The Perils of Energy Technocracy

Picking 'Winners' and Losers with no skin in the game  

by Donald Norman

“There is no evidence that government scientists and engineers are better at forecasting the future and know how the future will play out better than the scientists and engineers in private companies. Technocrats ignore the fact that private companies also hire scientists and engineers, (not to mention MBA’s and economists) and make investments based on their outlook for the future.”

The technocracy movement that arose in the early part of twentieth century advocated turning over the reins of governmental decision making to scientists, engineers and other “technocrats”. It was argued that the expertise of technocrats would result in better decisions than those made by private companies.

The idea of technocracy was embedded in the concept of central planning and was heralded by Thorstein Veblen and embraced by the Soviet Union. In the early years of the Great Depression the movement enjoyed renewed popularity, the belief being that technical, rational and apolitical expertise could revive the economy.

As an aside, one of the advocates of technocracy was M. King Hubbert who later developed his theory of Peak Oil production. Hubbert also proposed that energy certificates be issued to replace conventional money. These certificates could be divided equally among all members of a North American continental “technate.” Hubbert went on to become a geoscientist at Shell Oil.

A Comeback in Energy

Interest in the technocracy movement waned as the 1930s wore one, but surprisingly it is making a comeback in the area of energy. The Obama administration’s belief that the government can pick winning energy technologies is something that has a lineage reaching back to the technocracy movement.

Despite F. A. Hayek’s explanation as to how markets transmit information and coordinate decision making by individuals in the private sector, many in the current administration, along with its supporters, believe that Nobel Prize winning scientists like Secretary of Energy Steven Chu are better positioned to put the economy on the “correct” path to the future and do so faster than the market.

The problem with technocracy goes beyond the Hayekian information problem faced by central planners. Those making governmental investment commitments have little “skin in the game.” They are not risking their money or the money of investors who voluntarily opt to take on a risk.

Rather, they are risking the taxpayers’ money because the latter are unwittingly forced to become investors in government projects. The incentive structure faced by government decision makers thus is different than that faced by private companies.

Those investing in private companies and ventures can assess the risks they face. They have access to investment analyses and ratings by agencies like Moody’s and Standard & Poor’s. If a company is publicly held, investors can readily find measures of risk like Betas. What does the taxpayer have? They have the assertion that Stephen Chu and other scientists are better positioned than private companies to pick which technologies to underwrite.

Past as Prologue

The government has intervened in energy markets before. Aside from price and allocation controls on oil and price controls on natural gas, the government gave us the Power Plant and Industrial Fuel Use Act of 1978, which was premised on the view of experts that we were running out of natural gas and thus its use should be limited. Thus, the Fuel Use Act restricted the use of natural gas for industrial uses and by new power plants for electricity generation. Mercifully, this law was administratively and legislatively weakened and finally repealed in 1987. U.S. natural gas production went on to smash the previous record high, set in 1973, in 2011. The record was broken again in 2012.

The government picked another “winning” strategy when it established the Synthetic Fuels Corporation in 1980 with the goal of producing two million barrels of liquid fuel per day within five years. Alas, this winning strategy was done in by the subsequent decline in oil prices that began two years later and an administration that took a dimmer view of having the government pick winners. The Corporation was abolished in 1985.

Back to the (Predictable) Failure

Ignoring previous experience, the federal government got back into the energy investment business in 2009 and some were downright giddy. Susan Kraemer gushed that Stephen Chu finally put “the nail in the coffin of those who say the government can’t pick winners and losers”:

So picking winners to invest in on behalf of the public good makes sense. At least initially, they need government support. Now it looks as if our own government is getting as smart as the Japanese government was back in the ’90’s. Kudos to our new DOE. Today, I’m proud to be an American.

This exuberance came before Solyndra (recipient of a $535 million loan) went bankrupt. Fisker Automotive (recipient of a $529 million loan) recently laid off 75 percent of its staff and reportedly is on the verge of filing for bankruptcy. Tesla, another electric car producer and the recipient of a $465 million loan, claims to be turning a profit selling cars at prices ranging from $49,900 to $180,000. While Tesla purchasers like Leonardo DiCaprio are benefiting from the government’s support of Tesla, one can question whether the loan is in the public interest.

(As an aside, one can opt instead to lease a Tesla for $500 per month. Unfortunately for Tesla, analysts are questioning the reality of this lease price, claiming the true cost is much greater. On the plus side according to Tesla, the company reportedly reached “full profitability” during the latest quarter, although its statement didn’t specify what “full profitability” meant. It appears Tesla set the bar wherever it wanted to and declared victory.)

Market Discipline … Political Fad

A company in the private sector requires its investment projects to generate a return equal to or greater than the hurdle rate it establishes as a filtering device. Hurdle rates typically are linked to a company’s weighted average cost of raising capital and include the cost of issuing equity and selling debt. A risk factor may be added to the weighted average cost of capital that takes account of a project’s specific risk.

Companies will be forced by the discipline of market forces to scale back or even the pull the plug on investments which do not perform as expected. As Armen Alchian argued in his classic article, “Uncertainty, Evolution and Economic Theory,” companies that do not respond quickly will not maximize profits and thus eventually will be weeded out of the market by the competitive process.

The recourse to a subsidy or a low interest government loan is not an option for companies that rely on private financing. Further, these companies have no protection from competitors that enter the market offering new products or technologies (witness Betamax vs. VCR; VCR vs. DVD; DVD vs. streaming, Apple iPhones vs. Samsung Galaxy or Nokia Lumia, etc., etc.).

Such is not the case for government ventures. The government is able to “tap” into (or should I say “pick”) the pockets of taxpayers to keep a project going. Kraemer indicated that government support might be needed, “at least initially,” but the length of this initial period is left to anyone’s guess. Like government agencies that rarely are subject to “sunsetting,” a governmentally funded project can be kept alive simply because it is in the interest of politicians to underwrite projects that bring jobs to their districts.

Finally, there is no evidence that government scientists and engineers are better at forecasting the future or know how the future will play out better than the scientists and engineers in private companies. Technocrats ignore the fact that private companies also hire scientists and engineers, (not to mention MBA’s and economists) and make investments based on their outlook for the future.

The criticism leveled at this is that private investment decisions are guided by the profit motive. But what guides the scientists and engineers hired by government or who work for firms that are underwritten by the government? Is it simply their confidence in their vision? And, is there any evidence that their visions of the future are better than those coming from the private sector?