Combining price and quantity controls to mitigate global climate change
Uncertainty about compliance costs causes otherwise equivalent price and quantity controls to behave differently and leads to divergent welfare consequences. Although most of the debate on global climate change policy has focused on quantity controls due to their political appeal, this paper argues that price controls are more efficient. Simulations based on a stochastic computable general equilibrium model indicate that the expected welfare gain from the optimal price policy is five times higher than the expected gain from the optimal quantity policy. An alternative hybrid policy combines both the political appeal of quantity controls with the efficiency of prices, using an initial distribution of tradeable permits to set a quantitative target, but allowing additional permits to be purchased at a fixed "trigger" price. Even sub-optimal hybrid policies offer dramatic efficiency improvements over otherwise standard quantity controls. For example, a $50 trigger price per ton of carbon converts the $3 trillion expected loss associated with a simple 1990 emission target to a $150 billion gain. These results suggest that a hybrid policy is an attractive alternative to either a pure price or quantity system.