The Political Sustainability of Carbon Control Policies in an Evolutionary Economics Setting

This work represents a first attempt at analyzing the long term coevolution of market structures, technological change and government institutions. An empirical analysis of the U.S. electric power sector was conducted to validate the Grossman and Helpman (1994) "Protection for Sale" framework for use in modeling the interaction between the government and market actors. An agent based model with endogenous technological change was then used to explore how lobbying affects different carbon control policies as they evolve over time. In the empirical analysis, many electric power companies were found to benefit greatly from high carbon prices and can be expected to lobbying for such policies. In fact, in many situations the total near-term profit of the electric power industry increases with a price on carbon. The model was able to correctly identify nine of the top twelve contributing firms based on PAC contributions.;This analysis diverges from traditional methods by considering the institutional choice as the policy lever rather than the carbon price. In this setting, an institution adopting a plain carbon tax is found to have poor political sustainability except in certain narrow situations. When technological change and market structures produce consistently sloped supply curves there exists the possibility that enough firms profit from a carbon tax that the political resistance is overcome and the policy persists over time. This is more likely when the price elasticity of demand is low because higher carbon prices don't translate into reduced demand as quickly.;Political sustainability in carbon control programs is driven largely by heterogeneity. Identical firms react the same to proposed policy changes by definition. Heterogeneity admits the possibility of policy winners and opens the door to political sustainability. Even though heterogeneity drives political sustainability in the context of carbon control policy, it also has a tendency to be unstable. Heterogeneous firms engaged in competition will drive out the less competitive firms, producing a more homogeneous market. A constant stream of technological innovations is required to maintain the heterogeneity in the market needed to sustain a carbon tax.;Supplementing a carbon tax with a grandfathering policy wasn't seen to have a large effect. Depreciation, growth, and entrants all reduce the relative amount of grandfathered capital in the industry. This alone makes the policy less likely to succeed in generating higher carbon prices. Additionally, firms without grandfathered capital begin to lobby aggressively to keep the carbon price low. Similarly, distributing free carbon permits at the beginning of a cap and trade program did not produce large changes over the long term relative to a fully auctioned framework.;The two policies with the largest effect on decarbonization rates and lobbying levels were those that shared revenue with the market actors in some way. Long term carbon rights owned by investment banks provided them with a strong incentive to see high carbon prices. Similar outcomes were realized when a comparable amount of revenue was transferred back to firms via permits distributed for free based on each firms' market share.;This research has many implications for the design of market-based carbon control policies. First, the industry with the most carbon emissions is also one of the most inelastic: the electric power industry. Inelastic markets have the greatest potential for politically sustainable carbon control policies. Second, technological change in the electric power industry can potentially bring about rapid reductions in carbon intensities. These two important features bode well for the chances of creating a persistent policy. However, a carbon tax by itself (or fully auctioned cap and trade system) is not conducive to this outcome. Transient measures like capital grandfathering or limited allocations of free permits to incumbent firms do little to change the long run prospects of the program. However, they do not appear to hurt long term prospects either, so they may be useful as a way of onboarding existing firms. Distributing free permits based on a firm's market share (or recycling some of the program revenue in the same manner) is an effective way to increase the political sustainability of a carbon control program. This type of persistent revenue sharing improves policy sustainability in two ways. It creates a greater incentive for low carbon intensity firms to advocate for higher carbon prices and it promotes heterogeneity by making those firms more competitive. It also has the advantage of winding itself down over time. As the industry moves ever closer to carbon-free technology, the transfers implicit in revenue sharing will decrease to zero as well.;The increase in policy sustainability doesn't come free. The amount of lobbying increases substantially. Putting a price on carbon will adversely affect some firms in all but the rarest of circumstances. In order to ensure that such a policy persists across legislatures and technological advances, a supportive interest group needs to be established, and this tends to increase the amount of lobbying.