Common Tragedies

Thoughts on Environmental Economics


Posted by Daniel Hall on November 3, 2007

One of my blog colleagues and I were laughing the other day about how we are threatening to become known as the technology policy blog: we have been insistent — perhaps even obnoxious — in our repetition of the point that there are strong economic arguments for subsidies for technology R&D, given the inherent knowledge spillovers. I have recently been reflecting on another reason, less economic and more political, that we should have strong support for energy R&D: the credibility of long-term commitments made by governments, particularly democratic institutions.

To reduce greenhouse gas emissions it is vital that one way or another the government place a price on GHG emissions. Such a price will encourage the development and deployment of more climate-friendly technologies. The optimal path for such a price is to start at some lower level and gradually rise through time along a stable trajectory (essentially at the discount rate). Political reality will dictate that the price is not too high in the near-term — it is hard to imagine, for example, that we would tomorrow accept a carbon tax of $100 per tonne of CO2 emissions (the rough equivalent of a $1/gallon gas tax increase and more than a doubling of the price of coal-fired electricity). But eventually this may be indeed where we need to go.

The problem is that the people that will be making the promises to take us there someday — whether through tightening a cap or raising a tax — will not be the ones actually paying the piper down the road. Thus companies will inevitably face a kind of regulatory risk that will likely deter them from investing in even the privately optimal level of R&D — let alone the socially optimal level (remember those spillovers). This disincentive will be particularly strong in the early phases of any price-based program, as companies wait to see how society responds to higher energy prices and whether there is truly a broad-based commitment to remain on a path towards deeper emissions cuts.

This problem should be somewhat smaller in nations that have a history of credible and stable governments, and it can be lessened by establishing regulatory regimes that have clear goals and long time horizons.  But I suspect part of this credibility gap is inherent to democratic institutions — we can promise companies till we are blue in the face that there will be a carbon price of $100 per tonne CO2 in 2050, but they are far less likely to believe us today than in 2048.

Technology R&D subsidies therefore function as a signaling mechanism on the part of government — a near-term pledge that they are serious about their long-term commitments.

Of course, in the case of some governments, a still-necessary pre-condition is the establishment of any kind of long-term commitment to be serious about. Until then, the credibility gap will remain very large indeed.

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