Energy Policy vs. Market

November 14, 2011

by Chidem Kurdas

No matter how thoroughly public policy fails, there is no end to efforts in the same area.  Energy is a case in point. Reviewing the history of US energy policy in his new book, Columbia University legal scholar Michael Graetz writes: “The book  is, then, in one sense a story of failure…” 

Each era had its bad policy.  Richard Nixon froze oil prices. The artificially low price predictably increased the demand for gasoline while reducing its supply. The result: shortages and long lines of cars in front of gas stations, the drivers desperate to fill their tanks.

Then there is the corn ethanol scandal. The tax credit and tariff are a boon to corn growers while taxpayers pay an additional $1.78 for every gallon of gas replaced by ethanol.  The environmental benefit is largely a myth. Taking into account the fossil fuel used in its production, corn ethanol creates nearly as much carbon dioxide as gasoline.

Attempts to encourage renewable energy become boondoggles, often in the form of tax giveaways. Businesses with no connection to energy take advantage of this—-Google invested in a wind farm so as to offset profits from its search engine, according to news stories. Graetz has a nice quote from a congressman: “They’re not wind farms; they are tax farms.”

So the Obama administration’s $535 million loan guarantee to solar screen maker Solyndra is just another episode in the long-running series of interventions that do nothing useful for the environment but create great opportunity for political corruption. One of Solyndra’s investors was a fundraiser for Mr. Obama in 2008 (the White House denies that the fundraising had any influence on the loan).  Having gone bankrupt in September, the firm’s activities must have caused pollution rather then help alleviate pollution.

In a review of the Graetz book, Yale economics professor William Nordhaus says he largely agrees with the conclusions.  Interventions in the name of protecting the environment have been mostly useless and often harmful, but Mr. Nordhaus still hopes for what he regards as the right policy, namely taxes on energy use.

The tax argument, put forth repeatedly over the years by Nordhaus and others, follows straightforward economic reasoning. Energy consumption, whether of coal for generating electricity or gasoline in cars, creates externalities—costs that are not included in the price, ranging from pollution to road congestion. If the users paid the true price that includes those costs, they would find ways to make do with less energy. Energy taxes can be used to boost prices to reflect externalities.

But if energy taxes were legislated, the reality would almost certainly be a far cry from the optimal policy Nordhaus advocates. The bargains necessary for tax policy are sure to favor the politically connected while imposing the burden on large numbers of consumers and taxpayers. Like other programs, energy taxes would be subject to policy failure, their theoretical advantage notwithstanding.

Meanwhile the market price of oil has been risen over the past decade. This has pushed people to economize on energy, in effect achieving the same result as a tax. Recessions bring downward fluctuations but the price trend over time looks to be upward, providing a persistent incentive to find ways to reduce oil consumption.

Environmental policy makers tend to see the free market as a problem, not a solution. But the rising market price does what no government has been able to do. Without playing favorites and without imposing arbitrary rules, the higher price gets people to use less energy. This not-by-design result of the activities of numerous market participants is likely the only realistic route to reducing energy consumption.

Whatever the hopes for designing yet another, supposedly better, government program, chances are it will be another debacle. That’s the implication of the story Graetz tells. Therefore the best option is to let the market be; higher prices will consistently  reduce energy use. True, the market mechanism provides no patronage opportunities. Is that why it is unpopular with politicians and pundits?

7 Responses to “Energy Policy vs. Market”


  1. If politicians and pundits can’t use energy policy to supply their power and money, they’ll whip up something else from which to get these things.

    Wars, for example. On drugs. Or other countries.


  2. Surely we shouldn’t expect optimal policy outcomes any more than we expect optimal outcomes from markets. Perfection is the wrong standard for human institutions.

    Also, it isn’t a rising price that gets people to economize, but rather that there is a price at all. That oil prices have risen over the last decade is not an argument for or against adopting a policy to address externalities. (When oil prices fall in a few years due to the increasing supply and forthcoming Chinese recession, that won’t be an argument for or against a policy to address externalities, either.)

  3. Roger McKinney Says:

    If you want people to economize on energy use, quit building highways and end the mortgage interest deduction. The mortgage interest deduction encourages people to build bigger houses. Eisenhower’s interstate highway system encourages the use of inefficient modes of transportation. Rail is much more efficient at consuming fuel than are cars, trucks or airplanes, but travel by rail almost doesn’t exist. If the state would quit building new highways and end subsidies for air travel, more people would travel by rail and the energy savings would be far greater than any tax could accomplish. After all, demand for gasoline is very inelastic.

  4. chidemkurdas Says:

    Roger McKinney–
    The subsidy for home ownership does encourage larger houses because the more you own the greater the subsidy you benefit from. It is a common inconsistency in government that one policy encourages something and another policy discourages it. A glaring example is the subsidy for growing tobacco vs. regulation that discourages cigarette smoking.

  5. chidemkurdas Says:

    Michael Giberson–
    Re “That oil prices have risen over the last decade is not an argument for or against adopting a policy to address externalities…”
    Since policies that supposedly address externalities are ineffective or worse, I’m not sure what the argument is for adopting them.

  6. Roger McKinney Says:

    That’s an excellent point! In addition, a free market has positive externalities that everyone ignores. The case for addressing negative externalities should be balanced against the damage to the positive externalities, or simple cost/benefit analysis.

  7. chidemkurdas Says:

    A comprehensive perspective on externalities would show that a lot of policies don’t do what they claim. For instance, in the case of corn ethanol this would mean taking full account of the externalities in its production. Once you do this, its supposed environmental benefit becomes questionable. I believe sugar ethanol is different, but that is not the issue in the US.


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