Allelujah! Don't Divest! Invest!

In light of Australia’s questionable performance at the recent UN Climate Summit, two economics students went to a decadent bourgeois coffeehouse (i.e. the Gods Café) to discuss climate change policies…

 

LÉON: I just want to say I cringed when Abbott gave his speech about being a ‘good global citizen’ to the UN general assembly.

BARBARA: But here’s the thing – even though most Australians believe climate change is real, absolutely nothing is happening on the policy front. And some people are blaming economists for it! But economics also says we should be doing more for climate action. The government should drop their ‘Direct Action Plan’ in favour of policies such as investment into renewable energy.

Economics tells us people are generally risk averse – people prefer a certain outcome to an uncertain situation with the same expected payoff. It’s why we buy insurance even if our chances of a big accident in the future are tiny. The same applies to climate change. Runaway climate change is our accident and renewable energy is our insurance against it. By investing in renewables we are minimising the risk of a climate catastrophe in the future. Therefore, this is a welfare-improving policy for current generations.

LÉON: Okay, ignoring the fact that you are assuming we can aggregate group preferences into a coherent social welfare function, government investment into renewables is problematic.

Even if subsidies help the renewables industry succeed, any apparent super-normal profits they make will likely be illusionary. This is because these profits are often merely compensating for an earlier (and very expensive and risky) R&D stage. Subsidies can create excessive market optimism, encouraging new entrants to the industry, who then incur heavy costs in the R&D stage before failing dismally in the marketing stage. Not every firm with a brilliant concept for next-gen solar cells or wind turbines will be lucky. That’s just a fact of life. With that in mind, subsidies could actually hurt the industry and its investors in the long-run by distorting incentives. Of course, it goes without saying that this is just as true for existing fossil fuel subsidies as well.

BARBARA: But consider the potential jobs that could come out of investment into renewable energy! Renewable energy development is a sunrise industry – an industry that is relatively new and likely to be important in the future. As the demand for renewable energy increases, employers will hire new workers and develop new capital. This increases output and we could potentially tap into previously unrealised economies of scale. It’s a virtuous cycle of development!

In contrast, the value of coal, our second largest export, is steadily dropping. In 2011, coal exports were worth 46.8 billion dollars and this was mainly to China. But China is slowly shifting towards renewable energy to manage an ongoing air pollution crisis and the price of coal has dropped almost 30% between January 2011 and January 2014. We need to begin looking elsewhere, lest we become stuck in a sunset industries.

LÉON: I’m afraid I have two final objections. First, a deliberate expansion of the renewables sector could harm other industries which rely on a common pool of resources, particularly if these resources are highly scarce and supplied inelastically. These are inputs such as rare earth minerals, as well as scientists, engineers, and other skilled workers. Using subsidies to expand renewables energy development could contract other high-tech sectors in the short-run or medium-run.

Second, once you intervene in an industry you are creating a political constituency that may cause problems further down the line for policymakers. Whether you like it or not, the renewable energies sector is just like any other sector of the economy. If given the chance, it will attempt to seek rents and engage in regulatory capture. You only need to look at the political clout of the Australian carbon lobby to see how bad it can get.

Ha. I can see it already: in one hundred years’ time, the Australian fusion energy industry will be struggling under the hegemony of the solar and wind energy lobby. Hmm… that could be a good idea for a science fiction novel…

BARBARA: That would be a terrible novel. You should never, ever get published in any capacity.

LÉON: Too late for that, I think.