Last night I went to hear Warwick McKibbin at the Brisbane Institute talking about climate change. It was a good presentation and Warwick made an effective analogy between the McKibbin-Wilcoxen plan for climate change which uses fixed prices in the short run and fixed quantities in the long run, and the bond market, where central banks set short-term interest rates but allow long-term rates to be set by the market.
One thing I hadn’t realised, though, is that the plan doesn’t allow for international trade in emissions permits, even in the long run. McKibbin sees this as an advantage, since there’s less of a reduction in sovereignty, but I see it as a big problem for two reasons. First, there’s an obvious efficiency loss in not allowing countries with low-cost offsets to trade with high-cost countries. Second, the biggest source of credits so far is China, the country that is going to need the most persuading to join an international agreement (contrary to Warwick, I’m confident the US will ratify Kyoto, perhaps extracting some concessions on timing and targets, as soon as Bush goes out, and that Australia will do so then, if not earlier). The possibility of gaining credits, combined with the threat of border taxes on exports from non-ratifying countries will be needed to overcome the obvious free-rider problems.
It doesn’t seem to me that the restriction to national markets is crucial, at least to the long-term part of the plan. A modified version that incorporated some form of international trade would be more appealing.