Ryan Avent at Free Exchange criticizes University of Chicago economists Gary Becker, Kevin Murphy, and Steven Davis, for arguing in a WSJ op-ed that potential government action is causing uncertainty in the energy sector, which is in turn potentially causing a decrease in investment. Ryan argues that:

“…if American businesses are confident enough in their beliefs about a high carbon price to reduce investment in fossil fuels, then certainly they are also confident enough to increase their investment in alternative energies, are they not? Indeed, this is the entire point of a carbon price, passed or merely expected—that it will shift views about relative costs, thereby using market mechanisms to channel investments into lower emission sectors. In the authors’s view, by contrast, markets are simply dumb: able to see the downside to expected policy changes, but too stupid to go looking for the opportunities created by the shift.”

On the one hand, Free Exchange is right that the Chicago boys are ignoring the increase in alternative energy investment that will likely occur. However, if this increase will be far outweighed by the decrease in investment in fossil fuels, then the admission is not so conspicuous as Ryan has made it out to be.

My guess is that Ryan probably agrees with that, but he also thinks the increase in investments in alternative energies will be significant; at least significant enough that not mentioning it is a serious omission. So the real question is what will the net effect on investment be?

One important determinant is the level uncertainty about the increase in demand for particular alternative energies. The appetite for risk right now is not great, and if alternative energies are highly risky investments relative to fossil fuels, then total investment may drop substantially.

So if the government announced they were going to pass a cap and trade bill in 3 months, for sure, how certain would we be about what alternative energies were good investments? I don’t know. But one thing that would likely cause high uncertainty in estimating this is unreliable government subsidies or other policies that are greatly distorting the market, and the fact that the next “winner” in alternative energy might be whomever the Department of Energy decides. Wind energy, in particular, has been known to have boom and bust cycles based on government policy. Given the degree to which our and other governments have decided they will be picking winners and losers in the alternative energy market thus far, including the $163 billion globally that will be spent on green stimulus, I think it’s likely that marginal alternative energy investments are much riskier than marginal fossil fuel investments.

Of course there are others factors the will contribute to the net investment impact of cap and trade, some of which tilt the scales in favor of positive net investment. But the simple issue of uncertainty that I mentioned shows, I hope, that even if businesses are confident enough in their beliefs that a high carbon price will reduce investment in fossil fuels, it is far from certain that they should be confident enough to increase their investment in alternative energies by a substantial amount.

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