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The Limits of Cap and Trade

3 min readBy: William McBride

Europe’s system of cap and trade is all very good in the minds of theoretical economists. In practice, it’s predictably unworkable:

The association that represents Chinese airlines, including Air China, China Southern Airlines, China Eastern Airlines and Hainan Airlines, has said its members will not abide by the European Union Emissions Trading Scheme, which on January 1, 2012, was extended to international airlines that use European airports.

Following the inclusion of international aviation to the scheme onJanuary 1, after a failed legal challenge by representatives of theUS and Canadian aviation industries at the European Court ofJustice, the China Air Transport Association (CATA) released astatement confirming that its members would boycott the scheme.

Other nations’ airlines have begun to introduce surcharges on theirtickets to pass on costs to the consumer, but Chinese airlines havesaid that fares will remain the same and the Chinese government isreportedly considering countermeasures and a legal challenge inresponse.

CATA has estimated that the scheme will cost domestic airlinesaround USD120m during 2012, ramping up to more than triple thatfigure by 2020 as China’s domestic industry grows.

Under the ETS, from January 1, 2012, in accordance with theEuropean ETS directive, airlines operating into and out of the EU,regardless of how long that flight is in EU airspace, will berequired to surrender varying emission allowances, and will berequired to purchase any additional permits outside of their freeallowance.

Non-EU nations’ airlines would also be required to pay such anemissions taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. to the EU member state to which they most frequentlyfly, without any requirements that those EU countries use the fundscollected in emissions reduction efforts. As a result of the newprovisions, experts have calculated that passengers on long-haulflights may be faced with additional costs of between EUR2(USD2.77) and EUR12 a ticket.

Airlines are required to immediately begin purchasing emissionsallowances, but are only expected to remit the sums in 2013. Thescheme provides for penalties in the event that airlines fail tocomply, including fines of up to EUR100 for each tonne of carbondioxide emitted without the payment of a permit, and eventually anEU-wide ban on the offending airline.

The International Air Transport Association (IATA) has estimatedthat the cost to the entire aviation industry globally could beUSD1.6bn annually, at a time when the industry’s profitability hasbeen dented by the global economic crisis. IATA said that chargingpassengers for the cost of the ETS would undoubtedly impact therecovery of air passenger traffic.

Emissions trading schemes are meant to address the “negative externalities”, such as pollution and global warming, which are thought to result from carbon consumption. Wonderful. But how do we develop a consistent and widely accepted measure of the social cost of carbon consumption, when scientists don’t even agree that global warming exists?

The existence of particulate pollution resulting from carbon consumption is more widely accepted, but still the problem remains of quantifying the social cost, and estimates vary considerably. However, the estimates are all in the same direction, i.e. we know with a high degree of certainty that this pollution is a cost, not a benefit. Thus, on this basis there is some justification for a carbon taxA carbon tax is levied on the carbon content of fossil fuels. The term can also refer to taxing other types of greenhouse gas emissions, such as methane. A carbon tax puts a price on those emissions to encourage consumers, businesses, and governments to produce less of them. , usually implemented as a tax on gas, which of course the Europeans have fully explored.

And, plausibly, there is considerable noise pollution from airplanes, so slap another tax on them for that, which I’m sure the Europeans do. These taxes are relatively easy to administer, both for domestic and international, and non-EU, flights.

But the EU’s emission trading scheme requires another level of international integration and administration, in that non-EU airlines must register and subject themselves to the rules of the EU exchange. Ideally, this could work as smoothly as the New York Stock Exchange, or the Nasdaq, where many foreign companies are listed. The key difference is the EU scheme is a huge government monopoly. There are no other competing exchanges within the EU.

To make matters worse, it’s a monopoly administered by the EU — a strapped and increasingly desperate federal entity that looks likely to dissolve into bankruptcy in the near future. I’m sure the Chinese have noted as much.

Follow William McBride on Twitter @EconoWill