Thursday, February 19, 2009

On Crowding Out Green Technology

I have had lots of informal conversations with students and faculty around SPEA about the green technology investment provisions of the stimulus bill. With all that new government spending on green tech, will we get more grants for research? Should we hire more faculty in anticipation of getting a piece of all that spending?

One of the more difficult points to convey in these discussions is how "crowding out" works, and why it can actually result in less spending on green tech than what is in the stimulus bill. I think this might be of interest to non-economist readers of this blog, so with maximum simplicity, let me try and articulate the thought experiment to understand the crowding out phenomenon.

Suppose instead of thinking about some generic market called "green technology," we were thinking about seats on an airplane. These seats are, in a sense, auctioned off to potential passengers (who have travel options besides getting on this one particular plane), and a set of prices emerge for these seats. Now suppose P-diddy, who recently gave up his private jet, decides that he is going to purchase half the seats on the plane because he doesn't like crowded planes and long waits. To do this, he must "outbid" everyone else who would previously have ridden the plane in his absence.

Has the introduction of P-Diddy increased total spending on this plane's seats? Yes. The more relevant question is, did the amount of spending on plane seats increase by the amount of P-Diddy's spending? No, because the other half of the passengers who are now pursuing a different option, would have spent money on the plane seats too, had P-Diddy not showed up. These passengers who would have spent money to fly on the plane have been "crowded out" by P-Diddy's arrival.

So, when thinking about it in this generic market thought experiment, it becomes an empirical question as to how much crowding out will actually occur. Thinking about the administration of this spending though, further fogs the issue. Rather than purchasing resources for "green technology" generally, they are put in the position of purchasing particular types of green technology, and therefore picking against other types, including those that have not yet been discovered.

Again, lets simplify this by thinking of the market for green technology consisting of two submarkets: Windmills and Watermills. They have many resources in common, so the emergent price of the resources needed in each of these submarkets are heavily dependent on each other. So the introduction of a new buyer wanting more Windmills not only increases price of resources for Windmills, but also for Watermills. As a result, the previous buyers will observe an increase in the cost of both types of technologies, and will scale back their investments in each. While the new buyer will likely have increased total spending on Windmills, it comes at the expense of not only previous buyers of Windmills, but also ALL buyers of Watermills. So spending in one submarket crowds out the other submarkets as well, and it becomes even less clear that the new buyers spending will have actually increased total spending on the resources.

Much ultimately depends on the ability of new resources to shift out of non-green technology and into green technology. The greater this ability, the more likely that crowding out will be less of a problem for total spending on green tech. In the airplane example, it would depend on the ability of the airline industry to make new planes available for those who were crowded out by P-Diddy.

It's an empirical question, but it is mistaken to think of the stimulus bill investment of $x on green technology as new or additional total spending. The real effect will be $x-$c, and only time will tell us how big that crowding out effect is on $c.


Jason O said...

That darn P-Diddy is just using his money to hurt us little people. Worse, is that he is only doing it to build his image!

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