Thursday, June 04, 2009

Defending Big Government - Or Why We Can't Leave Energy Innovation to Markets

Marc Gunther, the excellent Fortune magazine and writer and fellow blogger at the Energy Collective, published a piece last week skeptical of the Obama Administration's new push to support the commercialization of advanced batteries in the United States and help accelerate the day when efficient plug-in hybrid electric vehicles are rolling off American assembly lines and parked in a driveway near you. At issue is $2.4 billion in new funding made available by the U.S. Department of Energy to support advanced battery commercialization and manufacturing.

Gunther quotes a Wall Street Journal article that shares his skepticism of this new funding, which will (in their words) "annoint" new technological and corporate "winners" -- something the Journal clearly sees as an unnecessary intrusion of government on free markets. Gunther agrees, writing:

"They’ve got a point, though, don’t they? One unhappy result of all the bank bailouts of the fall is that $2.4 billion doesn’t seem like much—hey, Citi alone has collected north of $45 billion, last time I checked—but a billion here, a billion there, and you’re starting to talk real money. And if electric cars are going to be as big a business as a lot of people think, then why government investment should be needed at all? Particularly since we have a climate change bill making its way through Congress that will, at long last, if all goes well, put a price on carbon emissions—thereby giving low-carbon energy sources what they desperately need, which is a fighting chance to compete with fossil fuels on something resembling a level playing field. I thought the whole idea behind cap-and-trade (which I strongly favor) is to capture the externalized cost of global warming pollutants, and then let the market figure out how best to reduce greenhouse gas emissions: regulation that would have a light touch but a profound impact.

But no—with Waxman-Markey, CAFE standards, biofuels mandates, subsidies for “green jobs” and the like—the administration is giving us a belt and a couple of pairs of suspenders, too. Much as I admire Steven Chu, the energy secretary, do we really want to entrust him and his staff to decide which battery technologies are likely to succeed and which companies can most wisely spend that $2.4 billion?"
And as much as I respect Marc Gunther, I quickly took issue with this pretty classic set of objections to government involvement in technological development. I wrote this response, which Gunther dubbed "WattHead Defends Big Government," and was happy to post at his personal blog and at GreenBiz. It has now been syndicated at The Energy Collective and at Reuters as well. Here it is for WattHead readers:

"WattHead Defends Big Government"

I’ve spent the past two weeks digging deep into the Waxman-Markey ACES climate bill, peering beneath rocks and shining my flashlight into its dark recess to figure out what it will and will not do. You can find that analysis at the Breakthrough Institute site here, and I highly recommend you take a look so you can get an accurate picture of what this “light touch-high impact” carbon pricing policy will actually accomplish.

The short answer: not very much at all.

The carbon price the bill will implement is likely to be between $12-20 per ton for the first decade-plus, according to the EPA analysis of the bill. That’s about 12 to 20 cents per gallon of gasoline, which on the low end is about as much difference as you can find between different gas stations on two sides side of town, and on the high end is lost in the noise of seasonal variation in gas prices. If you have little faith in the power of government, then I challenge you to explain how that kind of meager price signal is going to shift private investment and dramatically transform the $1.5 trillion combined U.S. energy and transportation markets. Please, tell me a convincing story about how that might work, because after spending two weeks reading the Waxman-Markey bill, I could use some more uplifting news.

The reason the CO2 price will remain so low is because the bill allows up to 2 billion tons of offsets (up to 1.5 billion which may be sources from overseas) to be used in lieu of cutting emissions here in supposedly ‘capped’ sectors. That’s enough to legally permit U.S. emissions to continue to grow at business as usual rates through 2030. So Waxman-Markey gives us no real “cap” on carbon and no significant price on carbon. Forgive me for looking for other ways to directly spur the transformative clean energy innovation we need — ways you may consider unfortunate degrees of “government intervention.” Given what’s at stake after all…

Also, as a kind of test to consider: many European nations have had gas taxes for decades that implement an effective carbon price in the hundreds of dollars a ton range ($2-5/gallon tax = roughly $200-500 per ton of CO2 equivalent carbon price!). So with such a powerful signal for private investors to develop alternative fuel vehicles, why haven’t firms in Europe invented and commercialized electric cars? Why isn’t everyone in Denmark driving EVs, one might ask?

The answer is because that’s not really how innovation works. Price signals alone do not spur adequate innovation. There’s a multitude of market failures at work, especially in the energy innovation sphere. I have a paper coming out in about two weeks which I’ll share with my readers and the The Energy Collective community that spells out a lot of these market failures (prelude: knowledge spillovers, very high capital barriers and non-differentiated commodities are three big barriers to sufficient private sector innovation investments). These are the kinds of market failures, which when combined with clear public imperatives for change, simply demand more active government engagement with innovation and industry than we all may find ideal.

For now, I’ll again challenge the typical assertions that private entrepreneurialism and investment (and the proper price signals) are all that’s required to spur transformative innovation by pointing you to my publication, “Case Studies in American Innovation: A New Look at Government Involvement in Technological Innovation” [PDF] for examples of how active federal government engagement and investment paved the way for so many of the technologies we now take for granted, including microchips, personal computing, the Internet, commerical aviation and jet engines, gas combustion turbines, nuclear power, wind power, solar power, etc. Take a look and see why I’m not as skeptical of the role of government as you are.

Finally, as a (mostly) side note, since you cite Tesla Motors targeting luxury car markets with their electric Roadster as a reason they should not receive federal incentives: the reason Tesla is starting with a $100k electric luxury car is because new technologies are routinely more expensive at their launch. If there isn’t a market for early adopters, the technology will never reach the economies of scale and spur the learning by doing (and continued innovation) that drops the price and improves the performance of the technology over time. Think flat screen TVs or cell phones: the first ones are far more expensive than most can afford. But now these technologies have reached economies of scale that drove dramatic price reductions and the technologies are affordable and (because of that) ubiquitous.

Tesla is looking to use luxury buyers - who routinely pay more for the cool new thing - to drive those initial economies of scale. They plan to produce the Roadster on a scale of 1,000s and at a cost of $100k. Their next model will use the same (and now cheaper) components and batteries at a larger scale and will be a luxury sedan selling for around $60k and at a scale of 10s of thousands. They then plan to produce a $35-40k sedan at a scale of 100ks per year, if all goes well. That’s just smart. Please don’t use that as a reason not to incentivize their technology’s development with public investment. If the government were willing to directly purchase batteries and serve as the early adopter themselves — as we did for microchips, radios, radar, lasers, early computers, and jet engines — we could bring this emerging technology to scale and down in price much more rapidly and pave the way for the kind of dramatic private sector innovation that occurred AFTER the government purchasing (and loss-leading) dropped these technologies in price. In short: we should be seeing far more direct public investment in the technologies to enable electrified transportation, not less.

Marc, I challenge you to wrestle with the history of innovation in a real honest way, and look for the role of government engagement in these technologies. The energy innovation imperative is simply too critical to leave to well-established (but quite inaccurate) myths about the infallibility of private sector innovation and the supposed ineptitude of any government engagement in the market. If the financial crisis taught us anything, I’d hope it was that we should revisit those myths with a pretty damned critical eye, eh my friend?

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