The Good, the Bad and the Ugly
29 March 2011
Andrés Jonathan Drew sets out parallels between Sergio Leone's classic film and EU emissions trading scheme
Sergio Leone's Spaghetti western classic The Good, the Bad and the Ugly is a film about the search for property - stolen Confederate gold - by bandits, during the quintessential war of ideas: the American Civil War. The protagonists are three shady characters - each respectively nicknamed after the title of film, and involved in a series of inter-related plots and subplots in search for the gold.
Two protagonists in particular, the Good and the Ugly, have a series of fallouts and redemptive episodes to reconcile their partnership in search of the gold. The film ends with Clint Eastwood - as the Good - exacting his final revenge by leaving the Ugly stranded in a cemetery in the dusty American south west with some gold, but no horse. The story of the European Union Emissions Trading Scheme would make for a bad Spaghetti Western, but many of the lessons it provides for policymakers worldwide have strong parallels with Leone's masterpiece.
The EU ETS is a story about the creation of property rights in greenhouse gases; the battle of ideas over climate policy; well-intentioned, but imperfectly informed policymakers; and well-funded lobbyists searching for bounty in the form of "rents" from regulation. The Good in this story is that emissions trading policy is potentially more efficient, effective and implementable than traditional command and control regulation.
But the EU ETS phase-one emission permit allocation rules have displayed significant evidence of political capture by interest groups - the Bad - characterised by well publicised windfall profits for electricity generators that resulted from free emissions permit allocations. Faced with the Bad, policymakers also dealt with significant informational asymmetry in gathering actual data on emissions from firms. This led to an over-allocation of emissions permits. The low and unstable carbon price these allocation failures caused resulted in the Ugly: the launch of ancillary support policies to drive renewable energy and energy efficiency that are less efficient and more exposed to lobbyist rent-seeking than a high, stable carbon price.
Yet phase three of the EU ETS appears to have redeemed emissions trading policy because allocation rules display less evidence of rent-seeking as more sectors are covered and more emissions permits will eventually all be auctioned. The low unstable carbon price might also be managed by member state carbon taxes that place a floor price on emissions permits - as announced in last week's UK Budget - and a more ambitious EU-wide 2020 carbon mitigation target currently under consideration. Therefore, the Good might still prevail.
Policymakers worldwide, inspired by the EU ETS's redemptive story, can learn two fundamental lessons about managing climate mitigation policy. The first is how to deal with strong interest groups and their desire to extract rents. Emissions trading, for all its failures, has an internal logic that converts foes into friends and can be improved over time. The EU ETS has been a remarkable example of how to lock-in climate policy, a feat most other OECD countries have yet to achieve.
In phase one, energy generators were compensated for their support with free emissions permits - now withdrawn for phase three. Energy-intensive industries are now being included in phase three and, like previous opponents; their cooperation is being induced with free emissions permits. Most importantly, this free lunch will eventually be eliminated with full auctioning as the general rule.
The second policy lesson is how to design climate policies that minimise the insurmountable information asymmetries faced by policymakers in deciding what bets to place on abatement technologies or low carbon energy sources. These choices are highly exposed to rent-seeking and capture by lobbyists. Instead of designing sub-optimal ancillary support policies, the EU ETS should be strengthened with more ambitious abatement targets and a carbon price floor.
If this is likely to be impractical or insufficient, policymakers should only support ancillary policies that are sanctioned by an independent expert body like the UK Committee on Climate Change, make use of market based instruments like a carbon tax and avoid complexity that make the system easier to game. The UK may adopt this strategy with its proposed energy market reform.
The symbolism of Clint Eastwood - the Good - riding his steed off into the wilderness with his share of the bounty and the Ugly left stranded in the cemetery with some gold, but no horse, is powerful. For EU climate policy the question still remains whether the costs of this adventure are going to be minimised and how to ensure that the union has both the gold and horse at the end of the story. The script for this film has yet to be fully written. For the sake of the EU and champions of emissions trading policy worldwide, let's hope the storyline is less dramatic than Sergio Leone's movie.
Andrés Jonathan Drew is the author of a recent Stockholm Network paper on the EU ETS and a researcher at the London School of Economics
Sergio Leone's Spaghetti western classic The Good, the Bad and the Ugly is a film about the search for property - stolen Confederate gold - by bandits, during the quintessential war of ideas: the American Civil War. The protagonists are three shady characters - each respectively nicknamed after the title of film, and involved in a series of inter-related plots and subplots in search for the gold.
Two protagonists in particular, the Good and the Ugly, have a series of fallouts and redemptive episodes to reconcile their partnership in search of the gold. The film ends with Clint Eastwood - as the Good - exacting his final revenge by leaving the Ugly stranded in a cemetery in the dusty American south west with some gold, but no horse. The story of the European Union Emissions Trading Scheme would make for a bad Spaghetti Western, but many of the lessons it provides for policymakers worldwide have strong parallels with Leone's masterpiece.
The EU ETS is a story about the creation of property rights in greenhouse gases; the battle of ideas over climate policy; well-intentioned, but imperfectly informed policymakers; and well-funded lobbyists searching for bounty in the form of "rents" from regulation. The Good in this story is that emissions trading policy is potentially more efficient, effective and implementable than traditional command and control regulation.
But the EU ETS phase-one emission permit allocation rules have displayed significant evidence of political capture by interest groups - the Bad - characterised by well publicised windfall profits for electricity generators that resulted from free emissions permit allocations. Faced with the Bad, policymakers also dealt with significant informational asymmetry in gathering actual data on emissions from firms. This led to an over-allocation of emissions permits. The low and unstable carbon price these allocation failures caused resulted in the Ugly: the launch of ancillary support policies to drive renewable energy and energy efficiency that are less efficient and more exposed to lobbyist rent-seeking than a high, stable carbon price.
Yet phase three of the EU ETS appears to have redeemed emissions trading policy because allocation rules display less evidence of rent-seeking as more sectors are covered and more emissions permits will eventually all be auctioned. The low unstable carbon price might also be managed by member state carbon taxes that place a floor price on emissions permits - as announced in last week's UK Budget - and a more ambitious EU-wide 2020 carbon mitigation target currently under consideration. Therefore, the Good might still prevail.
Policymakers worldwide, inspired by the EU ETS's redemptive story, can learn two fundamental lessons about managing climate mitigation policy. The first is how to deal with strong interest groups and their desire to extract rents. Emissions trading, for all its failures, has an internal logic that converts foes into friends and can be improved over time. The EU ETS has been a remarkable example of how to lock-in climate policy, a feat most other OECD countries have yet to achieve.
In phase one, energy generators were compensated for their support with free emissions permits - now withdrawn for phase three. Energy-intensive industries are now being included in phase three and, like previous opponents; their cooperation is being induced with free emissions permits. Most importantly, this free lunch will eventually be eliminated with full auctioning as the general rule.
The second policy lesson is how to design climate policies that minimise the insurmountable information asymmetries faced by policymakers in deciding what bets to place on abatement technologies or low carbon energy sources. These choices are highly exposed to rent-seeking and capture by lobbyists. Instead of designing sub-optimal ancillary support policies, the EU ETS should be strengthened with more ambitious abatement targets and a carbon price floor.
If this is likely to be impractical or insufficient, policymakers should only support ancillary policies that are sanctioned by an independent expert body like the UK Committee on Climate Change, make use of market based instruments like a carbon tax and avoid complexity that make the system easier to game. The UK may adopt this strategy with its proposed energy market reform.
The symbolism of Clint Eastwood - the Good - riding his steed off into the wilderness with his share of the bounty and the Ugly left stranded in the cemetery with some gold, but no horse, is powerful. For EU climate policy the question still remains whether the costs of this adventure are going to be minimised and how to ensure that the union has both the gold and horse at the end of the story. The script for this film has yet to be fully written. For the sake of the EU and champions of emissions trading policy worldwide, let's hope the storyline is less dramatic than Sergio Leone's movie.
Andrés Jonathan Drew is the author of a recent Stockholm Network paper on the EU ETS and a researcher at the London School of Economics
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