First, the good news. Prices of key clean energy technologies are plummeting, bringing many technologies, such as distributed solar and energy storage, closer and closer to mass deployment. The cost of solar panels today is about 20 percent below that of a year ago. And it should continue dropping for the forseeable future. In other words, the performance/price ratio is improving exponentially, like computer chips, if not quite as fast, and for different reasons — cost economies for the most part, as opposed to breakthrough technologies. The main driver of the plummeting costs is volume and successful efforts by the Chinese government to vertically integrate the Chinese solar industry, which now supplies over half of the world’s solar panels. (In advanced thin films, costs per watt are also coming down.) Even more dramatic price drops are occurring in battery storage across a range of chemistries, with prices halving in the the last year. Plummeting prices that translate to rising performance are good news for developers, electric carmakers, and the global industry at large.

The story is more complicated, however, in the United States, where we are in what might be described as the best and worst of times. This past year saw torrid growth in solar deployment in the U.S., with solar capacity doubling; wind installations also grew, and wind is now a very competitive source of power. Solar — already competitive with subsidies — will be competitive without them in several years. That is the good news. The bad news is that solar generation still supplies only 0.2 percent of U.S. electricity, and, what’s more, growth has been driven by the 1603 provision in the tax law that allows tax credits to be redeemed for cash. This provision expires on Dec. 31 this year. Since the financial crisis, tax credits deals to build everything from affordable housing to energy have exceeded the relatively thin pool of capital from investors seeking to shelter profits. That means tax credits absent the 1603 provision can be worthless. With extension of Section 1603 uncertain, the solar industry may face significant challenges beginning this winter.

Similarly, on the wind side, the end of the 1603 credit would take a toll, and the production tax credit for wind itself expires at the end of next year. While companies are scrambling to start projects before these deadlines pass, afterwards activity may fall of the proverbial cliff. In short, while global fundamentals for clean energy remain strong, the sector remains quite sensitive to government subsidy. In the U.S., with subsidy likely to change, and especially with gas prices likely to stay low as more shale gas comes onstream, we may see more clean energy activity shift overseas. (One potential fix to this problem: moving clean energy off “subsidies” and giving them equal access to the master limited partnership tax break that extractive industries like oil and gas enjoy.)

Indeed, despite intense focus by Silicon Valley and the support of the U.S. government, the U.S. is not catching up with Europe or China on clean energy, and in many measures, we are falling further behind. A few years ago, Germany adopted an export promotion plan that included factories as exports. It exported gas turbine and solar panel factories to China, which is how China has so rapidly come to dominate many areas of clean manufacturing. The Germans have done well selling machine tools to the Chinese while creating demand (and green power) at home through an aggressive feed-in tariff. The U.S., however — except for a few bright spots like Applied Materials, which makes equipment to manufacture panels; First Solar, a thin film manufacturer; a few innovators such as Sun Edison and Tesla; and a few large companies such as GE and IBM — has yet to find its way.

Why? Unlike Germany, which has deep credentials in improving manufacturing incrementally, we have excelled through innovating and creating new industries. For example, France Telecom deployed the minitel years before America went online, but U.S. companies ultimately came to dominate online technology once we created the open internet platform that allowed Yankee entrepreneurship to flourish. Yet despite developing scores of breakthrough energy technologies in our national labs and robust funding of clean energy companies, as I have written before, cleantech innovators have run up against the brick wall of a regulatory system that funnels purchasing decisions to regulated utilities. The latter are disincentivized by law to invest in new technologies. Meanwhile, in many states, the consumer remains locked out of the action entirely behind the Iron Curtain of the electricity meter. The sector is still attracting capital, but time is running out to upgrade the regulatory structure to what I have described as Electricity 2.0 to create large, gatekeeper-free platforms that reward innovation and investment.

If there is one strong positive on the clean energy front, it is that the consumer has been given a small seat at the table, notably through the introduction this year of the first two electric cars, the Chevy Volt and the Nissan Leaf, and in the form of the proliferation of direct generation of electricity, primarily from solar. The electric car is a technology that can engage the consumer on the ultimate playing field of new, more, and better. However, if the the cars fail to thrill, cleantech will experience a potentially huge setback. For that reason, making electric cars and charging infrastructure work has to be a key priority for the industry.

More broadly, the once-almighty American consumer, who has not only driven domestic growth in recent decades by controlling a huge chunk of GDP, but also funded the development of the Pacific rim, has been the missing force in the clean energy sector. Consumers are prohibited from directly buying clean energy by law in many states, in contrast to communications or the internet, where consumer demand drives rapid product life cycles and profits at a speed in sync with venture capital.

Indeed, the write-once, make-money-everywhere model of the internet is providing stiff competition for capital to cleantech, where local regulations and the gatekeeping role of utilities can sap the energies of even the best funded, most visionary entrepreneurs.

Nonetheless, my final takeaway was that while challenges abound, clean energy remains one of the largest, most important, and potentially most transformative projects of the 21st century. Our job is to engage the consumer, sweep away barriers, and play to America’s strengths in innovation, entrepreneurship, and out-of-the box thinking in the face of obstacles.

All of the sources of renewables grew, but the growth rates were modest.  Wind grew year-on-year by 12.5% and solar by only 3.5%.  These growth rates might be passable for mature technologies with a huge starting base.  However, for comparatively new technologies with a tiny denominator, these growth rates are not impressive.  True, the data do not reflect the full force of the Investment Tax Credit (for solar installations) extended last fall and the American Recovery and Reinvestment Act passed this winter — because of the lag in the data.  Still they tell at best a story of an industry surviving the recession.  They do not tell a story of economic rebirth based on the promise of a low-carbon future.

There are reasons to hope clean energy would be growing much faster than these rates–the goal of lowering greenhouse gas emissions, essential to addressing climate change, and the goal of creating a new wave of clean technology-driven growth.  (The goal of energy security is less dependent on renewable technologies since coal is present in the United States but is nonetheless also served by replacing oil in our nation’s energy mix.) 

However, there are also reasons to expect clean energy to be growing far faster than it is: the declining cost curves of renewables relative to fossil fuels, the large subsidies the government has put in place and the huge push America is making, from the president’s speeches to the T.Boone Pickens Plan for energy independence on down.  In many states, renewable energy is even mandated through a Renewable Electricity Standard.  Looking abroad, Germany produces 7% of its power from wind, about four times what the U.S. does, and Spain’s solar power capacity grew 364% in 2008.  Now that is the type of growth needed to have a real effect!  The fact is, U.S. growth rates in renewable industry are not meeting reasonable expectations for clean energy growth, let alone desirable targets.

I have been studying the question of why clean technology is moving so slowly into the marketplace in the United States and my research suggests that adoption of clean technology and renewable energy must be about more than pricing and incentives.  It is about decision-making and removing obstacles to the deployment of clean energy.  These obstacles are present, once you peer into the complex world of the electricity industry, in a host of non-economic barriers to implementation.

To understand why clean energy is not — even with large incentives in place — displacing dirtier forms of energy, it is important to recall the extraordinarily complex nature of the industry.  Like all large industries, the electricity industry has incumbents.  These incumbents–unlike, say, car manufacturers or computer companies — are protected by regulation.  During the 1990s, the industry was partially deregulated so that market forces were introduced in some parts of the industry in some regions.  However, the work of regulatory reform proceeded only part way, leaving the industry in a sort of limbo.  Today, some regions of the country have wholesale competition.  Others have limited retail competition.  Still others have wholly vertically integrated companies supplying their customers with soup-to-nuts service unchanged from a half century ago.  And there is limited trade in electricity — this in an era when frozen dinners served in the United States are made in Thailand and fresh flowers cut in Bolivia.

Indeed, the electricity industry is quite rare today in remaining geographically divided.  With some exceptions, it is illegal for a utility in one region to sell to customers in another.  There is effectively no such thing as national competition. There are, of course, many precedents for these legalized restraints on trade.  Banking used to be organized this way prior to reforms in the 1980s and 1990s.  Telecommunications after the breakup of Ma Bell but before the 1996 Telecom bill and development of national communications services was similarly organized by region.  In the case of electricity, besides the legal restraints on trade, there are major physical restraints in the form of lack of capacity on the grid to move power where it is needed.

The absence of universal market allocation of power means that decision making — of what types of power to buy, what types of clean technology to implement, and what types of infrastructure to build — is left frequently to a small group of decision makers who are also incumbents and have a rational bias towards decisions supporting their incumbent position.  A transformative technology, for example, could reduce the value of their legacy assets.  Building a new transmission line to connect wind power to the grid may make a plant they own obsolete.  It may therefore be entirely rational for them to discourage rather than encourage the deployment of new technology. 

It would be one thing if the decision makers were acting on their own.  However, typically they make decisions under the rate-base system that provides a guaranteed rate of return on anything they can place in the rate base.  This would ordinarily incent them toward over-investment.  However, since regulators oversee these rate cases and generally try to lower costs, the decision makers at utilities have a conflicting mandate to gain a high rate of return but also keep costs down.  This can lead to a bias toward investments that pay off immediately and against investments that pay off longer term.

The upshot is that getting the type of growth rates of renewables needed to unlock the economic and social potential of clean energy is likely to take more than economic incentives and mandates.  It may well require reform to remove obstacles to the deployment of new technology.

The energy bills now working their way through Congress contain some measures to address these problems.  But my research suggests more work needs to be done.

While the posture of India and China are problematic on their own, they make it harder for other countries to take action.  After all, if the world’s two most populous and dynamic economies, growing at about 7 percent (although down from China’s 13 percent growth in 2007), won’t opt in, why should the U.S., which contracted last quarter at a 5.5 percent rate?  With America’s standard of living under siege, putting America at a further competitive disadvantage–no matter how much carbon we emit per capita–is a tough sell to voters.  And what emerges is a classic collective action stalemate.

This dilemna highlights one of the diferences between greenhouse gas emissions and other environmental issues. Unlike cleaning the air or water, where the benefits are realized locally, keeping costs and benefits within one country, reducing emissions benefits the entire planet, but costs whomever does it growth.  This is what makes a global solution–such as that promoted by the UN through the Kyoto and now Copenhagen process–so attractive.  However, if China and India won’t come to the table, what should the U.S. do?

One solution attracting interest of late is the use of trade policy to punish carbon havens. Indeed, at the last minute, the House inserted into the Waxman-Markey bill a provision to impose tariffs on countries that do not take action to limit emissions.  In announcing his support for the House bill after its passage, President Obama flagged the provision as troubling insofar as it runs counter to free trade principles.

So is trade policy a valid tool in climate policy?  The New York Times recently argued that it is if enacted multilaterally, but not if it’s enacted unilaterally.  Paul Krugman, my professor of trade policy at Princeton, has endorsed the idea in theory.  My view is that trade policy is a problematic tool from a practical standpoint that would require significant new infrastructure to work at all.

The problem with using trade policy for an environmental purposes are fourfold.

First, trade actions have an unfortunate tendency to invite retaliation and provoke trade wars even in a multilateral context.  No matter how good your case, other countries can respond in kind.  The result is then a lengthy negotiation or WTO process that ultimately harms both parties.

Second, while the temptation to use trade policy to protect clean domestic industries against dirty foreign ones may be great, the track record for mixing the environment with trade is poor.  More often than not, environmental regulations have functioned as non-tariff trade barriers.  Domestic companies claim them when threatened economically, and verifying them becomes a political football. 

Third, as with food safety regulations, labor regulations, and other hard to measure quantities, measurement is labor intensive and becomes an impediment to good regulation.  This would complicate administering any tariff.  It might overwhelm the WTO.

Fourth, increasing the price of an import to protect a domestic industry can have the adverse consequence of increasing the price of inputs for other domestic products.  A classic example is that when the U.S. slapped a tariff on LCDs to protect LCD domestic manufacturers in the 1980s, it drove American laptop manufacturing offshore.  Taxing imports from carbon havens to protect domestic industries could raise manufacturing costs for other companies, causing the latter to shift their production to carbon havens. 

Those are the arguments against. On the other hand, giving imports a total pass not only harms domestic producers, but is tantamount to a cordial invitation to domestic companies to shift production–and jobs–offshore.  This issue came up, of course, in the NAFTA debate.  Ideally, there ought to be some middle ground.

To view how a tariff might succeed or not, consider the case of electricity-intensive aluminum production.  Rio Tinto, as one example, produces aluminum using hydro power in Canada but coal-based power in Australia.  Were the U.S. to slap a tariff on aluminum produced with coal-based power (hard enough to determine in and of itself), aluminum produced with hydro power would be cheaper. One outcome would be for Rio Tinto to phase out coal in favor of hydro in the production of aluminum.  Were that to occur, one might call a US tariff an environmental and economic success.

Another possible outcome, however, would be for Rio Tinto to fulfill U.S. demand with an unchanged mix of product that would cost buyers more due to the tariff.  In that case, U.S. companies might decide to shift the production of products using aluminum overseas.  This would be an environmental and economic failure.  The deciding factors between the two outcomes would probably be Rio Tinto’s ease of substituting a zero carbon energy source for coal, and the domesic companies’ difficulty of moving production of products using aluminum overseas.

In short, it is hard to predict in advance just how the tariff would impact the market, but it is clear that the more carbon havens that exist, the greater the likelihood that production will seek them out.

Currently a workable regime is not readily at hand.  Were a trade regime to ultimately be invoked, here are some thoughts to guide its development.

First, as with the capping of carbon emissions themselves, putting a price on emissions in imports should be pushed as far up the value chain as possible. This is because as products grow more complex, tracking their carbon footprint becomes more difficult and trade restrictions multiply.  Any trade-based taxes on carbon intensive goods should be directed upstream at basic goods such as steel or aluminum, not at finished products made from those commodities.  While this could drive downstream industries overseas, on balance, I think, it would be far less distortionary to address a few commodities than many products.

Second, some sort of standardized process for measuring carbon footprints needs to be devised.  However, it would be preferable for some private body to administer standards, rather than a governmental organization.  A number of creative startups are trying to devise novel ways of tracking carbon.  One such venture is Greenerone.com which uses crowd sourced information–or information gleaned for free by numerous reporters to track the environmental profile of products.  Others are working on more industry-focused products.  Whatever system is used should involve as little bureaucracy as possible, consistent with being stable and standardized. 

Another idea, admittedly bold, would be to devise some sort of average duty–product independent–to penalize countries that choose not to limit their emissions during production.  Such an approach would have to be administered multilaterally, lest it lead to an immediate trade war, thus it is not something the U.S. could do in and of itself.

The very complexity of using a trade hammer shows that it is far preferable to develop a coordinated multilateral regime than to use trade policy.  Free trade has created wealth since the days of the Minoans and since then for the Athenians, Carthaginians, Romans, Indians, Venetians, Portuguese, Spanish, British and yes, Americans, to name only a few.  It is, in contrast, a clumsy tool for achieving environmental goals.  Nonetheless, if India and China–and for that matter the U.S.,  refuse to address the problem of a changing climate, the pressure to use trade policy to achieve those goals will only increase.

Last week the Department of Energy released part of the $25 billion in loans provided for through the Advanced Technology Vehicles Manufacturing Loan Program, included in Section 136 of the Energy Independence and Security Act of 2007. The delay in releasing these funds had been one of the longest running scandals in clean tech policy. Upon taking office, the Obama Administration vowed to expedite their release and Secretary Steven Chu had made finalizing rules needed to administer the program a key priority. In the first installment of the loans, Tesla, the VC-backed California maker of an all-electric sports car, founded by Ebay veterans, will receive $465 million to make its compact, all-electric Model S sedan. Ford will receive $5.9 billion to retool 11 factories across five states to improve the overall fuel efficiency of its fleet.  Finally, Nissan will receive $1.6 billion to retool a factory in Smyrna, Tennessee, to make an electric vehicle that is being developed and initially manufactured in Japan. The remainder of the money will be released next year.

DOE’s announcement comes on the heels of the release of its formal $3.9 billion smart grid funding solicitation last week. The Funding Opportunity Announcement spells out the conditions and terms for those seeking funding for smart grid investments under the American Recovery and Reinvestment Act, the offical title of the stimulus bill signed into law earlier this year. These two developments, coming one after the other, are evidence that the DOE is moving rapidly on the President’s goal not only of getting money out into the economy to create jobs and drive demand, but also of making investments critical to a clean energy future.

In the case of the auto loans, they could not be more timely. Autos are a capital intensive business and with credit markets still impaired, it would have been very expensive or impossible for Tesla, for example, to borrow this money on its own. However, that does not mean that the loan is not good business for the government and Tesla. CEO Elon Musk indicated he thinks that Tesla may be able to repay the loan ahead of schedule. Tesla, despite some speed bumps in its early phase, is now profitable on a unit basis, meaning the approximately $120,000 price of its sleek sports car — which has a long waiting list — exceeds the cost of components.  Having also recently sold a stake to Daimler Benz, the company is now reasonably well capitalized. Recently, investor Steve Wesley indicated that Tesla’s sales are on track to pass $100 million, a common bar for conducting an IPO. If Tesla continues on its current track, it may be the first home run of the clean transportation industry. In any case, the DOE funding puts it on track to move from the sports car niche to the mainstream where it hopes to leverage the glamour associated with the roadster. While Ford and Nissan have greater access to the capital markets, these loans — provided for in the 2007 energy legislation in exchange for a commitment to higher fuel efficiency — will help achieve that goal.

In the case of the smart grid, the major barrier to moving forward has been undeveloped standards.  Normally, standards evolve slowly as industry players forge alliances and choose standards that already enjoy market adoption. In this case, the desire to stimulate the economy has accelerated this process. Secretary Chu and Commerce Secretary Gary Locke are overseeing an effort led by NIST to fast track standards for the grid to facilitate adoption. The disbursements made by DOE will indeed help establish standards insofar as the money spent will validate standards and increase adoption.

It is important that standards be as open and uniform as possible to create the broadest and fairest playing field for innovators to enter the smart grid technology market.  Because a smart grid is necessary to get clean energy online and also to drive the creation of new energy products and services, this is an area I believe is absolutely critical to determining whether clean technology can live up to its promise. 

While it remains to be seen how the smart grid will develop, these two announcements from DOE show that the Administration is on the case. These developments should be encouraging to anyone concerned about America’s clean energy future.

Business Week has a provocative article this week by Michael Mandel on innovation — or the collapse of it — in America. According to Mandel, many of our current woes stem from a failure to innovate over the last decade since the glory years of the late 1990s. While most Americans still take pride in our innovation, Mandel provides some sobering statistics: the wages of young college graduates — precisely the group that should be succeeding in the information economy — declined 24% between 1998 and 2007. The U.S. trade balance in high tech goods flipped from a $30 billion surplus in 1998 to a $53 billion deficit in 2007. Mortality statistics actually worsened for those 45 to 54, belying talk of medical breakthroughs.

All of this leads to my topic for today: making good on the promise of clean technology. Now one of the hottest areas in Silicon Valley and an area that the Obama Administration believes is key to powering prosperity, clean technology has — as John Doerr has said — more potential for wealth creation than information technology. Yet despite numerous technology breakthroughs, the clean energy and technology space has yet to generate the type of home runs on a company level or growth on an economy-wide level needed to reinvigorate the American economy and get wages moving upwards again.

In my view, there is no question that innovation is the key to America’s economic future. The wealthiest country in the world cannot compete with low-wages countries on labor costs. To sustain high wages, our people must create new industries in which competition is based on new capabilities and, in effect, scientific magic, not on who can make widgets for less. We have the best scientific infrastructure and system for financing innovation on earth. Nonetheless, as Mandel points out, our system has not delivered on an economy-wide level for the last decade. 

It is tempting to blame this on the policies of the Bush Administration. And the Obama Administration has begun to reverse a reliance on financial engineering, as opposed to real engineering, to get us back in the business of creating new products. However, to really get innovation back into high gear, I believe more steps are needed.

Within clean technology, a very promising area of innovation is the smart grid. However, virtually none of the money for smart grid included in the ARRA bill will go to young entrepreneurs — burrito-eating Stanford grads, as Doerr once described them. Because of a 50% cost-sharing requirement and large average size for grants, most will go to large regulated utilities. Moreover, the entire clean energy industry is hampered by a key difference between the energy industry and, say the Internet industry: the presence of incumbent players with an interest not in innovation but rather in preserving incumbency.

Many young clean technology companies find themselves in the role of selling to a small group of customers, most heavily regulated and unusually conservative. In a given geographic region, they may therefore have only one customer, creating a so-called monopsomy. Monopsomies, the flip side of monopolies, provide exceptional buying power to a single gatekeeper who can, if desired, not buy a product at all. A real life example of a monopsomist is a coffee buyer in a remote region who may have virtually unlimited power over small growers. Oil companies, similarly, enjoy government tax credits, market power and other incumbent advantages that can work against companies offering alternative technologies. So long as these sorts of gate-keepers and roadblocks to innovation exists, clean energy will fail to realize its promise.

What is the way around roadblocks to innovation in the energy sector? The answer, broadly speaking, is to get the end user or consumer involved.

The consumer is a great arbiter of product quality. Unlike a middleman, incumbent or gatekeeper, the consumer’s highest priority is features for money expended. In software, computers, electronics and sectors where the consumer is empowered, the consumer has driven innovation.

Two policy ideas stand out as ways to get the consumer involved in energy decision making. First, the smart grid itself, if developed in an open way, will drive innovation by allowing software developers, producers of services and others to build products around an open standard. On the other hand, the smart grid, if developed in a closed or proprietary way, will merely perpetuate the market power of insiders. The key is to set a standard that allows plug and play capability so that entrepreneurs can develop products for customers around it. Just as coffee consumers, once informed about fair trade, have begun to buy fair trade coffee, consumers, if given the choice, will buy products and services around the grid based on their preferences.

Second, it is time to revisit the issue of electricity reform to offer greater choice to consumers. Electricity reform began in the 1990s but came to a halt. Since then, we have learned what structures make markets work best and competition should be extended to the consumer level.

Finally, the government should be more flexible in how it supports research and development for clean technologies, to make more money available to smaller, more nimble firms as opposed to entrenched incumbents. While it may be possible for governments playing catch up to to bet on strategic industries, as Japan did after World War II, when it comes to innovation, picking winners should be avoided. No single analyst or committee, no matter how smart, can substitute for trial, error and the verdict of the marketplace.  However, government can encourage open standards and a level playing field to encourage numerous solutions to problems.  And by making money generally available not only to large players but to small ones, it can help rekindle innovation.

These three steps will help accelerate innovation in the clean technology space. And innovation is what is needed to raise wages, create jobs and get America’s economic engine hitting on all cylinders once again. 

Cross-posted at the NDN Blog.

The decision of the Obama Administration to embrace stronger fuel economy standards by 2016 is drawing praise from environmentalists but fire from auto analysts who say it will add to Detroit’s woes.  The decision to accelerate fuel economy comes on top of a variety of policy proposals to address climate change, the auto industry and transportation including the cap and market bill that was the subject of House hearings yesterday, the deliberations of the Auto Task Force over GM’s fate, replenishing the Highway Trust Fund and a proposal to offer clash for clunkers also in legislation working its way through Congress.  Here are my thoughts how higher fuel economy standards fit into the bigger picture.

First, fuel economy standards are among the least precise tools for addressing climate change.  The reason?  Fuel economy is the mathematical equivalent of lower gas prices insofar as its allow consumers to drive more for less.  While it is therefore good for motorists’ pocket books, its impact on emissions is ambiguous.  If you believe that people drive a certain amount each day and never vary that amount–then higher fuel economy translates directly to lower emissions.  However, if you believe that people drive more when gas costs less in other words that gas usage is price elastic–then higher fuel economy leaves more money in your pocket but does little to reduce emissions.  Last year’s falloff in driving when oil prices spiked (as well as numerous studies) suggests that gas use is price elastic. As a result, the primary impact of higher fuel economy is likely to be what economists call an improvement in consumer welfare but not a large reduction in gas emissions. 

Second, higher fuel economy–by lowering the cost of driving a mile–also runs counter to the idea of making carbon more expensive–the idea behind carbon tax proposals and the cap and market legislation debated yesterday.

Third, fuel economy standards like gas prices are likely to impact the quantity of gasoline consumed.  In fact that is the goal.  To the degree they lead to less gas consumption, they lead to fewer gas taxes collected.  Since the Highway Trust Fund which finances not only roads but a large share of mass transit in America relies on gas taxes, higher fuel economy standards may reduce money available for transportation.  Later this year, Congress will try to fix the finances of the Highway Trust Fund.  But we should be mindful that improving fuel economy cuts in the opposite direction of two other policy ideas: making carbon more expensive and replenishing infrastructure funds.

Finally, there is the cost to the auto industry of making cars more fuel efficient.  The Auto Task Force has adopted fuel economy as an unofficial goal and suggested Chrysler and GM need to improve fuel economy as a condition of survival.  However, there is no link between fuel efficiency and profitability and, if anything, the correlation is negative.  Large cars remain a requirement for families and Americans simply like them.  Indeed, a Chevy Suburban with five in it is far more fuel efficient than a Prius with one person in it.  Cash constrained Americans–the lower three fifths of our beleaguered consumers–also prefer to pay less up front even if they have to pay more for fuel later on.  This is a question of their internal discount rate and cost of capital–which in the case of the poor is very high.  Even the New York Times, discussing the looming GM bankruptcy yesterday, got its logic mixed up when it described the fact that 11 of 20 of GM’s best selling cards are gas guzzlers as a problem.  The company’s problem is not its money making cars but its money losers.

As I have written before the crisis of the auto industry is due to one thing and one only, the virtual halving of sales volume due to the financial crisis that makes it impossible for anyone, Toyota, Honda, GM or Chrysler, to make money in the United States.  Fuel economy is a largely separate issue.

All this is a long way of saying that the higher fuel economy standards are no magic bullet to the problem of emissions and the real requirement of all the policy suggestions currently floating around is that they work together in alignment.

Here are proposals that are aligned.

The cash for clunkers idea now before Congress that Jack Hidary and others have advocated makes sense because it replaces old, smoky cars with new clean ones and also will generate demand for cars at a time when sales are down.

Pricing carbon through cap and market makes sense because it will attach the costs of emissions directly to their source, carbon. 

Good old gas taxes which are a form of carbon tax make sense as well, since they connect the tax to the carbon.  In contrast, the Vehicle Mileage Tax that some have proposed, even apart from its Orwellian implications for our freedom, would remove any incentive to buy an electric car or plug-in hybrid or, indeed, own a fuel efficient vehicle.

Incentives for electric cars and plug-in hybrids make sense because they move us off gasoline entirely.  Indeed, higher gas mileage is only likely to lead to major reductions in emissions if it hastens a switch to electric vehicles.

All these goals require a healthy auto industry.  If the Auto Task Force can keep GM out of bankruptcy, this would be a good thing, as a drawn out GM bankruptcy could hobble America’s clean energy future.

In short, when dealing with issues this complex, it is vital that we get them right and that different policy proposals work together.  While higher fuel economy standards are not a bad thing, they need to be viewed as part of an overall plan to create a clean, healthy and robust American transportation sector.

The auctioning issue is not unimportant. When permits are given out, polluting is free and there are no immediate financial incentives to reduce emissions. On the other hand, forcing polluters to buy permits at auction places an immediate price on carbon, similar to a carbon tax, that creates an incentive to reduce emissions from the get go.

Like a carbon tax, auctioning permits also raises immediate revenue that can be used to invest in new technologies or offset the otherwise negative impact on the economy of higher carbon prices by reducing taxes elsewhere.

The downside of auctioning permits, however, is the immediate economic impact on industry and consumers of higher prices. For this reason, most cap and trade proposals have included, at a minimum, a transition period when permits are given out. The EU scheme allowed only 5% of credits to be auctioned in its rollout phase.

When permits are handed out free, no immediate incentive is created to reduce emissions. However, as emissions approach the cap, depending on the penalties for exceeding it, the cost of the permits will begin to impact the marginal cost of energy and energy or emissions-intensive products, creating an incentive to reduce emissions. Thus as the cap is approached, the system will begin to affect behavior. In the EU, while countries have begun to auction off more credits, the system still largely works on grandfathered credits and hinges on the cost of buying credits once the cap is reached.

The key point here is that auctioning is not an absolute requirement.

Far more important in the scheme of things is that failure to pass climate legislation this year would postpone action on climate change, perhaps indefinitely. There could be no more propitious time than now in this unique year in modern political history with a new Democratic president in his first year in the White House — who has made clean energy a key priority — and large Democratic majorities in both the Senate and House. Add to that the timetable created by Copenhagen. Next year things could be quite different, meaning the time to act is now.

Throughout American history, Congress has generally only passed major legislation either when conditions were especially propitious as they are now or in the midst of a major crisis. Since climate change is so gradual, we may not see a crisis that can be directly attributed to greenhouse gas emissions until it is too late to act.

Finally, some make the argument that no plan is better than a weak or flawed plan on the theory that Congress will only take this up once.

I disagree. In general, Congress is more likely to adjust something that exists than create something new and experience shows that regulations, once established tend to tighten, not the reverse.

Accordingly, today’s bill is an important step forward in addressing the challenge of climate change.

Cross posted on the NDN blog.

Forty years have passed since John McConnell, a peace activist and plastics pioneer, proposed the first Earth Day at a Unesco conference in San Francisco as a way to focus attention on our role as stewards of the planet. In that period, environmentalism has grown into a worldwide passion so ingrained that we routinely recycle bottles, paper and plastics and on Earth Day, at least in my small New York town, walk instead of drive children to school. In that sense Earth Day and environmentalism have been astonishingly successful.

At the same time, however, when we look about the planet it is clear that for all the steps taken so far the climate has actually gotten worse. Environmentalism can celebrate major victories in the United States of cleaning up our air and our water. However, we have meanwhile developed millions of acres of land with almost no regard for the environment. And the rise of China, India and the other rapidly developing countries has virtually doubled sources of pollution. Moreover, science suggests that it has been precisely during the last decade or so of human history that the earth’s climate has begun to experience dramatic stress from people as our greenhouse emissions have altered the earth’s absorption of energy from the sun.

As an optimist, I belive the world will collectively meet these challenges which are fundamentally about managing growth. The key element, recognized by McConnell when he chose the Unesco conference to propose the idea of Earth Day, is global cooperation. The last Administration retreated from working with other countries. The new Administration has redidicated itself to solving climate change but faces immense challenges, particularly, in the weak global economy.

Most major action is precipitated only by crisis. When the threat is is both distant and global rather than local in nature, acting in advance is that much more difficult. The foresight demonstrated at Rio, Kyoto, and the other key international meetings on the environment are, therefore, remarkable in history. But science suggests that cooperation is not only remarkable, but also vital to our survival.

On this Earth Day, therefore, I believe we should honor the idea of preserving the planet. But we also honor the key element in achieving that goal, namely working together to solve the problem. Not so coincidentally, 40 years ago, man first landed on the moon and people first saw the famous picture of the earth from the moon. What they saw was a fragile planet, no bigger than a pea in Neal Armstrong’s words, but for the first time, the whole earth as one, with one set of challenges, hopes and possibilities and a single destiny.

On the one hand, there has never been more enthusiasm for new modes of transportation such as high-speed rail and new approaches such as vehicle mileage tolling and congestion pricing. Billions in the stimulus bill and the Obama budget for rail have set off a frenzy of excitement about building high-speed rail in the United States. At the same time, however, the old system of funding infrastructure, the Highway Trust Fund, fed by gas taxes, has never been under greater stress. With a new transportation authorization bill likely to move this year, we stand at a key juncture in U.S. transportation policy.

Transportation reform is vital to building a clean economy. Not surprisingly, therefore, much of the discussion at Princeton focused on the irony of trying to fund the reinvention of transportation out of a five-cents-per gallon gas tax — at a time when reducing gas consumption has emerged as a national security, economic and environmental priority.

Currently, the Highway Trust Fund, built on nickel-a-gallon gas tax, accounts for the lion’s share of infrastructure funding in the United States — not only for roads, but for mass transit as well. But the fund is essentially depleted (having required a bailout last fall to stay solvent). Additionally, with construction prices higher but gas usage falling, the gas tax now provides only about half the purchasing power needed to sustain our current system, let alone make improvements.

As a result, many people have been talking about switching to a Vehicle Mileage Tax (VMT) as an alternative to the gas tax. A VMT would toll mileage, not gas, enabling the country to reduce gas consumption without starving its infrastructure. However, the “t-word,” as Mort Downey has described it, whether that refers to taxes or tolls, is highly controversial. White House Press Secretary Robert Gibbs recently struck down a suggestion by new Transportation Secretary Ray LaHood that switching to a VMT is on the table.

One alternative that would sustain historic levels of funding but would not provide funds for much new investment would be a dime-a-gallon tax. That would be the easiest — if least imaginative — fix.

A bolder idea is to create a national infrastructure bank as proposed by Sens. Chris Dodd and Chuck Hagel to tap private money for infrastructure investment, an idea endorsed by NDN (the think tank where I’m green project director). Indeed, the Obama budget would fund such a bank. However, in the current environment, private money is not as available as it was.

Last week, U.S. Rep. Earl Blumenauer, who spoke at NDN’s clean infrastructure event in January, introduced Clean Tea legislation to tap 10 percent of revenues from a cap-and-trade system of the type contemplated by the administration’s budget for transportation. Given the key role of transportation in emissions and cleaner transportation in reducing emissions, this makes a great deal of sense.

Everyone recognizes that the old system of a nickel-a-gallon tax combined with earmarks isn’t working. There is a great appetite to reform the basis for funding infrastructure and this year, a real opportunity.

Cross posted at the NDN Blog.

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As the economic recovery and investment package backed by the administration works its way through Congress, and more evidence about the nature of this recession surfaces, an interesting exercise is to think about how we want to emerge once it is over. In the midst of current economic turmoil, it may seem difficult to imagine the post-recovery world, let alone accurately predict it. Nonetheless, starting with an outcome and working backwards to a policy prescription is far preferable to policy based purely on the passions of the moment. Following are my thoughts on the world I would like to see in 2012 and the resulting implications for current policy.

First, by 2012, I certainly hope that a robust recovery is well underway. But to do that, we need to get through the pain now and resist any temptation to drag things out. In the years of true laissez-faire, before modern management of the economy, the typical business cycle ran about three to four years from top to trough. The United States entered recessions in 1893, 1896, 1900, 1903, 1907, 1910, and 1914, for example [PDF], with this pattern continuing through 1931. Modern economic policy combined with changes in the economy have tamed and extended the business cycle so that we have been averaging nine-year expansions interrupted by quick, shallow recessions. However, the Japanese example of the 1990s shows that policy can extend a slowdown if a country is unable to take its licks quickly, and then move on.We don’t want a Japanese-style lost decade. So a top priority is to face up to our problems now to clear the decks for the future.

Second, a recession of this depth virtually guarantees a strong expansion coming out. However, it is important that we lay the groundwork for an expansion that has three qualities. The expansion should create new high paid jobs, it should be broad-based, benefiting every income segment and region of the country, and it should contribute to our long-term productivity. The fact is not all expansions are alike. And the recent Bush expansion failed on all these counts. Lacking any science or technology component, it left tract houses and debt instruments, but no new industries to speak of. It benefited a small group at the top while the lower 80 percent -of Americans saw their incomes actually drop. And it made precious few investments in our future productivity. In contrast, the 1980s expansion created the personal computer industry, and the 1990s expansion saw the Internet — both dominated by U.S. firms. The 1990s built our broadband network on which much of our future productivity depends and raised middle class incomes. Both created great new American companies. So in 2012, I would like to see a recovery underway that is innovative, broad-based, and long-term.

Finally, in 2012, I would like to see the United States on a path toward environmental and climate sustainability. As the global population continues to explode, we can no longer take our earth’s health for granted. The consequences of ignoring the health of the earth are simply too dire to leave to chance and the negative consequences of pollution and climate change could easily eat up and make a mockery of the benefits of the next expansion.

So what are the implications for current policy?

First, we need to act decisively, but intelligently, to put this recession behind us. The stimulus package is not a cure-all, but it will help restore liquidity to the economy. The key here is to pass it quickly rather than haggling over details.The greatest task is probably to revamp and refashion the clumsy TARP program into a multi-pronged policy to restore the health of the financial sector. The government needs to help banks clear their books of non-performing loans. While new classes of bad assets are emerging daily, the largest class — as evidenced by the financial strength of banks who resisted their allure — remains the mortgage-backed securities and structured-investment vehicles that started the crisis. The government should corral these, buy them up and then sell them off to investors.

If the investors profit as did those who bought real estate from the Resolution Trust Company in the 1990s, so much the better. In turn, the government should also create a new U.S. mortgage with a stable, 5.25 percent interest rate to create the basis for secure, affordable home-ownership in years ahead. A comprehensive effort, building on Paul Volcker’s recent report, needs to begin to update our financial regulatory regime to prevent another crisis of this nature. And we need to dramatically strengthen the rights of the consumer of financial services. It is shocking that the financial services industry — with billions of taxpayers’ dollars in its hands and pockets — is at this moment lobbying against consumer protection. The gutting of usury regulation, credit and consumer reporting legislation, fairness in lending, and other post-war consumer protections by banking lobbyists in recent years clearly played a major role in the crisis.

Second, we need to ensure that the next recovery is broad-based. The answer here involves investing in education, middle-class tax relief, and our infrastructure to ensure that everyone benefits from the next expansion.

Third, we need to ensure that the next economy bolsters the long-term productivity of the United States. That means investing in science and technology to power innovation from which new industry must come, investing in greening our economy to cut energy costs, and investing in new infrastructure such as a smarter electrical grid, mass transit, and greener buildings to make our people more productive.The stimulus bill is an important down payment on the investments we need. However, by its very nature the stimulus bill is designed to get as much money out the door as quickly as possible. This means it cannot — in its current form — be expected to make all the long-term investments we need.

Finally, we need to make the energy investments and policy changes needed to restore our climate to health. Many of the green elements of the economic recovery and investment package that we at NDN began proposing last summer will help in this regard — from greening the federal government to providing tax credits for saving energy to investing in mass transit. However, the administration also needs to move forward on comprehensive energy legislation and a cap-and trade-system so that we can take a leadership role in global negotiations this year in Copenhagen.

As I often argued in the 1990s and discussed in my book, The Coming American Renaissance, and as National Economic Council chairman, Larry Summers, said this weekend on Meet the Press, America’s greatest days lie ahead of us. I am convinced that America will emerge from the current crisis stronger and that the years from 2012 to 2016 and beyond can be among America’s greatest.

To do that, however, we need to make the right decisions today to power the next round of prosperity. Cleaning up our financial sector, investing in our people, and investing in new clean technologies and infrastructure are the ways not only to get our economy back on track, but also to clear the decks for the the next great wave of economic growth.