Economists Can Be Helpful in the Era of Green Industrial Policy

A recent Energy Explained article by my colleague Robert Johnston highlights the global trend toward large-scale government interventions to bolster domestic clean energy production.[1] When President Biden unveiled his plan to simultaneously cut greenhouse gas emissions and support American production of clean energy, Harvard’s Jason Furman echoed what was on the minds of many economists: “Am I the only one who doesn’t care where the wind turbines are made?”

While “green industrial policy” is a hot topic among climate-focused experts,[2] economists—with notable exceptions—avoid it. Far more often, cheap imports of clean technologies like solar energy are celebrated as a key cause of decarbonization successes to date. But economic tools can be important contributors to developing smarter and more successful industrial policy strategies in the high-stakes transition to net-zero emissions economies.

Pessimism About Industrial Policy

Economists tend to be dismissive of industrial policy. In a recent article, Duke University’s Michael Munger argues that in a liberal democracy, a socially beneficial strategy of public support for domestic industries cannot be sustained, because political actors will choose to enhance their own power over the common good.[3] Others argue that politicians cannot identify a socially beneficial industrial policy in the first place, due to the lack of sufficient information about the workings of the economy and how it will evolve in the future.

Economists’ objections to industrial policy do not necessarily come from free-market zealotry—they recognize the major problems that arise from factors like externalities and market power. Instead, the objections reflect pessimism about the ability of governments to improve on suboptimal market outcomes, except in narrow and targeted ways.

Policy makers should take these concerns seriously. After all, policies that favor domestic over foreign producers often raise costs for consumers or taxpayers. And previous attempts to support domestic industries have produced as many failures as successes, and the failures have left harmful legacies in the form of protectionist policies, like the Jones Act that requires products to be shipped between US ports on American ships.[4]

The Increasing Irrelevance of Opposition to Green Industrial Policy

Governments have always provided support for domestic industries, but strict opposition to industrial policies would imply that doing nothing to support domestic actors is a better course of action. Prescriptions to avoid supporting domestic businesses and communities through the energy transition are rapidly losing their policy relevance, specifically due to the considerable risks of inaction.

The global transition to clean energy is accelerating, and greenhouse gas emissions are expected to fall in the coming decades. (To be fair, the pace of the decline is highly uncertain, and emissions have not yet started falling! [5]) The expected decline in emissions is a recent phenomenon (Figure 1) that presents an enormous risk to fossil-fuel-reliant economies. Intuitively, simulations of a decarbonizing global economy show degrading economic competitiveness of major fossil-fuel-producing countries like the US.[6]

A corporation that expected the demand for its product to slow or decline would be reckless not to shift its strategy. Similarly, in the face of decarbonizing energy systems, it would be reckless for governments to propose pathways to net zero emissions and simply cross their fingers and hope that domestic businesses and fossil-fuel-reliant communities successfully navigate the transition.[7]

Of course, the flip side of the waning demand for fossil fuels are unique opportunities to capitalize on emerging markets for the technologies that may dominate clean energy economies. Governments have sprung into action. A straight line can be drawn between the recent public investment plans of China,[8] the US,[9] and the European Union,[10] all of which seek to bolster domestic producers of low-carbon technologies. Smaller countries have little choice but to follow suit.

The policy-relevant question is no longer whether to engage in industrial policy (if it ever was), but rather how to craft strategies that put domestic industries in positions to succeed in a decarbonizing economy, while minimizing substantial policy risks.

Economists Can Help Design Smarter Green Industrial Policies

As governments increasingly intervene in decarbonizing energy systems around the world, economists can contribute to smarter and more strategic approaches.[11]

First, industrial policies would benefit from rigorous conceptual frameworks. The Biden administration says its industrial strategy focuses on areas “where relying on private industry … will not mobilize the investment necessary to achieve our core economic and national security interests,” which is a reasonable enough criteria, but it lacks sufficient detail to be actionable for specific decisions.[12] (For example, it is not responsive to Jason Furman’s apathy about where wind turbines are built.)

Economists can help to catalogue the myriad ways markets will fail to produce a smooth energy transition and the policy measures that can overcome those market failures. Considerable attention has been paid to cross-cutting market failures, such as the damages caused by climate change and the under-provision of R&D. Less attention has been given to the unique sets of market failures that inhibit the development of virtually all important decarbonization technologies—from electric vehicles [13] to next-generation nuclear energy [14] to clean hydrogen [15]—and to the need for resilient supply chains to sustain the deployment of these technologies.

Evaluating the possible corrections to these market failures includes identifying policy risks, and policy makers may take these warnings more seriously when communicated as plausible policy tweaks rather than strict opposition. For example, economists typically oppose “Buy American” provisions that mandate a portion of government purchases to originate in the country due to the benefits from cross-border trade.[16] But undiversified and unreliable supply chains present important risks as well. Creative strategies that encourage resilient, international supply chains within groups of aligned countries reflect a middle ground between protectionism and free trade. The Biden administration has supported such “friendshoring” policies.[17]

Another important way economists can contribute to industrial policy strategies is by rigorously analyzing data. Transitions to net zero are unprecedented, so little data exists from which policy playbooks can be drawn up. This will rapidly change in era of green industrial policy.

In 2019, a Nobel Prize was awarded to three economists who helped to reinvent the field of development economics to focus less on sweeping theories of poverty reduction and more on targeted interventions with data-driven experimental approaches to evaluation.[18] Similar approaches can help to identify successful and unsuccessful industrial and place-based policies. In the United States alone, the Bipartisan Infrastructure Law and the Inflation Reduction Act include dozens of measures and billions of dollars in investments in specific technologies, industries, or communities—each can be seen as an experiment, with results that will need to be evaluated in the coming years. These findings will help policy makers design more effective policies by iterating with trial and error.

Many economists are already hard at work. And the results can be surprising. For example, Harvard’s Dani Rodrik argues that the predominant focus of industrial policies on manufacturing jobs is misplaced, and policies should target the industries that are likely to provide high-quality job opportunities in the future, including smaller and more service-oriented sectors.[19]

A Supporting Role

Economists’ opposition to industrial policies often comes in the form of recommending a humbler role for government. To be helpful in the era of green industrial policy, economists may need to accept a humbler role for themselves, because economics alone does not provide any easy answers about how to help domestic businesses and communities successfully navigate an energy transition. Still, economists can play an important supporting role by providing policy makers with data and concepts that serve as useful inputs to industrial policy strategies.

To co-opt an old proverb, the best time for economists to work on green industrial policy was 20 years ago; the second best time is now.

Notes

[1] Robert (“RJ”) Johnston, “Industrial Policy Nationalism: How Worried Should We Be?” Energy Explained, Center on Global Energy Policy, February 7, 2023.

[2] Bentley Allan, Joanna I. Lewis, and Thomas Oatley, “Green Industrial Policy and the Global Transformation of Climate Politics,” Global Environmental Politics 21.4, 2021, 1–19.

[3] Michael Munger, “A ‘Good’ Industrial Policy Is Impossible: With an Application to AB5 and Contractors,” Journal of Law, Economics, and Policy 17, No. 3, 2022, 517.

[4] Matthew Yglesias, “The Jones Act, the Obscure 1920 Shipping Regulation Strangling Puerto Rico, Explained. Protectionism and Exploitation at its Worst,” Vox, October 9, 2017.

[5] International Energy Agency, “Global CO₂ Emissions Rose Less than Initially Feared in 2022 as Clean Energy Growth Offset Much of the Impact of Greater Coal and Oil Use,” March 2, 2023.

[6] J-F Mercure et al., “Reframing Incentives for Climate Policy Action,” Nature Energy 6.12, 2021, 1133–1143.

[7] The White House, “Economic Report to the President. Together with the Annual Report of the Council of Economic Advisers,” Chapter 7, April 2022.

[8] Institute for Security and Development Policy, “Made in China 2025,” June 2018.

[9] The White House, “Building a Clean Energy Economy: A Guidebook to the Inflation Reduction Act’s Investments in Clean Energy and Climate Action,” January 2023.

[10] European Commission, “The Green Deal Industrial Plan: Putting Europe’s Net-Zero Industry in the Lead,” February 1, 2023.

[11] Jason Bordoff and Meghan L. O’Sullivan, “The New Energy Order: How Governments Will Transform Energy Markets,” Foreign Affairs, July/August 2022.

[12] The White House, “Remarks on Executing a Modern American Industrial Strategy by NEC Director Brian Deese,” October 13, 2022.

[13] Ghazale Haddadian, Mohammad Khodayar, and Mohammad Shahidehpour, “Accelerating the Global Adoption of Electric Vehicles: Barriers and Drivers,” The Electricity Journal 28.10, 2015, 53–68.

[14] Benito Mignacca, Giorgio Locatelli, and Tristano Sainati, “Deeds Not Words: Barriers and Remedies for Small Modular Nuclear Reactors,” Energy 206, 2020, 118–137.

[15] Joseph Majkut, Jane Nakano, and Mathias Zacarias, “Making Hydrogen Hubs a Success,” Center for Strategic and International Studies (CSIS), July 29, 2022.

[16] “Buy American Is an Economic-Policy Mistake. President Biden’s Protectionism Sullies His Economic Agenda,” The Economist, January 28, 2021.

[17] Yvonne Lau, “What is Friendshoring? Janet Yellen’s New Strategy for Fixing the Supply Chain Crisis,” Fortune, July 19, 2022.

[18] The Royal Swedish Academy of Sciences, The Nobel Prize, Press Release, “Their Research Is Helping Us Fight Poverty,” October 14, 2019.

[19] Dani Rodrik, “An Industrial Policy for Good Jobs,” The Hamilton Project, Brookings Institution, 2022.

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