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Ignorant Arrogance: Energy “Market Failure” Revisited

[Ed. note: Dr. Grossman is author of the just-released U.S. Energy Policy and the Pursuit of Failure, an important and sobering tome with much insight about today's debate.]

The U.S. government has claimed over the years one and one reason only for government intrusion into markets: Market failure. As a Carter administration document put it:

The first assumption for any commercialization activity by the government is that the market either has failed or will fail to make the optimum choice … [and] that the government policy maker can make a better selection than can the market.

Every administration has reiterated something like this. The Clinton administration made the point that the government needed to get involved in creating an 80-miles-per-gallon “supercar” because as the president claimed, “[T]here are a lot of things that we need to be working on that market forces alone can’t do.”

In any case, the endeavor was a flop—like virtually every effort at government development of new energy-using technologies or alternative energy resources. It cost U.S. taxpayers about $1.5 billion.

Government Failure?

But what was that supposed market failure? Clinton didn’t say, but it seems his administration thought the failure was an information problem; the market was lacking foresight. The price of gasoline was too low (whatever that meant), and so government had to step in to help create something people would need when the price went up

There was, of course, an alternative interpretation of the state of the market: that is, the market was correctly signaling that there was no need for this technology. Neither consumers nor producers were interested in a “supercar” when the price of gasoline was low, and that if and when the price went up, automobile makers would offer higher mileage cars and consumers would cope.

As is usually the case with energy, this was a case of government failure, not market failure. The information gap and lack of foresight was the government’s problem, not the market’s.

Of course market failures do exist: cases of monopoly, public goods, externalities and incomplete or asymmetric information are generally accepted as the causes of market failure. But does the government actually identify a market failure when pushing a new energy program? Or do they just assume one?

In U.S. Energy Policy and the Pursuit of Failure, I concluded it’s the latter. It’s really easy to find a market failure if you want one. As Ronald Coase pointed out, from a strict neo-classical economic perspective all forms of economic organization—markets, governments and firms—are “more or less failures” and the goal should be to choose the form that in a given situation “fails least.”

It’s always the case that one can claim that markets lack foresight. Capital markets, for example, have often refused to back alternative energy projects like synfuels and large-scale solar. The reason is either that these projects aren’t commercially viable and give no indication they will be, or that the capital market itself is failing because investors are foregoing the large profits that lie ahead. As far back as the 1940s, government officials who wanted big new energy programs were claiming it was the latter. There is, however, little evidence that this was ever the case.

Obama Energy Policy

It isn’t clear just what market failure arguments are motivating the Obama administration’s vast, costly energy program. Initially, in 2009, the justification was probably externalities: fossil-fuel consumption was releasing too much carbon dioxide (CO2) and so we needed wind turbines, solar panels, and electric cars.

At that time, there were many catastrophe scenarios that argued the cost of the greenhouse effect would be on the order of trillions of dollars, and President Obama made much of that before taking office and in the early days of his presidency.

If that was supposed to be the market failure, then the administration’s idea for a cap-and-trade market made some sense but its alternative energy plans did not. Let’s leave aside for the moment the issue of whether climate change really is a problem and of the recent evidence suggesting that the catastrophe models are greatly off the mark. Just consider the cost of reducing carbon emissions through alternative energy as opposed to CO2 markets.

Depending on the technology, the cost of using so-called clean energy technologies could be more than an order of magnitude greater than it would be in carbon markets. Indeed as many studies have shown it’s not even clear that non-dispatchable windmill and solar generated electric energy will really reduce emissions much if at all. If the issue was only CO2, then alternative energy technology was a poor way to address it.

Of course, CO2 cap-and-trade programs are ironically failing, but the Obama alternative energy drive continues nonetheless. Climate externalities may still be the market failure justification for current policies, but I think actually it has shifted. Now it’s mainly just about commercialization of alternative energy technologies. And if there’s any market failure argument, it seems it’s the foresight issue again. The government is coming to our rescue because our markets can’t see straight.

Back to Carter?

But President Obama seems to be addressing the world that Jimmy Carter was living in the 1970s when oil and natural gas were supposedly running out and we would all have to rely on solar energy and other renewables, because those (along with dirty coal) were all that would be left.

As Carter argued, we would have to be led in this endeavor by an enlightened government. “The first principle,” he claimed, “is that the energy problem can be effectively addressed only by a Government that accepts responsibility for dealing with it comprehensively, and by a public that understands the seriousness and is ready to make sacrifices.”

There was an extraordinary degree of both ignorance and arrogance in that statement, yet if anything we seem to have even more of both today. The current policies, like Carter’s, are ignorant of how technology is developed from an idea into a commercial product—hint: it’s not with mandates and tax boondoggles—and arrogant in what they purport to achieve: the transformation of both our technology and our attitudes.

This combination—ignorant arrogance—is less a recipe for the transformation of life on earth than it is for waste and government failure. The only difference between Carter and Obama is that Carter thought the U.S. was in the midst of an energy crisis. He was wrong; it was a political crisis, but at least many people were clamoring for him to “do something” about energy.

Conclusion

Today, few are clamoring for action; no one is sitting on gas lines; energy markets appear to working fine when they’re allowed to. But let’s return to the Carter administration’s definitive word: “The first assumption for any commercialization activity by the government is that the market either has failed or will fail to make the optimum choice … [and] that the government policy maker can make a better selection than can the market.”

There is no evidence that the government is making a better selection than the market. With respect to energy, it has not made, and still is not making, a good one.

—————-

Peter Z. Grossman is Clarence Efroymson Professor of Economics at Butler University in Indianapolis, Indiana.  An overview of his research is here.

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3 comments

1 Rolf Westgard { 05.02.13 at 9:09 am }

Government plays a key role in funding the kind of basic research that industry can’t or won’t do.

Government research has been the basis for computers, communications, the internet, jet aircraft, pharmaceuticals, nanotech, etc. It’s a partner industry needs as we compete in a high tech world.

It’s when government goes into implementation like some of the energy programs such as Cape Wind, Ivanpah Solar and other $2 billion boondoggles that it falters.

2 rbradley { 05.02.13 at 10:20 am }

Roft:

There is a third big player that is between for-profit and government: the not-for-profit sector.

Major environmental groups that are wasting billions of dollars annually on climate alarmism and lobbying need to redirect their huge wealth to R&D (even just to supplement for-profit ventures) on what they really think is the for-profit ‘market failure’.

3 pgrossman { 05.02.13 at 4:06 pm }

I agree. As I argue in my book, the government has a significant role to play in energy R&D. But the problem is not only the boondoggles you name (and many others like them); it’s any government program with time-bound mandates and commercialization goals. A mandate (an RPS, the RFS, in fact a whole history of programs going back to Nixon’s Project Independence) is antithetical to basic R&D. A commercialization goal is as well. Mandates and commercialization efforts have cost taxpayers billions of dollars already but unless there is a change in how the government approaches energy policy, we’ll be paying billions more in the years to come.

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