China's clean energy drive

Evan Osnos writes a fairly laudatory article in The New Yorker on the Chinese government's effort to develop a clean energy industry. He begins by noting the seriousness of China's problem with air pollution:

Last year, the U.S. Embassy installed an air monitor on the roof of one of its buildings, and every hour it posts the results to a Twitter feed, with a score ranging from 1, which is the cleanest air, to 500, the dirtiest. American cities consider anything above 100 to be unhealthy. The rare times in which an American city has scored above 300 have been in the midst of forest fires. In these cases, the government puts out public-health notices warning that the air is “hazardous” and that “everyone should avoid all physical activity outdoors.” As I type this in Beijing, the Embassy’s air monitor says that today’s score is 500.

Yikes. Now, free market economics teaches us that the best solution to externalities such as pollution is to place a tax on them in order to both discourage their occurrence, make alternatives more competitive, and pay for the costs of clean-up. Much later in the article we find out, however, that not only is China failing to tax the production of air pollution appropriately, it's actually encouraging its use:

In the summer of 2005, Edward Cunningham, a Ph.D. student researching energy policy at M.I.T., was travelling in the Chinese countryside when he noticed something peculiar: the government was allowing the price of coal to rise sharply, after decades of controls. “I said, ‘How the hell?’ ” he recalled. “ ‘That can’t be right. Maybe this is just some freak anecdotal evidence.’ ” It was in fact a pivotal change: Manipulating the price of coal had always insured that Chinese utilities would produce ever more electricity, but the unhappy side effect was that utilities needed to build nothing more efficient than the cheapest, dirtiest plants. Coal prices had begun to rise, however, and that would leave power plants no choice but to install cleaner, more efficient equipment.

In other words, while many people are hailing Beijing for its attempts to foster development in the clean energy sector, the government has also played a large hand in creating the problem such initiatives are meant to solve.

Another lesson of free market economics is that government tends to allocate resources inefficiently, in large part because it is more beholden to political considerations than market signals. Basically, the correct incentives are not in place. Thus, it came as no surprise when I ran across this excerpt, near the article's conclusion:

America has a tradition of overestimating its rivals, and China is a convenient choice these days. But, as with Japan’s a generation ago, China’s rapid advances in science and technology obscure some deeper limitations. In 2004, a group of U.S.-based Chinese scientists accused the 863 Program of cronyism, of funnelling money into pet projects and unworthy labs. (A proverb popular among scientists goes, “Pavilions near the water receive the most moonlight.”) When critics published their complaints in a Chinese-language supplement to the journal Nature, the government banned it. Less than two years later, Chen Jin, a star researcher at Shanghai Jiaotong University, who had received more than ten million dollars in grants to produce a Chinese microchip to rival Intel’s, was discovered to have faked his results. It confirmed what many Chinese scientists said among themselves: the Chinese science system was riddled with plagiarism, falsified data, and conflicts of interest.

After the Chen Jin scandal, the 863 Program made changes. It began publishing tenders on the Web, to invite broader participation, and, to cut down on conflicts of interest, it started assigning evaluators randomly. But those measures couldn’t solve a larger problem: the system that allowed China to master the production of wind turbines and batteries does not necessarily equip China to invent the energy technology that nobody has yet imagined. “Add as many mail coaches as you please, you will never get a railroad,” the economist Joseph Schumpeter once wrote. Scale is not a substitute for radical invention, and the Chinese bureaucracy chronically discourages risk. In 1999, the government launched a small-business innovation fund, for instance, but its bureaucratic DNA tells it to place only safe bets. “They are concerned that, given that it’s a public fund, if their failure rate is very high the review will not be very good and the public will say, ‘Hey, you’re wasting money,’ ” Xue Lan, the dean of the school of public policy at Tsinghua University, told me.

While the author goes to praise the Obama Administration for "repairing the legacy of its predecessor" -- which apparently transgressed by reducing funding for clean energy projects -- the article makes clear the limitations and pitfalls associated with public sector involvement in this sector. If government seeks to promote a cleaner environment it can best do so by ensuring that prices set in the marketplace reflect environmental costs and properly taxing externalities. Venture capital and the picking of industry winners and losers, however, is best left to the capitalists.