How going to Green Energy Can Lead to a More Prosperous America

How the concept of leading sectors explains why a green energy transition can be better for growth than business as usual in a world without global warming.

One reason climate skeptics question the existence of anthropomorphic global warming sis they believe addressing climate change will have negative effects on the economy. This is probably wrong, but it is understandable because most skeptics are political conservatives, who tend to support economic policy, such as low marginal tax rates on high income earners, that selects for shareholder primacy (SP) business culture. Under SP culture, the objective of economic activity is to increase shareholder value, measured by stock market capitalization. That is, the goal of business (and economic policy) is to achieve a financial outcome; any economic growth that occurs is ancillary. So economic growth can be poor under such a regime, regardless of whether climate change is addressed no not. Because such an economy is not conducive to building the sort of new infrastructure required to address climate change, any serious attempt to address climate change will require a weakening of SP culture, which conservatives oppose.

In fact, the process of shifting from fossil fuels to green energy will very likely boost economic growth. Creating a carbon-free energy system will necessarily create new industries that do not exist now, which will enlarge the current leading sector, increasing the economic “speed limit” (the growth rate above which the economy begins to overheat, generating inflation). A leading sector is defined as a subset of the economy that grows at a faster rate than the rest of the economy, spearheading the economic growth process. It consists of a bundle of leading industries producing output in response to the creation of new categories of demand.

Personal transportation is a good example of a new category of demand. Consider a factory worker in 1900. He walked to work and did not spend money on personal transportation. The idea of an untapped demand among ordinary people for personal transportation beyond one’s own legs was not a thing in 1900. By 1970, it very much was a thing. Factory workers drove to work, and their households had a personal transportation budget consisting of regular expenditures for car payments, insurance, fuel, and maintenance. These expenditures provided sales for carmakers, insurance firms, petroleum companies, and service stations as well as income for their employees. The creation of this new category of demand spurred sales (economic output) that generated personal income resulting in more demand for the new thing in a virtuous cycle. That is, it served as economic stimulus, boosting economic growth.

Strong economic growth requires optimal economic culture (SC is better than SP), sound policy (low inflation and a sound financial system), and a deep reservoir of unmet demand for entrepreneurs to tap. This reservoir is provided by the leading sector. Larger leading sectors produce more growth. So, efforts to “beef up” the current information economy by adding more leading industries will very likely promote economic growth, even more so if we also get the culture and policy right. Old timers may wistfully recall the postwar boom, or Les Trente Glorieuse (30 glorious years) as it was known in France. GDP and wage growth was so strong then not only because the economy operated under SC culture, but also because the mass-market leading sector was very large, 25% of US economic output in 1970 was in manufacturing, compared to just 10.5% for the tech industry in 2020. About twenty years ago I did an estimate of the size of these two leading sectors, based on employment in the industries I selected as representative of the information and mass market leading sectors. I concluded the former was about half the size of the latter, which is consistent with the comparison metric presented above.

One kind of new category of demand occurs when there is an energy transition. Energy transitions, often coupled with transportation transitions, have enlarged several previous leading sectors. For example, the 8^th leading sector (US cotton/UK textile) saw the rising use of wood-fueled steam engines for transportation (steamboats). Coal has a higher energy density than wood and so was more suitable for long-duration ocean voyages. Following the development of an effective marine propeller, coal-fueled ocean-going steamships became feasible. Freight costs fell dramatically after 1850 as sail gave way to steam.

The next leading sector saw a larger transportation innovation and another energy transition. The invention of the railroad created an enormous demand for iron and steel to build the rails, the manufacture of which spurred the growth of the coal industry, which served as a key leading industry in the railroad-industrial leading sector. As with earlier steam engines, wood was used to power locomotives in the early days, but it was soon replaced by coal for energy density reasons. By the nineteenth century, home illumination had advanced from sooty fat lamps and expensive candles to well-trimmed oil lamps that produced less soot for a given amount of illumination. Whale oil was the most suitable oil for this use, but as this resource grew scarce, kerosene, a product derived from crude oil, was developed as a replacement, with the first crude oil well in America drilled in 1859.

The 10^th (mass market) leading sector saw yet another transportation revolution, the automobile, the single innovation most responsible for the personal transportation leading industry discussed above. Automobiles consisted of a heat engine mounted on a carriage connected to a mechanical powertrain that transferred power to the wheels. Coal-powered steam engines had the advantage of decades of development in locomotives, but using coal for cars was a non-starter due to the difficulty of solids handling. Hence steam-powered autos used more expensive kerosene as fuel, eliminating coal’s fuel cost advantage.

Petroleum is a complex mixture, only part of it is kerosene. Gasoline, a byproduct of kerosene production, was unsafe for use in either lamps or boilers because of its volatility and so had little value. The recently invented Otto internal combustion (IC) engine was designed to use a volatile fuel (alcohol) and could be modified to use cheap gasoline as fuel. Automobiles powered by gasoline IC engines would win out over steam. The growth in the personal transportation industry, created a huge demand for gasoline. An IC engine designed to burn another component of crude oil had been invented by Diesel around the same time as Otto’s engine. This meant that automobiles and trucks powered by Otto or Diesel engines gave high-value uses for most of the liquid components of crude oil, creating the modern oil industry, which provided a second leading industry making up the mass-market leading sector. In time, diesel replaced coal-fueled steam locomotives and oil replaced coal for residential heating, growing the industry further.

Coal was also used to produce a flammable “coal gas” that was used for industrial purposes and for residential lighting provided by gas jets. Crude oil extraction produced flammable “natural gas” as a worthless byproduct, which was typically flared off. With the construction of a suitable pipeline connecting the wells to urban areas, natural gas became available as a safer (coal gas is poisonous) and more energy-dense alternative to coal gas, resulting in its displacement. Coal displacement continues today, with the last bastion of coal use, electric power production with coal-fueled steam turbines, being replaced by natural gas-fueled IC turbines.

Note that replacement of coal with oil and gas was not because of rising coal prices due to resource exhaustion; there was plenty of coal. It was being replaced by a higher priced fuel that yielded non-price benefits of simplicity (IC engines were lighter and less complicated than steam engines) convenience (difficulty of solids handling ruled out coal for personal transportation) or safety.

The discovery of global warming (and the role greenhouse gases like CO₂ play in it) has made the use of fossil fuels inconvenient and unsafe. For example, global warming means higher sea level and greater storm surge damage from hurricanes, which is both inconvenient and dangerous for coast dwellers. Higher temperatures mean more hot days, which is inconvenient and dangerous for those living through heat waves. Higher temperatures mean more evaporation and lower soil moisture, which is inconvenient for farmers and more expensive for food consumers. Thus, just as factors other than fuel cost led to coal being replaced by oil and gas, so will the same lead to the replacement of fossil fuels by green energy.

This analogy with coal replacement breaks down because the inconvenience and extra cost of using fossil fuels is not directly connected to fuel use, as it was for coal. Some fossil fuel users experience little inconvenience or risk, while others experience more than their share. The mechanism of climate change provides this disconnect between fossil fuel use and adverse effects by introducing a buffering effect and a time lag. The buffering effect refers to the fact that the greenhouse effect acts on a global basis, serving to raise the average temperature by a bit over 0.3 degrees F per decade. In contrast, inconvenience and expense manifest as a result of adverse weather. Weather produces large fluctuations in temperature, precipitation and storm frequency/severity that make it impossible for ordinary people to discern the signal of rising irritable and costly outcomes amidst the noise of ever-changing weather. That is, there is no way fossil fuel market participants can properly account for the adverse side effects of fossil fuel use and take that information into consideration in establishing a market price. This is what economists call market failure.

The time lag means that the negative impacts of fossil fuel use tend to manifest sometime after the fuels were used, which exacerbates the market failure. For example, sea level change coming from warming is a lagging effect because it takes time for the ice to melt. Figure 1 shows a plot of past sea level values against the global temperature of that time. Unsurprisingly, warmer temperatures are associated with higher sea levels because the ice caps are smaller and the water that would be in the ice caps at lower temperatures is in the ocean, raising sea level.

Figure 1. Equilibrium sea level versus global temperature over the past 420 millennia

The figure suggests that for temperatures around where we are today, we might expect to see about 15 feet of sea level rise for every degree Celsius of warning. Based on current temperature trends we might expect to see 2-3 feet of sea level rise per decade, which we don’t see. The reason why is the data in the figure reflects equilibrium values. The period of time covered in the figure is more than four hundred thousand years, so the climate system had plenty of time to fully adjust to changing temperatures. In chapter 7 of America in Crisis, I did a very simple calculation to estimate how long it might take for sea level to adjust to an increase in global temperature. That is, how long would it take to melt the amount of ice needed to reach equilibrium? I came up with something like 1200 years to melt the 15 feet of ice associated with the one degree of global warming already achieved. I did not take into account how melting ice would affect albedo, or the impact of the release of greenhouse gases trapped in permafrost. Both of these would speed the melting process, so I looked at the historical record for previous examples of rapid sea level rise. These indicated considerably faster melting than my estimate has occurred in the past, but it is still a matter of multiple centuries for such a change to manifest. If the trend line in Figure 1 gives a valid prediction, Florida will be largely underwater in a future America, but only long after those responsible for its submergence have died.  Sea level change is the easiest effect to forecast, but also the slowest acting. Other effects such as changes in precipitation and severity of heat waves will happen much sooner, but are not easy to attribute, complicating individual efforts to obtain compensation for climate-related harm from fossil fuel users.

Once the damage becomes evident to all, trying to obtain compensation will bankrupt the economy, making use of torts impossible. It will be up to the government to deal with the mess. This makes the state the entity that will end up having to deal with the negative side effects of having permitted greenhouse gas emissions to continue as long as it did. So, it falls to the state to charge a fee for fossil fuel use now, in order to recover some of these future costs and to prevent those costs from snowballing out of control. The state operates according to political logic of course, and until harm is transmitted to governing elites and their donor class it is unlikely much action on this issue can happen. Discussion of the politics is a topic for a future post. Here I discuss what leading-sector-related benefits might come were the state to somehow deal with this issue now.

The best way to deal with climate change is to implement a carbon tax or equivalent that creates a cost proportional to the amount of CO₂ produced by the fuel. The level of the tax would start out small and then be raised over time in order to maximize the amount of revenue the tax raises. No effort would be made to try to measure harm, the objective is revenue, same as any other tax. The additional revenues would be applied to deficit reduction. This is because the cost of past use of fossil fuels will manifest as increased future government spending that can cause inflation. In other words, the carbon tax would be implemented as an inflation-fighting tool. A carbon tax can also be justified in terms of national defense as the cost of dealing with unmitigated future climate damage will weaken America relative to powers less vulnerable to warming, such as Russia or Canada, while the existence of nuclear-armed powers more vulnerable to climate (e.g. China, India, Pakistan) will mean a more dangerous world.

Suppose something like a rising carbon tax was implemented so that the attractiveness of using fossil fuels diminishes going forward, eventually becoming cost prohibitive. Doing this produces the same effect as the whale oil shortage did, causing price to rise and replacements to be developed. Once this process begins the example of the replacement of coal with oil becomes relevant. The fossil carbon content of fossil fuels makes them inconvenient as a fuel just as the solid form of coal made coal inconvenient. The carbon tax provides a measure of this inconvenience because it is the government, not the fuel user, who will be stuck dealing with it.

New leading industries (oil, gas, petrochemicals) appeared as part of the adjustment to the increasing unsuitability of coal as an energy source for pretty much anything. This came as new uses were found for different fractions of crude oil. Here electricity produced by solar or wind plays the role of crude oil and daytime electric power is kerosene. Solar and wind are intermittent sources, with solar producing little or no power much of the time (night and wintertime). One way to deal with this is to use a non-intermittent source like nuclear to provide a baseline level of power with natural gas taking up the slack when the renewable electricity is in short supply. Because nuclear is expensive and gas will be getting ever more expensive, it is desirable to employ cheap renewable electricity as much as possible. Renewable capacity can be built to be able meet all above-baseline power demand during daytime, even in the winter, twilight, and during calms. This is analogous to efforts to expand petroleum production to replace all whale oil with kerosene.

Such an electrical system will have a great deal of unneeded renewable electricity some of the time. This is analogous to the non-kerosene fractions of crude oil. Some of this excess can be used to charge batteries, which can then release electricity at night to substitute for increasingly expensive natural gas. Electricity has uses other than grid power, however. It can be used in electrochemical reactions to make fuels and chemicals. An obvious example is electrolysis of water to produce hydrogen. Water is cheap and excess daytime solar power is a cheap byproduct of producing enough power to meet demand when the sun is not maximally intense. This makes it a low-value byproduct analogous to natural gas in crude oil production. One could build a pipeline to transport hydrogen made from excess renewable energy to heavy industry like steel and cement makers as a replacement for expensive natural gas. Here natural gas plays the role of coal gas, and hydrogen that of natural gas in the previous energy transition.

Hydrogen can also be used a starting material for chemical synthesis, as natural gas is today. It can be used to convert non-fossil carbon sources like biomass, denoted as CH₂O, or even atmospheric CO₂ into hydrocarbon fuels, denoted as CH₂:

1.      CH₂O + H₂ → CH₂ + H₂O

2.      CO₂ + 3 H₂ → CH₂ + 2 H₂O

Reaction 2  is possible with century-old technology, but would be expensive due to the difficulty of recovering CO₂ from the atmosphere. Given the smaller amount of hydrogen used, the conversion of biomass to fuels seems more attractive. This is a two-step process, where biomass is reformed into “bio-oil,” a viscous oily mixture containing a lot of oxygen that has a low fuel value as well as being unsuitable as a replacement for conventional hydrocarbon fuels. This is a relatively low-tech process that would be done at the location where the biomass is produced, at lumber or paper mills for forest residues or by rural co-ops for agricultural wastes. The bio-oil would then to sold to refiners who would convert the bio-oil into higher value hydrocarbon fuels using a process called hydrodeoxygenation. Here hydrogen is reacted with the oil producing a diesel-equivalent fuel and byproduct water with the idealized overall process given by reaction 1. This product can replace fossil fuel-derived aviation and truck fuels with no reduction in performance.

Because bio-oil is a complex mix, a number of side reactions occur, producing undesired side products. Addressing these problems would require a large-scale research efforts at developing better catalysts and optimizing conditions for each specific type of bio-oil. In a world of CRISPR/Cas9 and abundant reducing power in the form of hydrogen or renewable-generated electrons, we might bypass bio-oil derived from existing biomass and instead design microbes that carry out reaction 1 directly or even produce fuels and chemicals directly from CO₂ and surplus renewable electricity.

Such efforts have not been done at scale, partly because at present hydrogen is expensive and using it to make fuels doesn’t make economic sense. It is only in a world in which rising carbon taxes makes fossil fuels less attractive as a resource and renewable electrical power generation during peak sunshine makes cheap hydrogen available that such research would make sense. To make this possible, government would need to build the necessary pipeline connecting solar hydrogen generators to hydrogen users which include demonstration plants carrying out hydrodeoxygenation of bio-oil. The oil companies would still be in the business selling hydrocarbon fuels and chemicals, except bio-oil (or a bioengineered alternate) would gradually replace crude oil as feedstock as the price of the latter rises. The government would initially pay for the hydrogen produced by the solar companies and then sell it to the fuel producers below cost, providing a subsidy needed to get the solar hydrogen production capacity built. In a world where the petrochemical giants are trying to morph into biofuel-chemical giants, opportunities to do new things will emerge, just as the initial production of oil to produce kerosene for lighting led to the development of uses for gasoline, diesel, natural gas and the development of the entire petrochemical industry.

It is these unforeseen developments that occur when an industry is shaken up by a paradigm shift, such as a transition to a new energy source, that create new leading industries that strengthen a rising leading sector. By creating a new category of demand for non-polluting energy, opportunities will arise to take the new inputs and capabilities created by this shift to create new categories of demand. For example, by converting bio-oil and hydrogen into plastics that are landfilled after use, biofuel-chemical companies can achieve “carbon sequestration” as a side effect of their plastics business. Although this would have a negligible impact on atmospheric CO₂ levels, it might be good for PR.

As the carbon tax rises, the value of fuels and chemicals not derived from crude oil will rise, and so will the hydrogen needed to make them. The government pipeline will become a profit-maker allowing the government to sell the business through an IPO to recover the costs incurred in the building of the pipeline and the subsidies provided to get the hydrogen market up and running. After this, normal market dynamics can operate it. Markets work well when there is full accounting for information, so prices are determined rationally, but sometimes they need guidance.

I should note that this hydrogen example is just an example of what cultural evolution might yield given the changing environment caused by a carbon tax or similar policy. What actually happens likely will be something different, since the prospects for a carbon tax seem dim and this assumes there will be a functional American state in the future. Dealing with climate change puts the same sort of demands on the state as large-scale war, and in a climate emergency it is likely the state would have to deal with both at the same time, which might be beyond its constrained capabilities under SP culture.

In fact, SP culture underlying what is called neoliberalism is the primary obstacle to addressing the challenge of global warming in a way that produces a broadly beneficial outcome. For example, oil companies have opted to oppose the replacement of fossil fuels rather than develop versions of their products that do not use fossil fuels. This likely reflects SP culture in which the objective of energy companies is not to sell energy, but to maximize shareholder value. By spending relatively small sums on political efforts to slow government efforts to promote fossil fuel substitution, they can direct investment into financial strategies to boost market capitalization in lieu of developing a green synfuel and chemical industry which they might have pursued under SC culture.