The US Gov’t as Venture Capitalist: Why Go There?

April 25th, 2013 at 1:34 am

Had a rousing debate on Kudlow tonight about the Fisker story that’s got a lot of folks like Larry K crying “Solyndra squared!”

Not so fast, dude.  Brad Plumer covers the details here, but Fisker Automotive is a small company that has been trying to break into the electric car market but now teeters on the edge of bankruptcy.  So…it happens, right?  Not every pony finishes the race.  What’s the big deal here?

From the AMs NYT:

No electric vehicle initiative backed by Washington seems more of a debacle than Fisker, which was given a $529 million federal loan in 2009 to advance the project. Two years later, after Fisker repeatedly missed production targets and other deadlines, the Energy Department suspended the loans.

Private investors also sunk about $1 billion into the company, but it’s the loan by the US government that a) genuinely rankles free marketeers like Kudlow, and b) provide a juicy talking point for Obama admin critics.

To be clear, the Energy Dept. froze the loan after $192 million back in June of 2011, and seized $21 million from the company’s reserves on Monday.  Also, as Plumer notes:

The Obama administration…stressed that Fisker was an anomaly. Nicholas Whitcomb, who directed the Energy Department’s advanced-vehicle loan program until recently, testified (pdf) that $8.4 billion in advanced-vehicle loans have been given out to five auto companies so far. While Fisker has performed poorly, he said, loans to firms like Ford, Nissan, and Tesla have helped build factories and are all scheduled to be repaid.

Whitcomb also noted that Congress explicitly provided a $10 billion credit subsidy to cover losses and bad loans, thereby acknowledging the “inherent risks of funding new and innovative technologies.”

One might also note, as an administration official did during testimony today, that about 2% of the government’s loans have defaulted, and there’s of course no venture capital firm out there that would come anywhere close to that level of success (if they bat 500, they’re doing great).

But putting aside all the political BS, the case raises good questions: why should the USG provide venture capital?  And if there’s a rationale, how much should they do, and on what terms?  What is an acceptable failure rate?  Is it zero, as Kudlow et al would argue?

The question of should the government backstop investments in new areas of research is actually an odd one, because it’s been doing so since before we were even a nation (the provisional government subsidized machine tools for weaponry to fight the British—in fact, much of what followed grew out of defense spending).  As I stressed on the Kudlow show, you simply cannot find an economically transformative innovation, from railroads to transistors to lasers to fracking to the internet, GPS, nanotech, and so on, that doesn’t have a government fingerprint on it somewhere.

There are numerous reasons for this history.  Absent early investment support, not enough private capital will be willing to risk early support of an unproven technology.  Scale is prohibitive when contemplating the railroads, the internet, or the smart grid.  Credit can disappear at critical moments, as in the financial meltdown out of which the electric automotive loan program arose.

Our international competitors understand this, and they’re far less squeamish about it.  Public/private partnerships are prevalent in Germany for example, where manufacturing policy is an explicit area of intervention.

So, does all that mean taxpayers have to live with the occasional failure in order to reap the benefits of transformative innovations like those listed above?  Probably so, but while I’m clearly a believer in public investment, I don’t love the idea of the federal government picking this firm over that one.  The record shows that doing so is not anywhere near as problematic as critics maintain, but let’s be real…there’s just a lot of ways in which that’s asking for trouble.

Perhaps a better way is some sort of arm’s length arrangement, where national policy picks broad areas of innovation to support where markets will underinvest, but assigns the choice of specific firms to groups of private experts and investors who will also have their own skin in the game.  Needs work, but that’s the idea.

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8 comments in reply to "The US Gov’t as Venture Capitalist: Why Go There?"

  1. foosion says:

    Government policy is littered with examples of the govt picking firms or industries for special benefits in order to advance what someone regards as a socially desirable goal. As a random example, should we stop funding specific fighter planes?

  2. Figs says:

    So Kudlow believes that the government’s failure rate as an investor should be zero? I know he’s using that as an argument for the government not getting involved in investment at all, but it seems funny that he’d hold the government to much, much higher standards than private industry, while at the same time arguing that government is bad because it can’t do equivalent things as well as private industry.

  3. Dave says:

    I think it is fine for the government to operate this way as long as it doesn’t wind up creating a monopoly in the process. I would stipulate that anything created using government venture capital cannot be patented. I think these ventures are best used to get industries moving to start, and to leave them on their own when they become profitable, but to try to leave the market as competitive as possible.

    So if all technology patents are to be owned by the public, thus unenforceable, then I think the industries can be left in a competitive state when the funding is withdrawn.

    Just a thought. I don’t know how the policies currently handle this.

  4. Dave says:

    Incorrect use of ‘stipulate’ above. Time for a nap.

    Anyway, I wanted to mention something that is often overlooked in debates about economic policy. We don’t seem to have a good sense as a country as to what it is supposed to do. What are the goals. Why don’t we have a 100% free market.

    Ultimately, the decisions are made by very few people that believe they know what is best, but of course, it always turns out to be what is best for the people they know. Then if you challenge them, they expect the same level of argument from the victims of their policies. If the victims cannot gather enough data and a convincing on the spot argument, then they aren’t to be heard. Their viewpoint doesn’t matter because it isn’t quite as coherent.

    Well, the masses and the victims of our policies don’t have the money to sponsor economic studies to try to explain their viewpoint. It is no wonder that people are angry with anything and everything government oriented. Their feelings are completely justified even if their arguments are completely incoherent.

  5. rootless (@root_e) says:

    Let’s turn off the internet, the highways, stop using integrated circuits, and give up all all other technologies that government invested in when private capital would not. The first time the US government invested in new technology was when it subsidized gun makers in the 1790s.

  6. Perplexed says:

    If Kudlow, Forbes, & Laffer are so concerned about “our” taxpayer money, why aren’t they pushing for elimination of patents like these St. Louis Fed economists are suggesting?
    Fed paper here:

    Somehow the money “we” pay through monopoly profits taxes and other forms of rents isn’t as valuable as if we paid it through direct taxation? At least with direct taxation “we the people” usually receive some benefit in return. With government granted monopolies, not only do “we the people” receive nothing, but it serves to impair our ability to gain from additional innovation by blocking it when it would impair monopoly profits. Who does this serve? Certainly not “we the people!”

    Engaging in these silly Lasez-faire arguments only boosts their credibility from silly hypothetical arguments to something serious adults would engage in real conversations about. Are these “private market” protagonists really suggesting that “we the people” should only invest in what “private investors” deem to be worthwhile from the standpoint of their own profitability? Or are they suggesting that government should somehow “force” private investors to invest in things “we the people” want invested in but “private investors” don’t view as profitable enough to compete with their existing choices? There is no “free market,” discussing what this fictitious “thing” would “do” is no more serious than discussing the “confidence fairy” or talking animals or any other fairy tale.

    If we continue to engage in it as it if were some kind of real conversation, it’s zombie status will continue forever; it will never die and make room for real adult conversation.

    If “we the people” choose to invest in innovations we want developed, who are they to question it? The real question about it should be: are “we the people” properly represented (without any outside influence) in our choices about these investments.

  7. M says:

    I’m not sure arm’s length is the way to go; I think DARPA is the model to emulate.

    The fact that the debate is not about how the gov’t should assist developing new technology but whether it should do so is… completely absurd.

  8. Kaleberg says:

    The U.S. government was providing industrial venture capital before there was a U.S. government. Look at Eli Whitney and his guns with interchangeable parts effort backed by the Continental Congress. It took another generation or two before the technology was made to work by Whitney Jr. & Sam Colt, but by the late 19th century every manufacturing firm was adopting “armory practice”. So, add interchangeable parts to the list of government boondoggles.

    If you study economic development, there are an awful lot of situations where no one wants to be a pioneer. It is all too easy to argue that an investment is very unlikely to pay off for a variety of reasons (e.g. It requires infrastructure, an ecosystem or a minimum purchase. It costs too much now, though it could be made cheaper.) Venture capitalists always say that you can tell the pioneers by the arrows in their backs. No one wants to be first.

    By funding the research and development and providing a market, the government can push the industry into being. Unlike a venture capitalist, the government doesn’t have to back the winner. Even if their hope goes bust, the technology is still out there. The engineers have been trained. Materials have been developed. The secondary suppliers are coming on stream and so on. The government can, or at least could, make up any loss by taxing the new industry.