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In Defense of Picking Winners

Virtually all economists working on climate change agree that we should price GHG emissions.  Doing so creates an incentive to reduce emissions without the government directing specific technology adoptions or activity changes, that is, without “picking winners.”

Nearly as many economists agree that we should subsidize basic R&D.  Doing so, accelerates the scientific breakthroughs that will be necessary to avoid even higher concentrations of carbon in the atmosphere.  Of course, we can’t and shouldn’t subsidize all basic R&D regardless of how nutty the idea or indirect the connection to GHG reduction.  We should subsidize the best ideas, that is, we should pick winners.

How does an economist hold both ideas in his/her head at the same time without risking spontaneous combustion?  Actually, it’s not hard.  The two policies are designed to solve two different problems. It’s no surprise that different problems require different solutions. 

Pricing emissions recognizes that the normally efficient system of pricing goods and letting people choose what to buy and sell breaks down when some goods are not priced (negative externalities, for instance).  Thus, putting a price on emissions fixes the problem that exists because we currently give away the right to pollute for free.

Pricing emissions is quite attractive compared to “command and control” pollution regulations, because the regulations don’t necessarily find the least expensive ways to abate the pollutant.  Pricing the emissions gives every polluter the incentive to compare the emissions price to the cost of abatement and then do the abatement that is less expensive than paying the price for emissions.  The regulator does not know as well as the emitters which are the most cost-effective abatement strategies.  And – critically – there is an alternative to regulation that is almost certainly more efficient: creating a price for emissions.

Unfortunately, such an elegant solution hasn’t been discovered for the second problem, incentivizing innovation.  The economics of innovation is like the engineering of electricity storage: a tremendously important field where progress has been frustratingly slow.  Innovation is a key driver of the economy, but decades of economic study have revealed few reliable facts or verified theories of how innovation happens and how public policy can enhance it.

Still, it is well known that knowledge creation has huge spillovers that the knowledge creator doesn’t capture or profit from.  Ironically, this is also an externality problem, but this externality is positive and results in too little innovation, in contrast to the negative externality of greenhouse gases that results in too many emissions.


Brightsource’s Ivanpah Solar Thermal Generator is one experiment that the U.S. government has picked to support

Intellectual property protection – patents, trademarks, copyrights, etc – are intended to address innovation incentive problems, but they are very imperfect solutions.  One problem with IP protections is that they give the creator a monopoly for decades, which is probably not the best policy when we need cumulative innovations in a hurry to address climate change.

That brings us to subsidizing innovation.  Among innovation scholars, subsidizing basic knowledge creation – fundamental science – is (you’ll excuse the expression) a no-brainer.  Yes, it requires picking winners among basic science research proposals, but there isn’t an elegant alternative available as there is with the problem of negative pollution externalities.  The spillovers from basic science research are huge, hard to measure or control, and almost certainly best left to diffuse without impediments.

More controversial is subsidizing downstream development and deployment, such as tax credits for building commercial-scale compressed-air power storage or a new nuclear reactor design.  Some economists argue that firms can capture most of the knowledge created from these sorts of activities and can benefit privately.  I used to be in that camp, but two things have changed my view.

First, I’m convinced there are significant knowledge spillovers that can’t be feasibly captured by a firm that develops or deploys new technologies.  Furthermore, we wouldn’t want them to keep that knowledge to themselves even if they could.  Importantly, the very fact that a firm is pursuing a new technology and is still in business — or has gone out of business — is a critical piece of knowledge to other firms considering work in the area.  Seeing that a firm is making money in a new line of business inspires other firms to investigate the business and to investigate how the first entrant is doing it.  Seeing a firm fail in a new venture is also valuable information to others considering similar activities.

Vogtle 1

Southern Company’s Vogtle Nuclear Power Plant — which Lucas blogged about a couple weeks ago —  is another government-supported project

That means that significant value from such experimentation spills over to other firms.  It’s a problem in all industries, but it is especially a problem in an industry with very high costs of experimentation — building the first small modular nuclear reactor isn’t like creating a new social network app — and with very uncertain value of success.  What makes the value of success so much more uncertain here than in most industries is the fact that the value will be driven as much by public policy towards climate change as by consumer demand.

The second thing that has changed my mind on subsidizing development and deployment of new energy (and energy efficiency) technologies is the need to solve the problem of global climate change.  We desperately need the knowledge to spill over to the developing world so they will move out of extreme poverty along a much less carbon-intensive path than we have taken.  We need innovations to be adopted as quickly and smoothly as possible around the world, a process that will almost surely be hampered by anything that relies on negotiations over intellectual property rights.  Subsidizing innovation can be tied to disclosure and reporting requirements that encourage replication and further innovation.

Just as with fundamental science, this doesn’t mean that every technology should be subsidized throughout the development process.   There are plenty of bad ideas out there that shouldn’t get money.  There are also plenty of plans that may work privately, but for which the spillovers are small.   Just as with fundamental science, this requires picking winners.  And because these should be experiments – the whole point is to do things for which the outcome is uncertain — many “winners” picked will turn out to be failures. 

And that’s ok.  We need to pick, and subsidize, the experiments that have the largest potential to create value in reducing GHG emissions and the largest potential for that value to spill over to other uses, other technologies, and other countries.  That’s not inconsistent with pricing GHG emissions.  It’s just recognizing that we face multiple challenges in fighting climate change and multiple strategies will be needed to succeed.

Severin Borenstein is now tweeting (nearly) daily energy news/blogs/research articles at @BorensteinS

Severin Borenstein View All

Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. Currently, he chairs the California Energy Commission's Petroleum Market Advisory Committee and is a member of the Bay Area Air Quality Management District's Advisory Council.

13 thoughts on “In Defense of Picking Winners Leave a comment

  1. I will only address the issue of taxing negative externalities.

    1. Whether an externality is positive or negative is something that can be assessed after the fact of its imposition. If CO2 warms the earth, that could be a good thing or a bad thing, depending on other factors such as the solar cycle, ocean currents et al, et al. Whether the people of earth benefit or suffer from increased CO2 is unknown until we increase the CO2. So far the people of earth have grown only fatter, richer, healthier and more numerous since CO2 levels started climbing in the 1750’s. There is no indication that increased CO2 has harmed a single human being.

    2. The premise that the potentially negative externalities of increased atmospheric CO2 will go un-shouldered is always false. Every human on earth, via his consumption and production activities is a net positive CO2 emitter. Human economic activity creates the climate change. The climate change, in turn will change human economic activity. It follows that every human on earth will bear the cost and/or reap the benefit of his net positive CO2 production via his changed consumption and production activities. Taxing CO2 is redundant. No further action is required.

  2. My thought is that basic research – for example, the federally funded NSF variety, is separated a bit further than Severin suggested from, say what the DOE did for Ivanpah solar. Seems like such a leap to compare “downstream development and deployment” with fundamental science research. Picking technologies to research is one thing, but I feel that picking companies to build them to scale is another altogether.

  3. When are these warming alarmists going to recognize that there are huge costs in raising energy prices world-wide! If it is not done world-wide we will lose the competitive advantage the fossil-fuel industry has given us! We are beginning to see what California with its carbon tax is going to end up with – enclaves of wealthy, but vast areas of lower-class and low average incomes in an expensive and dysfunctional state. What manufacturing and similar industries that are left will leave the state, along with most of what is left of the middle class.

    The science is hardly settled, as they claim, and the people who bet with their money are not buying that it is settled! Most believe some warming exists and that it is at least partly anthropogenic, but the vast majority consider AGW a low priority – 19th out of 20 issues!. They are buying coastal properties and coal stocks. BO, now seen by most as a terrible mistake. will not be there forever!

    The public needs an honest debate! The warmists should enter into such, and not hide behind calling critics heretics and members of the flat-earth society as Kerry did! They should be able to admit that there are many climate factors besides CO2 that are not yet well-understood, and that most climate models have been shown to be unreliable. A confident scientific sector should not have to whitewash leaked emails or call its critics lackeys of the fossil fuel industry funded by the latter! Yet, climate “science” is a huge vested interest that thrives on government and private funding as long as it continues to claim we face a climate crisis that is the greatest challenge of our time!

    The alarmists also need to admit that there are huge costs that come with reduced carbon emissions. Look what is happening in the EU where the climate policies of renewable energy subsidies and mandates, and of carbon taxes, are being abandoned because they tripled the cost of energy and were de-industrializing the continent! Its competitiveness and standard of living were being lost!

    And they need to admit that what the US does will have little impact in reducing AGW. They also need to admit that for many it is about government control over energy and thus the economy and increasing the tax money to fund them. Would they really prefer the lower average and more equal living standards for all to the free market system and the thriving economy and great wealth it has produced here, and has funded their activities – now coming more into question? Many of them behave as though they would prefer a global economic equality of lower levels.

    The great good of our strong US economy and the global wealth produced by US fossil-fuel techniques that our companies have spread around the world would be reduced. The billions spent combating malaria, AIDS, etc., as well as poverty, that has been funded by private and government aid would be reduced. Less than ever we do not have unlimited means. Longer term we face increasing deficits and have a huge debt to manage under the threat of rising interest rates, while demands at home rise.

    Recent studies indicate that increasing demands will push fossil fuel and CO2 production to a limit and eventual decline long before the end of the century. Nevertheless, there should be an open debate with all such factors included. Maybe the warmists are right that a climate crisis, one they need to describe with specifics, will come first. But we need an open debate and they need to convince us as to what parts of the science are settled and what are not, and what are future expectations, for example, in the important area of the study of the interactions between all parts of the biosphere.

  4. I doubt that Severin is arguing that innovators who receive government subsidies forgo patent protection. I suspect he’s talking about how society benefits from subsidizing positive externalities, from such things as the learning and knowledge that is generated when companies successfully or not so successfully develop experimental new technologies and scale them up. Because the externalities he’s talking about here provide knowledge needed to solving a huge societal problem like climate change, our government(s) should subsidize them! If successful, the innovator receiving the subsidies still deserves and will receive patent protection, just as drug companies that receive government R&D funding still receive patents on the drugs that the funding helps them develop.

    While it is true that venture capitalists have invested a great deal in alternative energy technology development, it is also true that government grants and other subsidies are playing a key role in their development.

  5. There is no tension whatsoever in the two policies. When there are market imperfections, raising prices has effect than we expect and imposes more cost on the economy than would be the case if the market imperfections were corrected or reduced first. R&D is one of the most widely acknowledged market imperfection, but there are many others. In the case of a climate change, the total social costs are large and the market imperfections are substantial because we are inducing change. There is strong theme in the climate change literature that concludes targeting and inducing change dramatically accelerates and lowers cost of the transition and lowers, as discussed in Chapter 5 of my recent analysis of performance standards shows The Intersection Of The Efficiency Gap And Climate Change Literatures

  6. Perhaps I’m making too large a leap here but it seems you’re suggesting that the recipients of subsidies for innovation will have to agree to forgo intellectual property protection. There’s actually a precedent from the Regan administration in which agencies were pushed to license intellectual properly developed with federal money.

    The fact is, private capital has plenty of incentive to invest. From my vantage point, there’s a lot of money being thrown at electric storage, for example, and there are a lot of interesting ideas being pursued. That’s an ares where throwing more money at the problem is akin to putting nine pregnant women in a room hoping a baby will be delivered in a month instead of nine. The same is true of solar PV, where I’m personally familiar with a bunch of interesting ideas that were generated and are being pursued by private capital.

    Nuclear reactors, and especially systems that are proliferation resistant and produce few long-lived by products, are an entirely different matter.

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