«I. Introduction Green growth can be defined as a trajectory of economic development that fully internalizes environmental costs, including most ...»
Much of the subsequent furor focused on two questions. First, did the Department of Energy (DOE), which administers the loan-guarantee program, exercise sufficient due diligence with regard to the commercial viability of Solyndra’s technology? Second, did Solyndra and its private backers exercise undue political influence to get the DOE to finance the company despite the evident risks? These two questions go to the heart of the argument against industrial policy, which rests on the government’s lack of omniscience and its propensity to political capture. Solyndra’s failure provides an apparent vindication of these concerns.
However, there is little that we learn about industrial policy and its uses and abuses from Solyndra’s bankruptcy alone. Under an optimally-designed program of industrial policy, some firms that receive public support will necessarily fail. In fact, if every subsidized firm were to prove financially successful, this would likely indicate that the program was vastly under-performing.
The reason is that green technologies are subject to significant ex-ante uncertainty. The uncertainty may be due to unforeseen scientific and technological developments, or potentially unpredictable price and other commercial trends (as in the case of Solyndra). In the face of uncertainty, it is optimal to finance a larger group of projects than will prove viable ex post.
For concreteness, suppose the public agency faces a continuum of applicants indexed by z [0,1], with ex-ante failure probabilities given by p(z). Let p(z) be weakly increasing in z, with p(0)=0 and p(1)=1. (As long as p(z) is not strictly increasing in z, we can have a range of projects for which the failure probability remains zero.) Let each project require public funding of amount K, and provide net return of π if successful (and 0 otherwise). The total budget, B, required to fund all
project funded and f(z) is the probability distribution function of z. The marginal project, in turn, is defined as the one that just breaks even in economic terms. Let r stand for the public agency’s opportunity cost of funds and assume π r, such that there are at least some projects worth funding. Then k is implicitly determined by the equation [1-p(k)]π = r. In this equilibrium, p(k) 0
portfolio of projects will more than pay for itself in aggregate, even though some investments will likely fail ex post.
This is of course what every fund manager or venture capitalist knows. The true measure of success is not whether some projects fail, but how the portfolio fares overall. A portfolio that screened out all projects with positive probability of failure would entail too small an investment (B) and too low an overall return. As Thomas Watson, the founder of IBM, supposedly advised cautious managers, “if you want to succeed, raise your error rate.” For publicly subsidized projects, there is an additional layer of considerations. In the absence of some kind of market failure, the public sector does not have any comparative advantage in undertaking such activities and should not be in the business of subsidizing or funding private projects. On the other hand, if green technologies both produce technological externalities and help counteract the under-pricing of carbon, as I have argued above, commercial profitability or breaking even is not the appropriate benchmark for success.
Suppose each successful project yields θ in external benefits per unit of capital invested, in addition to the private return of π. Now the marginal project k is defined implicitly by [1-p(k)](π + θ) = r, and has a higher default probability than in the previous case. The marginal project will in fact be one that makes losses on a commercial basis. The portfolio as a whole may bring below-market, even negative, returns if the externalities are sufficiently strong. In view of these considerations, a public program to encourage green technologies cannot be evaluated by the financial performance of the overall portfolio, much less by the success or failure of individual projects.
We have one detailed study that takes such a portfolio approach to public support in green technology and the results are quite instructive. In 2001, the U.S. National Research Council (2001, NRC) evaluated DOE initiatives in two areas – energy efficiency and fossil energy – between 1978 and 2000. The DOE had invested about $22.3 billion in these areas (or about 26 per cent of its total expenditures on energy R&D). The NRC identified many projects that had failed, but came to the
energy efficiency net benefits amounted to $30 billion – not at all bad for an investment of roughly $7 billion over 22 years (valuations are in 1999 dollars). (Note that the NRC did not attempt to estimate benefits that spilled over to other nations.) Interestingly, much of the net economic benefits could be attributed to “three relatively modest projects in the building sector.” Returning to the Solyndra case, we can conclude that its failure did not necessarily warrant the outcry and the immediate search for culprits that went on display. Many observers and Congressional representatives were too quick to jump to the conclusion that something must have gone wrong, and that somebody must be guilty. Solyndra’s offices were searched by FBI agents and the company’s top executives were hauled before Congress (where they took the Fifth Amendment).
Aside from the specific mistakes that may have been committed in this particular case (see below), what precipitated the reaction is that the logic outlined above had not been an explicit part of the loan-guarantee program’s design and communication strategy. The DOE program served a mixed-set of objectives. It never had a clear set of yardsticks for measuring and evaluating performance other than recouping the loan guarantees. Stimulating demand and employment, spearheading new technologies, competing with China, and environmental benefits all played a role in selling the program to Congressional interests and the broader public. The White House talked about positioning “the United States as a global leader in developing and manufacturing cuttingedge clean energy technologies,” “continued growth in the renewable energy sector,” spurring “innovation and investment in our nation’s energy infrastructure,” and creating “American jobs.”8 President Obama himself would state the case in explicitly national-competitiveness terms in October 2011, following the failure of Solyndra: “… if we want to compete with China, which is pouring hundreds of billions of dollars into this space, if we want to compete with other countries
that are heavily subsidizing the industries of the future, we’ve got to make sure that our guys here in the United States of America at least have a shot” (cited in Datla, p. 10).
The idea that a successful program would have to incur many individual failures along the way, even if well understood by the specialists, was not clearly articulated or explained. Partly as a result, the Solyndra failure was treated as an indication of a broader, systematic problem rather than as something that was within the normal parameters of the program.
Once it is understood that failure is part and parcel of a successful industrial policy effort, the question becomes how the cost of failures can be minimized. We cannot pick winners; this is a fact of life that is not a deterrent to industrial policy on its own. But we can, in principle, stop backing evident losers. The better we get at the task of letting losers go, the better our industrial policy. As elaborated further in the next section, this task requires clear benchmarks for success, close monitoring, and explicit mechanisms for reversing course. How well did the administration do on this score in the Solyndra case?
There are many indications that Solyndra’s progress – or lack thereof – was not sufficiently scrutinized. It appears that the company was selected early on as a showcase for the administration’s efforts and pushed through the approval process in record time. Silicon prices had already begun their precipitous drop before the loan guarantee was approved, which should have raised some concerns. As a subsequent Congressional report put it, “the lack of available competitor information for Solyndra and the rapidly dropping price of polysilicon and panel prices should have prompted DOE to reconsider the Solyndra loan guarantee or, at the least, postpone the Solyndra closing so it could examine how the Solyndra loan guarantee would be impacted by the Chinese pricing pressures.”9 And as Solyndra’s financial difficulties mounted, it seems that DOE officials justified the losses by arguing that this was common in all start-ups. In July 2010, the Office of Management and Budget
(OMB) sent DOE specific questions relating to Solyndra’s financial status and productivity. The DOE apparently never responded, despite repeated OMB requests.10 Similarly, a memo prepared for the President on the DOE loan guarantee program by Lawrence Summers, among others, in October 2010 did mention the need for “clear policy principles – and associated metrics for evaluation” as one of the options to be considered. But Solyndra was not mentioned as a potentially problematic case, and no action seems to have been taken in response.11 More damagingly, the administration invested substantial political capital in the company’s success, making a potential cut in support difficult to contemplate. The provisional loan commitment to Solyndra in March 2009 was marked by joint appearances by Energy Secretary Steven Chu and Vice President Joseph Biden (Datla 2012). And, as noted previously, President Barack Obama himself showed up at the company’s headquarters in California in May 2010 to publicly celebrate Solyndra’s apparent success.
Then there were Solyndra’s own political activities, which were substantial. As the New York Times notes, “Solyndra spent nearly $1.9 million on lobbying activities over a period of 43 months from 2008 to 2011.”12 This is a large number, which placed the Solyndra in the top tier of lobbyists among comparable energy companies.13 The scale of lobbying for a firm of its size and with such financial difficulties should have been a warning sign. Moreover, the principal private investor in Solyndra, George Kaiser, was an important fundraiser for Obama and he clearly had access to the Ibid., p. 135.
To illustrate some of the potential problems that may arise, the memo discussed another project, the Shepherd’s Flat loan guarantee. For the text of the memo see http://abcnews.go.com/Blotter/obama-talksbig-clean-energy-money-removed-key/story?id=12048872#.UaN5XndFVK0.
To compare Solyndra’s lobbying expenditures to other energy firms’ lobbying activities in 2011, see http://www.opensecrets.org/lobby/indusclient.php?id=E07&year=2011 and http://www.opensecrets.org/lobby/indusclient.php?id=E01&year=2011.
-19White House. Congressional investigators found that Kaiser had discussed Solyndra with the White House staff in February 2010 in Vice President Biden’s office.14 The Obama administration would maintain throughout that the loan guarantees were approved by the DOE purely on the merits of the case.
So there is plenty to criticize in the manner in which DOE managed Solyndra -- and the loan guarantee program as a whole. The lesson, however, is not that the administration should not have subsidized a company that eventually failed. There is no economic reason that the government should recover every loan. In view of the environmental and technological externalities, there is not even a case for insisting that the loan portfolio as a whole should make a profit or break even. The real lesson is that there were no safeguards in place against political manipulation and to ensure DOE could pull the plug if circumstances warranted it. Worse yet, the administration made it harder to reverse course by committing itself to the project politically.
The DOE’s loan guarantee program would eventually grow (by May 2013) to encompass 28 companies. Proponents would argue that, Solyndra notwithstanding, these companies had collectively created more than 20,000 jobs (Bump 2013) and played a role in “kickstart[ing] a fresh, promising, and environmentally responsible sector of the economy” (Oremus 2013). Many of the firms had begun to pay back their loans. Tesla Motors, which had received a $465 million loan guarantee in 2009, had seen its shares soar, and had repaid its loan early. Solyndra is clearly only part of a bigger picture. However, it will be years before we can reach a clear judgement as to whether the loan guarantee program as a whole was a success or not.
IV. Better rules for industrial policy The theoretical justification for industrial policies to promote green industries is strong. But such policies can be exploited by powerful insiders and overwhelmed by informational asymmetries
between the private and public sectors, as the Solyndra case well highlights. Skeptics rely on these arguments to argue for a hands-off approach. However these pitfalls are not special to industrial policy. Virtually any area of government policy is subject to similar challenges.
For example, education policy is motivated by arguments about educational externalities and social cohesion, even though there is much debate about how well it works, whether these ends are adequately served, and the extent to which insiders such as teacher unions distort its implementation. Health policy is driven also by a combination of social concerns and moral hazard/adverse selection considerations, but few would deny the role of organized political groups in shaping it. Infrastructure and telecom policy are rooted in problems of natural monopoly, but insiders and lobbyists play a large role in their formulation. Stabilization policy is motivated by Keynesian theories and is marked by virulent debates about its effectiveness.