The best way to reduce carbon emissions and combat climate change is through the use of a European-style cap-and-trade scheme, according to a paper by business school scholars.
The academics monitored the effectiveness of the European Climate Exchange (ECX) carbon trading platform and found it to be as efficient as Europe's two biggest exchanges, the London Stock Exchange and the Euronext Paris. Yet the EU Emissions Trading Scheme (EU-ETS) cap-and-trade scheme, in which permits to emit carbon, about 16 billion tons in 2013-20 (half of the European Union’s total carbon emissions) can be bought and sold, has been an expensive mess. The recession reduced industrial demand for permits so there is massive overcapacity in the carbon market and therefore low prices for permits. No emissions have really been 'saved', though they have been 'traded', and so the cost has been incurred but no value.
The ECX was created by the EU-ETS in 2005 as a scheme to achieve its obligations under the Kyoto Protocol to reduce carbon emissions and has persisted while American efforts such as the Chicago Climate Exchange closed years ago.
Despite its failings, writers in the International Journal of the Economics of Business say that the ECX is good enough to rationalize a mandatory emissions cap and trade scheme worldwide.
Their evidence? The value of the trades on the ECX were higher after the market closed, which hints of growing sophistication within platforms. They say it means that trades were made with greater confidence based upon increasingly detailed information. The business academics also said there are also signs of maturity based on increased liquidity - the immediate availability of a party to trade with - and price efficiency, which means all available information is incorporated into prices so they are traded in a relatively transparent manner.
The EU set limits and issued permits for how much carbon firms could emit into the atmosphere. If companies exceed their limit, they could incur regulatory penalties, which has not really happened due to the lower demand for permits but the EU-ETS says that by creating a market, it gave firms a financial incentive to reduce their carbon emissions.
The scholars are not blind to the problems.While apparently confirming the ECX's effectiveness; they state that it must change completely to survive Europe's economic downturn. The EU-ETS should be allowed to self-adjust emission caps - which means becoming more of an actual free market - in reaction to changes in the Eurozone's fortunes and industrial production. Currently the European Parliament must approve changes.
Co-author Dr. Gbenga Ibikunle, Lecturer in Finance and Climate Change at the University of Edinburgh Business School, said, "While individual responsibility for combating climate change is important, much needs to be done to incentivise companies - especially those who emit most of the world's carbon - to cut back too. This study shows that free market mechanisms such as the EU-ETS can be effective in doing that. Several other schemes around the world are already learning from this and adopting it as a model."