Wealth of Nations July 2005

The New New Economy Will Be All About Energy

With a gentle push from the federal government, America's dependence on oil will shrink much faster than people think. And it would be good if it did.

The Bush administration is inching toward a new position on global warming. At last week's G-8 summit in Gleneagles, Scotland, the president joined in a statement that recognized the potential scale of the problem and the need for action. The words were softer than the other leaders wanted, and nothing suggested that George W. Bush was changing his mind about the Kyoto agreement, a plan to curb rich-country carbon emissions that most other governments support (or say they support). But he pleased his British hosts by agreeing to stronger words than before. And he got something in return: support for the idea that future plans to curb greenhouse gases must include China, India, and other big developing countries.

The politics of global warming all points one way: Something must be done. The science, to be sure, is far from settled. A few outright skeptics are still asking awkward questions, but their numbers are dwindling, and they are quieter than before. Most experts agree that man-made emissions of carbon dioxide and other greenhouse gases are forcing temperatures up, and quickly. This position is voiced ever more loudly, confidently, and angrily. Leading scientists (not always climate scientists) are demanding radical action, and get all the press they can use.

Rhetorically at least, Europe's leaders have already surrendered to this pressure. As in other things, they are using American suspicion of international action as their excuse for failing to do more themselves. Obviously, Bush cares more about opinion in America than opinion in Europe's capitals—but the steady foreign criticism may influence some people at home. And the mood in the United States is shifting anyway, for other reasons. As in Europe, television news and other media have taken to linking every unusual weather event to man-made global warming. Hollywood has chipped in with The Day After Tomorrow, a well-executed (if frequently ludicrous) movie about climatic Armageddon. Politicians are sniffing the wind.

Ex-presidents, especially. Bill Clinton turned up last week at the Aspen Ideas Festival—a gathering of intellectually engaged American plutocrats. (The meeting was co-sponsored by The Atlantic Monthly, a sister publication of National Journal.) Admittedly, that setting is irresistibly conducive to lofty environmentalism, but what Clinton said about the greatest challenge confronting the world was still striking. It was not chemical, biological, or nuclear terrorism, he said. The worst that terrorists might do, even equipped with weapons of mass destruction, is kill a few million people. That would pose no real threat to the survival of our civilization, he said. Clinton could foresee only one such peril. It was global warming.

An indicator almost as compelling as Clinton's political instincts is the fact that most of the world's leading oil companies are now betting heavily on big shifts in the use of energy. They are investing billions to develop renewable alternative sources, such as wind, tidal, and solar power, and on technologies for capturing and storing carbon emissions. Energy companies and car manufacturers are working on designs for cheaper, lighter hybrid vehicles, which use much less gasoline; they are researching new fuel-cell technologies, which burn hydrogen with no harmful local emissions; and they are developing biofuels as another alternative to petroleum. Some of the firms' chief executives (such as BP's John Browne) are ardent evangelists for an alternative-energy future, inviting governments to join in promoting this vision, and sooner rather than later.

The single most powerful incentive for innovation in energy, of course, is the price of oil—and that too, thanks to OPEC and the pressure of global demand, is pushing the same way. For environmental reasons, the bosses of many energy-producing and energy-consuming industries are convinced that new restrictions on carbon emissions are coming anyway. So the commercial reward for innovation in alternative energy and conservation could be enormous.

One could go further—as Clinton typically did—and argue that global warming and expensive oil are not setbacks for the United States so much as wonderful opportunities. Bizarrely, when you recall that he sees global warming as so grave a danger, he compared innovation in energy to the leap forward in information technology of the 1980s and 1990s. The energy economy, he argued, is the next big thing. It could be as good for living standards and the creation of new high-wage jobs as the IT-led economic expansion that began toward the end of the 20th century.

Clinton's irrepressible optimism, undaunted even by (so he says) this threat to our very civilization, was as appealing as ever. The audience loved it—what a politician. But there is a big difference between the information technology revolution and the energy revolution that Clinton is calling for. Innovation in IT has unambiguously increased the economy's productivity and its capacity to sustain higher living standards. If innovation in energy is a response to a sudden scarcity of supply, or an unduly rapacious producers' cartel, or (especially) ill-conceived environmental regulation, the overall outcome might easily be lower productivity.

There would still be commercial opportunities. Companies that act quickly might make a lot of money and create jobs that would otherwise not have existed. But private profit and social gain are not always the same, as environmentalists rightly point out. (Farm subsidies increase farmers' incomes—at others' expense—and protect some jobs. But for the economy as a whole, subsidies are still a burden.)

In responding to the threat of global warming, governments therefore need to get energy prices right. That means properly aligned with costs and benefits, broadly defined. If governments do this, the innovation that happens will make their economies better off. If they get prices wrong, innovation, profit, and job creation might all still follow, but resources overall would be wasted, and living standards would be lower, not higher.

It comes down to whether the price of energy in different forms is right. First and foremost, is gasoline in the United States too cheap? Almost certainly it is, even at today's prices. One reason is global warming: This is an externality, not recognized in the price, that needs to be factored in. Another reason, just as significant, is that America depends for its oil supplies on the most politically unstable part of the world. The need for oil shapes the country's foreign and security policy. This policy in turn imposes great risks and burdens of its own. These are externalities too, hard to measure no doubt, but no less real.

The economic, environmental, and geopolitical benefits of cleaner energy, energy conservation, and reduced economic dependence on OPEC and the Middle East would be enormous. That is the case for taxing gasoline—not as heavily as Europe does, certainly not at first, but a lot more heavily than at present.

The same reasoning supports other kinds of economic intervention: bigger subsidies for research on alternative energy and for energy conservation, more-demanding fuel-efficiency standards, and so forth. Politically, some of these ideas are more palatable than others. Subsidies are always more popular than taxes—even though, whatever most voters or the Bush administration may believe, they come to the same thing in the end. (Ultimately, higher taxes always have to finance subsidies.) The economic merits of the different options vary as well.

Still, a plausible forecast would be that this government, or another, will do some or all of the above before very long. Maybe it's the altitude in Aspen, but I can even imagine the Bush administration, despite everything the president has said on the subject, bringing in a modest gas tax. Think how that would unsettle his critics. How could the Democrats oppose so bold an act of fiscal and environmental responsibility?

In any event, it might take less than one would think to push America and the rest of the world much faster down the alternative-energy path. The meeting at Aspen also heard from Amory Lovins, whom Clinton lauded. Lovins, the head of the Rocky Mountain Institute, has long advocated alternative energy and energy conservation. Earlier predictions of his about rising energy efficiency, dismissed at the time, have come true. His view is that the economy is poised to make huge new economic, environmental, and geopolitical savings over the next 20 to 30 years—through better conservation and switches to new fuels, such as hydrogen and biofuels.

Lovins argues that a relatively light-handed new energy policy might be enough to show business where things are going. By consistently advocating a new energy economy, and backing that up with relatively modest interventions here and there, the government, he believes, could unlock faster innovation and a far more rapid turnover of the installed stock of old-energy capital. If Lovins is right, America's dependence on oil will shrink much faster than people think. With a gentle push, it could shrink even faster than that, and it would be good if it did.

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Crook writes about the intersection of politics and economics.

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