Is subsidizing research a good substitute for pricing carbon?

So everyone who knows more about politics than I do (which is pretty much everyone) says that cap and trade, or any kind of carbon pricing, is dead.  That makes me, and I expect the vast majority of economists, very sad.  Republicans (and probably some Dems) are now pushing old command-and-control regulations, which make almost no sense in comparison to pricing carbon.

Another angle that makes at least some sense, and may be more politically feasible (I profess no insight), is to subsidize research and development of alternative energies.   Can we come up with energy sources that have no externalities and have private costs that are cheaper than current cheap but polluting energy sources?  Sitting from my armchair this seems dubious but possible.  

Here's Ezra Klein interviewing Michael Shellenberger:

Ezra Klein: It looks like a carbon-pricing bill is pretty much dead. What happened?
Michael Shellenberger: .... the green groups hired some of the best advertisers and lobbyists and spent $100 million. ... They had arguably the best mobilization environmental groups have ever done in the history of the environmental movement. It was the proposal itself that was impossible for this Congress, and any Congress in recent memory, to pass.

EK: Is there any near-term hope for the politics to change? Any reason to think that a future Congress will view this differently?
MS: I think that this is the end of cap-and-trade for a long time.....

EK: So then, what next?
MS: Our view is you need a price on carbon, but that it’s going to start very low..... So we need to be moving to a framework where at the center is technological innovation to close the gap between fossil fuels and clean energy. That might need to be funded with a small tax on carbon. But the center is the technological innovation.

EK: And to distinguish that from cap-and-trade, the idea here isn’t really that you’re pricing carbon, but that you’re funding research into alternatives.
MS: In the early years, that’s its primary purpose. .... A cost of $5 a ton is $30 billion a year. ... far below estimates of cap-and-trade. What conservatives and Republicans might find appealing is that this would be focused on technology innovation....everything from solar to nuclear, you should be able to appeal to some of them.

EK: And why put any faith in this? Why should we believe it’ll work?
MS: This isn’t something we think can succeed right away. .... We’re not going to do anything of consequence on reducing emissions without closing the price and technology gap between clean energy and fossil fuels, and we’re not going to make serious headway on technology innovation unless we fund innovation directly, .... The history of tech innovation in the U.S. is really a history of military procurement, R&D funding, science and engineering education, and demonstration projects.

EK: And how would this work, in practice? Won’t it just end up subsidizing a lot of waste?
MS:....Defense spends $80 billion a year on R&D. Is some of it wasted? Of course. Thomas Watson said, “If you want success, increase your failure rate.” ....We’re missing a demanding customer, which is what the Pentagon has been. You can point to waste there, but also amazing innovations in communications and rocketry. We look at Google and Apple and think the federal government had nothing to do with them, but without federal investment in computers there would be no Apple and without DARPA there would be no Google.

Given history, it seems likely to me that market failures on the innovation front may be as large as pollution externalities, which suggests subsidizing research and development may be a reasonable substitute for pricing carbon.  Of course, with two market failures the *best*  solution would involve at least two policy instruments--something like subsidize innovation and tax pollution.  That was the angle Waxman and Markey took.  But oh well...

So, my academic question of the day is, suppose there are two market failures, say a pollution externality and a public goods problem that stifles innovation for renewable energy, but suppose you can use just one instrument to deal with that problem, say, a tax on pollution or a subsidy on innovation.  Which would be best under what circumstances?  Can a toy model be combined with some stylized facts to suggest whether a pollution tax beats an innovation subsidy or vice versa?  Is it possible that the big policy push should have been (and should be) on innovation subsidies rather than carbon taxes even though both are theoretically optimal?


  1. I have entertained your "academic question of the day" before, mostly with non-point source pollution. I believe David Popp has talked about this double market failure in a few publications as well (mostly with regard to air quality). I'm afraid I don't have a research breakthrough.

    It occurred to me the other day that some innovations are really rent shifting rather than rent creating. Coming up with a way to eat someone else's lunch is quite a good trick. Put another way, innovations change the margin of *something* near zero. For instance, I guess they're still putting out yellow pages and everything, but I doubt I'll leaf through a paper yellow pages this year. If all Google did was to put business listings online for ad revenue, that would be a viable business model at the expense of yellow pages publishers. As yellow pages publishers exit, a pure rent-shifting innovation* increases resources by freeing the dead enterprise to work on something else...probably in another market entirely. This is qualitatively different from, say, semiconductors, where rents arise from gradual improvements and competitors stay in the game.

    Absent cold fusion or something similar, I am not seeing how the global climate change problem gets addressed without carbon prices, cap and trade, or unpalatably large public sector involvement. I don't see the innovation coming that -- absent policy -- is going to make fossil fuel operators hang up a "closed" sign.

    *Google is far from a pure rent-shifting innovator; I'm just simplifying.

  2. Well, the obvious candidate that comes to mind is nuclear fusion.

    Cheaper than current energy sources? Probably (the fuel can be found in water).

    No externalities? As far as I can tell.

    Market failure on research? Absolutely.

    Of course, the old joke is that economically viable nuclear fusion is only 50 years away and they've been saying that since the 50s.

    So I suppose the best people to talk to would be physicists for this. Or if we're looking at potential innovations we don't know about, well that would depend on what could be used as an energy source, and that would require input from physicists/chemists/engineers etc.

  3. J King:

    Nuclear fusion could easily be economically viable without going it being "cold". And as I understand it, "cold" fusion would require a big rewrite of physics and chemistry textbooks.

  4. I'm late getting to this, but thanks for your comments, Alex and John.

    I don't know if such a technology is possible. But I wouldn't bet against it. Technology has done some pretty amazing things in the past, but mostly with the help of government (even if some are loath to admit that). Defense spending comes to mind, the unintended *positive* effects of which just boggles the mind, and has changed our lives. It's sad the government never seriously subsidized alternative energy research but has subsidized polluting energy sources.

  5. I def. believe in the ability of a carbon price to efficiently allocate pollution..though it seems to little too late (assuming global warming is the problem it is claimed to be)..but my comment relating to this post is rather a question. I read a short article on prizes the other day in the economist. I have long thought that a substantial prize would be a great way to go, rather than selecting the "winners" who will recieve grants, tax breaks, ets. I don't know much on this subject and don't really want to take up too much time researching the subject..any comments/thoughts on why a government sponsored prize could not provide a great incentive to develop something groundbreaking?


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