Stifling Innovation by Subsidizing It

In 2007, the Advanced Technology Vehicles Manufacturing Loan Program was created in the Department of Energy to support the development of advanced (i.e., “green”) technology vehicles. Last year Congress appropriated $7.5 billion to support a maximum of $25 billion in loans. So far, the subsidies have been dished out to Ford ($5.9 billion), Nissan ($1.6 billion), Tesla Motors ($465 million), and Fisker Automotive ($528 million).

Darryl Siry, a former official at Tesla, has written a piece for Wired that illuminates a fundamental problem with the government trying to pick winners and losers in the marketplace:

To the recipients the support is a vital and welcome boost. But this massive government intervention in private capital markets may have the unintended consequence of stifling innovation by reducing the flow of private capital into ventures that are not anointed by the DOE.

Private investors, such as venture capitalists, make investments based on perceived risk and expected financial returns. Companies with government backing are more attractive to investors because government support “amounts to free leverage for the venture capitalist’s bet” given that “the upside is multiplied and the downside remains the same since the most the equity investor can lose is the original investment.”

According to Siry:

The proposition is so irresistible that any reasonable person would prefer to back a company that has received a DOE loan or grant than a company that has not. It is this distortion of the market for private capital that will have a stifling effect on innovation, as private capital chases fewer deals and companies that do not have government backing have a harder time attracting private capital. This doesn’t mean deals won’t get done outside of the energy department’s umbrella, but it means fewer deals will be done and at worse terms.

Siry concludes that a solution to avoiding these market distortions would be to “cast the net more broadly” by giving subsidies to more companies. That’s where I part ways with his analysis. The real solution is to get the Department of Energy out of the subsidy business -- and energy markets -- altogether.