U.S. Energy Policy and the Presumption of Market Failure

By Grossman, Peter Z. | The Cato Journal, Spring-Summer 2009 | Go to article overview

U.S. Energy Policy and the Presumption of Market Failure


Grossman, Peter Z., The Cato Journal


Over the last 35 years, the U.S. government has embarked on several major projects to spur the commercial development of energy technologies intended to substitute for conventional energy resources, especially fossil fuels. Those efforts began with the 1973 energy crisis when President Nixon became the first U.S. leader to announce a plan for energy autarky. Presidents Ford and Carter followed Nixon's "Project Independence" with similar pledges. But beginning with Ford's 1975 energy act, plans for energy independence were tied directly to the development of new, alternative energy technologies. Under President Carter in particular, the federal government embarked on highly publicized, heavily funded efforts at developing new technologies with specific timetables for commercial entry and, in a few cases, a timetable for mass market substitution. Current mandates for ethanol and other biofuels fit this latter objective.

The presumption underlying government alternative energy programs, including the ethanol program, is that voluntary market action is insufficient to develop new energy sources. Therefore, government has to step in to induce the technological development the market fails to create. Only through government intervention, according to this logic, can the market failure be corrected and the social benefits of alternative energy technologies be realized (Weimar and Vining 1992).

Whether a market failure has or has not existed with respect to alternative energy technologies, it is nonetheless relevant to ask whether the government's action creates a solution or a failure of its own. The importance of government failure has been highlighted in recent years as government efforts in such diverse areas as inland waterway development, antitrust law, and public transportation appear to produce far more costs than benefits, and sometimes may worsen whatever market failures they were intended to correct (Winston 2006). (1) The evidence suggests that with respect to alternative energy development, government failure has in fact been a more persistent and costly problem than market failure.

This article will argue that government energy policy has been based on faulty premises not only about the existence of market failure but also about the nature and process of innovation. Moreover, as this article will show, there is evidence that the private sector can develop energy alternatives more efficiently than the government.

The article is organized as follows: first, I discuss the basic idea of market failure and how it has influenced U.S. energy policy. I also suggest that governmental solutions would have been unlikely to succeed even if a market failure had been correctly identified. Next, I focus on three efforts at government-directed innovation: synfuels, nuclear fusion electric generation, and the high-mileage automobile. All three were given significant funding and programmatic timetables with benchmarks of success. None of those timetables were met, few of the benchmarks were achieved, and development funds were largely wasted. Finally, I end with a discussion of how the federal government continues to pursue the same kinds of policies that offer the promise of more failure.

The Market for Innovation: Market Failure or Government Failure?

Ronald Coase (1964) argued that all forms of economic organization--markets, firms, and government--are "more or less failures." That is, no real-world arrangement of economic institutions leads to ideal allocative or productive efficiency of the sort represented in the neoclassical model of perfect competition, which by definition allocates resources through markets so that there are no alternative arrangements that would lead to a higher level of social welfare. But since that model is based on unrealistic assumptions, Coase argued, it had to be assumed that all real-world markets fail to some extent, a point elaborated by Demsetz (1969). …

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