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German Leadership and the Pursuit of Energy Security in a Global Economy

by Adam S. Posen, Peterson Institute for International Economics

English version of article published in Sichere Energie im 21. Jahrhundert
December 2006

© Peterson Institute for International Economics, 2007.


A German version of this article was published in Sichere Energie im 21. Jahrhundert , ed. Jürgen Petermann, Hamburg: Hoffmann und Campe Verlag GmbH, 2007.


By its nature, shifting energy technology is a global challenge. Supply and demand for energy are set in global markets, and the environmental costs of overuse or excessive emissions spill over from country to country. Attempts to simply legislate desirable outcomes for energy usage, however, are likely to fail on two counts: first, many states, notably the United States but also large emerging markets, do not wish to subject themselves to external constraints in this area, and no force will make them do so; second, disregard of economic incentives with regard to energy will lead to self-defeating results—not least a lack of needed technological innovation and of the resulting technologies’ adoption. Making progress on the sustainable provision of energy in the 21st century will require policies that take into account the partially decentralized and largely self-interested nature of decision making in the global economy.

Starting from the premise that the major goal of any sustainable energy policy is to allow for global growth in energy demand while decreasing the rate at which carbon emissions are produced1—irrespective of the fuel sources or technologies involved—several basic parameters for policy must be recognized:

  1. Increasing energy usage is necessary for economic growth in the developing countries, and so demand must continue to rise, primarily from those countries.
  2. Restrictions on growth in the developed economies will do little to decrease energy demand, and could only be achieved through draconian measures.
  3. Progress must therefore be primarily through promoting gains in efficiency in energy usage, both in terms of properly pricing energy to reflect the true costs of that usage and of reducing the carbon emissions for given usage.
  4. Technological innovation will be key to reducing emissions.
  5. Businesses and households will respond to economic incentives in deciding how much energy in what form to use, and what innovations to pursue.
  6. There will inevitably be free-riding of some countries on others’ more responsible energy policies, and as a result some international inequities.

In this reality, future energy security will depend heavily on the leadership of some governments (and their societies) that are willing to bear a disproportionate burden of the costs or adjustments during some transition period of developing and adopting new technologies.

Germany in particular is well-suited to take on this leadership role.2 Germany has already shown leadership on the issues of environmental and energy sustainability, both intellectually and through its domestic policies. And it will spend the first half of 2007 in both the chair of the G-8 and the presidency of the European Union. The key is for Germany to accept uneven progress on energy conservation and on contributions to research and development, with less than proportional contribution from the US and some developing countries (perhaps far less initially), but getting such programs off of the ground. There will be those who will decry this unequal “contribution” as unfair on its face; others grasping the public good nature of reducing environmental damage, so that any amount reduced helps everyone, will still complain that the world needs multilaterally applicable rules (like the Kyoto Protocol) to function. These are niceties Germany acting as an economic hegemon in this area can disregard for the sake of substantively improving the global situation as well as serving its own ends, so long as the net benefit to Germany is positive.


Getting pricing right . A correct price of energy would charge the consumer (be that business or household) not just for the cost of discovery, refining, production, and transmission, including the producing firm’s return on invested capital—it would also charge for the “external” effects of energy usage, primarily the effect of carbon emissions on global warming. Despite there being essentially a single global spot market and price for the commodity fossil fuels such as natural gas, petroleum, and coal, pricing to the end user varies enormously around the world. Developing countries, including energy exporters, heavily subsidize usage in response to domestic political pressures and to simple equity concerns; developed countries differ in how much they tax energy, from the low level in the United States on up. The importance of these pricing decisions should not be exaggerated; given low elasticity of energy demand in response to price shifts, getting the pricing right (i.e., raising the price significantly in the United States and in parts of the developing world) would not be expected to significantly cut global demand.

What getting the pricing right could facilitate, however, is shifting the relative use of different sources of energy, such as coal versus petroleum, and of different energy production methods, in line with their relative impact on the environment. As argued recently by Klaus Lackner and Jeffrey Sachs, the best currently available means to making a significant different in emission levels is to encourage carbon capture and sequestration by energy producers, and by major industrial consumers of energy.3 In amenable developed countries, tightly targeted taxes combined with regulations on power plants could encourage or even require new energy production to conform to standards for sequestration, and the “right” price including those costs would then be presumably based on to the consumer. Since the major growth in power plant construction will come in China, India, and one hopes eventually the rest of the developing world, the rich countries would want to redistribute sufficient resources such that there would be no price disadvantage to those countries choosing the latest capture and sequestration technology when building plants.

The leadership strategy for Germany and like-minded developing countries therefore on this count would have two tracks. First, they could require that all new power plants opening within their own borders—or say within the European Union given achievement of consensus—include appropriate carbon capture and sequestration technology (it would be largely equivalent to put a sufficiently high tax on not including this technology). This cost would be passed on the consumers of these utilities’ energy production. The German and like-minded governments could alternatively subsidize the adoption of this technology, but that would be passed on through general taxes and therefore would do less efficient matching of payment with use. Second, the German and other governments could focus development aid to incentivize the construction of appropriately equipped power plants in the emerging markets. This could come through some combination reallocation of current development grants to this purpose, provision of additional money as matching funds for less developed country (LDC) governments taking this on, and/or getting agreement at the World Bank and other lenders to make this technology a condition of energy project loans (with some repayment of the additional loan amount required). To the degree that new power plants in the US and elsewhere would not adopt this technology, or that not every rich country would take part in funding the incentivization, it would be a potential gain for later, but no direct cost versus the status quo or the success of this initiative.


Funding research appropriately. Carbon capture and sequestration remains a technology with ample room for further development, and it is only one of several technologies that can be usefully pursued to decrease either the energy intensity of economic production and growth, or the emissions produced by energy usage. As discussed in the earlier chapters of this volume, changes in the powering of automobiles (hybrid engines, and perhaps hydrogen cell power supplies), improved solar energy collection, and better means for cleaning and liquefying coal, among many others remain to be developed. Arguably, the amount of research and development currently dedicated by the private sector to these technologies is less than optimal because the projected future stream of profits from such a technology does not capture the social and environmental benefits from successful implementation of such technologies. The high risk that for some of these technologies that no market would exist, even after development, without government commitment to establishing the necessary infrastructure or incentives for transition, may also deter the large upfront investments that would be required of the private sector.

Some form of public sector encouragement of and investment in research in these areas of technology is therefore likely required. That said, the historical record of industrial policy initiatives to promote desired technologies is nearly universally poor, costing a lot for very little in the way of results.4 Still, for a first step it would be better to have industrial policy funding going to even inefficient R&D projects on energy than to totally pointless or value-destroying projects. Given recurrent pressures for industrial policy in Europe to combat recession and global competition, Germany and like-minded governments could argue for this priority rather than wasting money on such ego projects as a European alternative to GPS or, worse, national champions of industry. The European Union for example could announce a project to build infrastructure for various forms of clean fuel automobiles and transport as well as making a commitment to shifting government transport fleets to the technologies that emerge.

Recent work by Michael Kremer and Rachel Glennerster on the pursuit of vaccines for ‘orphan diseases’ provides an additional model for the dealing with the issue of reluctance by the private-sector to make large upfront investments in desirable areas of energy research and development.5 This follows the now recognized best practices for government spending projects. First, it sets a goal rather than picking a winner in terms of a specific company or product design. Second, it guarantees a market for which there would not be sufficient demand in the absence of government guarantees, but which could be profitable and have private spillovers were such a market to come into existence. In these, it emulates the ingenious design for the international vaccines fund, emphasizing pull, rather than push. Third, it is a finite program, which could be tied to specific outcomes, and thus not become an ongoing transfer to industry. An expert panel including industry representatives could prioritize which areas would be specified as the goals of these programs. And it can be portrayed as giving EU industry a leg up on the Americans and Japanese, so there would be less political objection to other countries like the United States not giving their ‘fair share’ while still not actually being anticompetitive.


Setting an example to develop desirable norms. Given the denial in the face of scientific evidence of the urgency of many of the energy and environmental concerns by the Bush administration, and admittedly the far lower priority Americans put on these issues than Europeans even under Clinton administration, it is understandable that there is resentment across the Atlantic. Resentment, however, does not decrease the rate of carbon emissions or reduce energy usage per unit GDP. The adherence of various countries to the Kyoto Protocol, bringing the system into effect, will have some benefits, but not the same as those that would be achieved by bringing the US into greater restraint and channeling LDCs’ future energy demands in more efficient directions. Thus, it would be pointless for the German and like-minded governments to continue to worry about gaining international compliance with rules, let alone developing new ones.

Instead, Germany should be taking the lead by aggressively setting an example in energy and environmental policy that would perhaps encourage emulation by the United States, China, India, or others. Two such positive proposals that could in future entice US and perhaps Chinese participation, while costing Germany very little in terms of upfront investment, would be

  • Rapidly commercializing the products of the R&D investments . This would play to Germany’s industrial strengths, to American proclivities for private sector “solutions,” as well as to Bush’s previous rhetoric about hydrogen cars and the like, and to Asian (as well as Franco-Italian) desires for reaching a share of the technological frontier. If Germany is seen as gaining a commercial advantage through its development of clean technologies, the United States and others would be eager to follow and make technological investments and developments of their own. Look at the impact Toyota and Honda’s hybrid cars have had already on the US auto industry. German commitments to subsidize the infrastructure for, say, carbon sequestration or to have governments purchase clean fuel vehicles for their fleets, that resulted in leadership in new technologies that could also be sold abroad would stimulate efforts across borders and the Atlantic—while proposals for new rules or protocols would only encourage resistance.
  • Move towards a (unilateral initially) carbon tax . Germany should undertake a revenue neutral tax shifting, where current fees and taxes are replaced with taxes on carbon-based fuels and their use (beyond those already in place). Business taxes, for example, could be collected or increased on emissions and energy consumption, while the overall labor or corporate tax rate or Lohnnebenkosten were cut.6 Germany should then turn to other countries either needing (much of Europe) or seeking (the United States, mistakenly) to cut taxes and encourage them to make similar shifts. The efficiency gains to the German economy from reducing marginal labor and capital taxes while hitting inelastic energy demand would be large and evident, inspiring others to follow to keep up competitively. And over the longer term, as it becomes more and more difficult to tax mobile capital (and increasingly outsourceable labor), this would be a basis for coordination among countries to maintain tax revenues. The likely short-term effects on industrial competitiveness and investment in production in Germany would be near zero, if the tax cuts hit factors where the elasticity was higher than energy use, as marginal taxes on labor and profits almost certainly would be. This could also be a spur to similar taxes in LDCs where they often offer corporate tax breaks to encourage foreign investment, but where the efficient collection of tax revenue is a pressing matter.

The critical point is that in a decentralized global economy, the best way to change the behavior of other states is to show the benefits of one’s own domestic economic policy. Neither driving for bargains in international negotiations nor global regime building is likely to work without states believing economic policy shifts to be in their own self-interest. When enough states have that belief, international norms and perhaps regimes can emerge consistent with those successful policies. Ultimately, global leadership comes from the willingness to provide public goods in both one’s own national and the global interest, even if others free ride on that provision. Germany has it well within its power—and its economic resources—to contribute to Energiesicherheit for the 21st century by power of example, of innovation, and of targeted aid and taxation, even if the United States, China, and other major energy consumers do not initially cooperate.


Notes

1. Were wind, solar, or other clean power source to prove capable of providing ample energy, of course this problem would go away, but currently, there is no realistic prospect of that happening. Energy supplies, given the fungibility of various sources, are ultimately not constrained, so the issue is that of environmental constraints on energy usage.

2. This point was raised in broader terms in Adam S. Posen, “Mehr Mut, Deutschland!” Internationale Politik, March 2005.

3. See Klaus S. Lackner and Jeffrey Sachs, “A Robust Strategy for Sustainable Energy,” Brookings Papers on Economic Activity, 2005:2.

4. See Richard Nelson, Benn Steil, and David Victor, eds., Technological Innovation and Economic Performance, Princeton University Press, 2002 (particularly Posen’s chapter on Japan), and Marcus Noland and Howard Pack, Industrial Policy in an Era of Globalization: Lessons from Asia, Institute for International Economics, 2003.

5. Michael Kremer and Rachel Glennerster, Strong Medicine, Princeton University Press, 2004.

6. The recently implemented VAT hike in Germany by the CDU/CSU/SPD Grand Coalition justified by as similar tax switching argument, only to pursue deficit reduction is a squandered opportunity.


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