Suppose you believe that sooner or later, providing transport fuels will become a problem? What do you do, and more to the point, how do you go about it? The issues are surprisingly complicated, and as an example, consider the case of when the government wishes to promote ethanol from corn, as in the US.
This appears to eb a simple problem as the technology is well established, but that still leaves open the question, how do you do it? To encourage production, and avoid the moral hazard of selecting specific companies, or worse still, to defend against allegations that you selected your friends, the simplest procedure is to offer the money as a subsidy.
The reason for going after corn in the US is simple: when this was first considered, there was a surplus of corn and spare corn was cheap. However, corn is also a food, and the price elasticity of food is not a simple function. If you have too much food, depressing the price has little effect on increasing consumption, because you (or animals) can only eat so much. On the other hand, if you have too little, you (or animals) still have to eat, and accordingly there is competition for what is available and the price goes up significantly. Worse, there is not unlimited land on which to plant more. Accordingly, the end-result tends to be a function with a sharp bend and it is never clear where that is. Accordingly, the first corn plant makes ethanol with little downstream effect, and if the subsidy is enough, the plant makes money. Unfortunately, that encourages "me-too" investment and at some point the corn price rises.
While simple theory suggests that the price will rise to the point where further investment in ethanol is discouraged, simple theory overlooks the effect of response time. It takes perhaps years to construct such a plant, and if the initial indicators are good, usually there is an overinvestment in such plant. Accordingly, prices rise above where the subsidy makes a profit, which means there has to be a shakeout. What tends to be shaken out are the least efficient plants, or those with the least persistent backers, and paradoxically it is often the early plants that get shaken out.
From the public point of view, there is moral hazard in selecting specific companies and helping them; from the economic point of view there is hazard in subsidies; from the system point of view there is long-term hazard from doing nothing, because at some stage the transport costs will get put of hand and while eventually this problem may (or may not) be solved, eventually may follow the greatest depression of all time. So, the question is, what should be done, and how should it be done? In my opinion, there has been a serious shortage of thought on this issue. Don't we care if we all have to walk? Or is it just that the politicians do not care, because they believe that whatever else happens, they will never have to walk?
