Do borrowing constraints limit green investment?
Environmental economists have yet to pay much attention to liquidity constraints as an impediment to the green economy.
Ignoring uncertainty, households and firms should do projects that have a positive net present value. Many empirical economics papers such as this one examine how a household's decisions are affected by its initial wealth. For example, suppose that you must choose whether to attend UCLA or work at Starbucks. Ignoring financial aid and assuming you cannot get a loan from parents or a bank, if you do not have $12,000 in the bank --- you cannot attend UCLA because you can't finance the tuition payment. If this young person would have simply kicked back and drank a lot of beer at UCLA then this is not a big social loss but if this young person would have discovered a cure for baldness by studying at UCLA then guys like me would be forever grateful. Economists would call her "liquidity constrained" if attending UCLA is a net present value > 0 investment but she cannot do this "project" because she can't pay the upfront tuition.Skip to next paragraph
Mathew is an economics professor at UCLA and has written three books: Green Cities (Brookings Institution Press); Heroes and Cowards (Princeton University Press, jointly with Dora L. Costa); and in fall 2010, Climatopolis: How Our Cities Will Thrive in the Hotter World (Basic Books).
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Now, here is my point. Environmental economists haven't paid much attention to liquidity constraints as an impediment to the "green economy". But, the company "Solar City" appears to be focusing on reducing upfront costs of going green through a "leasing" program for solar panels. Details are here . As I understand it, a solar system for a home can cost $20,000 to $30,000 upfront. This is a big investment. Part of Solar City's business plan is to give you a financing plan to pay an annual rate (like rent) for your solar panels. A Behavioral economist would say that this backloads pain and makes the price less salient as you spread it out. A Chicago economist would want to know what is the implicit interest rate solar households are paying for this.
Permit me to give you an example;
Suppose I want to sell you my book Climatopolis today and I offer you two ways to pay for it:
Option 1: give me $100 now
Option 2: give me $10 a year forever. In an economy in which the market rate of interest is 5%; we know that the Net PDV of option #2 = 10/.05 = $200 .
So what? The consumer sees the low price of "$10" as an annual flow and the smart company collects $200 in present value rather than the measly $100.
Now if this large a profit opportunity exists then free entry predicts that Solar City will face competition as entry takes place.
But, their business model raises an interesting empirical question --- as financing on annual flow basis becomes easier; will more middle class households adopt solar? In part this depends on how "sexy" they view it, how much they believe it adds to a home's resale value, and what they believe is the price path for electricity in their community.
The other interesting piece of information I see at Solar City
http://www.solarcity.com/residential/solar-lease.aspx is the company's attempt to reduce risk for the installing household. They offer a money back guarantee and promises of skilled installation and repair.
Similar issues arise for small firms. As they consider how energy efficient to be, how do they finance costly upfront investments? Are there financing arrangements to share the risks and the returns with deep pocket investors?
Is there a possibility of a nascent literature on corporate finance meets environmental and energy economics?
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