The Infant Industry Argument and Renewable Energy Production

On December 20, 2012, the George C. Marshall Institute released a new report discussing arguments favoring protection and subsidization of renewable energy industries.

In The Infant Industry Argument and Renewable Energy Production, Dr. Sergey Mityakov and Margarita Portnykh, both of the Clemson University Department of Economics, examine the justification for and effectiveness of government support for the production of renewable energy.

They survey the array of state and federal subsidies, tax incentives, and production mandates, noting that “current government policies provide incentives only for production of clean energy,” but “they do little to solve potential market failures” and “as a result, those policies may prove to be quite ineffective instruments to stimulate the cost reduction in clean energy.”

Mityakov and Portnykh test the renewable energy sector finding that the expected decline in costs has not materialized.  For example, in the case of wind energy, they found that despite capacity doubling between 2001-2008, a predicted decline in costs “failed to materialize.”

Energy issues are at the forefront of the nation’s agenda.  Similarly, scrutiny of public spending is intense.  The Mityakov-Portnykh study shows that production supports are both poor energy policy and wasteful public expenditures.  A more effective approach would identify and then target the underlying causes of market failure in the clean energy sector.

“In this paper we review the necessity of government production subsidies for renewable energy on the basis on the infant industry argument, which argues that government support and protection of nascent industries is acceptable. We outline the very demanding conditions that are necessary for the government intervention to be justified.  The industry should first pass the Mill-Bastable test which consists of the following two conditions: (1) the costs of production should eventually be below the costs of technologies currently utilized; and (2) future savings in costs (compared to existing technologies) should compensate for the initial cost of supporting the infant industry. More importantly, the infant industry argument requires some form of market failure, e.g., learning externalities or imperfect financial markets; otherwise free markets would deliver the efficient outcome. Even in cases where such imperfections exist, support in the form of production subsidies is an inappropriate policy instrument, since it is unlikely to solve these market failures. Thus, current government incentives, which are aimed at stimulating production of and/or generation capacity for renewable energy, may not achieve the desired outcome. After reviewing current cost trends in renewable energy, we argue that they cannot be interpreted in favor of production subsidies. Evidence for wind energy seems particularly discouraging: despite considerably increased capacity in recent years, expected cost decreases have not materialized. We conclude that further research into the determinants of costs of renewable energy generation is needed before more money is spent on production subsidies, which are likely to be inefficient and inappropriate policy instruments.” –  Sergey Mityakov and Margarita Portnykh.

Partner & Fellow Blogs