The new Congress is beginning to consider various alternative energy and climate policies in the wake of last year’s collapse in the U.S. Senate of consideration of a meaningful, economy-wide CO₂ cap-and-trade scheme.  Among the options receiving attention are various types of renewable portfolio standards, also known as renewable electricity standards or clean energy standards, depending upon their specific design.  These approaches, which focus exclusively on one sector of the economy, would be less effective than a comprehensive cap-and-trade approach, would be more costly per unit of what is achieved, and yet – ironically – appear to be much more attractive to some politicians who strenuously opposed cap-and-trade.

True enough, these standards can be designed in a variety of ways, some of which are better and some of which are worse.  But the better their design (as a CO₂ reducing policy), the closer they come to the much-demonized cap-and-trade approach.

In an op-ed which appeared on November 24^th in The Huffington Post (click here for link to the original op-ed), Richard Schmalensee and I reflected on this irony.  Rather than summarize (or expand on) our op-ed, I simply re-produce it below as it was published by The Huffington Post, with some hyperlinks added for interested readers.

For anyone who is not familiar with Dick Schmalensee, please note that he is the Howard W. Johnson Professor of Economics and Management at MIT, where he served as the Dean of the Sloan School of Management from 1998 to 2007.  Also, he served as a Member of the President’s Council of Economic Advisers in the George H. W. Bush administration from 1989 to 1991.  By the way, in a previous blog post, I featured a different op-ed that Dick and I wrote in The Boston Globe in July of last year (“Beware of Scorched-Earth Strategies in Climate Debates”).

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Renewable Irony

by Richard Schmalensee and Robert Stavins

The Huffington Post, November 24, 2010

One day after the election, the White House press secretary Robert Gibbs said that a national renewable electricity standard could be an area of bipartisan energy cooperation, after President Obama had said cap-and-trade was not the only way “to skin the cat.” It is ironic that while cap-and-trade — a sensible approach to reducing carbon dioxide emissions linked with climate change — is dead and buried in the Senate, considerable support has emerged for an approach that would be both less effective and more costly. A national renewable electricity standard would mandate that a given share of an electric company’s production come from renewable sources (most likely wind power), or, in the case of a “clean energy standard,” from an expanded list including nuclear and hydroelectric power.

One irony is that cap-and-trade is a market-based approach to environmental protection, which harnesses the power of the marketplace to reduce costs imposed on business and consumers, an approach championed by Republican presidents beginning with Ronald Reagan. Within its narrow domain, the renewable standard approach, which involves nationwide trading of renewable energy credits, is also market-based. Whereas cap-and-trade would raise the cost of fossil fuel, as its opponents have stressed so effectively, renewable standards would raise the cost of electricity, which its supporters seem reluctant to admit.  If renewables really were cheaper, even with Federal subsidies, it wouldn’t take regulation to get utilities to use them.

A second source of irony is that renewable or clean electricity standards are a very expensive way to reduce carbon dioxide (CO₂) emissions — much more expensive than cap-and-trade. These standards would only affect electricity, thereby omitting about 60 percent of U.S. CO₂ emissions. And even then, the standards would provide limited incentives to substitute away from coal, the most carbon-intensive way to generate electricity. Even more problematic, renewable/clean electricity standards would provide absolutely no incentives to reduce CO₂ emissions from heating buildings, running industrial processes, or transporting people and goods. And unlike cap-and-trade, which would also affect oil consumption, the electricity standards would make no contribution to energy security. Only a very tiny fraction of U.S. oil consumption is used to generate electricity.

Increasing renewable electricity generation is no more than a means to an end for one part of the economy. Cap-and-trade keeps our eyes on the prize: moving the entire economy toward climate-friendly energy generation and use.

Those who believe that renewable electricity standards would create a huge number of green jobs have forgotten the lesson of Detroit: a large domestic market does not guarantee a healthy domestic industry. At the end of 2008, for instance, the U.S. led the world in installed wind generation capacity, but half of new installations that year were accounted for by imports. And a recent Lawrence Berkeley Laboratory study of the impacts of the economic stimulus package incentives for renewable electricity investments estimated that about 40 percent of the (gross) jobs created by new wind-energy investments were outside the United States, where many wind turbines are manufactured.

A sounder approach, for those concerned about green jobs, would focus on the long-term determinants of economic growth, such as technological innovation. That’s where cap-and-trade — which creates broad-based incentives for technology innovation — holds another edge over renewable electricity standards.

It is often argued that if cap-and-trade is dead, enacting renewable or clean electricity standards is better than doing nothing at all about climate change.  While that argument has some merit, since the risks of doing nothing are substantial, there is a real danger that enacting these standards will create the illusion that we have done something serious to address climate change.  Worse yet, it could create a favored set of businesses that will oppose future adoption of more efficient, serious, broad-based policies — like cap-and-trade.

If a national renewable electricity standard is nonetheless inevitable, it should not impose excess costs on businesses or consumers.  It should pre-empt state renewable portfolio standards, since with a national standard in place, states’ programs simply impose extra costs on their citizens without affecting national use of renewables at all. And any national program should allow unlimited banking to encourage early investments. No environmental or economic purpose is served by limiting banking to two years, as current Senate legislation would do.

Carbon cap-and-trade has been killed in the Senate, presumably because of its costs.  Renewable electricity standards or clean energy standards would accomplish considerably less and would impose much higher costs per ton of emissions reduction than cap-and-trade would.  This does not sound like a step forward.

Richard Schmalensee is the Howard W. Johnson Professor of Economics and Management at the Massachusetts Institute of Technology; Robert N. Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School.