Are subsidies fundamentally bad?  Are they fundamentally good?  Lets start with a challenge, try to think of an infrastructure industry that hasn’t received subsidies.  If you come up with one ( I have not been able to) then try this, put two columns on a sheet of paper and list major infrastructure industries that have received subsidies on one side and those that haven’t on the other.  Here are a few to get you started: Auto, Housing, Banking, Oil, Coal, Nuclear, Agriculture, The Internet.

I believe that subsidies are a tool, a means to an end.  When used properly, a hammer can be indispensable in building a house.  When used unskillfully, you can break your finger.  The same discussion can be had for government programs.  Many point to failed or poorly executed government programs as proof that the government is unable to do great things.  Two examples that immediately come to my mind are the B-2 stealth bomber (a hugely over budget, highly publicized weapons system that, while purchased and deployed, really has not live up to its billing) and Amtrak, a widely ridiculed train service that is heavily subsidized by the government.  Now here are a few success stories, the federal highway system, the Apollo Moon space program, the F-117 Stealth fighter and the SR-71 blackbird reconnaissance plane.

Now we can play the same game with private industry:  You say GE, I say Worldcom, you say Hewlett Packard, I say Enron, you say Proctor and Gamble, I say AIG.  Does the utter failure of these darlings of Wallstreet mean that private industry doesn’t work.  No, capitalism works well in many cases.  And government works well in many  cases.  Unfortunately we are living in a time when the polarization of left and right causes many of our decisions to be seen through the lense of absolutism, EVERYTHING must be market driven or EVERYTHING most be done for the good of the people by the all knowing government.  In fact, neither system is absolute.  They are only tools for optimization of the human condition.  When working in a healthy manner, our system of government allows for the interplay of government, individuals and industry to create play together for the betterment the citizenry.

A great example of where ideologies came together is in the emissions trading provision of the 1990 amendment to the clean air act.  Lets look at this, why should the government be involved at all.  Should private industry work this out.  The problem is that the damage from emissions is EXTERNAL to the transaction.  How can the market operate on pollution when it is not monetized in the purchase of the goods of the company doing the pollution.  And by the way, how do we truly monetize some of the damages inflicted.  So this is where government plays an important role.  The market, as built, often does not require corporations to pay for their degradation of the well being or property of others even though they are at cause.

Government plays an important role here by addressing these non-monetized issues that the market alone is not structured to address.  Its kind of like building a game.  Consider my favorite, hockey.  The object of the game is to get the little black thing in the other guys net.  However if you stop there people are going to get hurt.  So rules have developed along the way so that the game can be played in a fun, intense way but with “acceptable” trade-offs for risk vs fun and, in professional sports, entertainment value.  Can you imagine professional sports without rules and refs?  It would be a blood bath.  So to, a free market without a defined game, rules and enforcement is doomed to be a bloodbath.

In the case of the clean air act targets were set that were thought to be appropriate to achieving societal goals.  Prior efforts at cleaning up stack emissions envisioned regulations along the lines of requiring all emitters to upgrade their emission controls to some standard, typically with wording along the lines of “thou shalt use the latest and greatest technology no matter what”.  Under this approach, a new plant that had used good emissions control technology, but maybe not the best, was subjected to the same complete retrofit that an old plant that had been getting away with murder for decades.  So both might do a retrofit of similar cost but one would improve emissions a LOT and the other only a small amount.  This was very inefficient and penalized companies that had been proactive in reducing emissions.  So the administration of George H. W. Bush said, hey, can we design a market approach to efficiently accomplish the societal good identified by the government but which allows industry to efficiently accomplish this.  And so was born the highly praised emissions trading system.

It worked by defining a national target reduction of emissions and telling each company that they were responsible for a certain fraction of that.  So each company was granted an allowance to pollute a certain amount.  However, the genius of the system was that each company was allowed to sell their right to pollute to others.  The cost per ton of emissions abatement varied considerably from plant to plant.  Some plants could clean up rather inexpensively while for others it may have been quite costly.  So the ones that could clean up inexpensively did so.  Since they were cleaned up they had excess permits to pollute and they could then sell these to the plants whose clean-up was prohibitively expensive.

This was a really neat outcome.  The country accomplished its emissions reduction goals at far less expense to industry than had been estimated.  Industry was treated fairly and given a system to get their house in order together without government telling them how to do it.  This was a fabulous example of staying mission focussed.  It could have gone differently.

Imagine if the green leaning folks had moralized that no plant should be allowed to pollute more than a certain amount, that it was fundamentally wrong on a moral basis.  That everyone had to come around to their way of thinking because they did not have the willingness or flexibility to listen to and find value in other points of view.  Had that happened we would likely still be bogged down in the quarrel of who was right and who was wrong rather than how can we solve this problem.  The latter scenario is where renewable energy in the United States now finds itself.

There are a number of societal problems with extraction based energy approaches.  These can be solved with substantial expansion of renewable energy.  There is a wide spectrum of tools by which this can be accomplished from old fashioned, inefficient to modern market based approaches that could harness the power of market forces to accomplish a societal good.  Unfortunately, we have lost our way.  There is a perverse undercurrent in our country that equates the nacent renewable energy industry with subsidized, inefficient waste while turning a blind eye to the heavily subsidized, mature extraction energy industries of coal, oil, gas and nuclear.  These mature industries that bring a lot of negatives to the table are being nurtured with subsidies and protected from being accountable for their unmonetized societal damage, leaving someone else to pay the bill.  Meanwhile, renewable energy is available to solve, or help solve, a whole host of societal problems.  Many of these are hard to monetize and therefore are hard to put into the transaction.  So the mature industry that is creating a lot of harm is being subsidized with the supposed free marketeers mum while those same people are screaming that the new, promising industry that creates jobs, reduces emissions, reduces dependence on hostile sources, these are being rested on an unequally applied “moral” standard of free market capitalism.  This is indeed a case where the rules of the game are not in the interest of the fans or the players.

Copyright Clayton Handleman all rights reserved 2011

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One Response to Subsidies

  1. Clayton says:

    Isn’t it ironic that the supposedly socialist democrats are calling for reduced subsidies to the Oil companies, which are reporting record profits, while republicans are saying keep them in the name of protecting jobs. I guess some jobs programs are OK ?


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