A spat has broken out between the IPA and government supporters on the carbon tax.* We have been following the argument quite closely here at the Cat. The latest instalment is here. The argument appears to be two-fold: what is a free market (relative to an artificial market) and what is the value of government created property rights?
So what is the role of government in a free market? Let’s have Ludwig von Mises explain (Human Action, p. 257) (emphasis added):
There is in the operation of the market no compulsion and coercion. The state, the social apparatus of coercion and compulsion, does not interfere with the market and with the citizens’ activities directed by the market. It employs its power to beat people into submission solely for the prevention of actions destructive to the preservation and the smooth operation of the market economy. It protects the individual’s life, health, and property against violent or fraudulent aggression on the part of domestic gangsters and external foes.
A carbon market does not fit into that definition – quite the contrary. In the carbon market the government has first nationalised and then privatised the atmosphere, creating the right to pollute, and then vesting those rights largely in the hands of foreigners (the EU). Australians are then required to purchase the right to pollute in Australia from those foreigners. This is not a voluntary exchange – it is driven entirely by government coercion and thus cannot be described as being a free market.
In addition these rights to pollute would never evolve naturally. This raises the issue of where do property rights come from? There are two broad theories in this regard: the efficiency theory (ala Harold Demsetz) and the legal-centric theory (ala Itai Sened). I’ve written about this before so here is an extract:
Property rights exist to facilitate the acquisition, control, and exchange of assets. While many definitions of property rights are similar, the literature shows disagreement as to the source and origin of property rights, particularly the role that the state plays in originating, specifying and developing these rights. Alchian (1965: 129) is emphatic, “If … I talk as if the property rights were enforced by formal state police power, let me here emphasize that such an interpretation … is a gross error.” Alchian, however, also recognizes that there are many counter-examples to his “gross error” and appeals for edification. Some authors (Barzel 1997, Ellickson 1989, 1991) differentiate between economic rights and legal rights. It would seem that not all economic rights are legal rights, but that a subset of legal rights will always be economic rights.
In short the relationship between the emergence of property rights and the state is the subject of debate and controversy. Early theories of the emergence of property rights did not envisage an active role for the state. Demsetz is the classic paper in this area that property rights emerge to internalize externalities in response to changes in technology and relative prices. Property rights in this model are endogenous. Eggertsson (1990) refers to this model as naïve, as Demsetz makes no attempt to model the social and political environment in which the rights arise.
…
The opposite view of the emergence of property rights is the “legal centralist” view. Sened provides a recent example of scholarship in this area arguing that property rights cannot exist without centralized law enforcement as well as the state having a monopoly in violence. In his model, property rights arise out of the interaction between political entrepreneurs who wish to internalize some opportunity and government officials. Sened (6, original emphasis) writes that, “governments must grant rights before they can protect them.” Further he writes, “[s]uch rights cannot emerge or persist unless they serve, directly or indirectly, the interests of the central authorities that pay a remarkable cost to protect and enforce them” (7). Sened argues that four conditions are necessary and sufficient for rights to emerge: the right must be valuable, right-holders must desire the right, rule-makers must desire to enforce the right, and some duty-bearers respect the right. In the legal centralist approach, property rights may be efficiency enhancing or not. Political entrepreneurs may lobby for property rights that increase output or for rights that monopolize some aspect of the economy (i.e. the political entrepreneur may represent an interest group).
So I’m happy to believe that the government can create property rights in the atmosphere and then to try force people to trade in those rights. But here we run into a hidden assumption in the whole “market-based” approach to public policy. That is, “any market is a good market”. But I’m not convinced anyone really believes that proposition. Consider, for example, slavery – as I understand it there is such a market; yet I’m not convinced anyone would publicly argue that property in human beings was acceptable even though the government had declared it to be so. Indeed government sanctioned slavery has a long history.
So let’s have a look at Sened’s four criteria:
1. The right must be valuable. Well, let’s be blunt, the right to pollute only becomes valuable when the government creates an artificial scarcity. To date despite their very best efforts governments around the world have failed in this regard.
2. Right-holders must desire the right. This one is tough – right-holders only desire the right because they are mandated by government to do so. As such the right is like any other impost (or tax) and will be characterised by sullen compliance, obfuscation and avoision.
3. Rule-makers must desire to enforce the right. Here is another problem – political support for carbon markets is weak. The Coalition doesn’t support it at all and the ALP is wavering.
4. Some duty-bearers respect the right. Well, no. Not really. Ask yourself this, if the government were to halt trading in carbon markets would a black market in carbon evolve? No? I don’t think so either. Yet there are many, many black markets in all sorts of products and services. Consider for example another government created property right; Copyright. Despite having the ability and opportunity many people do not pirate tv shows or photocopy books and the like. But would anyone voluntarily trade carbon if they didn’t have to?
To Sened’s list I would add:
5. Must have some (economic or social) value.** Now our Green friends tell us that carbon markets do have great value. Okay. Yet they have failed to convince on this score. Part of their problem was poor strategy. As Lord Stern said, “If you don’t care about future generations, you won’t care about climate change”. That is exactly right.
So government can create property rights but that isn’t saying government should create property rights nor does it guarantee that those rights would persist. To put it in terms lefties can understand, the social licence for carbon markets is about to be revoked.
* The latest article is written by John Daley – CEO of the Grattan Institute who makes the following disclosure:
John Daley does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.
The Grattan Institute was founded by a $35 million grant from the Rudd government.
Update: A lurker emails to say that the Rudd government gave the Grattan Institute $10 million – not $35 million as I thought it had. That’s all okay then. 
Update II: The disclosure statement has been modifed:
Grattan Institute began with a $15 million endowment from each of the Federal and Victorian Governments. In order to safeguard its independence, Grattan Institute’s board controls this endowment. The funds are invested and Grattan uses the income to pursue its activities.
** This could be similar to Sened’s first point but I really want to hammer this point.