Last year, the world invested more money in renewable energy than ever before, at over $257 billion [1]. There is no question that renewable energy projects need finance to develop and commercialize. According to the International Energy Agency (IEA), $37 trillion of investment will be needed in the world’s energy supply system over 2012-2035, of which a growing component will be in renewable energy [2]. But where should this money come from? And what is the government’s role in this?

This year’s US presidential debate highlighted the divide in political opinion on energy policy, as the candidates took sides in a determined discussion over whether or not the government should be in the business of financing renewable energy. This article takes a look at the topic of renewable energy financing – specifically, under what conditions government intervention would be warranted, and what form such intervention might take.

Why would the government invest in renewable energy?

There are a few common reasons used to justify a government role in renewable energy investment, including energy security and affordability, the potential for job creation, future economic strategic positioning, and addressing environmental and other externalities. But these problems and their related policy approaches need clarification. Yes, renewable energy could contribute to all of the goals above, but does that make it the best policy to achieve these goals?

The energy security argument asserts that the ticket to achieving greater security and affordability is to invest in renewable energy that can be produced at home and doesn’t rely on the whims of fossil fuel markets abroad. But in general for energy production in the US, domestic fossil fuels win out over renewables in terms of cost-effectiveness [3]. Domestic coal is abundant and cheap, and the availability of natural gas has skyrocketed in recent years, driving down prices that are likely to render this option affordable in the medium term [4]. It’s true that renewable technologies have increased in cost effectiveness over time, but parallel improvements in fossil fuel technologies make it harder for the economics of renewables to stack up by themselves.

Similarly, the idea that government investments in renewables can spur job creation doesn’t hold in the long term. In a recession the government might look to promote job creation through government expenditure targeted at specific industries, but in the long run the economy is at its optimum when industries are operating the most cost-effectively. Again, if fossil fuel based energy is more cost-effective, that means investing in carbon-based fuels and their related job opportunities.

A longer-term view of investment in renewables is that it has the potential to position the US competitively in future clean-energy technology markets and industry. But the evidence is unclear around this strategy — when Germany made significant investments in solar photovoltaic (PV) technologies their production of these systems boomed, but once China entered the market German companies’ share of the global PV market reduced from 69% in 2004 to 21% in 2010 [5].

This leaves only one substantial reason why the government might want to invest in renewables — that the price of energy does not capture environmental and social costs and benefits (otherwise called “externalities”). This idea suggests that fossil fuels are being unfairly favored despite negative external impacts, and renewable options need a leg up to realize the social benefits that they could bring. Private investors are unable to gain the full social benefits of investment in renewable technology, so the government needs to step in to fill this gap. As climate change becomes a greater problem, this reason may take center stage.

What can the government do?

If we acknowledge that investing in renewable energy can have social and environmental benefits beyond those that the private sector can capture itself, then the government and its policies can impact investment through: changing the allocation of costs and revenues from investment; altering the allocation of risk; or guiding the business and technology choices of investors. The federal government has traditionally used finance to promote the development of new energy sources and technologies, improve extraction and production of an energy source, or encourage domestic production of an energy source.

To achieve these goals the government has a host of potential financial tools, including:

  • Direct grants and investments whereby funding is transferred directly to recipients, often for research and development (R&D);
  • Loans and loan guarantees, catering for the risk that the private sector and investors face in either R&D or commercialization and expansion stages; and
  • Tax incentives that help improve the economics of either initial investment or operations in renewable technologies [6].

Over time, virtually all sources of energy have received some form of US government support. As far back as 1916 the government introduced tax incentives to encourage companies and individuals to drill for oil. In the 1930’s, the government focus shifted to federal finance for dams and hydroelectric power. From the 1950’s onward the government financed research in nuclear power and in recent years the government has provided finance for alternative and renewable energy [7]. The graph below shows the value of preferential taxes (e.g., special deductions, tax rates, tax credits, and grants) for different sources of energy in the US since the 1970’s. It shows the decline in fossil fuel and the rise of renewable energy based tax preferences over time.

Source: Congressional Budget Office 2012

What should the government do?  Two sides of the story

With these tools available to the government, what should the role of government be in financing renewable energy development in the US? This is where it gets less clear, and there is a spectrum of views on how or if the government should invest in renewables.

“Government should lead the way”

Those that argue for an active government role in financing renewable energy view the social returns to investment in renewables as being much higher than the private returns, justifying an active government role in providing economic incentives for investors to transition to renewable energy. They highlight how the externality costs of fossil fuels are shouldered not by fossil fuel producers, but rather by wider society. For the US this might include the cost to the defense budget of securing the supply and transit of oil, the future costs of climate change, or the life cycle costs of coal estimated at $330 to $500 billion dollars annually in the US, with additional qualitative costs including harm to air quality, watersheds, land, plants, animals, families and communities [8]. As these external costs usually do not factor into the private sector’s priorities, advocates see it as the government’s role to make sure these costs are addressed.

Another case for a significant role for government in renewable energy finance is where there are gaps in the private sector’s appetite for investment, due to the risk profile or longer-term horizon of investments. The presence of this gap is harder to quantify as investors search for investment opportunities across the spectrum of risks and timeframes, but maybe a constraint on investment in technologies that would bring substantial benefits to society.

“Leave it to the market”

On the other hand, those that advocate a diminished role of the government in renewable energy finance argue that current prices actually closely reflect social costs, and that the market will take care of the development of renewable energy as it becomes cost-effective. As the costs of PV technology, wind turbines, energy storage, and other clean energy technology have decreased over time, they have become competitive in their own right and it would have been inefficient for the government to invest in uneconomic technologies at an early stage. Advocates of a market-based approach believe that the government has no place in ‘picking winners’ for investment and knows no better than private investors what to invest in for the long term.

Another argument is that the external cost of various energy sources is too uncertain, and the external costs of renewable energy could be equal or even greater than traditional fossil-fuel based technologies, e.g., through environmental costs of technology manufacturing. Estimates of environmental and social damages associated with energy sources are wildly variable based on the fact that we don’t know what the costs of climate change are, and health costs are highly uncertain. The estimated impact of greenhouse gas emissions varies widely due to uncertainties about the future [9].

So where do we go from here?

A recent report on global trends in renewable energy found that investment in renewables has been increasing dramatically — globally it accounted for 44% of new energy generation capacity last year, compared to 34% in 2010 and only 10.3% in 2004. The source for most of this financing was the private sector, but the government and public sector still played an important role. In terms of international dynamics, China surpassed the US’s total annual investment in renewable energy in 2009, and invested the most of any country, at $52.2 billion, in 2011 [1].

While the investment opportunities for renewable energy continue to grow, the question is to what extent the government ought to finance such investment in the US. There is clearly some role for government policy to assist in a transition to clean energy, but the final say on how much should be spent rests on to what extent we think prices in the market do not reflect the true costs of non-renewables, and where the gaps in private sector finance lie.  In reality both sides of the debate can find evidence and reasoning for a larger or diminished role of government in the renewable energy sector, but the key is to first ask what the end goal is, and to develop policies accordingly.

Kai Graylee is a Masters in Public Administration in International Development student at the Harvard Kennedy School


[1] UNEP (2012) Global Trends in Renewable Energy Investment 2012, UNEP Collaborating Centre for Climate and Sustainable Energy Finance

[2] IEA (2012) World Energy Outlook 2012, International Energy Agency

[3] US EIA (2011) Levelized Cost of New Generation Resources in the Annual Energy Outlook 2011, US Energy Information Administration

[4] IEA (2012) Medium Term Gas Market Report 2012, International Energy Agency

[5] Der Spiegel (2011) German Solar Firms Eclipsed by Chinese Rivals

[6] Congressional Budget Office (2012) How Much Does the Federal Government Support the Development and Production of Fuels and Energy Technologies?

[7] Robert H. Bezdek and Robert M. Wendling (2007) A Half Century of US Federal Government Energy Incentives: Value, Distribution and Policy Implications, International Journal Global Energy Issues (Vol. 27, No. 1, 2007), pp. 42-60

[8] Harvard Medical School (2011) Mining Coal, Mounting Costs. Center for Health and the Global Environment

[9] Richard Tol (2005) The Marginal Damage Costs of Carbon Dioxide Emissions: An Assessment of the Uncertainties, Energy Policy 33, 2005, pp. 2064-2074.