Wednesday, January 26, 2011

The Great Misallocators?

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."
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.

2 comments :

completelybaked said...

Mr. Kahn,

Thanks for taking on this issue.

Aside from the carbon externality, (which US lobbyists seem quite capable of insuring will never be priced accurately -- in the US, at least), what about subsidies to the fossil fuel suppliers that renewable energy producers must compete against? Taxpayers in the US pay a lot to keep fossil fuel prices artificially low by paying for things like cheap land leases for strip mines and drilling operations that irreparably damage our landscape, tax loopholes that permit oil companies to write off overseas royalties as foreign taxes, dealing with environmental nasties like mercury and radioactive isotopes in our air and heavy metals in our water, communities and ecosystems destroyed by natural disasters due to global warming, or by oil spills, and last but not least, defense of overseas oil interests by our troops.

It's tough for a nascent industry like renewable energy, which upsets the status quo to such a large extent, to survive in the face of all those opposing forces.

more info about fossil fuel subsidies: http://completelybaked.blogspot.com/2011/01/replace-fossil-energy-subsidies-with.html

David K. Bellman said...

Optimistically I believe renewables can survive and thrive given the desire by many. An innovator is needed. There is much money to be made for that person.

http://allenergyconsulting.com/blog/2012/01/30/green-energy-better-and-more-sustainable-without-subsidy/