Cap and Don’t Trade

A few weeks ago I shortly presented the cap-and-dividend proposal by US Senators Maria Cantwell and Susan Collins. While reading this article at TripleCrisis (actually on the broader issue of the “ownership” of natural environment) I realized that I somewhat misinterpreted the idea of cap and dividend.

While I thought that it includes a trade component – in reality it doesn’t. That imposes the question: is this good, bad, or maybe equal?

I shall begin with quoting the praise of cap and trade schemes by no-one less than Herman Daly, one of the pioneers of ecological economics. In his 1996 book “Beyond Growth. The Economics of Sustainable Development” he has written:

The tradeable pollution permissions scheme […] is a beautiful example of the independence and proper relationship among allocation, distribution, and scale. [p. 52]

The question to consider is (to use Daly’s categories): is auctioning, in the form as proposed in the cap-and-dividend scheme, fitting the distribution category only, or is there a sort of allocation as well (scale can be ignored here, for we are talking about a cap-and-dividend scheme)?

But the first question that must be cleared in the beginning is: why is there no trade component in the cap-and-dividend proposal? James Boyce from TripleCrisis gives the following answer:

And the permits are not tradable – any more than other sorts of permits, like hunting permits or driving permits, are tradable – so that unlike cap-and-trade, the bill does not create a new sandbox for Wall Street to play in.

The still ongoing economic (and, in its origin, financial) crisis has powerfully shown what may happen if we let the Wall Street “play in a sandbox”. A clear lesson to be learned from the global crisis is indeed: don’t create further sandboxes if you can omit it.

Having the question of “why no trade” answered, we can focus on the actual issue: can we omit the trade component without impeding the functionality whole scheme? I would argue that yes, we indeed can do it.

Since there are no giveaways of pollution permissions, the market actors in consideration have to auction – i.e., buy – all the certificates they (think they) need. By doing this, they already do allocate – they have to decide how many permissions they need in the relevant period. If they mis-allocate, there is no possibility for them to buy more certificates during the period or to sell some they don’t need. That’s bad for them, possibly for the whole system as well – in the short run. In the long run, it appears rather to be an incentive for the enterprises to allocate (auction) more carefully and efficiently – they will learn from their failures in preceding periods. Meanwhile, those who allocate more carefully and efficiently than others will be rewarded: they don’t waste money.

Of course, it is important that permissions expire at the end of every issuing period (this is straightforward), and that the periods are relatively short. But, by and large, cap and trade seems to fit the requirements called by Daly, while at the same time omitting the danger of creating a new “sandbox” for the Wall Street (as traditional cap-and-trade schemes do).

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