The national economy is weak, but things were hopping in Moulton Township when I worked on our farm west of Chandler late last month.
On Friday, the Pizza Ranch in Edgerton had 12 construction workers in addition to the usual locals. On Saturday, a concrete mixer truck roared by in one direction or another every few minutes. A local excavating contractor had a bulldozer going in a soybean field and trucks hauling gravel. The fuel dealer was out filling up sundry cranes, backhoes and forklifts. A concrete pump from across the Iowa line had its enormous boom extended as a general contractor was pouring the base for a turbine tower.
All of this activity was sparked by a 10-megawatt wind project.
The project was certainly good for the local economy of southwest Minnesota (full disclosure: my wife and I have a 5 percent share). As an economist, however, I must ask if it is good for the nation as a whole, since the project does not spring from pure free-market forces but instead depends on government mandates and subsidies.
If, on balance, the project does have benefits to society greater than its costs, one must question further whether the policies we are using to achieve a worthy objective are efficient ones. Could we achieve the same goal at lower cost to society?
Neither ethanol nor wind power would be viable in a pure free-market environment with no government action. That does not mean, however, that society would be better off, since both reduce external costs imposed on society by burning the fossil fuels, petroleum and coal, that these new technologies replace.
Among economists, even the deepest free-market devotees know that when producing some product involves external costs — true costs that are borne by someone in society other than the producer or the consumer of the good — leaving things up to private markets can result in a situation in which society is made worse off.
In the case of both oil and coal, air pollution — including nitrous and sulfur oxides and sundry particulates — is one external cost. Both oil and coal liberate carbon dioxide, the harmful effects of which are highly disputed among the general public. Burning coal also may release mercury, and the use of motor fuels raises harmful carbon monoxide levels in urban areas. Moreover, many argue that importing oil creates the need for defense expenditures to protect U.S. supplies from troubled areas.
So these two energy sources do involve significant external costs. What should we do about them?
Since 1921, when English economist Arthur Pigou addressed the issue, there has been broad consensus among economists that the first and best measure is to tax the product in question by an amount equal to the external cost involved in its production. Raise the cost of the polluting product and you create both incentives to use less and to produce a better alternative, as ethanol or wind may be. The next best alternative is issuing permits to pollute that can be traded.
Economists agree these measures produce greater reduction in external costs such as pollution than other alternatives, with lower costs to society. And they agree that arbitrary mandates like Minnesota’s are the worst alternative, with the highest costs and least efficiency. The effectiveness of subsidies for pollution-reduction equipment or to cleaner substitutes fall somewhere in between.
These less effective measures, however, are what we currently use. Minnesota has statutory mandates requiring arbitrary percentages of ethanol in gasoline and renewable energy as a fraction of all energy sold. The federal government subsidizes both wind and ethanol significantly, although the ones for wind expire periodically, causing a boom-and-bust cycle. Our project got funded in time, but the lack of extensions for the federal subsidy is leading to a near-shutdown of new projects. A turbine blade plant in Pipestone, 23 miles from our project, has halted production. Extending the subsidy runs counter to budget cutting.
Some call for a nationwide federal mandate similar to Minnesota’s. This would be the economically least efficient way for government to promote wind development, and its feasibility in the current political climate is uncertain.
Ethanol plants and wind projects are generally popular among farmers and in the rural areas where they provide short-term jobs and spending during construction and longer-term ones for operation and maintenance. Yet ironically, these also are the areas where voter support for smaller government, less spending and less regulation is strongest.
Some things are clear. If CO2 emissions truly cause no harm, both Minnesota’s mandates and federal subsidies for wind and ethanol probably are not justifiable and make our society poorer. However, even leaving CO2 aside, burning fossil fuels does create external costs that for 40 years now we have chosen to control with the most expensive and least effective alternatives. Moreover, coal and especially oil receive large implicit subsides embodied in special tax breaks for their producers.
If we truly made all fuel sources face their true social cost, there probably would be a major role for wind and for ethanol from some sources. Yet, rhetoric describing more market-friendly and efficient alternatives to current policies as “job-killing” probably has poisoned the well for years to come. We thus will continue to pursue good goals with bad policies.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.