By Larry Marsh, Kansas City Star Midwest Voices columnist

Should we let Nancy Pelosi and Harry Reid pick the next big thing in alternative energy? Will their pet projects save the day, or turn out to be losers that crash and burn?

Perhaps there’s a better way. The fundamental problem is our failure to account for unwanted side effects which economists call negative externalities such as pollution and our dependence on fossil fuels and foreign oil imports. We all pay a price for these negative externalities through the inefficient allocation of our resources.

For a product to be produced efficiently, the full social cost of producing it must exactly match the private cost the firm uses to calculate its profits. Otherwise, the firm will overproduce and generate negative externalities or underproduce and generate positive externalities. An example of a positive externality would be the protection your friends and colleagues get when you get vaccinated for a readily-transmitted disease which is why most societies subsidize vaccinations to some extent.

Economists are not against pollution. Pollution is fine as long as it is at its optimal level. The problem is that the current level of pollution is way above its optimal level. Consequently, we need to bring down the pollution level.

Environmental and geo-political negative externalities mean that the social cost is often considerably higher than the private cost (the price we now pay). You probably feel that we are already paying too much at the pump. Unfortunately, if the true social costs were covered, the pump price would be even higher.

There are two possible approaches to solving this problem. The first approach calls for adding just enough tax to bring the private cost up to the social cost. This first approach would account for the environmental and national security damage caused by buying oil from our adversaries by imposing a tax such as that proposed under the carbon-credit-trading tax system. Alternatively, a second approach brings the social cost down by subsidizing some environmentally friendly form of alternative energy that either we produce or is produced by our geo-political friends.

While this second approach seems less painful, it is also a lot more dangerous. The first approach handicaps carbon polluting forms of energy, and creates a level playing field for alternative energy solutions, making them all considerably more profitable than they are today. The second approach requires that we pick a winner or some subset of possible winners. But how do we choose? What if we are wrong?

Until the late 1700’s, the British (and others) suffered severely from not being able to calculate longitude at sea. Ships that used dead-reckoning (straight point-to-point sailing) were attacked by pirates while those deviating from these sea lanes got lost at sea. The solution that paved the way for the British Empire was not discovered by the usual suspects at Oxford or Cambridge. Instead, a peasant in the British countryside with almost no formal education solved the problem. He had never even been to sea before devising his solution!

Some think the solution to our energy problem is wind or solar. But wait, maybe there’s something better just around the corner. Yes, there’s a newly fashionable geothermal, heat-pump-like solution based on ammonia which has a much lower boiling point than water. Should we bet our chips on this seemingly cheap solution or is there a fatal flaw or a better method or combination of methods waiting in the wings?

Instead, why don’t we take the first approach and let the free market sort this all out to find the most cost effective solution? Mistakes will be made, but at private expense. Before long, true winners will emerge.

Perhaps we should stop screwing around, and just take our carbon tax medicine. Otherwise, we could be sick for quite some time.

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Also see:

Define energy independence in terms of both oil price and quantity

A Gas Plan for Congress: A dynamic self-adjusting price floor for gasoline

Deprive petro-dictators of oil money with a price floor on crude oil imports

Law professors propose new gas tax with categorical tax rebates

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