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«I. Introduction Green growth can be defined as a trajectory of economic development that fully internalizes environmental costs, including most ...»

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Dani Rodrik1

School of Social Science

Institute for Advanced Study

Princeton, N.J.


July 2013

I. Introduction

Green growth can be defined as a trajectory of economic development that fully internalizes

environmental costs, including most critically those related to climate change, and that is based on

sustainable use of non-renewable resources. Green growth requires green technologies: production techniques that economize on exhaustible resources and emit fewer greenhouse gases. The availability of green technologies both lowers social costs in the transition to a green growth path and helps achieve a satisfactory rate of material progress under that path. A critical task facing policy makers is ensuring investments in green technologies take place on an appropriate scale.2 If markets worked well, natural and environmental resources were priced appropriately at full social marginal costs, and technological benefits were fully internalized by those who undertook R&D, we could in principle leave such investment decisions in the hands of entrepreneurs, corporations, and financial markets. But there are three sets of considerations that drive a wedge between private and social returns to investment in green technologies.

First, the development of new technologies generates positive spillovers that are not fully captured by the original investors. These may take the form of cross-firm externalities, industry-wide learning, skill development, or agglomeration effects. Such “market failures” exist in general for all This paper was written for the Grantham Research Institute project on “Green Growth and the New Industrial Revolution.” It was completed at the Blavatnik School of Government, University of Oxford during my tenure as Sanjaya Lall visiting professor; I thank both the Blavatnik School and the Sanjaya Lall Memorial Trust for their support. I am also grateful to Adele Faure for excellent research assistance.

For various analytical perspectives on green growth, see Jaffe et al. (2004), Acemoglu et al. (2012), Bowen and Fankhauser (2011), Schmitz et al. (2013), Karp and Stevenson (2012), Hallegatte et al. (2011), and de Serres et al. (2010) for conceptual analyses of policies that promote green growth. On industrial policy, see Rodrik (2007, chap. 4) and Rodrik (2008), on which this paper draws.

-2kinds of new technologies, whether they are of the green or dirty kind. However, their novelty, their highly experimental nature, and the substantial risks involved for pioneer entrepreneurs suggest green technologies may be particularly prone to these failures.

An additional reason why green technologies may need to be publicly subsidized is that carbon (which I use as shorthand for greenhouse gases [GHGs] generally) is greatly mispriced. This is a second-best reason for government intervention in support of green technologies. The presence of subsidies on fossil fuels and the failure to implement taxes or controls that would internalize the risks of climate change result in the user cost of carbon falling substantially below the level that is appropriate from a long-term societal perspective.3 This means that the private return to green technologies lies significantly below the social return, even when we ignore the traditional R&D spillovers.4 These two considerations provide mutually reinforcing reasons for why the world would be collectively better off if governments nurtured and supported green technologies. However, what is true for the world as a whole need not be true for national governments interested in maximizing domestic welfare. The benefits of carbon abatement represent the archetypal global public good, generating strong incentives for individual countries to free ride on others’ efforts. In a world where governments do not internalize the global benefits of carbon taxes/controls in the first place, it is unlikely that they will place much value on green technologies on account of these technologies’ impact on the global stock of GHGs. Similarly, R&D externalities from the development of new green technologies are in many instances global rather than national. Learning spills over quickly across national borders to firms located in other countries. This also dilutes the incentive for national governments to invest in green technologies.

The IMF (2013, pp. 13-14) estimates that effective subsidies on energy amount to $1.9 trillion (or 2.5% of world GDP). The bulk of this subsidy arises from the absence of taxes needed to internalize the negative climate and health externalities generated by burning fossil fuels.

This second-best role for policies supporting green technologies is also emphasized by Jaffe et al. (2004).

Bosetti et al. (2010) consider quantitatively the role of innovation policies to substitute for explicit carbon control policies and conclude that they are not sufficient, even under optimistic assumptions, to stabilize GHG concentrations and temperatures.

-3Yet as I document in the next section, government support for green industries is rampant, both in advanced and emerging economies. Often, the motive seems to be to give the domestic industry a leg up in global competition. Under certain conditions, this may be a sensible strategy from a national standpoint – although the global implications (absent the two considerations above) are often ambiguous or negative. For example, a first-mover advantage in certain technologies can tilt the future path of technological development in a direction that is closer to a country’s initial comparative advantage, providing long-term terms-of-trade benefits to the home economy. Or, subsidizing investment in home technologies can shift rents from foreign producers in imperfectly competitive industries. Such competitive motives are the third set of considerations that drive a wedge between private and social optimality in markets for green technologies.

Normally, we consider these competitive motives to be of the beggar-thy-neighbor type.

Terms-of-trade or rent-shifting effects are zero-sum from a global standpoint, and any resources invested in generating those national gains come at the cost of global losses. However, in the highly second-best context of green growth, national efforts to boost domestic green industries can serve to offset the two sets of market failures discussed above, even if the motives are narrowly national and carry beggar-thy-neighbor connotations. When cross-border spillovers militate against taxing carbon and subsidizing technological development in clean industries, boosting green industries for competitive reasons is largely a good thing, not a bad thing. However, by the same token, when these national strategies take the form not of subsidizing domestic industries but of taxing or restricting market access to foreign green industries, they have to be considered triply damaging.

Luckily, as the overview in the next section shows, trade restrictions have so far played a small role relative to subsidies to domestic industry.5 Economists traditionally exhibit scepticism – if not outright hostility – toward industrial policies. But these considerations suggest that they should look kindly at industrial policies geared An important exception that does not take away the main point is the raising of tariffs on imports of Chinese solar panels in the U.S. and Europe (Deutch and Steinfeld 2013, Freund 2013). On the potential conflict between green industrial policy and trade laws see Wu and Salzman (2013).

-4towards green technologies. Industrial policies have an indispensable role in putting the global economy on a green growth path. The imperative of addressing climate change places industrial policy squarely on the policy agenda of governments.

The trouble is that industrial policy has a very chequered history. While it has undoubtedly worked in many places in East Asia to foster structural change and new industries (Japan, South Korea, Taiwan, China), in advanced countries and many developing countries it remains synonymous with white elephants, rent-seeking, and good money spent after bad. In truth, such caricatures are wildly at variance with the actual contribution industrial policy has made to technological development in the United States and Europe (Block and Keller 2011; Mazzucato 2011). And infantindustry promotion in developing nations does not quite deserve its negative reputation in academic circles (Rodrik 1999). Nevertheless, making industrial policy work is a challenge, and one that needs to be confronted head on if green industries are to play their proper role in green growth.

The case against industrial policy comes in two forms. The first counter-argument is that governments do not have the information needed to make the right choices as to which firms or industries to support. Usually presented with the formulaic statement “government cannot pick winners,” this suggests governments are likely to make lots of mistakes and hence waste considerable resources, even when they are well intentioned. The second counter-argument is that once governments are in the business of supporting this or that industry, they invite rent-seeking and political manipulation by well-connected firms and lobbyists. Industrial policy becomes driven by political rather than economic motives. In the United States, the case of Solyndra – a solar cell manufacturer that folded after having received more than half a billion in loan guarantees from the U.S. government – provides a recent illustration where both failures were apparently in play. I shall review and discuss the Solyndra later in the paper.

I will argue in this paper that the first of these arguments – about lack of omniscience – is largely irrelevant, while the second – about political influence – can be overcome with appropriate

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pick winners. Mistakes are an inevitable and necessary part of a well-designed industrial policy program; in fact, too few mistakes are a sign of underperformance. What is needed instead is a set of mechanisms that recognizes errors and revises policies accordingly. This is a much less demanding requirement than that of picking winners. The chief argument of this paper is that an explicit industrial policy that is carried out self-consciously and designed with pitfalls in mind is more likely to overcome the typical informational and political barriers than one that is implemented, as is so often the case, surreptitiously and under the radar screen.

The outline of the paper is as follows. In the next section, I provide a brief overview of the range of green industrial policies already in place in the United States, Germany, China, and Japan. I then discuss the case of Solyndra, where I argue the real lessons are quite different from those that are conventionally drawn. In section IV I provide some general guidelines about the design of industrial policy. In section V I offer some concluding remarks.

II. A snapshot of green industrial policies in selected countries It is generally accepted that governments have been timid in reducing GHG emissions and instituting other steps that would avert catastrophic climate change. Yet there has been plenty of government activism in the area of “green growth.” Look around most developed and emerging market economies and you will find a bewildering array of government initiatives designed to encourage renewable energy use and stimulate green technology investment. Even though full pricing of carbon would be a far better way to address climate change, it appears most governments would rather deal with the problem through subsidies and regulations that increase the profitability of investments in renewable energy sources.

As Steer (2013) points out, the concept of “green growth” has spawned the idea that policies that promote environmentally friendly technologies are actually advantageous from a national standpoint. Such policies are viewed as providing broad-based technological capabilities, a head

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words, green growth has become “sexy.” Steer (2013) notes that more than 50 developing countries have now instituted practices such as feed-in tariffs or renewable energy standards to foster green technologies – costly policies “that at first sight seem not to be in their country’s narrow interest” (2013, 18).

It would take too much space to cover the full range of these policies. Here I provide a quick overview of existing programs in two advanced countries and two emerging-market economies: the United States, Germany, China, and India. The relevant information is summarized in Tables 1-4. The tables list for each of the countries the key pieces of legislation, policy tools used, and illustrative programs. The information has been compiled from national and international sources.

Among the countries shown, Germany and China have the most aggressive policies. But even the others make use of a wide range of policy instruments. While some of the instruments listed do not qualify as industrial policies (e.g., cap-and-trade policies, mandated energy efficiency standards), many others clearly are (R&D grants, government procurement, subsidized loans and loan guarantees, direct subsidies).

In addition to a 40% GHG reduction target, Germany has an extensive array of initiatives.

These include R&D support of several billions of euros (focusing on wind energy, PV renewable energy systems, integration of renewable energies, geothermal, solar thermal power plants, and low-temperature solar thermal energy installations), long-term low-interest loans (for solar PV, biomass, wind energy, hydropower, or geothermal, and electricity or heat from other renewables), an energy and climate fund (spent on various support programmes relating to energy efficiency, renewable energy, energy storage and grid technology, energy-efficient renovation, national and international climate protection as well as electro-mobility), a climate protection initiative (with projects in areas such as refrigeration technology and biomass research), and a climate technology initiative (aiming to mobilize bilateral technology cooperation with countries that have German

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- Clean Air Act; National Energy Conservation Policy Act; Energy Policy Act of 2005

- Energy Independence and Security Act of 2007; Energy Improvement and Extension Act of 2008

- Food, Conservation, and Energy Act (2008 Farm Bill)

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