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Markets vs Governments in Energy Policy

by Michael Levi
March 21, 2011

I started reading Dani Rodrik’s engaging new book, The Globalization Paradox, last week. Rodrik makes his core point early and often: Too many policymakers and economists assume that markets and governments are substitutes; much more often, though, they’re complements. As he notes, this is particularly important to remember at the international level, where governance is inherently weak. Students of energy and climate policy would do well to keep this powerful idea in mind.

The simplest instance in the traditional energy world involves financial speculation. Too  many people have knee jerk reactions against any type of meaningful regulation of financial trading in energy-related products, believing that more government means less market. But as Daniel Ahn argues in a recent CFR working paper, better regulation and appropriate government intervention can actually enhance the credibility and attractiveness of commodity markets, ultimately enlarging rather than shrinking them.

The classic climate policy example comes from the debate over global cap-and-trade. As David Victor argued persuasively in The Collapse of the Kyoto Protocol and the Struggle to Slow Global Warming, policymakers made a big mistake in trying to create international carbon markets where they lacked sufficiently robust governance. The result was distrust in the system, and, over time, hesitancy in expanding it too far.

Energy technology offers another example. Many people argue that the best way to globalize (and thus speed up) energy innovation is through a maximalist push for free markets for cross-border trade and investment in clean energy technologies. But, as my colleagues and I argued in a study published last fall, sometimes that absolutist position doesn’t work. Citizens need to know that a big push on, say wind power, won’t simply shift jobs to wind turbine manufacturers overseas. That doesn’t mean that we should embrace protectionism, but it means that a healthy balance must mix markets and prudent government reassurance.

I could go on with this list: people argue against any use of the SPR on the grounds that it interferes with the “free market”, but if you are never willing to intervene, people may well reject the market outright (perhaps demanding price controls); people say that the market alone should determine the future of nuclear power, but if regulators don’t do their job in keeping it safe, citizens will simply say no. We too often get trapped in simplistic markets vs governments debates. The real question is how best to use government to strengthen markets, not whether one is better than the other.

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