Fiscal Stimulus and Renewable Energy

Here's a question I've heard twice in the last few days.

If the federal govermnent is going to spend money on a fiscal stimulus package, why not spend it on investments in renewable energy?

So let's break this down. A fiscal stimulus package is likely in the works. It will entail (probably) investments in infrastructure: Roads, bridges, schools. Stuff like that. The idea is that we're in a period of falling employment. The falling employment means people have less disposable income. So consumer expenditures fall. Which causes firms to cut back more on production and investment. Which means more falling employment. It's a downward spiral.

The idea behind the stimulus is this: Use road construction to put some people back to work. These people, who would otherwise be unemployed, will take their paychecks and spend them. This spending will help keep businesses afloat, and will mean fewer job losses elsewhere in the economy. That is, building roads will mean, for example, fewer layoffs at Ford.

But why roads? Why not spend the money on sources of renewable energy?

The answer is this: We know we need roads. We know there are bridges and schools that need replacing. So, the payoff to investing in roads and bridges and schools is known. In other words, it's not hard for the government to answer the questions of "What roads should we build?" Or, "What schools should we replace?"

With renewable energy, it's much less clear (I think) which investments will pay off and which will not. As a result, it would be more difficult for the government to determine what to invest in. And before you say that we should invest in all forms of renewable energy, consider this: We have limited resources to invest. So we should be careful to invest in the forms of alternative energy that appear to be most promising.

Governments are pretty bad at "picking winners" when it comes to making investments. This is something markets are better at. Entrepreneurs, who have their own personal wealth at stake when making business decisions, are motivated to figure out which forms of alternative energy investments are likely to pay off. This is a setting where markets are likely to make better investments than governments.

We need a fiscal stimulus package to pull the economy out of its spiral. Government should invest in something in order to achive this aim. But if the government is going to invest, it should invest in the things that it's comparatively good at investing in. Roads.

So how can we stimulate private investments in alternative energy? Simple: Tax carbon.