The Low-Carbon Diet

EDITOR'S NOTE: Implementing cap-and-trade systems can compel the free market to reduce carbon emissions that in turn may help slow down climate change, writes Joel Kurtzman, senior fellow at the Milken Institute and executive director of its Save program on alternative energy, climate change and energy security. For his full essay, please visit the Foreign Affairs magazine's Web site. A few excerpts:

The global economic crisis has battered the free market's reputation, but the market nevertheless remains a powerful tool both for allocating capital and for effecting social change. Nowhere is this truer than with the challenge of confronting and reversing climate change. Of all the market-based tools available for addressing this problem, the most potent are cap-and-trade systems for greenhouse gas emissions.

In their most basic form, cap-and-trade systems work by making it expensive to emit greenhouse gases. As a result, the owners of an emissions source are motivated to replace it with something less damaging to the environment. If they are unable to, the trading provisions allow them to purchase permits to continue emitting until they are ready to invest in new technology. Over time, as the amount of carbon allowed into the atmosphere is reduced, the price of a permit is expected to increase.

Capping carbon

Although leaded fuels and acid rain were big issues in their day, they are small-scale problems compared to climate change. At its worst, acid rain harmed marine habitats and cropland, primarily in North America and Europe. But climate change affects the entire planet.

Climate change is not just an environmental problem; it is a humanitarian and health problem with multiple dimensions. Scientists warn that sea levels will rise, rainfall patterns will be altered, storm patterns will change, and the locations of deserts, cropland, and forests will shift. As a result, famine and disease could spread, leading to increases in migration from environmentally devastated countries to Europe and the United States.

But there is another issue that makes tackling climate change more difficult than removing lead from fuels or stopping acid rain: emissions of greenhouse gases are a byproduct of economic growth. Leaded fuel was the key to only a single industry, and the processes leading to acid rain were central to just one or two sectors of the economy. Unlike these pollutants, emissions of carbon dioxide are fundamental to almost every aspect of the global economy. Leaded gasoline had a relatively cheap substitute (unleaded gas), and emissions of sulfur and nitrogen oxides have relatively straightforward technological fixes. By contrast, the fossil fuels that produce greenhouse gases are not so easy to replace.

No taxation without mitigation

Cap-and-trade markets for greenhouse gases, such as the Chicago Climate Exchange (CCX), already exist in the United States, and a number of large companies and institutions have already joined the exchange to trade the right to emit carbon. These include Safeway; the Ford Motor Company; several universities; some smaller municipalities, such as Oakland and Berkeley, California; and several state and county governments. Although membership is voluntary, each entity signs a legally binding contract that requires it to reduce its emissions. In a few cases, companies have already made money as a result of their abatement processes, whereas others have had to pay in. Those that have profited joined the exchange because they knew that organizations that exceeded their contractually bound emissions targets would have to buy credits from those emitting less than their limit; polluters have participated in order to show their green credentials and to respond to consumer demand for cleaner energy.

Despite these promising examples, critics of cap-and-trade systems argue that imposing taxes on fossil fuels and on emissions of greenhouse gases, such as carbon dioxide, methane, ozone, and chlorofluorocarbons, is the better policy because it is simpler to enact, more difficult to corrupt, and easier to enforce. Although it is true, for example, that raising the price of cigarettes through higher taxes has helped curb smoking, increased taxation only addresses one side of the issue - restricting one type of behavior but not promoting another.

Market magic

Climate change comes at a time when a number of technologies, such as wind power, geothermal energy, and certain types of solar energy, have matured to the point where they can produce abundant supplies of clean energy - albeit not as cheaply as traditional energy sources, such as coal. The missing ingredient for combating climate change is access to capital - a problem that cap-and-trade systems address head-on. Until permits are traded and the price of carbon is set, price uncertainty will cloud the market. Over time, however, as the number of permits falls at regular intervals, the price of carbon will likely rise. The cost for emitters will increase in inverse proportion to that for organizations investing in abatement. As industries and investors begin to see carbon winners and carbon losers emerge, behaviors will begin to change.

Cap-and-trade systems do not need a lot of moving parts: they can be reduced to six basic elements. First, cap-and-trade systems need firmly set long-term emissions caps that place an unambiguous limit on the amount of carbon dioxide permitted to be released into the atmosphere over the long haul.

Second, permits must be allocated to emitters. Ideally, the initial permits should be free, so that the proceeds from trading go directly from major emitters to those cleaning up their acts, something that the oversight and auditing provisions of the American Clean Energy and Security Act of 2009 will ensure.

Third, cap-and-trade programs should include offset provisions that provide emitters with alternative ways of removing carbon from the atmosphere.

Fourth, emitters should be allowed to "bank" their permits so they can use them in the future. They should also be allowed to borrow permits against more expensive future allocations. Fifth, all emissions activities must be professionally audited to ensure that a ton of carbon really is a ton of carbon.

And finally, regulators and others must refrain from setting a minimum or maximum price for emissions and must allow the market to set its own.

The market is a powerful force for allocating capital and creating wealth. And at a time when climate change threatens the globe, it can also be a powerful force for social change. With so much at stake for the environment, cap-and-trade legislation cannot wait.

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