What America Can (and should) Learn from Europe

By Timothy Damon ’12

America has a long and proud history of firsts – the first airplane, the first man on the moon, and so forth. This heritage makes it all the more surprising that the United States would give up its leadership in innovation when it comes to the world’s greatest problem: climate change. One of the largest examples is allowing Europe to establish the first-ever market mechanism for reducing greenhouse gas (GHG) emissions.

The EU - One Step Ahead in Reducing GHG Emissions

In 2005, the European Union (EU) implemented the Emissions Trading System (ETS), a cap-and-trade system aimed at reducing its GHG emissions. The principle of cap-and-trade (C&T) is relatively simple, and the idea actually came from a previous program the US EPA used to fight acid rain pollution. Basically the government sets an annual limit on GHG emissions and those who wish to legally emit must acquire permits (also called allowances) to cover their activity. These permits may either be given away or auctioned off. The “trade” in C&T refers to how permits will be bought and sold between different emitters depending on how much it would cost them to change their behaviors; if you can reduce your emissions more cheaply than the price of a permit, then you will make those changes and sell your extra permits to someone else for whom reducing emissions would be more expensive. The great cost-effectiveness of C&T comes from this high level of market-based flexibility.

The EU-ETS was devised to use this mechanism to help the EU meet its GHG reduction commitments under the Kyoto Protocol. The program began with a test run for the period of 2005 through 2008. Several problems emerged, as Ellerman and Jaskow explain. First, the absence of accurate emissions data at the start lead to the over-allocation of permits (defeating the point of the cap by allowing emissions to exceed the limit). Second, the market price of the permits experienced vast fluctuations due to pressures of global energy costs and the lack of accurate information upon which to base predictions. Third, energy companies gained substantial windfall profits because the permits were given away to them for free, even though they had a value on the market (though this did not stop the companies from raising prices for consumers). These problems complicated the trial phase of the EU-ETS, but they also provided important lessons – lessons that the United States could draw upon for crafting its own national C&T policy.

A C&T mechanism has emerged as a possible means for America to reduce its own GHG emissions. While the United States has lost the chance to pioneer this new system, coming second does mean the EU-ETS can serve as an example of what not to do here. The solutions are relatively straightforward: allow sufficient time before starting the program to collect accurate emissions data to avoid over-allocation, make permit cost projections and future policy  impacts clear to minimize the price volatility caused by uncertainty, and give away fewer permits for free to reduce the extent of windfall profits (and generate more revenue for other uses). The Europeans have tested the waters for us. Now it is time for America to step up and implement its own improved C&T policy to contribute to global efforts to reduce GHG emissions and stimulate a vibrant new green economy.

For further reading:

The success of the EU-ETS

10 lessons the US can learn

Works Cited:

A. Denny Ellerman & Paul L. Joskow. The European Union’s Emissions Trading System in Perspective. Prepared for the Pew Center on Global Climate Change. May 2008. Massachusetts Institute of Technology.