Eco-nomics: California's Carbon Market

California is in the process of creating perhaps the world's largest carbon market and, in so doing, putting economic theory to the test. Here is an excerpt from an article by Reuters' Rory Carroll:

"This is by far the most ambitious program to reduce greenhouse gas emissions in North America, and by some measures the world," said Franz Litz, a senior fellow at the World Resources Institute.

California regulators are convinced they have the data and intelligence necessary to improve upon the system running in the European Union, which has shown results but has also experienced theft and fraud.

California officials say the market is a key part of implementing a six-year-old law that requires it to slash its emissions back to 1990 levels by 2020.

California also has the advantage of being a very large state -- independent of the United States it would represent the world's eighth-largest economy.

It plans to launch its market in conjunction with the Canadian provinces of British Columbia and Quebec, and officials hope the market will one day draw in other U.S. states and perhaps even Europe.

So officials at the state's Air Resources Board (CARB) are confident it will have the liquidity necessary to reflect an accurate and predictable price.

Many businesses hoping to profit from the trading of carbon credits and major environmental groups agree with the state, saying the market will give power plants and factory operators the flexibility to decide how to reduce their output of the heat-trapping gases.

At the same time, they hope the market's incentives will ignite the ingenuity of the state's businesses, which will invent the clean energy technologies to be sold around the globe like so many Hollywood blockbusters.

Economists love cap-and-trade for a simple reason, it allows for the most efficient reduction of carbon emissions to achieve a target.  The ones that can do so at the lowest cost will and those that find it quite expensive will buy credits from the cheap reduction firms. Thus is the target met and the expense to the economy minimized.  But achieving such a market requires quite a lot of bureaucracy and (as the European experience has shown us) leaves a lot of room for fraud.

But if the California market is successful it will lower the fixed costs for other states who which to participate, for they only have to join in the California market rather than try and create their own from scratch.  There are still many legal and political challenges to the California market, however, so stay tuned.