Washington being what it is, the backlash against green subsidies is no surprise. But it’s an overreaction every bit as hysterical as the pro-Solyndra hype was. Industrial policy does have a checkered history, and in much of the developing world government intervention in the marketplace has translated mainly into crony capitalism. But in other places the story is more encouraging; many economists argue that government intervention in the market was instrumental in the postwar rise of countries like Japan, South Korea, and Taiwan; more recently, Germany has built a sizable solar industry using subsidies. It’s certainly true that we don’t want government to be in the business of helping decide which big-box retailer or maker of MP3 players has the best chance of succeeding. But it’s also true that there are a few industries where it makes a lot of sense for the government to complement the market by subsidizing research and development. Renewable energy is one of them.
That’s because the energy market is not like most other markets. Indeed, the economics of alternative energy are such that private investors, left to their own devices, are bound to underinvest in it, since the considerable social benefits—cleaner air, fewer greenhouse emissions—accrue to everyone, not just to direct customers. That means that the economic rate of return is significantly less than the social rate of return. Energy markets are also dominated by entrenched, regulated companies, and that reduces the incentive for investment; despite the immense size of the energy market, as of 2005 spending on energy R. & D. accounted for just two per cent of total spending on R. & D. in the U.S. This creates an opportunity for the government to add value by investing smartly, just as it can add value by spending money on education or infrastructure, other areas where the social returns are greater than the economic ones.