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November 25, 2009

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Bubble, bubble toil and the trouble with too much air power

HUMAN history is littered with spectacular bubbles created by herd investment behavior, ranging from tulipmania in the 1630s to the dotcom/fiber optics frenzy in the late 1990s.

Ethanol gasoline investment came into fashion in Iowa, Kansas and several corn-growing US states in 2006.

The more recent example was the US real estate and mortgage bubble that ultimately led to the worldwide economic recession.

All bubbles of course eventually burst. The most tragic, according to my calculation, was the Dutch tulip craze. After the dust settled, tulip bulbs sold for what was then equivalent to three cents on the US dollar, compared with its peak.

A possible bubble currently brewing in China is in the new energy sector, particularly in areas of solar photovoltaic and wind power generation.

Due to low production costs, China was able to quickly dominate the global market in the polysilicon industry, a key input component that goes into photovoltaic panel manufacturing.

Overcapacity

But the global financial crisis largely quenched the overseas demand, causing a glut of overcapacity. A similar picture is unfolding in wind power generation.

The number of wind power equipment manufacturers increased from 10 to 70 in just a short period of two years. Wind power generation capacity already exceeds 35 million kilowatts, while the amount of power capacity that can be adequately absorbed by the current grid system is only 1,000 kilowatts.

According to a recent report released by the State Electricity Regulatory Commission, one third of the wind power plants in China stopped operation as a result.

Although prospects for the new energy industry are bright in the long run, the cold hard reality is that these industries are simply not sustainable without government subsidy at current cost levels.

Consider the cost of good old coal generation at 0.2-0.3 yuan per kilowatt, while solar power generation is still above two yuan (29 US cents) per kilowatt. Wind power may be a bit less expensive, but taking into account the grid build-out to these remote areas and the energy storage buffering facilities to accommodate wind power's fickle temper, the cost is still several times more expensive than coal.

If previous bubbles serve as any guide, there seem to be two kinds of bubbles at work, one that is constrained within its own sector, and the other that spreads out to the entire economy. We surely keep our fingers crossed that a possible bubble in the new energy sector will be constrained within its own fence.

Meanwhile, it is time to take a step back to take advice from Keynes about long-term investment. In his "General Theory of Employment, Interest and Money" (1936) Keynes expresses skepticism about the ability and inclination of "long-term investors" to buck market trends.

Cooperation

New energy equipment manufacturers tend to be too optimistic about the future of the industry. Local governments and businesses need to cooperate to develop a market and technologies for new energy sources on a gradual basis.

At the same time, the government must encourage businesses to build up their core technology competitiveness vis-a-vis foreign suppliers, strengthen oversight on environmental protection, and limit predatory new entries.

China's new energy industry needs to secure competitiveness in the global market. Over investment and overlapping construction undermine the overall health of the industry. China should establish a cooperative development system in which equipment manufacturers, power plant companies, and grid operators can jointly cultivate a healthy and orderly competitive environment.


(The author is associate professor of economics at the University of International Business and Economics. The views expressed are his own. His email: johngong@gmail.com).


 

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