Turnbull must tread carefully on climate change policy transition

Prime Minister Malcolm Turnbull, right, and Environment Minister Greg Hunt will need a more robust climate change policy ...
Prime Minister Malcolm Turnbull, right, and Environment Minister Greg Hunt will need a more robust climate change policy for more ambitious targets. Alex Ellinghausen

The object of greenhouse policy, Malcolm Turnbull reminds us, is to reduce emissions.

For that, he says, you use whatever mechanism does the job most effectively, at the time, in the market.

For a relatively small emissions reduction effort, that might be the Abbott government's direct action program, although it will depend very much on the extent to which the slowdown in economic growth and Labor's emissions trading scheme have temporarily slowed the growth of emissions across the economy.

But, as the global emissions reduction effort steps up, the limitations of the Abbott scheme will become more apparent.

The most obvious limitation is the burden of emission purchases on the federal budget. As targets become more ambitious and the cheapest emission reduction strategies are exhausted, the cost of meeting the targets will rise disproportionately.

Another, less-obvious cost, is that of the regulations required to support the government's limited emissions purchasing program.

The so-called safeguard regulations are designed to ensure that emission purchases are not offset or even overwhelmed by increasing emissions elsewhere in the economy.

Reduction on the cheap

The government is, in effect, trying to achieve emissions reduction on the cheap.

It is paying for emissions reduction in one part of the economy, and if it did no more than that, it could claim to have reduced emissions from what they otherwise would have been.

But it wants to do more than that: it wants to reduce economy-wide emissions relative to a particular target. It can be certain of doing that only by limiting emissions growth across the rest of the economy.

The government will be, in effect, balancing a combination of emission purchases and regulation.

Initially the regulation might be relatively light-handed, but the government clearly sees the need for a binding regulatory constraint on future emissions growth. As the cost of emissions purchases blows out, the government's reliance on regulation will increase.

That is when the flexibility of Julia Gillard's emissions trading scheme will be sorely missed.

Under the ETS, industries confronted with high emission reduction costs could buy permits from those with low costs. The government set the overall level of emissions, but industry could distribute the emissions-reduction effort so as to minimise the cost in jobs and income.

Huge prize awaiting

Of course, the cost of emissions reduction can also be reduced by technological change. There is a huge prize awaiting anyone who can make coal clean or solar energy cheap.  

But the more governments depend on crude regulation, including renewable energy targets, the greater will be the economic and political cost of greenhouse policy.

For the moment Turnbull is fervently committed to the Abbott government's direct action policy, for obvious political reasons.

However, he will not have failed to notice the flexibility built into Abbott's scheme.

In reality, regulation, emissions taxes, and permit markets are points on a continuum. Emissions regulation with low fines becomes almost indistinguishable from a carbon tax. Polluters either avoid the tax by cutting emissions or pay the fine or tax, depending on which is cheaper.

And a tax attached to a licence is only a short step away from an emissions trading scheme.

It is easy to imagine how the current scheme might evolve with the emissions targets.

Driven by public opinion

Global targets are likely to be driven primarily by public opinion in the United States. If the American public wants tighter targets, countries like Australia will have to impose the same competitive disability of their goods and services. The US Congress will insist.

As the economic and fiscal cost rises, the emissions reduction policy will have to be adjusted to fit.

Keen-eyed political commentators say Tony Abbott was already showing signs of becoming more flexible on climate change policy. That's unsurprising, because at the beginning of his leadership Abbott laid out a quite flexible approach.

Under his government, Australia would not push ahead of the global effort to cut emissions. However, if the world got serious about emission reduction, everything, including an emissions trading scheme, would be back on the table.

Turnbull must tread carefully, of course. Allowing the cost of the Abbott government policy to become apparent is one prerequisite for successful change. Avoiding Gillard's mistakes is another.

Gillard's most obvious mistake was to promise there would be no carbon tax. Turnbull will be under pressure to make exactly the same pledge in the coming election campaign.

Her second mistake was to gloss over the cost to households. People did not understand how the ETS would work and were unpleasantly surprised when the retail price of energy went up. Perhaps they won't suffer the same delusion twice, but I wouldn't count on it.

RBA governor Glenn Stevens will address the annual conference dinner of the Australian Business Economists in Sydney on Tuesday, November 24. For bookings: abe.org.au