April 26, 2011

Picking Winners or Losers

By Lewis Milford

Some arguments never die.

Recently, some members of Congress criticized Energy Secretary Chu for “picking winners’ through his research and development programs like ARPA-E. This is an old canard that often comes from people who really think that the private sector alone, without government help, creates products and services.

The evidence is so overwhelming to the contrary that the debate seems almost one sided by now. Everything from computer chips to cars is a result of long-term government research and development—as well illustrated in a recent Breakthrough Institute report.

The argument against picking winners is especially wrong for emerging technologies that require deep and persistent public support.

In the late 1990s, two Harvard professors in a book titled “Investing in Innovation: Creating Research and Innovation Policy that Works” demolished the myth that government should not be in the business of “picking winners.” And they came up with some surprising conclusions about the role of government in technology innovation.

Branscomb and Keller describe how this bias against a government technology role can lead to two incorrect conclusions:

…First, that markets do that most effectively; and second, that pork barrel politics is more likely to support the losers anyway. This neat two-step eliminates from the role of technology policy everything for which government is institutionally well-suited, from infrastructure building and investment incentives to support of skills training. It then notes that what is left is, of course, institutionally more appropriate for the market. The argument is legitimated simultaneously by our ancient faith in markets and our recent cynicism about politics.

They admitted that the “picking winners and losers argument” might apply to some government efforts but not to the development of new technologies. Here’s why:

  • Private markets often under-investment in new technologies; “empirical evidence suggests that as a result of spillovers of all kinds, the social returns to R&D spending on new technologies far exceed the private returns, perhaps by as much as 50 to 100 percent.” Private rates of return may not equal social rates of return—companies often cannot appropriate all the social benefits of an innovation and so fail to invest in what could be socially optimal technology.
  • Because innovation is highly contingent—the actions of developers, governments and users are highly uncertain, making good information hard to come by, leading to great risks for investment—there is an inevitable misallocation of resources. “Some bets will pay off; some not at all. Winners and losers can only be positively identified in the revealing gaze of hindsight.”
  • And finally, “…there is absolutely no evidence, beyond the economist’s leap of faith, that private investment is any more capable than public investment of separating the winners from the losers before the fact. The major difference is that private losers exit the market, while publicly backed losers are held to the higher standard of wasting taxpayers’ money.”

Further, they confront another myth about government technology policy—that the federal government has in the past and in the future should only focus on R&D rather than commercial diffusion and use. Instead, they point out, in those areas where success has occurred, government has in fact played a much more expansive role than simply research and development.

The most unlikely proof is in the defense area. Referring to the post-World War Two period in the U.S. regarding defense industry support as the most obvious time when many government policy tools were used, they note:

Public spending supported the enormous development costs of relevant new technologies…In these cases, government underwrote the basic science research at universities and labs; direct R&D contracts accelerated the development of the technology; and defense procurement at premium prices constituted a highly effective initial launch market…A variety of mechanisms, ranging from patent pooling and hardware leasing (such as machine tool pools) to loan guarantees for building production facilities, helped to lower entry costs, diffused technology widely among competitors and set the stage for commercial market penetration. Aspects of this support model were adapted for government investment in other sectors, notably for public health, and produced similarly beneficial results…

In the defense area, the U.S. government did not limit its role to only R&D, the typical critic’s myth, but “to the successful launch and diffusion of a technology development path—a trajectory—whose characteristics corresponded to the requirements of the commercial marketplace.”

So to those who say, don’t pick winners, say it has always been so, and the country is better off for it. The alternative is to let losers win, and who wants that.

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