transaction cost other issues I was struck by your comment about old-fashioned command and control and doesn't that just suggest that the cap needs to be tightened well you you could so let's say that is a political issue I mean one of the problems of cap and trade I find is it's too explicit and so but I would also argue it's more effective in reducing emissions than the old-fashioned commanding control where you have a lot of hoopla about adopting the amendment and then and it's typically sort of a uniform standard that then has to be applied in a world of tremendous cost heterogeneity and so what happens is so we have people from the standard isn't particularly demanding others from it imposes extraordinary cost and for them they always come in for some sort of relief and arguably they should receive it because you know there plant whatever a reason but the relaxation is always one side no one ever comes in says this is really easy for me you ought to tighten the sad for me and the regulator doesn't know for whom it's easy what this system does is they okay it's up to you guys to figure this out and the market actually works that out so the one that has cheap abatement cost actually does a lot more because it pays them to do that to supply the other what you'd like to do if you had known missing from habitant regulator who you know you all or the world were a burr hole it was average or homogeneous but it isn't so I think that's the issue so it's easy to appear tough with command and control it isn't as easy with cap and trade but you know this is testing the blood of because the the real tightness of the command and control that's I said the alluring promise I mean whether commanding control delivers these expected results can be questioned and I was saying you know I don't think it does if you match the rhetoric with what actually happens I think it much less so than what you're seeing the cap and trade