For nearly three decades, climate policy experts have debated the value of emissions trading. Some view cap-and-trade as an optimal strategy for mitigating climate change, arguing that it creates the most flexible and administratively efficient means to achieve least-cost emissions reductions and to promote innovation.Footnote 1 In contrast, emissions trading sceptics claim that the benefits of cap-and-trade are oversold. Not only do they dispute the impact on innovation, they also argue that emissions trading actually increases administrative burdens on already overtaxed regulators by requiring them to develop expertise in both pollution control technology and the economic transactions associated with emissions trading.Footnote 2 Despite this scepticism, emissions trading schemes for greenhouse gases (GHGs) have become a favoured policy solution.Footnote 3 Thus far, however, these programmes have achieved only moderate success.
In Making Climate Policy Work, Danny Cullenward and David Victor argue that moderate success is the best that one could hope for. They contend that market-based climate policies such as emissions trading and carbon taxes – but especially emissions trading – are inherently limited by political realities and the constrained institutional capabilities of most governments to enact and effectively manage market-based policies. Using examples from emissions trading schemes around the world, particularly Europe and North America, the authors show that emissions trading systems are rarely designed to actually produce substantial emissions reductions. Instead, they argue that cap-and-trade systems function as ‘Potemkin markets’, which create the appearance that low-cost emissions trading is responsible for GHG reductions even though other regulatory tools have been responsible for most emissions reductions to date. Rather than expending the political capital to substantially improve or completely scrap cap-and-trade systems, however, Cullenward and Victor recommend that policymakers and advocates scale down their expectations for emissions trading and focus instead on developing industrial policy that will actually yield significant emissions reductions.
The authors make their case over a preface and nine chapters. The first six chapters focus on describing the flaws in emissions trading systems and the ways in which politics make such flaws inevitable. Chapters 7 and 8 focus, briefly, on potential reforms, and Chapter 9 concludes. As this review illustrates, the bulk of Making Climate Policy Work is focused less on presenting strategies for ‘making climate policy work’ than on detailing why emissions trading will never perform as well as its strongest advocates contend. While the book would have benefited from more detail about effective climate policy, its insights into the political drivers of dysfunctional market designs are thoughtful and revealing.
In Chapter 1 Cullenward and Victor describe the theory of politics underlying their critique of these instruments. This theory posits that two dominant political variables limit the efficacy of market-based strategies. Firstly, they argue, interest groups – including emitters, low-carbon industries, civil society, political leaders, and the broader public – collectively tend to shy away from policies that create uniform and transparent price signals, which are bedrock features of functional pricing mechanisms. Secondly, they contend that institutions – which include formal and informal rules, norms, and practices that affect behaviour and administrative performance – undermine the development of effective regulation. Collectively, they claim, these political variables tend to produce ineffective and distorted market designs. They then seek to substantiate this claim in Chapters 2 to 6.
Chapter 2 describes how interest groups and institutions have led politicians to pursue a set of hybrid regulations that undermine the efficacy of emissions trading schemes. Firstly, they note that, although many economists consider carbon taxes to be superior because of their simplicity and clear price signals, carbon taxes are rarely politically viable because they may lead to transparent price hikes (which are bad from an interest-group perspective, as voters may hold politicians accountable for escalating prices), and because many jurisdictions have institutional rules, such as supermajority requirements, which make them more difficult to enact. Accordingly, politicians opt for more complex and opaque policies, which include emissions trading schemes and direct regulation. Between these two options, Cullenward and Victor believe that direct regulation better accommodates political realities. Policymakers can tailor regulations to the needs of specific regulated entities without necessarily affecting other regulated parties or weakening the broader regulatory scheme. Policymakers can adjust the mandates or issue subsidies to mitigate the economic impacts on consumers and voters. Moreover, the complexity and opacity of traditional regulation give policymakers leeway to create and amend rules without triggering a broad public outcry. Emissions trading systems, in contrast, are not amenable to politically driven tailoring because they are supposed to create a uniform price for emissions allowances. When policymakers inevitably create exemptions in emissions trading systems to control prices or protect favoured industries, they distort price signals and weaken the market. Subjecting emitters to a blend of traditional regulation and cap-and-trade regulation also distorts the market. Nonetheless, to assuage various constituencies, policymakers have enacted a mix of traditional regulations and market-based mechanisms. As a result, direct regulations are often responsible for the majority of emissions reductions, while emissions trading schemes serve as Potemkin markets.
In subsequent chapters Cullenward and Victor also challenge the widely held view that expansive emissions trading systems are superior to more narrow systems. Emissions trading theory posits that carbon markets should cover as many emissions sources from as broad a territory as possible to enable robust emissions trading, increased flexibility, and low costs.Footnote 4 Cullenward and Victor assert, however, that it is actually better to create market-based systems that have narrower application, lower expectations, and thus fewer exceptions. In economy-wide trading programmes, they argue, policymakers are more likely to include exemptions and market-distorting rules, such as free emissions allowances for trade-exposed industries and capacious use of low-quality carbon offsets. If markets span multiple jurisdictions, they are even more likely to include distortionary exceptions, as political leaders insist upon rules that protect local interests from the impacts of a global or regional market. Moreover, they argue, the institutional capacity to administer linked markets usually does not exist. The European Union Emissions Trading System (EU ETS)Footnote 5 is the only robust, multi-jurisdictional market that has withstood the test of time and undergone substantial reform. Cullenward and Victor contend that is because the EU had an existing regional governance structure in place well before embarking upon developing an emissions trading programme. In contrast, where governments have tried to use emissions trading as a mechanism to spur the creation of multi-jurisdictional governance structures – notably with attempts to link the economy-wide emissions trading system in California (United States (US))Footnote 6 to other western states and Canadian provincesFootnote 7 – they have tended to fail. The only other multi-jurisdictional system with any longevity, the Regional Greenhouse Gas Initiative (RGGI)Footnote 8 in the eastern US, was intentionally designed to accommodate a weak regional governance model that allows participating states to depart from the system as political leadership changes.
Somewhat counter-intuitively, Cullenward and Victor argue that the RGGI could serve as a model for other realistic carbon markets. To many, the RGGI exemplifies the downsides of low-ambition, single-sector carbon markets. In addition to allowing member states to join and depart with relative ease, the RGGI only regulates carbon dioxide (CO2) emissions from the electricity sector and its allowance prices have remained low; but, to Cullenward and Victor, the RGGI is performing about as well as one could hope. Unlike the Californian cap-and-trade scheme, which exempts some of the state's largest fossil fuel sources, the RGGI is not riddled with exemptions. Unlike both the EU ETS and the Californian system, the RGGI has not been plagued with huge over-allocations of emissions allowances and extensive banking rules, which make market reforms difficult to achieve. Instead, the RGGI has been relatively stable, with predictable prices and steady revenues. The electricity systems in RGGI states have also steadily decarbonized (albeit at a relatively low rate), thanks mostly to separate energy policies, as well as to the steady revenues provided from the RGGI.
Those revenues are arguably the most important benefit of emissions trading schemes, according to Cullenward and Victor. Indeed, their observations about carbon market revenues are particularly insightful. Chapter 4 offers an expansive critique of how these revenues are spent, arguing that too large a portion is directed away from decarbonization and towards political pork and interest-group preferences. To address this misdirected spending, Cullenward and Victor propose in Chapter 7 that a small fraction of revenues be sacrificed as political pork, but that the majority be committed to decarbonization initiatives, and particularly to supporting research, development, and the deployment of innovative technologies necessary to accelerate decarbonization. As with their recommendations regarding carbon market reforms, the authors encourage policy changes that they consider to be politically viable rather than what may be optimal.
The last substantive chapter of the book (Chapter 8) contains two broad recommendations for reform. Firstly, the authors encourage policymakers to right-size carbon markets, so that, like the RGGI, they regulate single sectors and, ideally, sectors for which carbon-reduction technologies are already relatively mature and affordable. Cullenward and Victor advise policymakers to accept the reality that regulation and emissions trading will operate alongside each other and that Potemkim markets will persist. By accepting this reality, policymakers can design markets to be as benign as possible. Secondly, to achieve deep emissions reductions, the authors encourage policymakers to pursue industrial policy. Through industrial policy policymakers would break the challenge of decarbonization into smaller components, on a sectoral or technology-specific basis; use penalties and other regulatory hammers to encourage industries to reduce emissions; and encourage industries to experiment and learn by offering public financing and support for technological experimentation and diffusion of successful technologies. While carbon markets would provide some of the financial resources to support industrial policy, they would otherwise play only a minimal role in actually enabling decarbonization.
For the reader interested in a detailed description of how this industrial policy should work, Making Climate Policy Work might fall short of expectations. The book's recommendations are quite thin and short on detail. However, for anyone seeking to understand how political realities clash with carbon market ideals, Making Climate Policy Work is informative and full of important detail and descriptions of the rules that affect emissions trading systems. Whether policymakers and interest groups will see themselves in the book's descriptions or agree to abandon their decades-long efforts to create ambitious multi-jurisdictional cap-and-trade programmes, however, remains to be seen.