Issue Summary: Gains from (Cap and) Trade

January 1st, 2014 marked not only the beginning of a new year, but also the beginning of a new era of carbon policy in North America. For the first time, Quebec and California committed to using market-based instruments to reduce GHG emissions by officially linking their cap-and-trade systems.

This Issue Summary examines the mutual economic benefits that can be gained from the adoption of linked systems between distinct jurisdictions.
 
Key Messages

  • Research sponsored by Sustainable Prosperity shows that the linkage between Quebec and California’s emission trading systems is expected to be an economically efficient way to address greenhouse gas (GHG) emission reduction objectives in both jurisdictions.

 

  • The research finds that allowing flexibility in the linked systems has been important - particularly given the substantial differences in the economies and emissions profiles, the design features of the cap-and-trade systems systems, and the use of revenue from allowance auctions.

 

  • Early analysis suggests that both jurisdictions will gain as the linking of emissions trading systems will bring down total costs of reducing emissions. The benefits are expected to be higher for California, because firms in the state will receive net inflows of carbon finance as Quebec industries purchase relatively lower-cost California allowances while only slightly increasing California allowance prices. Linked cap-and-trade systems are not the silver bullet in climate change mitigation policy, but are important examples of market based instruments that can be very effective to both reduce emissions and create positive economic conditions.

 

  • In the absence of a national climate change policy framework in either the U.S. or Canada, pursuing the linkage of emerging and future state and provincial emissions trading systems may be the most likely scenario for comprehensive climate policies in North America. The results of the first linked auction, to take place in June 2014, will provide an opportunity for further analysis of the economic and environmental benefits of linked cap-and-trade systems.

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About the Project

The goal of this project is to shed light on the relationship between economic activity and the environment by exploring the linkages between changes in our natural capital and our measures of productivity generally, and through the construction of an environmentally adjusted measure of productivity specifically.

While it is now commonly accepted that economic activity and the state of our environment are linked, many economic measures still fail to incorporate the environment – both the things we draw from it and the pollution we release into it. By developing and calculating measures of productivity that include natural capital, Canada may be able to better understand these linkages. This, in turn, may lead to the identification of strategies that can help Canada become more efficient and innovative in the use and protection of natural capital, and thus more productive and more prosperous.

Using the forestry sector as a case study, this project aims to construct an environmentally adjusted measure of multifactor productivity. In doing so, we aim to add another layer of understanding to the environmental and economic performance of this sector. The proposed measure will have relevance to the Canadian economy as a whole.