Thoughts on Cullenward and Victor’s Making Climate Policy Work

Danny Cullenward and David Victor’s thoroughly researched and thoughtful book, Making Climate Policy Work is definitely worth a read for anyone interested in climate policy. Even though I was ultimately unconvinced, it presents the best case I’ve seen against the carbon pricing-centric approach to climate policy that I favor.

Cullenward and Victor perceptively diagnose the pathologies affecting carbon markets, particularly with regard to carbon offsets — arrangements under which regulated entities are permitted to emit more carbon in exchange for funding emissions abatement or negative emissions activities outside the scope or jurisdiction of the emissions trading system they are subject to. Their point that international offsets discourage countries from adopting mandatory emissions policies is especially compelling, in my view.

Even on offsets though, I think the authors’ claims may be a bit too strong at points. For example, they repeatedly state that offsets oversight has to be 100% successful at guaranteeing additionality and avoiding leakage to avoid a loss in environmental effectiveness. I see two issues with this. First, there can also be leakage from covered domestic sectors, so only leakage in excess of that would be a true net loss. Second, and more importantly, couldn’t the challenge of offsets governance be greatly reduced by crediting claimed foreign emissions reductions on a less than 1-to-1 basis? For instance, each ton of foreign emissions reduction could generate 0.25 tons of emissions credits. The ratio here is arbitrary, and the real number would be based on an estimate of non-additionality and leakage rates, with some margin of safety.

Now, the point about discouraging mandatory emissions efforts in other countries might mean offsets still aren’t worth doing on these terms (this is my view on most days), but I would have liked to see Cullenward and Victor address this question head-on rather than pretending we face a binary choice between eliminating offsets entirely and crediting foreign emissions reductions at par.

I also agree with the authors that most people who think about climate policy don’t take the need for climate leadership to produce followership seriously enough. Since climate change is an inherently global problem and the leaders’ share of global emissions is shrinking, effective climate policy must get a handle on emissions outside Europe and the US (regardless of whether it is accurate to characterize the US as a climate leader at the moment).

I’m not sure I’m on board with their prescriptions for addressing this, but I welcome their efforts to move the discussion in this direction. Those interested in my own thoughts on the subject should read Incentive Compatible Climate Change Mitigation: Moving Beyond the Pledge and Review Model and The Carbon Price Equivalent: A Metric for Comparing Climate Change Mitigation Efforts Across Jurisdictions.

Now, onto some deeper disagreements. First, a lot of Cullenward and Victor’s claims about the practical relevance of carbon pricing are based on the observation that the marginal abatement cost associated with other emissions policies is much higher than prevailing prices in existing pricing programs. But marginal abatement cost is a misleading measure of effort that rewards inefficient policies; of course, the most efficient policies look bad on this measure! MIT environmental economist Christopher Knittel’s work showing the cost-saving impact of even a modest carbon price seems relevant here and belies the authors’ “Potemkin markets” framing.

Incidentally, the much-derided “green pork” must be associated with very high marginal abatement cost, almost by definition. Does that somehow make it good? The bottom line here is that emissions reductions are what we should care about, and marginal abatement costs are not a good proxy.

Second, Cullenward and Victor repeatedly claim that most of the pathologies of carbon markets also apply to carbon taxes, but they never really argue for this claim. As a strong supporter of carbon taxes, I would have appreciated a clear argument on this point to engage with.

They also suggest that the cap and trade systems they focus their attention on are more prevalent than carbon taxes partly for procedural reasons, pointing to EU rules as an example. But they fail to note that tax measures hold a privileged procedural position in US federal policymaking, as they can be passed via budget reconciliation. Given that their book is, at least in part, an intervention in the current debate over the path of federal climate policy in the US, this strikes me as a significant oversight.

To be fair, it’s clearly true that carbon taxes share the features of transparency and fungibility of effort that the authors see as liabilities. I take these points to be the most potent criticisms of economy-wide carbon pricing as such, as opposed to critiques specific to carbon markets or carbon pricing’s particular design features. So, let’s drill down on this issue.

First, Cullenward and Victor repeatedly assert that economy-wide pricing leads to ambition being limited to that which is politically viable in the weakest link sector. This is not intuitively obvious to me, and Cullenward and Victor don’t devote much space to building a robust theoretical or empirical case for it. It seems just as plausible that mixing sectors where high ambition has strong political support with other sectors results in something like the average supportable marginal abatement cost. It’s not at all clear to me that this wouldn’t be a superior outcome compared to allowing big differences in marginal abatement cost across sectors.

Indeed, the low allowance prices in RGGI’s electricity-only carbon price do not seem to support the view that limiting the scope of pricing necessarily enables greater ambition. It’s also noteworthy that California’s Low Carbon Fuel Standard is a common example of high marginal abatement cost that has come up in the discussion of Cullenward and Victor’s book. But transportation fuels are precisely the sort of high-salience sector that shouldn’t be able to support ambitious mitigation efforts. This doesn’t seem to fit Cullenward and Victor’s story very well.

I also have questions about the authors’ analysis of high gas taxes in Europe. They say this should not be interpreted to indicate that Europeans are indifferent to high gas prices, only that they’ve anchored to the high prices after decades of high taxes. Let’s assume this is true. Does that not suggest that Americans could also be made to adjust their anchors if a large gas tax increase (or economy-wide carbon tax) were introduced and remained in place for several years? If Europe could get over the hump, why can’t we?

All that said, I do think the argument that transparency and fungibility are political liabilities is worth taking seriously. Some sectors suffer from either high consumer price salience (gasoline) or lack of cheap, near-term abatement opportunities and are exposed to foreign competition (steel, cement, and other energy-intensive trade-exposed [EITE] goods). But some proposals, including the Climate Leadership Council’s Carbon Dividends Plan, take these challenges seriously and address them head-on.*

The salient costs problem is addressed by crediting a salient benefit in the form of similarly salient quarterly carbon dividend payments that will more than compensate most households for the economic burden of the carbon fee. While Cullenward and Victor do briefly discuss carbon dividends, they do not directly engage with the key political rationale.

The EITE goods problem is addressed via the border carbon adjustment. Strangely, Cullenward and Victor are fairly dismissive of border adjustments in the context of their carbon pricing discussion, but then warm to the idea in the context of their favored mix of regulation and industrial policy. These two discussions of border carbon adjustments are emblematic of the book’s broader tendency to shield the author’s favored policies from the same level of rigorous scrutiny applied to carbon pricing. In reality, both the technical challenges and the WTO compliance hurdles are much higher for border adjustment of industrial policies and regulations than they are for carbon taxes. In particular, taxes may use the “front door” option for WTO compliance, under which the border adjustment could comply with the core of the General Agreement on Tariffs and Trade and so do not need to resort to an Article XX exception. For more discussion of the international trade law issues associated with border carbon adjustments, see Incentive Compatible Climate Change Mitigation: Moving Beyond the Pledge and Review Model (the relevant discussion starts on page 947).

If we can solve the problems of high salience consumer prices and EITE goods, and carbon taxes are largely free of the other pathologies of carbon markets, then why shouldn’t a high and steadily escalating economy-wide carbon price be the centerpiece of domestic climate policy?

Now let’s turn to Cullenward and Victor’s own policy prescriptions. First, it’s worth noting that for a book called “Making Climate Policy Work,” I was surprised to discover how few of the book’s pages were dedicated to the authors’ positive program. Like Yoram Bauman, I’d like to see the authors develop their positive ideas more fully, perhaps in another book.

Consider the authors’ idea of segregating climate spending into separate accounts for transformative investments, low-cost emissions abatement, and “political spending.” Their motivation is clear enough. Political forces lead too much ostensibly green spending to be diverted to “green pork” that mostly rewards politically powerful constituencies rather than producing environmental benefits. But political considerations cannot be ignored, so the best we can do is limit and segregate political expenditures and make sure they deliver maximal political bang for their buck.

I’m sympathetic to Cullenward and Victor’s goals, but highly skeptical that this proposal is viable in practice. Politicians like being able to claim that their spending both furthers high-minded goals like climate change mitigation and rewards key constituencies.

They blur the lines between “green spending” and “green pork” for a reason. Robbing them of the ability to claim that individual line items serve both purposes is unlikely to serve their political ends. Nakedly political spending can end up being a political liability. No one who remembers Ben Nelson’s “cornhusker kickback” or Mary Landrieu’s “Louisiana Purchase” from the Affordable Care Act saga should doubt this. Adam Smith & Bruce Yandle’s work on “Bootleggers and Baptists” coalitions is relevant here.

This leads into my central concern with Cullenward and Victor’s prescription. They say we should scale back our expectations for carbon pricing because the politics are too hard, pointing to low existing carbon prices and narrow scopes of effective coverage as evidence. But they fail to offer a clear and convincing argument that the politics of industrial policy are likely to work better. They astutely observe that green spending can rapidly devolve into green pork, but they don’t see this as a reason to rely less on government spending in climate policy. Indeed, they want it to take on a more prominent role, along with traditional regulatory approaches.

Before we take their advice, we should demand a convincing argument that the politics of green industrial policy and green regulation are genuinely favorable, and more so by a sufficient margin to overcome their shortcomings in terms of efficiency. Consider the “penalty defaults” that Cullenward and Victor favor because they are “both more draconian and more ambiguous” than compliance penalties. These defaults would impose catastrophic consequences on firms that fail to comply but can be delayed “if good efforts are made and solutions prove difficult to find.” Why exactly would industry players that are hostile to pricing policies acquiesce to the introduction of such “big hammers?” Once such defaults are in place, wouldn’t regulated industries have incentives to exaggerate the difficulty of finding solutions?

Carbon pricing elegantly solves this knowledge problem, giving firms every incentive to act on opportunities for low-carbon breakthroughs whether the government knows about them or not. The carbon tax penalties for failing to reduce emissions under carbon pricing are known, quantifiable, and calculable into the future. The authors seem to think the unpredictability, unquantifiability, and potentially catastrophic nature of their preferred alternative is a selling point. This claim lacks clear support.

More broadly, it’s not like green industrial policy and traditional regulation haven’t been tried. I’m old enough to remember the green investments in ARRA and the excruciatingly slow roll-outs and legal battles over the Clean Power Plan and other carbon regulations. Carbon pricing hasn’t worked well enough yet, but nothing has. The failure of climate policy to date is not an indictment of carbon pricing or any other particular policy; it’s a sign that climate change is a really hard policy problem.

I also worry an approach to climate change that centers industrial policy and traditional regulation will tend to produce what Steve Teles calls Kludgeocracy, governance that advances via a series of “inelegant patch[es] put in place to solve an unexpected problem.” Since economy-wide carbon pricing pushes for decarbonization on all margins at once, there’s no need for a series of patches to address rebound effects and other unintended outcomes of policies like vehicle efficiency standards that only operate on one or two margins.

None of this is to say that carbon pricing is a panacea or that there is no role for industrial policy or traditional regulation in climate change mitigation. At the very least, complementary policies like land use reform to allow denser development are needed to enable the market to effectively respond to the price signals sent by carbon pricing. My views on complementary policies (with a subnational focus) are laid out in Subnational Climate Mitigation Policy: A Framework for Analysis.

Regarding industrial policy, my view is that it’s best to think of carbon pricing and industrial policy as addressing two overlapping but distinct market failures. Carbon pricing addresses the basic emissions externality. The carbon emissions generated when I fly on a plane or turn on the air conditioning impose costs on other people, which carbon pricing forces me to account for.

Industrial policy is (or should be) mostly focused on the problem of innovation as a public good. Some innovations produce positive externalities; their private returns are lower than their social returns, so free markets tend to underinvest in them. This is not a problem unique to low-carbon technology, but it interacts with the emissions externality.

Innovation policy is not a substitute for climate policy as such, at least not as a general matter. It’s possible we’d get lucky enough that clean technologies get so cheap that no one has a reason to keep using dirty technologies, but it would be foolish to rely entirely on the hope that this comes to pass.

I think Cullenward and Victor know that, which is why they want traditional regulation and carbon pricing to be included in the policy mix. Our disagreement is about relative emphasis.

On that point, I’m open to being convinced that the political advantages of industrial policy and traditional regulation are sufficient to overcome the acknowledged efficiency advantage of carbon pricing, but so far I’m not convinced.

I congratulate the authors on an important contribution to the climate policy debate and look forward to further engagement with them on these issues.

*While I am an employee of the Climate Leadership Council, the views expressed in this review are my own and do not necessarily reflect those of the Council or its staff.