How do we foster innovation to solve COVID-19 and climate change?
Ten days ago the Food and Drug Administration issued an emergency approval for remdesivir. It’s too soon to know how effective the antiviral drug will be in the treatment of Covid-19, but its development provides a great example of the economics of innovation.
As an economist who studies energy and the environment, I’ve followed closely a series of major innovations over the last decade including the falling costs of renewables, the growth of hydraulic fracturing, and energy-efficient lighting. Like many economists, I believe much more innovation will be needed in this sector if we are to “bend the curve” on carbon dioxide emissions.
Innovation is innovation – whether we are talking about antiviral drugs or low-carbon energy — so much can be learned from understanding individual case studies. What is interesting about remdesivir is that two very different stories have emerged, and they illustrate some of the key underlying themes in the economics of innovation.
Capitalism to the Rescue
The first story told about remdesivir is that it is a product of the free market. This Wall Street Journal op ed, for example, points to “privately owned” companies, “risk-taking shareholders” and “America’s laws and market system” as the key ingredients in the drug’s origin story.
Central to this world view is the idea that the profit motive is a powerful stimulus. Innovation requires costly investments made over a long time period and Gilead, the company that is developing remdesivir, would not have made these investments without the potential for significant profits.
The free market has long been a key theme in low-carbon energy innovation as well. Venture capital firms and other investors make profits when their efforts are successful, but they also lose money when their efforts fail. This “survival-of-the-fittest” winnowing helps allocate resources to the most promising technologies.
An Incomplete Story – Twin Market Failures
The power of the free market will certainly continue to be part of the story as we look for solutions to Covid-19, climate change, and the world’s biggest challenges.
But this explanation is incomplete. There are two market failures that mean that regardless of how well the free market works, it never is going to deliver enough innovation:
- Unpriced negative externalities. These include carbon dioxide emissions from fossil fuels and virus transmission to third parties, for example.
- Knowledge spillovers. These are benefits that cannot be captured by the innovator because they “spill over” to other companies, sectors, countries. Ironically, this is also an externality, but in this case a positive externality.
Yes, Gilead could end up earning large profits. Yes, an innovator who develops a better light bulb can earn large profits. But because of these two market failures, companies are unable to capture the full societal benefit of new discoveries, and thus have insufficient incentive to develop these innovations in the first place.
The Crucial Role of Federal Funding
Which leads to the other story emerging about remdesivir — innovation comes from government support. This New York Times article, for example, puts federal funding at the center of the drug’s origin story:
“The story of remdesivir’s rescue and transformation testifies to the powerful role played by federal funding, which allowed scientists laboring in obscurity to pursue basic research without obvious financial benefits. This research depends almost entirely on government grants.” — Gina Kolata in the New York Times, May 1, 2020
This view of innovation emphasizes research universities like UC Berkeley, where I work. The research underpinning remdsesivir goes back 20+ years to work done at Vanderbilt University and the University of North Carolina by virus experts who “just wanted to know” how viruses work.
Government support has played a role in major low-carbon energy innovations too, from solar panels to wind turbines to LED lighting to lithium ion batteries, and is the rationale for U.S. Department of Energy national laboratories including Lawrence Berkeley National Laboratory, NREL, Argonne, and Oak Ridge. Economist David Popp in a recent Hamilton Project Paper argues that the U.S. federal government should be spending even more on low-carbon energy research.
Especially when it comes to investments in basic science, the knowledge spillovers are potentially so large relative to immediate profits that it would be a mistake to leave these investments to the market. These are long-term, long time horizon investments for which the societal rate-of-return exceeds the private rate-of-return.
All of the Above
So which is it? The free market? Government support? The answer is, of course, all of the above. Interestingly, the Wall Street Journal op-ed makes no mention of the role of government beyond patent protection, while the New York Times article makes no mention of private enterprise. But either story is, in itself, incomplete.
It has never been more important to understand the process of innovation, and economics implies that we need both free markets and government support. I have no idea where the solutions will come from for Covid-19 or climate change. But the origin of these future innovations is very likely to include both these ingredients.
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
Suggested citation: Davis, Lucas. “Remdesivir, Low-Carbon Energy, and the Origins of Innovation” Energy Institute Blog, UC Berkeley, May 11, 2020, https://energyathaas.wordpress.com/2020/05/11/remdesivir-low-carbon-energy-and-the-origins-of-innovation/
Lucas Davis is the Jeffrey A. Jacobs Distinguished Professor in Business and Technology at the Haas School of Business at the University of California, Berkeley. He is a Faculty Affiliate at the Energy Institute at Haas, a coeditor at the American Economic Journal: Economic Policy, and a Faculty Research Fellow at the National Bureau of Economic Research. He received a BA from Amherst College and a PhD in Economics from the University of Wisconsin. Prior to joining Haas in 2009, he was an assistant professor of Economics at the University of Michigan. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.