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The Right Green Industrial Policies

MÁLAGA, SPAIN – The future of our planet depends on the world economy’s rapid transition to “green growth” – modes of production based on clean technologies that significantly reduce emissions of carbon dioxide and other greenhouse gases. Yet carbon remains badly mispriced, owing to fossil-fuel subsidies and the absence of tax revenues needed to address the global externalities of climate change.

In this context, subsidies that promote the development of green technologies – wind, solar, bio-energy, geothermal, hydrogen, and fuel-cell technologies, among others – are doubly important. First, they nudge pioneers to invest in uncertain, risky ventures, with the resulting research-and-development efforts generating highly valuable social benefits. Second, they counter the effects of carbon mispricing on the direction of technological change.

These two considerations provide mutually reinforcing reasons for governments to nurture and support green technologies. Such support has, in fact, become extensive, both in advanced and emerging economies. Look around these economies and you will find a bewildering array of government initiatives designed to encourage renewable-energy use and stimulate green-technology investment.

Although full pricing of carbon would be a far better way to address climate change, most governments apparently prefer to rely on subsidies and regulations that increase the profitability of investments in renewable energy. Often, the authorities’ motive seems to be to give domestic industries a leg up in global competition.

Normally, we would consider these competitive motives to be beggar-thy-neighbor in nature. Market-share considerations are zero-sum from a global standpoint in traditional industries, and any resources invested in generating national gains come at the cost of global losses. 

But in the context of green growth, national efforts to boost domestic green industries can be globally desirable, even if the motives are parochial and commercial. When cross-border spillovers militate against taxing carbon and subsidizing technological development in clean industries, boosting green industries for competitive reasons is a good thing, not a bad thing.

Opponents of industrial policy rely on two arguments. The first is that governments do not have the information needed to make the right choices about which firms or industries to support. The second is that once governments are in the business of supporting a particular industry, they become vulnerable to rent-seeking and political manipulation by well-connected firms and lobbyists. In the United States, the 2011 bankruptcy of Solyndra – a solar cell manufacturer that folded after having received more than a half-billion dollars in government loan guarantees –seems to illustrate both failures.

In reality, the first of these arguments – lack of omniscience – is largely irrelevant, while the rent-seeking problem can be overcome with appropriate institutional design. Good industrial policy does not rely on governments’ omniscience and ability to pick winners; indeed, failures are an inevitable and necessary part of a well-designed program.

While it is too early to reach a conclusive verdict on the US loan-guarantee program, it is clear that the Solyndra case cannot be properly evaluated without taking into account the many successes that the program has spawned. Tesla Motors, which received a $465 million loan guarantee in 2009, has seen its shares soar and has repaid its loan early. An evaluation of US Department of Energy efficiency programs found that the net benefits amounted to $30 billion – an excellent return for an investment of roughly $7 billion over 22 years (in 1999 dollars). Interestingly, much of the positive impact resulted from three relatively modest projects in the building sector.

Intelligent industrial policy requires mechanisms that recognize errors and revise strategies accordingly. Clear objectives, measurable targets, close monitoring, proper evaluation, well-designed rules, and professionalism provide useful institutional safeguards. As challenging as applying them may be, they constitute a much less formidable requirement than that of picking winners. Moreover, an explicit industrial policy – conducted self-consciously and designed with pitfalls in mind – is more likely to overcome the typical informational and political barriers than one that is implemented surreptitiously, as is too often the case.

Green industrial policy can be damaging when national strategies take the form not of subsidizing domestic industries but of taxing foreign green industries or restricting their market access. The case of solar panels provides a cautionary tale. Trade disputes between China, on the one hand, and the US and Europe, on the other, have attracted much attention. Fortunately, this is the exception rather than the rule for green industrial policy. Trade restrictions have so far played a small role relative to subsidies to domestic industries.

In practice, we are unlikely to get purely green industrial policy, which would focus solely on the development and diffusion of green technologies while excluding considerations of competitiveness, commercial gain, and employment growth. Indirect but politically salient objectives such as “green jobs” will most likely continue to present a more attractive platform for promoting industrial policy than alternative energy or clean technologies.

From a global standpoint, it would be far better if concerns about national competitiveness were to lead to a subsidy war, which expands the global supply of clean technologies, rather than a tariff war, which restricts it. So far, we have been getting the former, though there is no way to determine whether, or for how long, this trend will continue.