Do Profit Incentives or Subsidies Encourage Energy Innovation?

PolicyMic pundit Jonathan Gillman discussed the “unrealistic idealism” of many in the green movement in a recent post, and he references my recent post on eliminating subsidies to the energy industry. Although I agree with him that little can be done to mitigate climate change and that the green movement would benefit from increased realism, I disagree that alternative energies would be economically unviable in the absence of subsidies to the energy industry. On the contrary, profit incentives work better than subsidies in encouraging innovation.

In the profit-loss system of our economy, the prospect of profits encourages individuals and firms to take risks and to innovate, and the losses weed out failure. By picking select industries or activities to subsidize, the government penalizes success and rewards failure, reversing to some degree the incentive structure that the profit-loss system would otherwise provide.

Allowing the profit and loss system to allocate resources efficiently in a free market is a less-costly way to encourage innovation in energy technologies. However, when the government provides subsidies for a favored industry or activity, it mutes the “loss” signal because it insulates producers from risk to at least some extent. 

Additionally, in subsidy programs, the state government redistributes wealth to special interest groups in the form of concentrated benefits (e.g., fossil fuel producers, ethanol producers, wind producers) and it diffuses the costs of these benefits to all those who remain unsubsidized in the marketplace. This places the unfavored groups at a disadvantage by making it harder to compete in the marketplace, as I have discussed before on PolicyMic.

From the perspectives of economics and fairness, government subsidy programs targeting the energy industry defeat their ostensible intended purpose, which is encouraging innovation and the development of alternative energies. Furthermore, it is likely that a high level of government subsidy to the energy sector reduces the levels of private investment that would fuel innovation — an economics concept called crowding out.

That stated, I concur with Gillman that naivité is too prevalent in the green movement. For example, President Obama recently pledged to help species adapt to climate change. Is this goal realistic or even feasible? Do government officials even have the knowledge of how to help them adapt? What will this cost? Won't this come at the expense of other government programs? Doesn't the process of adaptation happen during a period of time much longer than a presidential term? 

Questions like these and others require much more thought before action. When they’re not understood properly, then I agree; here the green movement is often naive.

Photo CreditWikimedia Commons

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Christine Harbin

Christine Harbin considers widespread economic freedom to be one of the most important goals for sound public policy. She holds undergraduate degrees in economics, mathematics, and French from the University of Wisconsin–Madison, and an MBA from the University of Wisconsin–Eau Claire.

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