A Better Idea than the Carbon Tax
In which I highlight, for Bloomberg, a cool idea from Florenz Plassman and Nicolaus Tideman to create a futures market for the cost of carbon emissions:
Nicolaus Tideman and Florenz Plassmann, economics professors at Virginia Tech and SUNY Binghamton respectively, have an ingenious solution. In a paper published in 2010, they say polluters should be made to buy a special 30-year, zero-interest bond from the government for every unit of pollution they emit. The government would set the principal at a reasonable upper-limit estimate of the per-unit cost of pollution. The bond's redemption value, though, would be set in the future. Bondholders would receive what is left of the principal after subtracting the actual cost of the pollution as determined by an independent agency at the bond's maturity.
Investors could trade the securities in a secondary market, creating a prediction market for the cost of emissions. Investors who think the bond market is overestimating future costs will buy the bonds. Those who think the market is underestimating the costs will sell them.
"If you're going to deal efficiently with pollution, it's appropriate to put an incentive on people to economize," Tideman said in an interview. "But you've got to get the price right. Experience tells us that the best way to get information about the future is a futures market. Our proposal adapts a futures market to address climate change."
Tideman's and Plassmann's insight is that policymakers don't know the actual future costs of pollution and don't need to guess. Their market would determine the actual liability of most polluters, except for those who chose to hold the bonds to maturity. This solution uses the ability of prediction markets to synthesize a price from disorganized, disconnected bits of knowledge.