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Using Government to Spur Innovation

It’s hard to get industrial policy right. But when done correctly, it’s a great way to solve big problems.
October 18, 2016

Industrial policy has “a long and divisive history,” David Rotman writes in “Capitalism Behaving Badly.” If by crafting industrial policies government’s purpose has been to direct “innovation and growth to achieve a desired objective,” then policies have often failed.

Rotman concedes, “Even advocates of industrial policies acknowledge that they have had a checkered history.” As the Harvard economist Dani Rodrik puts it, while industrial policies have “undoubtedly worked” in a number of countries and could boost green technologies, they have also been associated with expensive fiascoes and “white elephants” like the Concorde, a beautiful plane meant to showcase British and French aerospace industries whose every flight lost money. More recently, the failures of President Obama’s stimulus bill, including the bankruptcies of favored companies like the solar-panel manufacturer Solyndra, have shown how hard it is to get industrial policy right.

Another story in this issue suggests why this should be so. “Elon Musk’s House of Gigacards,” by Peter Burrows, describes the entrepreneur’s audacious plan to have the electric-car company Tesla buy the solar-panel provider SolarCity for more than $2 billion in stock. On its face, the plan is alluring: “The combined company will generate power for customers on stylish roofs with embedded solar panels, store it in Tesla battery modules, and, of course, use some of it to power Tesla vehicles.” But Tesla and SolarCity are deeply unprofitable ventures (the former lost $2.5 billion over the last five years, even more than the latter squandered), and the combination is unlikely to make them profitable.

Tesla and SolarCity benefit from a variety of federal and state policies designed to stimulate demand among potential customers. The cost of ­Tesla’s cars is reduced by a $7,500 federal tax credit and by other state incentives (Tesla helpfully lists them all on its website), and it enjoys direct subsidies, including California’s Zero Vehicle Credits. Similarly, SolarCity’s panels were made an attractive investment to homeowners by the federal Solar Investment Tax Credit and by state incentives. These are more or less defensible policies, if governments’ goals are to underwrite the transition to electric vehicles and renewable energy, although the effectiveness of the mechanisms is unknown. The unprofitability of both Tesla and SolarCity is the strategy of their boards and management, indulged by the public markets, and cannot be attributed to incentives and subsidies. (A skeptical observer might wonder, nonetheless, whether such losses would be tolerated in their absence.)

It is the other benefits Tesla and SolarCity enjoy that raise eyebrows. In 2009, during the financial crisis, Tesla was given a $465 million low-interest loan by the U.S. government, for which taxpayers received no shares and without which the company would not have survived. The case of SolarCity is even more striking. The innovative gigafactory in cloud-socked Buffalo is the direct result of the New York state government’s goal of creating advanced manufacturing jobs in the city. As an earlier story by ­Rotman (“Paying for Solar Power,”) explained, “Buffalo is attempting an economic comeback fueled by the state’s Buffalo Billion initiative, a multiyear redevelopment plan spearheaded by Governor Andrew Cuomo … At the heart of the city’s ambitions is the solar factory, which New York is spending $750 million to build and equip. SolarCity … will lease it, essentially for free, and has committed to spending $5 billion … over the next decade.” At least some part of the instability of the House of Gigacards is surely attributable to poorly conceived policies.

Smart policy can help solve big problems, especially when there has been some kind of market failure—for example, when it comes to capturing the externalities of the greenhouse gases that cause global warming. Many of the world’s most important innovations, including the Human Genome Project and the Internet, were the result of publicly funded research conducted in the context of government strategy. Policy can drive economic growth. But industrial policy gets into trouble when it does some of the things federal and state governments are attempting with Tesla and SolarCity.

First, governments are notoriously poor judges when it comes to picking individual winners: in the absence of well-designed rules and procedures, investment in companies is often the result of political whims and can be hard to end. Second, the goals of a policy must be clearly defined and noncompeting: mixing goals such as creating manufacturing jobs, encouraging solar energy and electric cars, and competing internationally can too easily lead to an end in which none of the goals are realized.

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