Government directed innovation leads to rent-seeking, undermining innovation

Incentive problems concern whether policies can be designed in a way that is compatible with incentive structures throughout society. Any policy implementation needs to consider the extent to which political decision makers, administrators and commercial forces are driven by incentives that make policies work out as intended. The literature on political economy often highlights public actors’ goal setting as a matter of aligning between different types of interests, including the vote maximizing behavior of politicians and budget maximizing among government agencies. Moreover, politics and public grants in particular are frequently influenced by lobbying of special interest groups at the expense of taxpayers and the public (Niskanen 1975).

Incentive problems help us explain some of the results regarding why public policies for innovation have delivered meagre results. Different public programs tend not to be closed down, even when they have no positive effects, arguably due to the budget maximizing nature of government agencies and the need of politicians to appear as decisive. Government initiatives can also lead to firms developing opportunistic behaviors which, ultimately, can result in both cheating and corruption. A recent German study found that soft loans have not necessarily gone to firms that need them most, but to firms where management have personal connections to funding agencies (Haselmann et al. 2018).

Furthermore, even support or cheap loans are not free as they are always associated with a search process that requires personnel resources, both for the firm and the administrative body. Competition may be distorted, and selective support can create skewed incentives where firms spend more time applying for grants and lobbying for support than they do developing their products and services (Baumol 1990). There is also a risk that politicians prioritize what benefits them in the short term rather than making decisions that benefit society in the long term. There is always a risk, then, that support schemes and an active innovation policy will be exploited by opportunistic politicians as well as authorities and firms. One example comes from contemporary developments in Spain, where an overly supportive scheme for renewable energy resulted in a bubble of solar cells and wind power, as well as considerable levels of corruption. The support was so generous that growth became unmanageable for the government, which eventually had to withdraw the support it had assured would apply for years to come (Alvarez et al. 2009). This shows that public initiatives for innovation are associated with considerable incentive problems.

To sum up, there are several theoretical arguments why a market’s conditions would produce an insufficient supply of innovation, suggesting that policy efforts are needed. These are, however, associated with their own difficulties, both with regard to access to relevant information and incentives of the actors involved. The fact that innovation is important for the economy therefore does not imply that R&D or specific firms should be supported by authorities. A functioning policy for growth therefore needs to strike a balance: Policy failures may be as problematic as market failures.