A curious aspect of the debate surrounding the introduction of the Carbon Pollution Reduction Scheme (CPRS) has been accusations from both sides of politics that the other is causing uncertainty for business.

The implication is that if it were up to them, there would be no such uncertainty – businesses would know exactly what they are in for. However, there is uncertainty at the heart of any Emissions Trading Scheme (ETS) that even a dictatorship could not eliminate.

To understand why, it is useful to understand the two alternatives to an ETS.

The first alternative to an ETS would be for the government to force each firm to reduce their carbon emissions by, say, 15 per cent. Although this would reduce carbon emissions to a level deemed appropriate by the government, the costs are unknown – there is price uncertainty.

The second alternative to an ETS would be for the government to implement a carbon tax. This means that firms have to pay some amount, say $15, for each quantum of carbon they emit. Although this provides firms with certainty over the price, there is a loss of certainty over the amount of carbon that will be abated – there is quantity uncertainty.

Now let us consider an ETS. Under an ETS the government sets the number of permits that it will issue – it has quantity certainty. But the price that will have to be paid is initially unknown because it is determined by the market for carbon permits. Firms will not know exactly how much they are going to have to pay for a permit until the market is working, and the amount they have to pay determines the amount that each firm abates. Although the amount of carbon that will be abated economy-wide is known, it is difficult for each firm to know how they will be affected.

For either party to argue that there would be certainty as to the impact of the ETS under them does not seem completely correct as there is uncertainty inbuilt in any ETS.

Further reading:
Dr Lawrence Summers, President Obama's economics advisor, talks a little about carbon trading in a speech available at http://blogs.wsj.com/washwire/2009/03/13/remarks-by-lawrence-summers-at-...

Dr Summers says: 'Let’s be realistic. Sooner or later we will have to reduce our dependence on foreign energy and contain our carbon emissions. As Federal Reserve Chairman Ben Bernanke’s doctoral thesis demonstrated 30 years ago, unresolved uncertainty can be a major inhibitor of investment. If energy prices will trend higher, you invest one way; if energy prices will be lower, you invest a different way. But if you don’t know what prices will do, often you do not invest at all. That is why we must move forward as rapidly as possible to reduce uncertainty and carefully create a new cap-and-trade regime.

There is another benefit as well. As many enlightened business leaders have recognized, the confident expectation that pricing policy will discourage carbon use in the future will spur a whole range of green investments in the present, when our economy can benefit from all the investment it can get. And in the long run, we believe this will create millions of new jobs. And the evidence is clear: we can choose to lead these industries, with all the commensurate economic and political and environmental benefits, or we can choose to lose out on these jobs and these opportunities.'