Chances are good that legislation to “cap and auction” greenhouse gas (GHG) emissions will become law as early as 2009. While many environmentalists, utilities, and energy companies agree that cap and auction is the right framework, huge differences remain. Environmentalists want an 80% reduction of GHG emissions by 2050, or sooner. Energy companies want more modest reductions and for pollution allowances to be given away rather than auctioned. The energy lobby will likely favor, and environmentalists oppose, a “safety valve” to prevent the price of carbon dioxide (and thus the cost of energy) from rising too high.

Though the regulatory aspects of managing greenhouse gases are important, the biggest reductions in emissions won’t come from regulations but from technology innovations that lower the price of clean energy. The opportunity for agreement between industry and environmentalists lies in using revenues from auctioning emissions allowances to fund major investment in clean energy technology and infrastructure. But before describing what this win-win might look like, we need to understand the lessons of the Kyoto treaty.

The failure of Kyoto

Many environmentalists believe that Kyoto’s failure is due to Bush administration opposition to it. This story gives too much credit to the U.S. and too little responsibility to the wealthy nations that ratified Kyoto. The latter saw their GHG emissions go up, not down, by 4% from 2000 to 2004. In Britain and Germany, emissions fell not because of Kyoto but because Margaret Thatcher broke the coal miners’ union, moving Britain to cleaner-burning natural gas, and because the East German economy collapsed after the fall of communism, reducing a reunified Germany’s reliance on dirty coal plants. When you remove Germany and Britain from the calculation, European emissions rose 10% between 1990 and 2005. The reality is that Europe hasn’t reduced its emissions because its policymakers fear the backlash that will result from higher energy prices and slower economic growth.

U.S. lawmakers considering cap-and-auction legislation will soon face the same challenge as lawmakers in Europe: increase energy prices too much and face a public backlash; increase them too little and have no impact on emissions. This is the heart of the Kyoto problem. For regulations to work, the price of fossil fuels must increase enough that clean energy alternatives become cost-competitive.

“Renewable Energy Cheaper than Coal”

There is a better way. Instead of making clean energy relatively cheaper, a new, post-Kyoto agreement should focus on making clean energy absolutely cheaper. The right model comes not from past efforts dealing with pollution problems but rather from investments in technology innovation and infrastructure. Silicon Valley, we often forget, was largely built on U.S. government contracts. In the 1950s, the Pentagon guaranteed the market for computer microchips, driving the cost of a single microchip down from $1,000 to $20 in less than a decade. Before that the Pentagon subsidized radio. And the Internet’s precursor was invented in a Defense Department lab.

Perhaps because they know this history, some Silicon Valley executives and investors seem to understand the energy challenge better than policymakers. In November, Google announced a “Renewable Energy Cheaper than Coal” initiative to invest hundreds of millions of dollars in wind and solar power. But achieving this objective requires a global investment in the hundreds of billions, not millions. What would happen if Europe and the U.S. guaranteed the market for silicon solar panels—as we did with silicon microchips? We know that for every doubling of production of solar panels, price drops 20%. Experts say it would cost $50 billion to $200 billion to make solar power as cheap as coal power.

Solar and wind are just part of the solution. What’s needed is a portfolio of investments made by the world’s wealthiest countries. The U.S., Europe, Canada, Australia, and Japan should create a 10-year, $1 trillion energy fund to invest in a range of technologies—including geothermal, efficiency, carbon capture and storage, nuclear, low- to zero-emissions technologies, and other advanced energy technologies—many of which (like solar) would be manufactured in China. The prospect of substantial new investment might persuade China to adopt some emissions limits or even a carbon tax.

Raising the money

Whether through auctioning permits or taxing carbon dioxide directly, federal carbon regulation can potentially generate tens of billions of dollars annually for clean-energy investments. These investments should include dramatic increases in funding for basic research in the energy sciences, a 10-year commitment to buy down the price of solar technology and battery and other energy storage technologies, and a commitment to build a smarter and more efficient electricity grid.

Just before the Bali climate change conference last December, more than three dozen Nobel laureates and energy scientists sent an open letter to presidential candidates and members of Congress calling for a minimum of $30 billion per year. Just as past public investment in railroads, highways, microchips, the Internet, computer science, and the medical biosciences triggered billions in private investment, and paid for themselves many times over, so will new investments in energy. One econometric analysis found that a $300 billion investment would pay for itself in 10 years through energy savings, economic growth, job creation, and profit taking.

It’s time for a new energy strategy that aligns economic and ecological interests and appeals to the aspirations of both developed and developing nations.

Ted Nordhaus and Michael Shellenberger are co-authors of Break Through: From the Death of Environmentalism to the Politics of Possibility, and founders of the Breakthrough Institute.