Thursday, May 17, 2012

What is the case for government funding of mitigation research?

I ended a recent post by suggesting that serious consideration should be given to Bjorn Lomborg’s view that mitigation of climate change is likely to require a substantial increase in government funding of relevant research.
That position is somewhat at odds with a view that I have held for a long time that governments should stay out of the business of trying to pick technological winners by funding research and development. I acknowledge the case for public funding of basic research on grounds that it is a public good that would not be adequately supplied via the normal operation of market forces. If someone suggests, however, that governments should become heavily involved in funding of research into alternative energy because the world is running out of cheap sources of fossil fuels, I would regard that as a fairly silly idea. When the world does start running out of cheap sources of fossil fuels the prices of those resources can be expected to rise, providing a strong market incentive for private sector investment in research into alternative energy sources.

So, what grounds are there to argue that carbon taxes and emissions trading schemes that impose a cost on carbon emissions will not have a similar effect on research incentives? I don’t see any. In both cases, as the production of energy through conventional use of fossil fuels becomes more expensive the market should provide adequate incentives for research.

The case for substantial government involvement in funding of research directed toward mitigation of climate change cannot rest on arguments that apply to equally to many other forms of research, even though some eminent economists may think it does. For example, Ross Garnaut argues (in Chapter 9 of his 2011 climate change report) that ‘the carbon price alone will not lead to adequate investment in research, development and commercialisation of new technologies, because the private investor can capture only part of the benefits’. Similar externalities apply, of course, to a wide range of research, development and commercialization activities throughout the economy. Perhaps the existence of such externalities warrants some government assistance to industry, such as allowing capital spending on research and innovation to be treated for tax purposes as a current rather than capital expenditure.  It might also warrant some government involvement in funding of development rather than just basic research, particularly since it is often difficult to draw a line between R and D. But it would be difficult to justify the large increase in tax – and associated economic costs – which would be required to embark on a major program of government funding of research, development and commercialization of new technologies in all sectors of the economy.

It seems to me that the case for substantial government involvement in funding of research directed toward mitigation of climate change must rest on a form of government failure (the difficulty of obtaining international agreement for concerted action) rather than on market failure (or externalities). If governments were able to agree to an appropriate carbon price the case for additional government funding of research would disappear.

Bjorn Lomborg seems to be on strong grounds in arguing that international agreements to invest in research and development are likely to have a greater chance of success than carbon-reduction negotiations. Wealthy countries are less likely to object to making greater research contributions. Agreements to fund more research may also be seen as likely to make it easier to negotiate future carbon reductions by reducing the cost margin between existing fossil fuel technologies and less polluting technologies.

However, there is potential for gradual mitigation to continue to occur even in the absence of international agreements. Governments of countries with high per capita emissions will continue to come under political pressure – from internal and external sources - to reduce greenhouse gas emissions. Perhaps the most likely outcome is that the world will stumble on toward a reduction in greenhouse gas emissions, relative to what would otherwise occur. The climate will nevertheless continue to change. This may impose high costs on some people (those faced with high adaptation costs relative to their current income levels) and benefits to some others. But the general story might be one of successful adaptation.

If that is the most likely scenario, it would make sense to view increased government involvement in research to mitigate climate change as a precautionary measure. It is probably worth doing even though it will, hopefully, not be necessary. Imagine a scenario where climate change accelerates and costs of adaptation begin to rise steeply. My guess is that in that situation, international agreement would be reached fairly quickly by the United States, China and Europe to cut emissions of greenhouse gases drastically and take steps to ensure that other countries do likewise. The economic cost of such reductions in emissions will be very high if there is still a substantial cost margin between energy generated using conventional fossil fuel technologies and cleaner technologies.

So, it seems to me that the case for substantial government involvement in funding of research to mitigate climate change is largely precautionary. It is in our interests to reduce the risk that will be posed to our standard of living if we have to make sharp reductions in greenhouse gas emissions at some later stage.

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