Masque of the Green Death

Recently other parts of the grown-up blogosphere woke up to the implications of a fact which alert RBC readers will have known for some time if they´ve been Paying Attention. To wit, that solar PV has been growing at breakneck speed for the last decade, driven by an almost equally rapid fall in prices. If this continues, solar electricity could well become the cheapest generating technology as early as 2020.

Solar has written the doom of coal on the wall, and probably oil, not a moment too soon. It couldn´t happen to nastier industries. Paul Krugman; Kevin Drum; an even more optimistic take here. Here´s Kevin´s extrapolation, a little different from my paper exercises, but the same story:

What surprised me was this put-down from economist Tyler Cowen (his italics):

… The real question is whether we see industry-wide price changes as would befit a systematic solar energy revolution.Is there any reason, based in industry-wide market prices, to be optimistic about the near-term or even medium-term future of solar power? I don’t see it.

You´d be hard put to find a better illustration of the old chestnut about the EMH economist whose friend tells him there´s a banknote lying in the road:

Can’t be. If there was a bill on the ground, somebody would have already picked it up.

Where to begin? Most normal people would say: that´s another nail in the already well-sealed coffin of the EMH. But faced with indisputable facts about solar market prices and installation quantities, Cowen´s response is: where´s the solar boom or fossil bust in asset prices? He can´t see one, so the facts must be wrong, or more politely epiphenomenal noise. Note that the objection is not based on any falsifiable hypothesis about solar PV, such as: Germany will have to cancel its solar PV feed-in tariff as unaffordable, silicon feedstock supply will hit a new bottleneck like the one that kept prices from falling in 2004-2008, solar PV will turn out to cause cancer, impotence and obesity or at least will be thought to do so. (Now there´s a hot tip to the oil industry PR men: work up some scares.) For the record, while Germany did reduce its feed-in tariff, China has announced one.

However, simply asserting the primacy of facts over speculation will not do. You have to sauce the data with a theoretical narrative.

1. The global solar PV business is extremely competitive (good news, in spite of numerous casualties like Solyndra). There are plenty of suppliers at each stage in the chain. No single company has a monopoly, or even a serious edge in technology. This by itself makes an asset bubble unlikely; it´s impracticable to pick likely winners, and bubbles are not driven by prudent, diversified portfolio investors. To a first approximation, solar PV wafers, modules and panels are manufactured quasi-commodities, like fridges and DVD players. It´s also important that this is a global industry, even though China is coming to dominate the wafer end. Its growth and technological advance is less and less dependent on policy vagaries in any one country. The USA in particular is very much a second-division player.

2. Because it´s growing so fast, and installation demand is sensitive in the short run to unpredictable policy changes in key markets, the solar PV industry is prone to short-run cycles of over-and under-capacity. At the moment, it´s overcapacity, and stock valuations are down. So what? The cycles tell you nothing about the trend.

3. Solar energy, like wind, is paradoxically not a natural resource industry. Over a 50-year horizon at least, there are no serious constraints on the energy sources. (Brett, I recognize that wind runs into problems of interfering with weather patterns when you get up to tens of terawatts.) The same goes for the inputs: sand and tiny amounts of rare earth dopants for solar; steel and a little hydrocarbon resin for wind. Hydro does face natural resource constraints, and so does geothermal a long way down the road. For practical purposes, the production of solar and wind generators are manufacturing industries.

That is, their general production function is characterised in the medium run by constant returns to scale. You can expand supply at the same cost by building identical new factories and training new workers without practical limit. By Econ 101 principles, you would not expect to see significant price changes in such industries other than those driven by improvements in technology, and short-run cyclical ones which most manufacturers prefer to replace with queuing and promotions. If you´d been trying to observe the personal computer or mobile phone industries recently, or the refrigerator and car industries in the 1930s, or railways in the 1870s, just by looking at the unit prices, you would have missed most of the action, which was in the quantities shipped.

Both solar and wind energy are also demonstrably characterised by impressive economies of scale from learning; nuclear power, the reverse. There is no reason to think that any of these trends will stop any time soon. In solar, the principal avenue is reducing the high cost of feedstock of appropriate purity, rather than struggling up a diminishing-returns curve, as Solyndra did, to wring out increases in conversion efficiency.

4. The absence of reaction in the asset and commodity markets for fossil fuels does not prove that their doom is not written. First, the projection of current trends only suggests that solar PV will be cheaper than fossil for electricity generation in 10 years´ time. Meanwhile, oil in particular will have a fantastically profitable Masque of the Green Death. The usual myopic effects of commercial rates of discount are reinforced by the incentives on managers to have an even shorter horizon. You won´t see oil companies´ stock prices fall for a good while yet. Coal? Sooner I think; as renewables provide electricity, coal´s only market, while substitution for oil in transportation has to overcome the battery bottleneck for cars, and nothing´s in sight for aviation. The going-out-of business party will be terrific, though I do hope they don´t take this approach to downsizing the clerical help:

Eugène Delacroix, The Death of Sardanapalus, 1827

5. There is something deeply weird and misguided about giving cognitive priority to prices over quantities. Any economic transaction involves both a price and a quantity. So economics as the study of such transactions must look at both. But I´d go much further than this truism. Prices belong to the universe of information; they are signals about reality. That reality consists, for the economist, in stocks of assets, workers and knowledge, and flows of labour, goods and services. These stocks and flows exist in the physical universe of matter, independently of the price that may or may not be attached to them. It is these flows alone that create utility. A Leontief input-output matrix using incommensurable physical units – tonnes for steel, kwh for energy, hours for labour – is a useful if limited tool for understanding. A matrix of prices without quantities to attach to them is useless.

One of the functions of economics as a science is to allow its students to tear the veil of money illusion and see this real world of utility beneath the epistemic flux and foam of transactions. You don´t have to endorse the false labour theory of value to assert that quantities are ontologically prior to prices. If that´s Puritan fundamentalism, I say: sign me up, John Calvin.

Apologies to Poe for ripping off the title of his great story.


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