Calfornia’s New Industrial Policy: Tesla

Pulling away ever farther from the federal government Washington, California seems to be developing its own strategic industrial policy.  This one is not only designed to create jobs in its electric car industry led by Tesla, but perhaps to flip the state to a future in which electric vehicles replace gas-powered vehicles to become the new norm.

When I was a doctoral student at Berkeley in the 1990s, strategic industrial policy was much in vogue.  Leaders in this field were some of my professors: Laura Tyson, John Zysman, and Stephen Cohen, housed at a local industrial policy think-tank on the Berkeley campus, BRIE: The Berkeley Roundtable on the International Economy.   Led by best-selling books such as Manufacturing Matters, the purpose of the institute was to articulate a case for government intervention in domestic industry, particularly in high-tech manufacturing. 

At BRIE, lasses-faire, Adam Smith, David Ricardo and comparative advantage were all out.  Strategic planning was in.  Confidence abounded at BRIE in government’s ability to pick high-tech winners, a confidence not shared by most other economists.  Partnerships between national governments and industry were key to maintaining an edge in leading industries.  While in many economics and business circles of the 1990s South Korea and Japan were seen as job-stealing villains, at BRIE they were leaders and heroes, pointing to a new type of partnership between government and industry that would dominate traditional free-market approaches.

This type of coordination (or collusion as seen by detractors) between the state and industry is embedded in California State Assembly Bill 1135.  Passed by our State Assembly and under review in the State Senate, the bill sets aside $3 billion for rebates from consumer purchases of electric vehicles. The curious part about the writing in the bill is that “electric vehicle” (EV) is defined in a way that rather remarkably fits the description of the new Tesla Model 3.  Purchasers of hybrids (like my own wonderful Chevy Volt, and others like the Nissan Leaf, and the Toyota Prius) would not collect any of the $3 billion.

There is an uproar by some about how large subsidies for individual vehicle purchases could become, an uproar that is far from unreasonable.  The California Air Resources Board would determine the size of a given rebate based on the difference between the cost of an EV and a comparable gas-powered car.  So if the EV you like costs $40,000 (like, er…the Model 3) and a comparable gas-powered car is, say, $25,000, the federal government (as long as their subsidies last) would contribute $7500 and the state the other $7500.  But this could balloon substantially with a more expensive Tesla costing $100,000, where the comparable gas-powered car might be argued is closer to $60,000, resulting in subsidies that reach $30,000 or more.

But to me this isn’t the interesting part of it.  What is intriguing is how this kind of state-led industrial policy could disrupt the standard classical laws of economics based on diminishing returns, and flip the state to a new transportation equilibrium in a context where increasing returns are likely to be in play.  These increasing returns occur on two complementary fronts.

The first is Tesla.  One of the main issues facing the automaker is that the price of its cars is too high because the automaker has not yet achieved the economies of scale necessary to drive down the average cost of production for its vehicles.  Tesla craves scale like an NBA center craves leg room in the front seat of a Model 3.  And scale for Tesla is difficult as long as the whole U.S. economy and its infrastructure are coordinated on a gas-powered automobile equilibrium.  Even in my fair state of California, the vast majority of the state’s infrastructure, its network of highways, fueling stations, and repair shops, has catered for a century to a transportation equilibrium centered around the combustible engine.

But suppose that due to heavy state subsidies, consumers were to dramatically increase their purchases of electric cars.  And suppose that these purchases were large enough that the equilibrium in California were to flip to a new one that began to favor electric cars.  That would be good for Tesla, because California is a big state.  It would be selling lots of cars right here at home.  And the increased domestic (in-state) sales might be enough for it to gain traction on increasing its economies of scale, spreading out some of its massive innovation overhead and lowering its costs of production to make the prices of its cars more competitive, even in other states and overseas.  The combination of increasing returns to scale and the ensuing demand for electric-car infrastructure and its ubiquitous charging stations, would make electric cars easier and easier to own, creating a feedback loop driving up purchases of EVs and further reducing production costs.

The other potential winner in this scenario is California—arguably on two fronts.  The first is economic, where the expansion of Tesla, and other EV automakers that might want to have their own piece of the state’s EV market, could create agglomeration economies in the EV industry and a plethora of new jobs.  The second way California wins is environmental, where a wholesale conversion to EVs would mean, if not less of our lousy traffic, at least breathing cleaner air while your stuck in it.  This is assuming, of course, that the source production of electricity is relatively clean.  But California is the cleanest state in the nation with 29% of its electricity coming from renewable sources compared to only 13% nationwide.

I’m not sure whether I support AB 1184 as it stands.  It is an unabashed giveaway to a particular industry, and even more, to a particular firm.  The tax credit should be expanded to hybrid vehicles; anything so specifically targeted at electric-only vehicles is too blatantly targeted at Tesla.  It is also a non-progressive subsidy that is likely to favor rich people who buy Teslas and are the last to need a tax break.  Subsidies per car should be capped at something reasonable.  On the other hand, we have been stuck in a gas-powered automobile equilibrium for too long, and for the good of planet earth, it’s time to bust out of it.  Legislation that looks something like AB 1184 may be part of the solution.

Follow AcrossTwoWorlds on Twitter @BruceWydick.


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