Subsidy reform and renewable energy levelling the playing field

While subsidies often have detrimental impacts, governments can have a clear and pressing policy goal for which subsidies are an appropriate instrument. The existence of market barriers to the introduction of climate-friendly technologies provides an example where subsidies may be justified. Renewable energy sources, which often have high initial (capital) costs and concomitant risks, may be subsidized by governments wishing to encourage investments in new capacity or in research to meet environmental or social goals.

Lowering the unit costs of emerging renewable technologies like solar PV or wind requires experience — which comes from building and operating plants. The time needed to gain this experience may be too long for the market to bear without a degree of government support. The facts bear this out. Few energy technologies have reached maturity without substantial public sector investment.

Identifying a 'good' subsidy is essential to the task of reform. Experience shows that good subsidies should be:

• well targeted so that only a fairly narrow group of consumers or producers are recipients;

• soundly based, so that incentives to provide the service efficiently are not undermined;

• practical, so that the financial resources are adequate and the management of the programme is feasible and affordable;

• transparent, so that the financial costs and the provisions of the programme are clear;

• in effect only for a limited lifetime (i.e. have a sunset provision) and be predictable, so that recipients can plan for future phase-down and phase-out;

• close to market (technologies that are 'deserving' of subsidies should not be oversubsidized lest the subsidy stifle commercial discipline and competition; the subsidy provided should be only equal to the magnitude of the externality);

• competitive, so that subsidies are provided through competitive mechanisms so as to ensure that excess 'rents' are dissipated.

Adopting or removing subsidies must take these properties into account. In addition, the phasing in of reforms can be done over a period of time to reduce the resistance and pain. If new subsidies reduce the economic status of a specific group, compensating measures can be (and may need to be) introduced if such a goal is considered desirable. For example, if subsidies directly supporting energy prices are to be removed, they may be offset by loans for introducing new, energy-efficient appliances. Thus, while energy costs rise (and demand falls), the final price to the consumer may stay level — or even decline. Such multi-goal strategies must be developed and implemented — which, in turn, requires that politicians communicate to the public the overall benefits of subsidy reform.

Subsidies for renewable energy may be usefully focused in three areas: (1) reducing technical barriers; (2) overcoming market impediments (including through the internalizing of externalities); and (3) addressing administrative barriers and social and environmental constraints.

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