Building the green economy

Since the recent UK budget, the government has announced plans to water down a number of ‘green’ policies. Before he was Prime Minister, David Cameron promised to lead the ‘greenest government ever’, but the realities of politics have resulted in a significant U-turn. Various governments around the world have been supporting green industries, from electric and hybrid cars, to renewable electricity generation. Is it important to do this? And can the development of these industries be simply left to the market? This is really an old debate about industrial policy, applied to some of the latest industries.

The argument for industrial policy or government support for particular industries, can be made with reference to ideas in economics about market failure and market imperfections. For example, if generating electricity through the burning of fossil fuels is cheaper than doing it through renewables, then in the absence of government interference, the market will select the former to supply energy. In industries consisting of large companies and resultant barriers to entry (in the absence of perfect competition), what is known as the minimum efficient scale for profitability means that suppliers have to have a certain scale of production, taking advantage of economies of scale, in order to be profitable and competitive. It is possible that only with government support and protection will they be able to reach such a scale. Once they are profitable and viable at a particular scale, such support can be withdrawn. This is the classic infant industry argument. Once the ‘infant’ has grown up, it can operate without support.

The infant industry argument can be applied to firms competing domestically, for example in energy production, or internationally, say in the production of solar panels.

The idea of linkages also suggests a potential need for supporting particular industrial sectors. The car industry, as an example, requires components manufactured by other firms and, further back in the production process, steel and plastic as basic inputs. Thus promoting car manufacturing can lead to the development of other firms ‘linked’ to it in the production process. This may require further interventions to make sure that domestic rather than foreign manufacturers act as the suppliers, and that they become efficient, but such policies were successful in Japan and South Korea in the post-war period, as well as in China more recently. With regard to green industry, solar panel or wind turbine manufacturers could be encouraged to grow by policies which support the use of renewable energy sources. If they become internationally competitive they would provide a source of exports.

Industrial policies are not without potential problems. Firms that receive support may not become competitive and if they do not then the support should be withdrawn. Support conditional on achieving a certain level of productivity and profitability is one way for the state to try to enforce improving performance. The ‘infants’ need to ‘grow up’. This can be difficult if the ‘rents’ or support provided by the state are captured by particular firms which then lobby or bribe politicians to continue to provide this support however much the firms fail to develop. This form of corruption can prevent industrial policies from working and can lead to wasteful subsidies to firms which never become efficient. This is a key explanation as to the success or failure of such policies. It is not that industrial policies should never be used, but that political factors should be taken into account when designing such policies.

Another argument for state intervention to promote green industries concerns the externalities or costs imposed by the  incumbent firms on the environment. Externalities are costs external to and not paid by a particular firm, but which fall on other firms or the community or society at large. Such costs could be in the form of cleaning up pollution or the larger and longer term costs of climate change. Taxing the polluter will increase economic efficiency by forcing it to ‘internalise’ the externality and pay the costs itself. Taxing electricity generated by fossil fuels, and subsidising renewables, could have this effect.

The state can also provide infrastructure which encourages the take up of more environmentally friendly products by consumers, such as recharging points for electric cars. Of course, there is no point establishing a huge network around the country in the absence of a certain scale of ownership of the cars themselves, so this sort of support will have to proceed more gradually and in line with demand.

Finally, the state can support research and development for the industries of the future. Private firms often fail to take the necessary long view and can underinvest in research which has social benefits. The iPhone, although designed and produced in the private sector, was the product of various technologies developed through state support: the internet, GPS, the touch screen and voice activation are state-sponsored technologies. In this way, the state often finances high risk research, before the private sector finds ways to utilize it. This kind of public investment can of course fail as well as succeed, but that is not to belittle its potential to help drive technological advancement.

Thus it is possible that the current UK government is making a mistake in withdrawing support for a greener economy. The development of the latter can not be left entirely to the market, and doing so may impose significant costs on the environment. Developing green industries can benefit from an industrial policy which includes state R&D spending, as well as the nurturing of particular sectors, conditional on performance which ultimately becomes competitive and profitable.

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