Source: Productivity Commission, 'Productivity Commission submission to the Prime Ministerial Task Group on Emissions Trading', Productivity Commission Submission, March 2007, p. viii.
A system that involves as many countries as possible would minimise scope for 'free riding' whereby countries that are not members would place the burden of adjustment on participating members. But there are many—perhaps insuperable—barriers to a global emissions trading system, especially one with fixed targets and timetables. First, developing countries understandably do not wish to forgo growth to placate rich country concerns over global warming and so are reluctant to join an emissions trading system that might curb their growth. Second, some countries have reservations about the rigidity of a system with fixed targets and timetables given the uncertainty over the economic consequences of global warming. In particular, governments are concerned that strict adherence to targets could damage their economies.
As noted, in addition to reducing demand for fossil fuels, it will be necessary to increase the supply of alternative forms of energy. While there are alternatives to fossil fuels—nuclear, geothermal, wind power, solar, biofuels, hydrogen fuel cells etc.—they currently provide only a portion of present energy needs. Although there are advocates for each of these different forms of energy, we do not know what the precise combination of alternatives that eventuates will be.
Markets will play an important role in determining this. That's because markets create incentives to change behaviour on the demand and supply side. On the demand side, as the relative prices of energy-intensive goods rise, users will reduce demand for goods that are energy-intensive and increase demand for goods that are less energy-intensive. This process will also create incentives for suppliers of goods to produce less energy-intensive goods and to find the least-cost way of doing so.
It is tempting for governments to get involved in this process by favouring particular technologies or 'picking winners'. The risk is that governments may end up supporting industries which will not be viable over the long-term. Rather, the best strategy for government may be to resist making premature choices and instead focus on eliminating barriers to the development of new technologies—for example, by addressing market failures—and providing incentives for the development of the most cost-effective ways of reducing emissions.
L. Nielson, Emissions Control: your policy choices, Background note, Parliamentary Library, 10 May 2010.