Innovation Before Carbon Pricing

How Economists Misrepresent Energy and Technology

Carbon taxes are in vogue. Economists’ predilection for price signals as the universal solution has fused with environmentalists’ impulse to punish Big Oil and Big Coal to make carbon taxes the darling of the climate change debate.

It’s the elegant solution climate hawks have been looking for since the death of cap-and-trade. But as Dr. Rob Gross, the Director of the U.K. Imperial College Centre for Energy Policy and Technology stated, this idea is, “so simplistic it is absurd.” Carbon taxes are doomed to fail because they do little to drive what is needed most: innovation that generates affordable clean energy that all 7 billion humans will want to adopt, not out of altruism or coercion, but out of self-interest.

Economists’ attraction to a carbon tax was on full display recently when economist Greg Mankiw wrote in the New York Times, calling a carbon tax a climate policy “America could live with,” compared to the grab bag of regulations and fuel standards targeted by the Obama administration.

Carbon tax supporters believe it will lead consumers to use less dirty energy. Mankiw writes, “When making everyday decisions, people would naturally look at the prices they face and, in effect, take into account the global impact of their choices.”

If greenhouse gasses were a pollutant like sulphur dioxide that largely stays within national borders such a policy might make sense. But they are not. It’s a global pollutant. That’s why we talk about addressing global warming, not American warming.

Mankiw’s preferred climate solution aims at getting U.S. consumers to buy slightly more fuel efficient cars or turn off light bulbs more regularly because energy prices are modestly higher. This will have little impact on global emissions because virtually all their growth will be in rapidly growing developing nations like China and India. Moreover, greenhouse gases are not like traditional pollutants in another sense: they are cumulative, essentially filling the atmospheric “bath tub.” We therefore can’t afford to simply slow their growth; we need to dramatically cut emissions.

This gets to the second major problem with the carbon tax. The only way to get to dramatic cuts in global emissions is by developing significantly cheaper and better clean energy technologies. Current clean energy alternatives cost significantly more than conventional energy. Expecting consumers and businesses, especially in poor developing nations, to pay a large price premium for clean energy is wishful thinking.

The only path to cheap and reliable clean energy is innovation: better batteries, better solar cells, better biofuels, better nuclear reactors, etc. Unfortunately, few economists focus on innovation and to the extent they do they see it as “manna from heaven,” something that just happens. To the extent a carbon tax induces innovation it is through the magic of the market: higher prices provide an incentive for entrepreneurs to develop a better energy mousetrap.

Economists have built a cottage industry out of comparing carbon taxes, cap-and-trade, and conventional pollution regulations. But an innovation strategy to develop cheaper, better clean energy technologies doesn’t make the cut. Frankly, this shouldn’t be a surprise as innovation is not part of neoclassical economists’ lexicon. In Mankiw’s seminal textbook Principles of Economics, the word “innovation” is barely mentioned in almost 900 pages of text.

But breakthrough technologies like jet aircraft, gas engines, computers and cell phones have never emerged because their competitors’ price increased. Steve Jobs didn’t develop the PC because the price of a typewriter went up. We have to only look to Europe for a natural experiment. Their gas prices are more than twice as high as in the United States and serve as a defacto carbon tax. While Europeans buy smaller cars and take more mass transit, they don’t buy more electric vehicles because they are expensive and provide limited range. While a higher gas price can spur carmakers to make smaller, more fuel efficient internal combustion engine cars, it has not and will not spur them to develop cheap batteries that let you drive 500 miles without a charge.

So where do breakthroughs like cheap clean energy come from if not from marginally higher prices? As innovation economist Mariana Mazzucato recently opined, “A quick look at the pioneering technologies of the past century points to the state, not the private sector, as the most decisive player in the game.” In other words, smart government innovation policy that works with industry is how the world will get cheap clean energy.

For policymakers, this means fully funding clean energy research budgets and strategically supporting proof-of-concept technology demonstrations and early commercialization. To be clear, a carbon tax can make this easier, especially if some of the revenues are devoted to a smart and effective clean energy innovation system. But to believe that modest price signals in the United States alone will transform the world’s energy system is an illusion. As such it’s time to overcome climate policy group-think and embrace a robust clean energy innovation policy.

Matthew Stepp is senior policy analyst at the Information Technology and innovation Foundation (ITIF) and Alex Trembath is a policy analyst at the Breakthrough Institute. This article is reprinted with permission and originally appeared on The Hill's Congress blog.

Photo Credit: (left); Xinhua/ (right)