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«Green industrial policy Dani Rodrik* Downloaded from at Princeton University on February 5, 2015 Abstract Green ...»

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By August 2011 Solyndra had gone bankrupt. Its collapse raised questions in the eyes of many observers about the desirability of ‘picking winners’, as the Obama administration had apparently done. It also highlighted the risks of political favouritism and cronyism, which many thought had played a role in the administration’s continued support of Solyndra.

Green industrial policy 477

Table 3: China’s green growth policies

Important laws and policies Renewable Energy Law (2006) 12th Five Year Plan (2011–2015): energy efficiency, carbon emissions reduction, and new energies are priorities 12th Five Year Plan for Energy Development 12th Five Year Plan for Solar Power 12th Five Year Work Plan on Controlling GHG Emissions Energy Saving and New Energy Vehicle Development Plan (2011–2020) National Medium- and Long-term Development Plan for Renewable Energy (2007) Medium- and Long-term Energy Conservation Plan (2004)

Tools used

Downloaded from http://oxrep.oxfordjournals.org/ at Princeton University on February 5, 2015 Feed-in tariffs for solar, wind (at the national and provincial levels) Fiscal incentives to support R&D or manufacturing in renewable energies (including VAT and income tax breaks, exemptions from custom duties and import VATs) Concessional lending for renewable energy projects Subsidies to green technologies (including to solar photovoltaic (PV) manufacturers) Mandated energy reductions for largest firms (~17,000 MW) National cap on energy consumption, coal output Forthcoming national emissions trading system (envisaged for 2016–20, following the pilot projects) Forthcoming fuel economy standards for automotive industry Direct funding to R&D Significant government programmes Pilot cap-and-trade programmes in Beijing, Tianjin, Shanghai, Chongqing, Shenzhen, and Guangdong and Hubei provinces, covering 256m people and accounting for 3.5 per cent of global economy Solar Roofs Program and Golden Sun Program: provide investors with financial incentives and scientific and technological support for solar energy projects

Large R&D programmes, parts of which support clean tech development:

- National Basic Research Program (‘Program 973’)

- MOST’s innovation fund for small technology-based firms

- MOST’s National High-tech R&D Program (‘863’)

- Key Technologies R&D Program Top 10,000 Enterprises Energy Efficiency Program City-based pilot projects to construct low-carbon transport systems The reason behind Solyndra’s collapse seems clear in retrospect. Solyndra’s technology for producing PV cells relied on CIGS (copper indium gallium selenide) as the semiconducting material, instead of silicon, which was vastly more common in the industry. CIGS was cheaper than silicon but less efficient at converting solar energy.

Solyndra was founded at a time when silicon prices were rising rapidly. The competitive case for Solyndra relied heavily on silicon prices remaining high. But from early 2008 on, silicon prices tumbled as precipitously as they had risen earlier, thanks in large part to new capacity coming online in China. Within a year, spot prices for silicon collapsed from more than $450/kg to less than $100/kg (Figure 1). At such prices, Solyndra’s technology had no chance to compete with conventional silicon-based PV cells. Meanwhile, PV capacity expanded six-fold globally between 2007 and 2010 (Table 5). The company failed even though it had met its own technological and cost-reduction goals.

Much of the subsequent furore focused on two questions. First, did the Department of Energy (DOE), which administers the loan-guarantee programme, exercise sufficient due diligence with regard to the commercial viability of Solyndra’s technology? Second, 478 Dani Rodrik

Table 4: India’s green growth policies

Important laws and policies National Action Plan on Climate Change (2008), consisting of eight missions, including the National Solar Mission Integrated Energy Policy (2006) National Electricity Policy (2005) Energy Conservation Act (2001) Air (Prevention and Control of Pollution) Act (1981) Environment (Protection) Act (1986)

Tools usedRenewable portfolio standard

Downloaded from http://oxrep.oxfordjournals.org/ at Princeton University on February 5, 2015 Renewable Energy Certificates for wind, solar, and biomass power plants (but market near collapse) Generation-based Incentives for wind and solar (providing payment per kWh) targeting large-scale independent power producers (on and off) Accelerated depreciation for wind investments, targeting smaller investors (currently on hold)

Set of feed-in tariffs, varying by state and source type:

- State-level feed-in tariff for wind power for 13+ states

- National feed-in tariff only for federal or inter-state power generators (few)

- Gujarat has a feed-in tariff for solar-generated electricity, with at least two other states possibly following suit Fiscal incentives (e.g. reduction of tariffs on solar imports and concessional lending) Subsidies to R&D in renewable energy (Planned) Insurance for solar power producers against default by state utilities (‘Solar Payment Security Account’) (Planned) Pilot Emissions Trading Schemes in three states Significant government programmes Jawaharlal Nehru National Solar Mission National Mission for Enhanced Energy Efficiency National Clean Energy Fund (funded by coal tax) Solar Cities Development Programme (forthcoming) 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 programme 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 programme 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 zϵ [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 Green industrial policy 479 Figure 1: Solar-grade silicon prices ($/kg)

–  –  –

2005 128 88 833 339 153 241 1,782 2006 342 170 926 469 178 374 2,459 2007 889 387 938 777 269 542 3,801 2008 2,038 813 1,268 1,399 401 1,207 7,126 2009 4,218 1,411 1,503 1,496 580 2,107 11,315 2010 10,852 3,639 2,169 2,022 1,115 4,248 24,047 Source: Deutch and Steinfeld (2013).

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 projects that are worthwhile can k be expressed as B = ∫o f(z)Kdz, where k denotes the marginal 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 and there will be many projects that are funded yet have positive probability of failure. The 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.

480 Dani Rodrik 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 Downloaded from http://oxrep.oxfordjournals.org/ at Princeton University on February 5, 2015 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 programme 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 US National Research Council (NRC, 2001) 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 conclusion that the portfolio’s net benefits for the US economy had been positive overall. In 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 ensued. 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 programme’s design and communication strategy. The DOE programme 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 programme to Congressional interests and the broader public. The White House talked about positioning ‘the United States as a global leader in developing and manufacturing Green industrial policy 481 cutting-edge clean energy technologies’, ‘continued growth in the renewable energy sector’, spurring ‘innovation and investment in our nation’s energy infrastructure’, and creating ‘American jobs’.7 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, 2012, p. 10).

The idea that a successful programme would have to incur many individual failures along the way, even if well understood by the specialists, was not clearly articulated Downloaded from http://oxrep.oxfordjournals.org/ at Princeton University on February 5, 2015 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 programme.

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.

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