The Economic and Political Theory behind Renewable Energy Policy

In this article, I will walk through three key innovative economic policies governments use to encourage renewable energy deployment, ranging from traditional command-and-control to market-based designs, and details the economic and political theories at their core.

In the face of a climate crisis caused by greenhouse gas emissions, 4.2 million deaths per year caused by ambient air pollution (WHO) and an over-reliance on crude oil, scientists, policymakers and industry are constantly searching for pragmatic solutions. The energy industry is a particular culprit of causing environmental damage in order to satisfy ever-growing demand. Fossil fuels currently account for 79.7% of worldwide energy consumption (IEA). In the US, electricity generation creates 76% of anthropogenic greenhouse gas emissions and 93% of total US anthropogenic carbon dioxide emissions (EIA). Currently, global warming is causing severe, potentially irreversible environmental damage to the planet. Renewable energy offers an effective, reliable and scalable alternative to fossil fuels which not only mitigates climate change, but also advances energy security, creates jobs and combats respiratory health issues. However, the high cost of installation, complex logistics and absence of remuneration for third party spill-over benefits have historically made renewable energy uncompetitive when placed against fossil fuels and nuclear energy. Thus, governing bodies have intervened on a local, regional, national and international level, often at great cost, to support the development and deployment of renewable energy technologies.

Renewable Portfolio Standards (RPS)

RPS are a command-and-control policy that requires electric utility companies to source minimum quantities of electricity (specified by capacity or sales) from renewable sources. They are the most prolific of all renewable regulatory policies and are heavily focused on in the literature. RPS adoption and policy design can be illustrated through three political economy theories of regulation.

The Public Interest Theory of Regulation asserts that regulation is required to mitigate the effects of market failure, by internalising negative externalities such as carbon dioxide emissions or localised air pollution. The government is modelled as a benevolent social welfare maximiser with the ability to compute costs and benefits. Public Interest Theory predicts that states with higher potential benefits of RPS relative to its costs will show greater adoption of the policy. While the reduction in greenhouse gases emitted provided by renewable energy are an international benefit, ancillary benefits associated with reduced local pollution (such as a reduction in nitrogen oxides, sulphur dioxide and particulates released) are also realised. This would make RPS more strongly favoured in states suffering poor air quality. While renewables can also create negative externalities (such as the altered aesthetic of the landscape caused by onshore wind farms), these are unquantifiable, making them difficult to incorporate. Alongside the environmental benefits of promoting renewable energy, Rabe (2006) refers to the economic boost brought about, mostly through job creation. Madsen, Telleen-Lawton and Shriberg (2007) claim that in a scenario where electricity demand levels off due to energy efficiency gains and 25% of electricity is sourced from renewables by 2025, 88,000 more person-years of employment through 2020 would be created, over the base case of ‘business as usual.’ These lead to the predictions that states with poor air quality and states with high rates of unemployment are more likely to enact RPS.

Stigler (1971) disputes Public Interest Theory and argues that regulation is designed and managed for the benefit of the industry. This reasoning was extended by Becker (1983) and Peltzman (1976) who demonstrate that regulation may be understood as the result of rivalry between groups with distinct interests. Proponents of RPS are represented in three groups: consumers disturbed by the environmental damage of carbon dioxide emissions; infrastructure developers of renewable generation facilities, and landowners who can lease their land to infrastructure developers. This theory predicts that the groups with larger and stronger stakes in regulatory policy are more likely to adopt RPS. In addition, supporters of Private Interest Theory, such as Olson (1964) assert that the quality of the organisation of the group will also play a role. Producers of fossil fuel electricity generation lose out from the implementation of RPS, specifically natural gas suppliers, which have been found to be displaced by RPS to a greater extent than coal (Palmer and Burtraw, 2005). This theory can be tested with a number of hypotheses, such as the assertions that more citizens with vehement environmental concerns, a larger and better organised renewable energy industry, and greater landowner interests are all predictors of an increased likelihood of RPS adoption. On the other hand, an energy industry with a strong reliance on natural gas is less likely to enact a state-level RPS.

Following the dominance of the Private Interest Theory of Regulation, economists such as Kalt and Zupan (1984) and Levitt (1996) have turned their attention to the impact of political leanings of legislators, as they believe the legislators’ ideology is the public-spirited response to society’s issues. In their study, Poole and Rosenthal (1984) show that Republicans and Democrats who represent the same state, express disparate voting patterns. They find support for the popular notion that tougher environmental regulation is supported more strongly by Democrats. This leads to the prediction that higher occupation of Democrats in state legislature seats is a predictor of in-state requirements and increase likelihood of RPS adoption.

Public Benefits Funds (PBF)

PBF are an incentive-based policy, providing stimulus for investment in goods and services that are threatened in a competitive environment. PBF trust funds that are generally financed by System Benefits Charges (a consumption tax on energy bills) but may also be funded through private agreements with utility companies or voluntary donation. They have broad applicability in the projects that they finance compared to Clean Energy Funds, as they also fund energy efficiency initiatives. They often accompany penalty-based policies, partly serving to reduce the utility companies’ opposition to RPS.

The theoretical justification for incurring the costs of implementing a PBF with distortionary taxation is the need for redistribution. Pigou (1947) emphasises the efficiency loss created when public expenditure is funded through distortionary taxation, which should be considered alongside the direct cost of PBF. This creates issues in running a cost-benefit analysis, as the costs of inefficiency caused by taxation are not directly observable. Nonetheless, PBF are widely adopted in promoting sustainable energy generation. The principal theoretical idea to be used in cost-benefit analysis is the marginal cost of public funds (MCF), being the multiplier of the direct cost of resources used to reach the shadow price of resources used by the public sector. That is, the ratio of marginal social value of government-funded resources to the marginal social value of the resources in the private sector. In the scenario of first best conditions, marginal social costs of distortionary taxes are equal to marginal social benefits, implying an MCF equals one. Legislators and many academics, such as Pigou (1947), believe the MCF is greater than one, due to the fact that the government is dependent on distortionary taxation to finance expenditure. Samuelson (1954) shows that higher MCF lowers both the optimal level of public goods provision and the optimal size of the state. The second-best solution can be defined using several different methods, depending on which tax instruments are available.

Advocates of surcharge-funded PBF highlight its qualities, such as categorical cost control, which allows for maximum renewables deployment subject to a budget constraint. These abilities make it both more politically viable and more practical as a strategy. If an auction system is used to distribute funding, the policy has the potential to enhance competition and innovation in renewable energy technology. Kirshner et al. (1997) argue that a centralised system can be administratively simple. However, opponents of PBF assert that they are insufficient to maintain the existing production levels of many early adopters. In addition, they refute the political popularity of PBF, due to its perception as a distortive tax, adding that PBF would also diminish the renewable energy sector in the highly competitive energy market. They object to the notion of efficient centrally administrated funds, emphasising the opposition of the California Public Utilities Commission to centrally dispensing funding, due to excessive administrative complexity.

Mandatory Green Power Options (MGPO)

MGPO are a market-based policy, whereby consumers can communicate a preference for renewable energy by opting to pay a surcharge that has been approved by the state utilities commission. Under an MGPO, electricity suppliers are required to offer this choice to consumers. The most common offering is known as Voluntary Renewable Energy Tariffs, in which consumers pay in return for a pledge that a given proportion of their electricity consumption will originate from renewable sources. The surcharge for renewable energy is approximately $2 per 100kWh (Shrimali & Kniefel).

Currently, the cost of electricity from renewable sources, while rapidly falling for some sources, remains above the cost of power from conventional fuels (IRENA). These costs are levied directly or indirectly on the consumer either through increased prices or taxation. Whilst preferences are steadily shifting towards renewable energy, it will ultimately be consumers’ willingness-to-pay (WTP) that will determine the success of MGPO (Roe, Teisl and Levy). Sundt and Rehdanz (2015) analyse WTP for renewable energy by running a meta-regression of the summary indicators from a group of comparable studies. Their quantitative analysis establishes universal comparability of consumers’ WTP for green energy and investigation of prevailing preferences. The US population was found to have one of the highest WTP per household per month. Yet, different renewable energy sources were found to have different WTP, a result echoed by Borches et al. (2007) who found solar PV preferred to wind and biomass being the least preferred. These findings on consumers’ WTP should translate to MGPO being successful in states where it is implemented, particularly for solar PV.

Governments have long been accused of not doing enough to tackle climate change; however, the implementation of these and other policies all over the globe has meant that almost 20% of renewable energy consumption originates from renewable sources. The political and economic theories that are taught at universities are helping governments to design policies that secure the health and wealth of future generations.