By David G. Victor and Kassia Yanosek

After years of staggering growth, the clean-energy industry is headed for a crisis. In most of the Western countries leading the industry, the public subsidies that have propelled it to 25 percent annual growth rates in recent years have now become politically unsustainable. Temporary government stimulus programs -- which in 2010 supplied one-fifth of the record investment in clean energy worldwide -- have merely delayed the bad news. Last year, after 20 years of growth, the number of new wind turbine installations dropped for the first time; in the United States, the figure fell by as much as half. The market value of leading clean-energy equipment manufacturing companies has plummeted and is poised to decline further as governments strapped for cash scale back their support.

The coming crisis could make some of the toughest foreign policy challenges facing the United States -- from energy insecurity to the trade deficit to global warming -- even more difficult to resolve. The revolution in clean energy was supposed to help fix these problems while also creating green jobs that would power the economic recovery. Some niches in clean energy will still be viable, such as residential rooftop solar installations and biofuel made from Brazilian sugar cane, which is already competitive with oil. But overall, the picture is grim.

Whether this shakeout will strengthen or weaken the clean-energy industry will depend on how policymakers respond. The root cause of today's troubles is a boom-and-bust cycle of policies that have encouraged investors to flock to clean-energy projects that are quick and easy to build rather than invest in more innovative technologies that could stand a better chance of competing with conventional energy sources over the long haul. Indeed, nearly seven-eighths of all clean-energy investment worldwide now goes to deploying existing technologies, most of which are not competitive without the help of government subsidies. Only a tiny share of the money spent on clean energy actually goes to innovation.

Building a more viable clean energy economy will require three shifts in approach, all designed to increase innovation and competition. First, the U.S. government should adopt policies that give private industry a stronger incentive to buy clean energy technology. Today's policies rely too much on unreliable subsidies to "push" new technologies into service. Indeed, these subsidies are the root cause of the clean energy industry's boom-bust cycle. Every few years, key federal subsidies for most sources of clean energy expire. Investment freezes until, usually in the final hours of budget negotiations, Congress finds the money and investors rush back in.

This volatile approach to policy explains why most money in clean energy favors low-risk conventional technologies that can be built quickly, before the next bust. Moving beyond subsidies -- essential in this new era of tight public budgets -- will help build a more competitive industry over the long term.

The best approach to "pull" new clean technologies into the market would be to impose a cap or tax on global-warming pollution. For now, however, such ideas are dead in Congress. Second best would be to set a federal clean-energy standard. Making such a standard work will require rethinking what counts as clean energy. Most policy has focused on renewable energy, which in practice has been a huge bet on wind power and corn-based biofuels. A broader approach that includes clean natural gas and even new nuclear power sources would help build a bigger political coalition in favor of clean energy innovation.

Second, the U.S. government must focus the scarce fiscal resources it devotes to clean energy on smarter subsidies that can close the funding gaps in technology and commercialization. (Pull strategies cannot do all the work alone; the push effect of subsidies must be shifted from mature technologies to a wider array of earlier-stage technologies that need government funding.) Money should focus on fundamental research as well as on funding demonstration projects for the most promising ideas.

Third, the U.S. government must do more to engage with emerging markets, which is where most of the growth in energy consumption and investment in infrastructure will occur in the future. Doing so will require, among other things, launching cross-border partnerships that include both governments and firms and creating larger markets for clean energy. The U.S. government should encourage U.S. firms to spend funds from government-sponsored clean-energy research on joint projects with foreign companies.

Big changes in the energy industry do not happen overnight. The bold goals of energy independence and of radically shifting to renewable energy may be attractive to politicians who prize what is popular over what actually works in the long run. Today's short-term policies have produced a clean energy industry that depends too much on subsidies and focuses on technologies that cannot compete at scale with conventional energy.

The crisis in the clean-energy sector is here. It presents an opportunity for the U.S. government to devise smarter, more sustainable policies -- policies that put a higher priority on innovating today with an eye toward tomorrow. Such a strategy will be politically difficult to carry out in these times of shrinking government budgets. But these are also the times for making tough choices.


David G. Victor is a Professor at the School of International Relations and Pacific Studies at the University of California, San Diego, and Director of the school's Laboratory on International Law and Regulation. Kassia Yanosek, Founding Principal of Tana Energy Capital LLC, has worked in private equity and at Bechtel and BP


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