IRENA, like others, does not specify the sources of the historical or future finance for the renewable energy sector. In fact, from the market failure perspective, the damages from climate change are a negative externality of energy production, hence require a corrective tax, while innovation requires correcting the positive externality of knowledge-spillovers.
But existing public-sector policies fail to tax carbon, not least due to the difficulty of agreeing on one tax internationally, and subsidies have been employed instead. This approach, however, overlooks what the public sector in fact does, besides giving subsidies in the market for electricity producers. The public sector is much more active in directly financing renewable energy innovation, creating markets, and, in the process, taking on high risks. First of all, public actors in renewable energy innovation are active along the innovation chain.
But public actors are distributed and highly active further along the chain: more applied research and development takes place in such diverse settings as the German Fraunhofer Institutes e. Government activity is also widespread at the demonstration level of new technologies; a recent study of demonstration projects first of a kind in concentrating solar power, wind power, and biofuels finds that the median public share of funds financing those projects is above 50 per cent Nemet et al.
At the subsequent market-creation and deployment stage, another variety of public actors are active, ranging from government agencies and investment funds, through tremendous amounts invested by state banks, to state-owned utilities, which have pioneered European offshore wind farm deployment Mazzucato and Semieniuk, In fact, at the deployment stage, publicly controlled organizations where the public has at least a 51 per cent share for stock-market listed organizations , are now responsible for almost half of global asset finance for utility scale power plants Mazzucato and Semieniuk, For smaller capacity, public actors provide important demand-side finance, such as subsidies for rooftop photovoltaic cells and individual wind turbines in Germany by the German development bank, KfW KfW, , and also larger-scale solar and hydro power plants in China by its Ministry of Finance Lo, Figure 5 summarizes the discussion, by replacing the public actors from other sectors, shown above in Figure 1 , with those specific to renewable energy innovation finance.
The data also show that this variety of public actors is not neutral, but gives directions to innovation. Public actors invest in portfolios that favour one or another technology. Figure 6 shows the portfolios of asset finance for deployment invested by four different types of public actors, aggregated over individual organizations within each type. The shares are calculated separately for two periods: —8, and — Clearly, the different types of actors held widely differing portfolios.
In the aggregate, government agencies invested in a relatively balanced portfolio across technologies—governments have not picked one winner technology, but supported innovation across a suite of alternatives within renewable energy. However, state banks were in turn more diversified than publicly owned utilities, which, outside China, targeted the financing of wind energy, and especially offshore wind investments after This distinguished them not only from other public actors but also from privately owned utilities whose share of investments in offshore was lower than that for state banks they invested heavily in less risky onshore wind.
While the review of organizations was selective, it emerges that in countries with a strong renewable energy sector, public organizations were active along the innovation chain, which is typical of the market-shaping behaviour of the public actors we discussed above.
Notes : The share of the portfolio invested in each of 11 technologies is on the y-axis. The dark bars show the share of investment in the period —8, the light bars the share of investment in the period —14 that go to a particular technology. CSP stands for concentrating solar power, PV stands for photovoltaics. Marine refers to energy gained from the ocean, whether through wave or tidal energy. Data sources are explained in Mazzucato and Semieniuk Many of the reviewed public actors are also mission oriented.
Innovation in the energy sector has historically been driven by missions.
In the s, the mission was to boost national security by reducing dependence on the then expensive crude oil from OPEC countries. As with previous missions, these investments are not justified by correcting a market failure but by achieving a goal. In this specific case: the halting of global warming.
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Thus the ARPA-E mission is to catalyse the development of transformational, high-impact energy technologies. The mission of the German KfW Group is to support change and encourage forward-looking ideas— in Germany, Europe, and throughout the world. We shape technology. We design products. We improve methods and techniques. We open up new vistas. Agencies in the energy sector have also been able to attract top talent. In sum, a slate of the most influential public institutions funding renewable energy research do not understand themselves as fixing market or system failures—they see themselves as pushing new and exciting horizons.
Lastly, there is also evidence in the renewable energy sector, and clean tech more generally, for public actors leading in risk-taking across the business cycle. The technologies listed in Figure 6 above are ordered according to an increasing degree of technology and market riskiness from left to right. Thus, publicly owned utilities take on considerable risk by investing a large share of their portfolio in offshore wind. In a companion piece Mazzucato and Semieniuk, , we have not only justified this risk ordering, which is ordinal and suggests that onshore wind is no more risky than any other technology investment on average, but does not attempt to quantify the amount of risk taken; we have also shown that according to this measure public actors hold on average a much riskier portfolio than private actors in asset finance, at least when excluding the Chinese utilities charged with onshore wind diffusion.
Here, we push this research one step further and analyse how high risk-taking by private actors is correlated with co-investment by public actors. We single out investments into high-risk areas only.
Figure 7 correlates the private investment into high-risk assets with the participation of public actors in private high-risk finance. It plots the share of total private funds invested in high-risk assets in any single year against the share of these high-risk funds that are invested into an asset in which at least one public actor is also investing. In , only about 1 per cent of private funds went into high-risk projects and, of these, only 18 per cent had a public co-investor.
Both shares increased over time, so much so that a decade later, in , around 10 per cent of private funds went towards high-risk investments, while the share of these high-risk projects co-funded by a public organization stood at above 50 per cent. The correlation is high indicated by the grey linear fit , when one excludes three exceptional years— through —during which massive Keynesian stabilization programmes kicked in, inundating markets with grants and loan guarantees.
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That coincided with private actors financing more risky projects with private funds only but backed by public guarantees. These statistics show that as more public actors were stepping forward to finance assets, the private side became more willing to invest in the higher-risk deployment.
Scatter of annual share of high-risk private renewable energy investments involving a public financing partner x axis vs the annual share of private funds invested into high-risk assets y axis. The inset shows a time series of the share of finance that public actors provide in the joint deals with private actors. Notes : Edges connect subsequent years. The dotted lines indicate years with significant grant and loan guarantee support as part of post-crisis government stimuli that imply indirect public support to high-risk deals carried out exclusively with private funds.
The exceptional measures taken in —11 by governments indicate that in the energy sector, over the last business cycle, public financing was significantly driven by a coordination failure logic. Figure 8 shows clearly how the grants for renewable energy research, development, and demonstration given out by the US Department of Energy DoE and all other grant-giving organizations spiked in those 3 years and dropped back almost to pre-crisis levels. A similar, albeit less pronounced pattern can be detected in investment behaviour of the big development banks—China Development Bank, KfW, and European Investment Bank.
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However, while declining, these banks have kept their investment at a much higher level than pre-financial crisis. It remains to be seen how public funding for renewables will be impacted if and when a business cycle boom occurs. Annual total of grants given for clean energy research, development, and demonstration, split into US Department of Energy DoE and other grant givers. In sum, the patterns we see in public financing for innovation in renewable energy, and clean tech more generally, are very far removed from the indirect policies recommended by a market failure approach.
A market-shaping perspective that sees the state as entrepreneurial and risk-taking, and distinguishes public actors with missions, highlights these patterns. In spite of these massive interventions, the grand challenge to keep temperature rises to a modest level suggests that even the existing activities have been insufficient to mobilize the finance that is forecast as needed for achieving the mission of limiting global warming. The market-creating and -shaping perspective leads to the conclusion that even more active public-sector involvement in financing innovation is needed to realize the 9 per cent compound annual growth rate in clean energy investment that IRENA estimates is needed over the next 15 years.
It is, of course, possible to argue that the public financing stymied overall financing as opposed to boosting it, and we return to this caveat in our concluding discussion. Yet the evidence also from earlier transformative innovations, the problem that markets first have to be created before they can be corrected, and the seriousness of this and other grand challenges should caution against foregone conclusions.
It seems risky not to explore the possibility that public actors that help direct innovation to certain mission-determined outcomes through massive financing of innovation may be an important driver of the transformation of how we produce energy. In this article we have focused on the strategic role of public financing of innovation and the way it can shape and create markets. We have looked at three key features of this process: i investing along the entire innovation chain, not only in classic public-good areas; ii the mission-oriented nature of the agencies involved; and iii their lead risk-taking role, independent of the business cycle.
We have argued that looking at these three features of the system help to see the limits of the traditional market-failure framework. We then applied this perspective to the emerging clean technology sector, as an example of transformative innovation needed to confront a societal challenge. The market-shaping approach suggests that public financing must be proactive and bold, creating directions, and transcending the role envisaged by market- or also system-fixing approaches.
For the challenge to mitigate climate change, if the recent international agreements to fight climate change are to have effect, it is important for public organizations financing innovation to be mission-oriented and entrepreneurial. We have shown that public actors are active; yet given the estimated need for investment in this sector, this is not enough.
To experience a full blown clean energy revolution, the lessons from the IT revolution are clear: the visible public hand is required; it must be distributed across the whole innovation chain through different actors; and justifications for the investments cannot be limited to periods with low interest rates. Even if the world was experiencing high growth, it would not be enough for tax breaks to incentivize green investments. They would need to be crowded in by public funding, simply because there is as yet no market that can work efficiently with private actors at its centre.
Two caveats to these statements are in order. First, there is no automatism whereby public involvement in financing innovation leads to superior outcomes; what we have argued against here is the assumption that public-sector financing is systematically inferior to that by private actors. While the examples above focus on public investments that have led to important successes e.
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These include products like the Concorde aircraft, which ultimately failed commercially; the discovery of new drugs of which most attempts fail ; or the provision of guaranteed loans to companies which then might go bankrupt. As stressed above, however, any venture capitalist will argue that attempts to innovate require exploring new and difficult paths, and that occasional failure is part of that journey.
Innovation is intrinsically uncertain Dosi and Edigi, and results in failures from time to time. This trial-and-error process, in which tolerance of failure is also the road to success, is accepted in the private sector. Failure of government investments, on the contrary, is regarded as a sign of incompetence The Economist , If the government acts as lead risk-taker, then it should be accepted that there are failures, as long as there are successes. It is important then, not to categorically dismiss public financing because some of the projects fail, but to ask what are well-designed policies for public financing of innovation.
A second caveat regards the motivations behind public-sector financing. Public choice theory and related new public management theory have highlighted the problems associated with government failure arising from rent-seeking, whereby public officials are captured by vested private interests Tullock et al. Rents arise when value is extracted through special privileges Krueger, , and when a company or individual grabs a large share of wealth that would have been produced without their input Stiglitz, p.
Then financing for innovation could go to those special interests that are not the best innovators but those with the best connections to the public funding agencies. Our lens, far from denying this problem, sheds a different light on it. The question is whether rent-seeking is more problematic with a weak, passive state than with a strong one. It could be that rent-seeking is even more damaging when the public sector only attempts to facilitate rather than create additionality through mission-oriented policies that crowd in the private sector, making private investments happen that would not have anyway, a problem discussed in the economic development literature Khan and Kwame, Or whether it is more problematic when theory tells a wrong story about who the innovators are e.
In the US, capital gains tax fell by 50 per cent in 5 years at the end of the s as a result of pressure from the National Venture Capital Association Lazonick and Mazzucato, In fact, some rent-seeking may be encouraged precisely by the problematic assumptions regarding the role and value of public investment. The article has emphasized the need of innovation for patient strategic capital that is lacking in the private sector, due to both the short-termism of the private financial system, but also the properties of innovation: highly uncertain, cumulative, collective, and with very long lead times.
This leads to a depth and breadth of public investment that is broader than traditional perspectives admit. Oxford University Press is a department of the University of Oxford. It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide. Sign In or Create an Account. Sign In. Advanced Search. Article Navigation.