Can the Government Pick Technology Winners? Can Anyone?

Fuel cell powered and hybrid buildings offer several benefits

Since President Bush's State of the Union Address, government officials have made three policy proposals regarding government subsidies for hydrogen. President Bush initially proposed $1.2 billion in research subsidies over five years, which has increased to $1.7 billion. Second, the U.S. and the European Union have agreed to coordinate and sponsor joint support of hydrogen research. Third, Representatives Cox (R-CA) and Wyden (D-WA) have introduced a bill in the House of Representatives to subsidize the construction of hydrogen fueling infrastructure.

When politicians put forth subsidy proposals like these, one of our primary concerns should be their answer to this question:

How do you know you are picking the right solution? How do you know? And if you are so sure, then why isn't someone already doing it?

Governments (and corporate bureaucracies, for that matter) have a very poor track record of picking technology winners, and we have little reason to believe that the success rate with hydrogen research will be any different.

The most dramatic example of government subsidies to unsuccessful commercialization research is the thermal solar research during the Carter administration. In the wake of the energy crisis of the 1970s, President Carter approved a $105 million annual budget for research into thermal solar technology. Five years of massive amounts of research did not yield a commercially viable competing technology to the old photovoltaics, which had of course continued to innovate during the solar thermal research. This abysmal success rate was one of the factors leading to the decline in the solar research budget under the Reagan administration. To this day photovoltaic solar is the premier solar technology, and it continues to improve, thanks to both private and public research funding.

The solar thermal example raises two important points. First, government-funded research is subject to political dynamics, which are usually much more short-sighted than the timeframe required in research that goes into new and improving energy technologies. It could have been possible that with more than five years of research solar thermal technology could have hit a breakthrough (although the solar engineers I�ve talked to are not convinced about that), but the political dynamic in Washington typically does not exhibit the kind of patience that is required in the face of applied technology research.

Furthermore, it's important to remember that for hydrogen generation, storage, transport, fuel cells, fueling infrastructure, and so on, there are several competing technologies all innovating simultaneously. We don't know which one in each area is the most commercializable, and even if we have some ranking of them, a sudden discovery in one technology could upend that ranking in an instant.

If the government is going to subsidize them, will they pick one in each area, the one that their scientists perceive as most likely to succeed? Or will they fund parallel duplicate research on competing technologies? Picking one in each area, the "picking-the-winner" approach, is very risky — what if the one they pick is not the winner? Multiply that problem by the fact that we are looking at technologies in at least five different connected areas from generation to fueling, and the probability of picking the combination of those technologies that will succeed technologically and commercially is pretty slim.

If the government attempts to pick winners through targeted subsidies and picks wrong, then we are stuck with that bad, costly mistake. This mistake becomes particularly costly once, say, companies start building hydrogen fueling stations, investing in a lot of fixed infrastructure of very specific assets, and then it turns out that the most commercially viable way to deliver the hydrogen is not compatible with those specific assets. That�s a lot of wasted investment, and if subsidized, a lot of wasted taxpayer money.

In other words, investing in technological change requires accepting both some risk and some uncertainty. There are both risks (facing a known set of choices with known probabilities for each choice) and uncertainty (facing an unknown set of choices in an unknown probability distribution) that some research will not pay off. Should taxpayers bear that risk and that uncertainty?

The way investors use market processes to deal with such unknowns is to hold diversified portfolios of venture capital. Venture capital firms do not typically sink all of their resources into one technology that they believe has the highest probability of winning — they hedge that investment by investing in other technologies, in other industries. They want to maximize their risk-adjusted profit, knowing full well that some research will result in new technologies that deliver new and/or improved benefits at lower costs to consumers, and some will not. Such a portfolio approach is a hedge against the pervasive inability to pick winners. Experience with government research suggests that its track record does not improve upon the private investment portfolio approach. Governments are no better at picking winners than investors using market processes, although neither has a 100% success rate; nor should we expect one.

One of the arguments in favor of targeted government technology research subsidies is that such subsidies will reduce unnecessary duplication of research efforts. If there's duplication of research, that means that there is plenty of private-sector interest in the topic, so increasing government subsidies will only serve to crowd out that private investment in research. Why spend taxpayer money that way when private investors are willing to incur research costs?

One typical answer to that question is that duplicative research efforts are wasteful dissipation of resources in the race to be "first to the finish line." I disagree. If you try to channel these efforts and guide research with an objective of minimizing duplication, you are very likely to fail, because the duplication is never perfect — even if several people are working toward the same goal, such as smaller methanol fuel cells, the variations in their procedures, their materials, their ways of approaching the problem, and just sheer luck will all lead them down different paths. It's that human variation that maximizes the potential benefit from research. All of that seeming duplication also does something incredibly valuable: it maximizes the probability that the researchers will find dead ends and eliminate them from further exploration at that time, in that application.

Government research subsidies and those who argue for them also tend to overlook a very important part of the technology diffusion process: consumer demand. Technologies that do not meet consumer needs for practicality, convenience, carrying capacity, power, and aesthetics will fail, regardless of their scientific virtuosity or cost-effectiveness. Failure to take into account consumer demand even further inhibits the ability to pick winners, and also point to another difference between private investment processes and government subsidy processes.

If government subsidies are going to occur, then they should not be for commercialization of specific technologies or for the rollout of specific fueling infrastructure. Not only is that the area where the ability to pick winners is the lowest, it is also where private companies already invest substantially, and therefore where the potential for government funding to crowd out private funding is the highest.

It is important to remember that technological change is incremental and evolutionary, and that the most potentially important changes can be very different from what you might have expected at the beginning of the research. Predicting what will succeed and what will be a dead end is difficult, so any policy decisions that steer research along this unknown path could do more harm than good.

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.

This is part 5 of Reason's 5-part Let the Hydrogen Economy Evolve series:

Part 1: The Science of Hydrogen Fuel Cells
Part 2: The Economics of Hydrogen: Innovation in Mature and New Technologies
Part 3: Are Hydrogen Fueling Station Subsidies Necessary?
Part 4: Hydrogen-Powered Buildings
Part 5: Can the Government Pick Technology Winners? Can Anyone?