The Infant Industry Argument and Renewable Energy Production

January 14, 2013 | 00:00

The Infant Industry Argument and Renewable Energy Production

In this paper we review the necessity of government production subsidies for renewable energy on the basis on the infant industry argument, which argues that government support and protection of nascent industries is acceptable.

We outline the very demanding conditions that are necessary for the government intervention to be justified. The industry should first pass the Mill-Bastable test which consists of the following two conditions: (1) the costs of production should eventually be below the costs of technologies currently utilized; and (2) future savings in costs (compared to existing technologies) should compensate for the initial cost of supporting the infant industry.

More importantly, the infant industry argument requires some form of market failure, e.g., learning externalities or imperfect financial markets; otherwise free markets would deliver the efficient outcome. Even in cases where such imperfections exist, support in the form of production subsidies is an inappropriate policy instrument, since it is unlikely to solve these market failures.

Thus, current government incentives, which are aimed at stimulating production of and/or generation capacity for renewable energy, may not achieve the desired outcome. After reviewing current cost trends in renewable energy, we argue that they cannot be interpreted in favor of production subsidies. Evidence for wind energy seems particularly discouraging: despite considerably increased capacity in recent years, expected cost decreases have not materialized. We conclude that further research into the determinants of costs of renewable energy generation is needed before more money is spent on production subsidies, which are likely to be inefficient and inappropriate policy instruments.

To readl the full paper, click here.

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