Green energy vs. the dirty status quo

Can green energy find its own market without the government's help?

By , Guest blogger

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    A wind turbine at the National Wind Technology Center spins on a sunny day near Boulder, Colorado. Guest blogger Matthew E. Kahn weighs the problems and benefits of government subsidies for green energy sources like wind turbines.
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The WSJ has published an editorial chiding President Obama's new economics guru (Jeffrey Immelt) for looking for a government handout at the same time that he celebrates "market capitalism".

"Less laudable is Mr. Immelt's habit of inviting government to be his business partner and promoter. In his 2008 letter to shareholders, the CEO declared that the financial crisis and election of Mr. Obama meant that the U.S. economy had been fundamentally "reset."

His key line: "The interaction between government and business will change forever. In a reset economy, the government will be a regulator; and also an industry policy champion, a financier, and a key partner."

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This is an invitation to the same kind of capital misallocation that led to the housing bubble. Mr. Immelt's particular goal is to promote policies and subsidies that aid green energy, in which GE is deeply invested. But if wind turbines are a good business, they will find a market on their own. If wind power turns out to be an uncompetitive bust, then the government will have misallocated hundreds of billions more dollars that could have found more productive uses."

I have mixed feelings about this WSJ paragraph and I believe that it is crucial for economists to debate its merits.

On the one hand (as a University of Chicago economist), I agree with every word that the WSJ has written here.

On the other hand, we delve into the nasty "theory of the second best". In a world where we are unable to enact carbon pricing, how does "green energy" compete against the dirty status quo fossil fuel sources? We appear to be in a multiple equilibrium model. IF we priced the carbon externality, then GE could invest with confidence in green tech and Adam Smith would be happy. Since we haven't (and won't) price the carbon externality, companies such as GE face political uncertainty concerning whether "green tech" is a wise investment.

So, I believe that wind turbines would be a better business if we introduce carbon pricing --- what are the right incentives to implement to promote "green tech" given that the public has rejected the first best strategy? I have mixed feelings about the Renewable Portfolio Standards.

This paper by Larry Goulder and Rob Stavins offers some insights about this issue.

Returning to Dr. Immelt, there is a game theory issue that hasn't been discussed. When big business anticipates that government will be its partner, this raises nasty strategic issues ranging from "too big to fail" to "adverse selection". Milton Friedman's tough love (that there would be no bailouts or special treatment of the private sector) sent clear "rules of the game" signals to big business. In the Obama Age, big business will spend more time lobbying for favorable rules and less time thinking about how to compete on the international market. We need our best companies to be focused on market competition not on seeking an inside track by hiring K Street lobbyists.

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