Subsidies vs. market apporach
Q: As the prospects for a climate bill in the Senate get dimmer, some in Congress have said the solution is not to limit U.S. emissions but instead invest in green technology (wind, solar or earth's natural heat) that might be able to produce the same energy but with less pollution. Is this a good way to go, instead of setting a legal limit on emissions?
While government subsidies for "green technology" may be a piece of the total picture, the only way to efficiently generate the levels of investment needed to wean the economy from carbon-heavy sources of power is a price signal which could be generated as a tax or, more likely, as a cap-and-trade.
While subsidies can help support moves toward green energy, they will be a drop in the bucket compared to what is needed. A price on carbon, however, will tell all economic players--from power producers to manufacturers to buyers--that its time to change their long term business plans and unlock (pdf) the potential of a green economy.
In 2007, the respected consulting firm McKinsey and Co. estimated that we will need over $50 billion dollars in annual investment over the next two decades to transition away from fossil fuel to lower carbon sources of energy. The government is unlikely to provide that support over the long term; only an economy-wide market approach will attract that kind of investment. Other mechanisms, like research grants or business loans, will be insufficient both in size and scope.
Another problem with a subsidy-driven approach is that the government will be forced to pick technology winners and losers: Should we invest in photovoltaics or solar thermal? Rather than a government official making these choices, it is better to have that call made by investors with millions of dollars riding on this decision (and therefore strong incentives to get it right). Decisions make in the free market will tend to do better when betting on technology.
A carbon price would help correct market failure created by fossil fuel use and attract investor funds (as opposed to taxpayer dollars) to green technology. With carbon pricing, the less a firm pollutes the more it'll save. Carbon pricing will be like a starting gun initiating a race to create more powerful and cost-effective green technology. Right now, we have companies lined up on the starting line, waiting to take off--they only need to be given the signal and they'll start running.
An oft-cited example for comparison is the computer industry, where the competition to create faster and cheaper technology has created exponential growth in computing power. In the same way that we have laptops today that have the power of a room-sized computer decades ago, a carbon price could spur the creation of vastly more effective and cheap solar panels in the future in a way that government programs simply will not.
Though subsidies would certainly be better than nothing, and while they could help bump America towards a clean energy economy, it would be a weak sauce compared to a comprehensive price signal that would engage in full measure the innovative genius of our economy to create the solutions we need.
Richard L. Revesz
February 3, 2010; 7:15 PM ET
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