Industry Instability through Subsidies

Highly subsidized solar power plants have been producing a lot of power in sunny southern Spain. The hope of this project was to replace dirty coal power with clean, renewable solar power. The project recently took a heavy hit when Spanish government officials came to the conclusion that many of these power plants would have to be subsidized indefinitely. As a result funding was abruptly cut and a cap was placed on solar power plant construction.

This is a good example of government subsidies moving an industry out of equilibrium. If the government subsidies had equaled the environmental costs of coal power generation as perceived by the Spanish public, then the value of the externalities would still be paid through private means in a typical Coasean scenario making the “green” option viable with or without government help. The problem of the government subsidies is the governments have a hard time judging the true cost of an externality thus they often over of under subsidize or over subsidize projects that could be taken care of in the market.


Willy said...

In the US ethanol production is another example of a subsidized energy source with poorly considered externalities. David Pimental of Cornell University in his article entitled "Ethanol Fuel from Corn Faulted as ‘Unsustainable Subsidized Food Burning’ compares the cost of production and the value of output of corn based Ethanol in the US. I can personally attest that the price of corn to feed beef cattle was shifted to the point at which cattle feeders and producers could not afford to raise beef because corn was being bought to produce ethonal with govt subsidy money. The free market for resources was affected by an outside force which in turn caused inefficiency in the market.

Spencer said...

I think it is interesting that while the subsidies were certainly too high the companies who benefited from them that are well run managed to restructure and are turning a profit now with limited or no subsidies. The US should certainly consider the externalities in attempting to encourage solar power but with a smaller subsidy or one that adjusts over time the positive externalities of clean and renewable power could outweigh the potential negative externalities from government involvement in the market.

Matthew said...

I am with you on the whole subsidies issue, but I did come across this article. I wonder it tax breaks are considered subsidies? If they are, we might need to look a little bit more into the numbers that everybody is throwing around. I still believe that there are issues with the subsidies programs, but I wonder how far off things are. Here is an article that I found. There is also some biased built into it, but I wonder how much? http://www.grist.org/article/2009-09-22-fossil-fuel-subsidies-dwarf-clean-energy-subsidies-obama-wants/

Eric said...

It seems to me that the post and all the comments are firmly against subsidies. I'm confused because if it wasn't for government subsidies many of us in this class couldn't afford higher education. In some instances subsidy is wrong but in others its right? its simple economics that subsidy leads to market inefficiencies but occasionally its worth it.

Dr. Tufte said...

Eric's point is well-taken. However, there are plenty of studies showing that subsidization of college education has gone way past any point of efficiency. Further, it seems like it has gotten to the point where states may simply not be able to pay for this nonsense any more - this is why a "public" school like SUU spends so much time on fundraising, and raising fees on students.

Anyway, back to energy subsidies. A ballpark for the price of electricity is 10 cents per killowatt-hour. This includes all the discovery, extraction, transportation and infrastructure costs. And DO NOT FORGET that it includes all the pollution costs that the firms in the supply chain can pass on to consumers or otherwise not avoid.

Given all those costs, what do we seriously believe are the (uncovered) external costs? Ten percent? Fifty percent?

I've asked this question of many people over the years, and 50% is a good upper bound on what the serious environmentalists thinks. If so, that means that the maximum subsidy or tax break that is reasonable is about 5 cents per killowatt-hour.

That figure is 1/14 of the subsidies to solar power in Spain, and about 1/5 of the subsidies to solar in the U.S.

The only way you can take solar power seriously is if you refuse to take these numbers seriously. Most people just prefer not to ask.