Misunderstanding the issues

David Brooks writes a thoughtful article today on the Obama administration’s attempts to spur innovation in clean technology, and he recites a common fallacy in the environmental policy space. Namely, that the problem of technological substitution can be solved through market-price corrections alone. This is why he laments the subsidies granted to early-stage technology firms and pines for a carbon tax instead. 

One can bucket mitigation technologies into roughly three groups. Imagine that there is a cost curve in front of you, like the McKinsey curve, with the cost of each technology on the y-axis, and the amount of mitigation opportunity on the x-axis. Imagine that these technologies are ordered from left to right, lowest to highest cost.

There are two important horizontal lines to draw through this graph. The first is at y = 0. It’s hard to beleive, but there are mitigation technologies that actually pay for themselves, and then some. These technologies are negative cost. There a host of reasons that they don’t get deployed / implemented; let’s call these policy issues “Barriers”. The first thing to understand is that since these already are profitable, it’s not clear that a price correction will solve the underlying issue. Perhaps making them even more profitable will do the trick, but perhaps not.

Now imagine that we agree that there is a social cost of each ton of CO2-equivalent; let’s call this cost SCC (the social cost of carbon). The next important line is at y = SCC. If you implemented a cap-and-trade or carbon-tax scheme, presumably all the mitigation opportunity below this line would be implemented. Let’s call these policy issues “Incentives”. 

Finally, there are opportunities above the y = SCC line. These technologies would not be implemented even with a market price on carbon, because they are too expensive. The aim of policies targeting these technologies should be to bring the cost down to below the y = SCC line, or to “bend the curve”, so to speak. Let’s call this group “Innovation”. Now, you could argue that establishing a price on carbon would incentivize entrpreneurs to bring the cost of these technologies down, but that argument works for any price on carbon, even 0 (i.e., there is always an incentive to bring the cost of technologies below the incumbent).

Knowing that the speed of cost reduction at y = 0 has not been what we need, and not knowing what it would be at y = SCC, it makes intuitive sense to tackle the cost reduction problem directly for technologies that are at y > SCC.