Since the start of the Obama administration, the United States has invested more than $1 billion1 in federal seed funding for energy innovation through the Department of Energy’s Advanced Research Projects Agency for Energy (ARPA-E). In Canada, where energy is a provincial area of responsibility, governments have spent even more: Alberta alone invested CDN $1.25 billion2 to develop innovative carbon capture and storage (CCS) technologies.
Governments support innovation because it has broad popular appeal. After all, the word innovation simply means “to come up with something new” and if society has a problem, what better way to respond to it than with something new? But generating innovation is a complex undertaking, and governments in Canada and the United States have struggled to find a return on their investments in energy innovation.
Robert Solow won the Nobel Prize in Economics in 19873 for his work in the 1950s that showed that one path to national economic growth was technical progress that led to improvements in productivity (that is, more output with the same inputs). Before Solow, the Keynesian economic model focused on expanding the national endowments of certain factors, such as natural resources (discovered through exploration) or population. Solow showed that where new technology produced productivity improvements – think of the way email boosted the speed and efficiency with which we share information – national output and wealth would increase.
All innovation is not the same. PayPal founder Peter Thiel4 notes that incremental, or marginal, innovations occur all the time as firms update and improve their processes to yield small gains that, over time, amount to major cost savings and upgrades to product performance. The low-risk, high-reward nature of these kinds of innovations leads most successful firms to pursue them. The more valuable, and also riskier, type of innovation is the breakthrough or disruptive idea that creates a new industry or transforms our lives. These are riskier, and often require incentives or significant up-front investment before they pay off. This is where venture capital and governments often seek to play a role.
“At the 2015 United National Conference on Climate Change in Paris, the governments of the United States, Canada and other nations made commitments to reduce carbon emissions dramatically by 2030.”
Yet a recent report in the Wall Street Journal by Alison Sider5 found that in 2016 venture capitalists have been shifting away from investments in “clean energy” because risks were high and the returns underwhelming compared to other tech sectors. With private capital becoming scarce, energy innovators will look increasingly to the public sector for seed capital.
Governments, including the new U.S. administration, will be eager to respond. At the 2015 United National Conference on Climate Change in Paris6, the governments of the United States, Canada and other nations made commitments to reduce carbon emissions dramatically by 2030. Technological breakthroughs that make it less costly to reach these goals will be politically easier for governments.
As a result, the governments of Canada and the United States – including governments at the provincial, state and even municipal levels – are adopting industrial policies to promote the development of clean energy firms within their jurisdictions. Some of these will be innovative new firms, and others will be firms bringing innovation in the energy sector to a new location.
Simon Fraser University economist Richard Harris, in a classic 1985 book Trade, Industrial Policy and International Competition7 written for the Macdonald Royal Commission on Canada’s Economic Prospects argued that Canada needed an industrial policy to support the development of innovation in Canada. Without such a policy, Canada’s openness to international trade would lead foreign innovators to exploit Canadian market opportunities and take the profits from such ventures home with them. Harris observed that Canada and the United States could well become rivals in pursuit of innovation.
The Conference Board of Canada’s international benchmarking of innovation8 suggests that Canada would begin such a rivalry at a clear disadvantage. Based on its review of 21 indicators, it found Canada ranked thirteenth of 16 countries. The United States ranked third.
“A recent report in the Wall Street Journal found that in 2016 venture capitalists have been shifting away from investments in “clean energy” because risks were high and the returns underwhelming compared to other tech sectors.”
Notwithstanding the policy objective for energy innovation to lower Canada’s carbon emissions, if Canada is at such a clear disadvantage, should it even bother to compete to generate energy innovation? Why not just wait and import breakthrough technology when it is developed abroad (at others’ expense)? Queen’s University Smith School of Business Professor Kristian Palda argued in a 1993 study for the Fraser Institute9 that governments attempting to promote innovation through industrial polices invariably succumb to the temptation to “pick winners” among competing technologies for political, rather than market, reasons and that government investment programs are too frequently diverted by skilled lobbyists to support unworthy experiments.
The United States government has made these mistakes, too. George Mason University economist Veronique de Rugy testified before the U.S. Congress10 that the Obama administration’s attempts to subsidize startups to transform the U.S. energy sector had resulted in expensive failures like Solyndra, a solar cell producer that went bankrupt in 2011.
Yet as the World Bank’s Christopher Colford noted11, the challenge for governments is patience. The United States public sector support for energy innovation during the Ford and Carter administrations (1974-1980) led to the development of hydraulic fracturing and horizontal drilling technologies that transformed global energy production – 30 years later.
The public sector is often seen as a source of “patient capital” by markets, and potential energy innovators will continue to seek taxpayer support in Canada and the United States. Yet as Palda and de Rugy warn, there is a significant political risk for governments associated with support for innovation through direct investment. Perhaps by working together, governments in Canada and the United States can share the risk and our economies can share in future rewards.
Christopher Sands is Senior Research Professor and Director of the Center for Canadian Studies at the Johns Hopkins University School of Advanced International Studies, the G. Robert Ross Distinguished Visiting Professor in the College of Business and Economics at Western Washington University, and a nonresident Senior Associate of the Center for Strategic and International Studies.