F.A. Hayek and the European Emission Trading Directive

Speech given by Waldemar Ingdahl at the Tech Central Station Europe and International Council for Capital Formation seminar "Can we reduce greenhouse gases without reducing EU competitiveness?" in Brussels May 19th 2003

Ladies and gentlemen,

At the end of the 1960's no European country had a clearly defined environmental politics. It was first in connection with the EU- heads of state summit in Paris 1972 that the commission started its work with environmental policies and it was also then the first action programme was presented.

These last 30 years we have seen great changes in environmental laws. The priority of the environment has been gradually elevated on the agenda of the community. With the Amsterdam treaty the juridical framework for the environment was strengthened. One of the most important goals in the treaty of the community is now to strive for a sustainable development and a good protection for the environment. The community's definition of sustainable environment can shortly be stated as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs" which is a definition that stems from the Brundtland commission in the '80s. In the EU there are at present more than 200 regulations that span, in principle, on all areas of the environment. About 40% of all transgression errands on member states are concerning environmental issues.

In the EU environmental concerns are seen as being "integrated". The cares for the environment must not be detached from other areas of concern, and must considered from the beginning. This must be relevant on all areas, as for instance energy production, transportation, agriculture and tourism. It must also be directly integrated in corporations' business plans.

Member states are not allowed to sidestep the implementation of EU laws. If a member state is seen by the commission to do this, they are taken to the community's court. There is also a pressure to conform, for instance through the commissioner for the environment Margot Wallström's "name, fame and shame" seminars, where it is presented how far member states have implemented the directives.

Information is also very important in the EU environmental strategy. By involving the public in order to raise the quality of the legislation and NGO's, the media, the schools and corporations should be involved as quickly as possible in forming the decisions for policy, and are also seen as important parts in spreading knowledge and awareness of the environment in order to be implemented in everyday life by the citizens. "Everybody has to contribute and we must spread our knowledge and be examples," says commissioner Wallström on her website.

Thus we can assess that the scope of EU policies on the area of environmental politics is quite far-reaching.

Which bring us to the topic of today: greenhouse gases and the trading of emissions,

In the 6th Environmental Action Programme (the present one) the limitation of climate change has been upgraded on the agenda of the commission as one of the top priorities after the Kyoto Protocol of 1997.

The EU has committed itself to reduce its emissions of greenhouse gases by 8% until the years 2008-2012 compared to the levels emitted in the year 1990.

Now, between 1990 and 1998 emissions of greenhouse gases fell according to the EU by 2.5%, but this was mainly achieved through the United Kingdom switching from coal to gas as most important source of energy, eliminating most of its coal industry ("the dash to gas") and through the restructuring of the re-united Germany's heavy industries. Most other countries increased their emissions, and the commission states that one of the hardest problems is to coordinate what the different member nations should do to meet targets.

The EU means that because the energy sector is the sector that contributes the most to global warming the level of energy consumed must be reduced through structural changes. The commission wants to achieve this through several ways like taxation, improving the efficiency of production, improving the effectiveness of consumption, and supplanting old sources of energy with alternatives like wind power.

Taxing energy in order to make it more expensive for people and industries to use it, of course raises the costs for production, and decreases EU corporations' competitiveness on world markets. This is why the EU Environment Council, approved the European Emissions Trading Directive, in order to make this as cost efficient and cheap as possible. It is scheduled to come into effect in 2005.

Companies will be set a cap on how much they can emit in a given period - in this case, of the carbon dioxide (CO2) emissions- and are allowed to trade these "allowances". A company that over-complies with its initial limit can sell its surplus allowances to others that find it more costly. The price of allowances should settle at the level that reflects the overall lowest-cost way of limiting emissions. As an efficient tool for controlling emissions, it is stated as an economist's dream, and climate change (where the environmental damage does not depend on who does the emitting, or where) is said to be a problem ideally suited to the tool.

The Directive requires each European country to establish a domestic emission trading system based on consistent principles and with similar sectoral coverage - applied to power generation and much of European heavy industry. The allowances thus created will be tradable across the whole of the EU, so as to create an efficient European-wide trading market. The system will cover over 40% of European carbon dioxide emissions, thus representing the cornerstone of efforts by European countries to implement their Kyoto commitments.

Estimates say, that the total value of the allowances will exceed ten billion Euros each year. The thought is that limiting emissions makes polluting a scarce resource, and scarcity brings economic value.

This makes the question of how allowances are distributed between companies a rather touchy subject - and one which the Directive largely leaves up to the member states as they move towards implementing the system in national law. The industry lobbied for the Directive to require governments to give out the allowances for free, by implication primarily to the current emitters. The European Parliament dissented, and flexed its muscles on the issue of allocation - and the Directive now allows governments to auction up to 10% of the allowances.

The directive makes it clear that the European proposal is a prelude to gain experience and advantage prior to the global scheme due to come into force in 2008 under the terms of the Kyoto treaty.

What would Nobel laureate economist Friedrich Hayek, have thought of greenhouse gas emission trading? Should not he have approved of this more market-based way than exclusively via regulation?

I think that in the light of the Austrian school of economics, and its views on the nature of markets, he would have dissented. Markets are spontaneously evolving societal processes that require experimentation, not something that can be created by a "single best solution" decision from the top. In a system of emission rights governments create an artificial shortage of energy and subsequently allocate rights to use this energy to individual corporations. Particularly it would benefit a small number of large energy producers. These companies then have a sort of monopoly. As a result, they have a vested interest in preventing any reversal of the artificial shortage, for instance as a result of technological breakthroughs or new climatological insights that could possible show that man-made emissions of greenhouse gases don't have influence on the climate, as previously thought. In that case, their emission rights, which they may have bought for significant sums, would be worthless.

How emission rights should be shared out is a problem. Some companies have already invested heavily in clean technology. How can we avoid these companies being put at a disadvantage towards competitors that emit more? In addition, a system of tradable emission rights requires monitoring of implementation and enforcement of contracts. The amounts involved will probably be considerable and temptations to cheat will be significant. All this will require a large bureaucracy, both in regards for the governments and the corporations furthering increasing costs of business.

Furthermore, such a system runs the risk of conflicts, in the form of sanctions to compel enforcement. That could lead to trade wars or, increase international tension. It is also conceivable that purchase of emission rights by western companies in the Third World will place a brake on local industrialisation in those countries because the CO2 emissions quota have already been sold.

There are also dangers outside the material sphere. Granting power to politicians to determine who in society may use energy forms a major threat to the individual freedom of the citizens. This could strengthen the position of those currently in power and their followers, resulting in discrimination against companies that do not enjoy close relations with the authorities.

Elements of central planning would be incorporated in our market economies under the banner of market conformity, which would represent a clear change in the development trend towards more market and less government.

So F.A. Hayek's answer to today's topic would be: not by the European Emissions Trading Directive.