Coalition plays chicken with first non-core promise

Pressure over carbon pricing and emission trading schemes is building globally and locally. AAP

Australian climate change inaction is often excused with “unless China and the US do something, why should we?”. But, with China’s recent introduction of a cap-and-trade system and Barack Obama’s move against the “Flat Earth Society”, the rules of the game have radically changed - globally and locally.

The Coalition, still tipped to win the Federal election, may find the game has also changed for its Direct Action policy as domestic pressure heats up too.

Calls to keep carbon pricing have begun emanating from the business community, with many in favour of international emissions trading. This week, the industry group Businesses for a Clean Economy released a survey that showed only 3.3% of the 180 business respondents didn’t want a carbon price. Another 3.3% were unsure. Energy suppliers are also reportedly nervous about the Coalition’s policy, calling for more detail.

In the face of such global and local ructions, the Coalition’s Direct Action policy and the dismantling of the carbon price policy is likely to be one of the first “non-core” policy shifts after the release of the inevitable white paper excesses, when the true cost of purchasing the current property rights are realised.

Core of the matter

Every new government has a set of ideal policies that it sells to get elected. However, the difference between the rhetoric and reality of election promises has been defined by the idea of “core” and “non-core”, made infamous by John Howard. And I predict that the Coalition’s stated abolition of the carbon price is a furphy.

There are two ways to deal with a good that creates externalities in policy. The first is to create a market-based solution where a price is introduced, which allows the market to build in the real cost of the resource usage. This is done primarily via a tax or a transferable right to pollute such as a cap & trade system. The market responds to this by either introducing greater efficiency and/or passing the price of this increase along the consumption chain.

This system is improved by adding a supply constraint (below current levels), which prevents the resource being consumed at the same previous rate and allows the consumer to bear the cost. This then allows enterprise to determine the best use of the resource at the least cost. By allowing trade between larger groups - like a multinational trading system - greater savings are made.

Barack Obama talks about efforts to reduce carbon pollution at Georgetown University on June 25. AAP

The second approach is the command and control. In this case, the policy determines the ideal world and sets rules for individuals - like cash for clunkers. This mechanism then by-passes the market, preventing enterprising individuals from adapting to the new state of the world at the least cost solution.

The coalition has announced that it wishes to abolish the market system in favour of the second approach, calling the policy Direct Action. “Action” may signify something is happening, but the system creates far greater public costs and business uncertainty.

Business deals with markets daily: they know that prices rise and fall. They know how to manipulate markets to their advantage and that their portfolio of rights to pollute has a value. This market value then provides a degree of certainty about how they conduct business and, through time, the scarcity value of these rights increases, especially when stock is removed from the market. Even in the depressed carbon market, these rights have a value that business can leverage.

Command and control

The problem with command and control is that if the first command step doesn’t work, then another command is issued, and so on. In this case, a degree of uncertainty exists for long-term investment, either about providing the service that allows control and/or wondering which new command may impact on their business structure.

The Chinese government realised that their former approach of command and control was the least efficient system and launched a cap and trade system on June 18. The US proposed policy is one of command and control that directly targets those who emit CO2; however, the desire for bilateral cooperation allows for the inevitable switch towards trading permits.

But what is clear is that the world has turned on a dime in a matter of weeks, with a radical shift in the rules of the global Climate Change game and a redrawing of the line between rhetoric and reality on local carbon pricing.