Two Ways to Understand the Logic of Carbon Trading

Current debate among the pros and the cons on carbon trading spread out in wide range from the pessimistic to optimistic views, from the full of prejudice to the full of trust opinions. Carbon trading (as part of climate change discussion) supposes not to be a talk among certain groups of people, rather it must be discussed by every single person on earth because we are all contributing to the emission and (potentially) affected by the global warming. Therefore it is important to provide idea about the logical basis of carbon trading so then we can always back to the origin of the idea when we have different views. I would offer two logical bases to understand the carbon trading. All of them based on three assumptions; these are: we agreed that climate change is real and bad, trees or forests are able to remove carbon and other green house gases, and most importantly is that emission reduction is our common objective.
The first logic is the externality. That is the external cost or benefit of any human activity. This is not new for economists but very important to understand by people who had not chance to study economics. Externality can be positive or negative from demand or supply side; it depends on the gap between the private marginal cost/benefit with the social marginal cost/benefit. If the social marginal cost is higher than private marginal cost, we call it negative externality. Positive externality occurs when private marginal benefit is greater than social marginal benefit. For example, when we ride a car for certain distance which make us burn one litre of gasoline, the private marginal cost is exactly the cost of one litre of gasoline (market price), say IDR5,000. The social marginal cost of burning additional one litre of gasoline, however, is the air pollution that contributes to the climate change. The exact cost of the pollution made by one litre of burned gasoline is most likely much more than IDR5,000. Meanwhile, for positive externality, we can take tree growing as an example. If someone grows a tree, his or her marginal benefit is the tree itself, which can be the wood, the fruit or other parts of the tree. The social benefit of having another tree, however, is more than that because the tree removes the carbon emission in the air which contributes on climate change mitigation.
The gap between the private and social marginal benefit/cost is the reason of carbon trading. Those who create negative externality must pay more than his or her private cost (market price of the product i.e. one litre of gasoline). The additional payment must be transferred to the tree growers who create positive externality; this will close the private and social gap. Furthermore, this is an effective market instrument because it provides disincentive to the polluters and, in the same time, offers incentive to the carbon removers.
The second logic is incentive and disincentive on achieving the carbon quota. To make it simple, let say total global emission is 1000 tonnes per year in 2009. All countries agreed to decrease the emission down to 800 tonnes per year by 2010. Let say we agreed to oblige all countries decrease their emission by 20 per cent of their 2009 baseline by the end of 2010, and we only have two countries in the world. For example, County A produced 800 tonnes, while Country B produced 200 tonnes in 2009. This means Country A must lower their emission to 640 tonnes, while Country B is 160 tonnes by 2010. If Country A believes that it cannot lower that much and only commit to 720 tonnes, while Country B plans to decrease more to only produce 80 tonnes by 2010, then total world emission will be 800 tonnes, which means meet the target. However, Country A must pay the additional opportunity cost of Country B for the extra 80 tonnes. At the end, the world creates more social surplus in the short run and, in the same time, invests more for the long run global welfare.
The implementation, however, is not as simple as it is. It needs standards (e.g. of how to measure the emission of different human activities, and how to define the price of carbon), strong willingness to pay for the long run benefit, clear and transparent organization and procedures including who and how to use the money gained from carbon trading, and so on and so forth. It is possible to find the evil when it comes into the detail, however, this should not make us oppose the idea of carbon trading because the idea itself is fair and promising to make our earth better in the future. What we have to do is to move on working in the details and make it transparent to public so then there is no space for the evil to hide its face.