The Economics of Climate Change: An Examination of the Mckibbin-Wilcoxen Hybrid Proposal for a Carbon Price for Australia

Abstract

Many countries are contemplating the design of institutions to address ‘the greatest market failure the world has ever seen’.3 In Australia, a carbon trading scheme is being considered, and prominent amongst the proposals being discussed is the ‘McKibbin-Wilcoxen hybrid scheme’ (2007, 2006, 2002).4 We critically examine the literature on this proposal. As a national trading scheme there is much to admire in the institutional arrangements suggested, and this is our most important conclusion. Nevertheless, we do seriously question the theoretical framework advanced to justify the hybrid structure – a framework that is also used in some sections of Stern (2007) and elsewhere. We argue that by justifying their proposals in terms of theories conceived in the 1970s when it was believed that pollution could be contained and its damages quickly ‘cleaned up’, the authors run the risk of confusing or misleading a lay audience by stretching the credibility of benefit-cost analysis, potentially undermining broader support in the process. Rather than having to posit unknowable short and long-run marginal benefits curves, we believe it is more sensible and credible to argue in terms of ‘cost effectiveness analysis’; that is, achieving a long-run national target in the most cost-effective (and painless) way possible. By analogy, we favour taking the ‘Hungarian’ path to economic transition rather than the ‘Russian’ route.

Keywords: Economics, Climate change, Carbon tax, Carbon trading, Carbon offsets, Optimal abatement models, Social cost of carbon, Cap and trade, Market-based instruments