What impact will Rudd’s floating ETS have on the economy?

Prime Minister Kevin Rudd says he’ll ditch the carbon tax in favour of a floating price on emissions a year earlier.

But what impact will it have on the broader economy, from relying on Europe to transitioning to a low-carbon economy? Crikey asks the experts?—?who seem pretty relaxed about the whole thing …

Broader macro impact: Zero,” said Jim Minifie, program director of productivity growth at the Grattan Institute. ”This is not a Chinese shadow banking crisis or another policy failure from the European Central Bank. The rest of the world cares a smallish but non-zero amount about what Australia does. This latest wobble from higher fixed to (probably) lower variable price will hardly register.”

The move to a floating rather than set carbon price is more a political issue than an economic one, says Minifie. “Investors in Australia have long been conditioned to expect emissions policy to change frequently,” he told Crikey. “All investors have to be looking forward to likely conditions over a couple of decades anyway rather than conditions in any one year. So what do they do: they try to keep their options open and choose less capital intensive or more flexible generation options like open cycle gas, which is not that low in emissions and is rather high cost. This latest switch around just confirms that you can’t rely on the politicians.”

Dr Frank Gelber, chief economist at BIS Shrapnel, agrees that since the floating carbon price was going to be implemented by mid-2015 anyway, bringing it forward isn’t an earth-shattering decision. ”That was what we were always going to go to,” he told Crikey. “Is it sooner, is it later, it doesn’t really make a huge amount of difference, except that it does change electricity prices, of course. But the real issue is how we get through this soft patch in the economy and how we get the non-mining part of the economy working.”

Sure, the change to a floating price will have an impact on the budget?—?with $3.4 billion the figure currently bouncing around. “The budget will be higher, the deficit will be higher,” said Gelber. “It’s interesting that the government now recognises that this is not the right time to be really tight on budgets.”

The plan is to tie Australia into the European carbon market?—?on Friday carbon credits cost just 3.95 euros per tonne (about $5.70 AUD). In Australia the carbon price is currently fixed at $23 a tonne.

But the European carbon market won’t always be so weak. “Europe will eventually drag itself out of recession in the first half of next year,” said Michael Knox, chief economist and director of strategy at RBS Morgans. ”The reason the carbon price is soft is because pure manufacturing is soft in Europe, because investment is soft. If you had a significant recovery in the European economy, two things would happen. Firstly the demand for carbon credits would rise, forcing up the price, and secondly the euro exchange rate would rise against the Australian dollar. It makes us inherently vulnerable to shocks within the European economy that has nothing to do with us, so it adds an extra level of risk to the Australian business sector.”

Moving to a floating price will help business, which have been struggling with the carbon tax, says Knox. ”The problem is, the carbon tax has been very damaging in Queensland,” he told Crikey. ”Employment data shows there’s been a significant reduction in the employment sector, I’m sure you’d see similar data in Victoria. Cutting the carbon tax by two-thirds obviously reduces the damage by two-thirds, but it still has a negative effect overall on the economy.”

The move to a global scheme has been a long time coming, notes economist John Quiggin. ”In the context of a comprehensive global agreement, there are strong reasons for preferring a global market in emissions permits,” he said. “In current circumstance, the choice is less clear cut.”

He suggests reviewing the history of Australia’s carbon price policies:

  • The original CPRS proposed floating prices from the outset with a ceiling and floor, with a possible link to international markets later;
  • The Carbon Pricing Mechanism scheme actually legislated had a fixed price for a period of three years;
  • The agreement with the Europe Union announced in 2012 shortened the fixed price period and, more importantly, linked our scheme to the EU; and
  • Rudd’s announcement brings forward the link by a year.”

The crucial decision here was the link with the EU,” said Quiggin. “Whether this turns out well or badly depends on how well the EU manages its scheme. Although the problems with the EU scheme are well known, it has probably been more cost-effective than regulatory alternatives like that proposed by President Obama following the rejection of cap-and-trade by the US Congress.”

This article originally appeared on Crikey.


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