Making a Case for Innovation Investment in an Era of Austerity
“[I]nnovation and technological change are undoubtedly central to the growth process; over the past 200 years or so, innovation, technical advances, and investment in capital goods embodying new technologies have transformed economies around the world.”1
-Federal Reserve Chairman Ben Bernanke, May 16, 2011
Many policymakers are fond of saying the American government should run more like a business. If the CEO of an American company faced similar circumstances to what the U.S. faces today, the solution would be simple. He or she would go to his board and shareholders with a plan to both cut unnecessary spending and invest in new product development and promising markets. If that CEO instead went to the board with a plan that cut everything, eliminating any hope for growth and recovery, he or she would be fired.
As Washington struggles to develop a path to get the deficit under control, policymakers should follow the CEO model. With $2.3 trillion at stake, the global clean energy market is one place where the United States must invest in new product development. Seizing a large share of the clean energy sector would fuel the growth the United States needs to eliminate our budget deficits.2 There are three factors holding back American success in clean energy innovation:
- Energy companies invest far less in R&D than companies in other sectors;
- It takes a long time to commercialize clean energy technologies;
- Our foreign competitors have a big, but surmountable, lead.
This is an example of where, as Chairman Bernanke has said, “the tendency of the market to supply too little of certain types of R&D provides a rationale for government intervention.”3 Yet instead of helping American businesses win this competition, the debate in the Capitol is about whether there is any role for federal investment in energy, particularly around innovation.
As a center-left organization that has aggressively called for putting everything—including entitlements and revenue—on the table to tackle the debt, we believe that the country needs to make tough choices. But we can and must address the deficit in a serious way while also strengthening long-term U.S. economic growth. That requires a shift in the debate from whether the United States should invest in clean energy innovation to how we should do it in a way that maximizes economic growth.
Time and Money: Why Clean Energy Innovation is Different
The private sector is not structured or able to solve the clean energy challenge on its own. It is not investing sufficient amounts in research and development and lacks the incentives to do so. Additionally, federal investment in private sector clean energy R&D and innovation has been uneven over the past three decades, and where there has been funding, investors face a sometimes byzantine and unapproachable bureaucracy that can stymie even the most intrepid entrepreneurs. U.S. businesses are ill-equipped to create, develop, and deploy the new technologies that would make clean energy cheap and establish national leadership in the sector.
1. The Energy Industry Invests Less in R&D than Other Sectors
The biggest challenge facing clean energy is money. The public and private sector are not investing enough to drive innovation. Compared to federal healthcare, defense R&D, or the Information Technology sectors, all energy—not just clean energy—is funded far below average. This is because conventional energy is cheap and reliable, and energy research, development, and deployment are extremely expensive and inherently risky. Given the early stage of clean energy markets, it is of particular importance to fund innovation now to bring down technology costs. Moreover, we must clear away the thicket of bureaucracy facing companies that do receive federal R&D funding.
To understand the great capital challenge that clean tech innovation faces, we have to take a look at the bigger picture. In the United States, the private sector barely invests in any energy research. Where U.S. industries, as a whole, spend an average of 2.6% of their revenue on R&D, the energy industry invests a paltry 0.23% of revenue on any kind of research—clean or conventional.4 This includes funding for expensive research into conventional fuels, such as ultra-deep water drilling and new oil refining techniques, which is an important point.
Forget about the pursuit of clean energy; the energy sector relies on the same fuel sources that have provided reliable, inexpensive energy for more than 100 years. There is not an economic imperative to spend more. This stands in stark contrast with the hyper-competitive pharmaceutical industry, where new drugs supplant old ones every year. Pharmaceutical companies spend 19% of revenues, or about $39 billion each year on R&D.5 Even American automakers, despite tough economic times, still invest $17.5 billion in R&D.6
Energy innovation that is occurring is coming from much smaller startup companies that rely on venture capital and newly unleashed federal investments. This has helped give rise to the likes of Tesla Motors (electric vehicles), Bloom Energy (fuel cells), Better Place (electric cars), and Bright Source Energy (solar thermal power). The Great Recession, however, has greatly reduced the flow of venture funding to clean tech companies just as the global competition to foster new companies heats up.7 After climbing steadily from $262 million in capital clean energy investments in 2003, venture capital investments peaked at $4.1 billion in 2008. It fell by over 50% in 2009.8 The trend is not abating. The most recent venture capital investment reports show that funding has dropped 55% this year over the same period in 2009.9
Expecting private sector spending to support the entirety of clean energy innovation and R&D puts American businesses on an unfair playing field with their international competitors. As business leaders have made clear, private sector money, whether through direct corporate investment in innovation or through the capital markets, simply is not sufficient. Jeff Immelt sums up the private sector frustration well: “The United States is falling behind because we don't have the markets or the will—our policies are short-sighted and our markets aren't set up to reward energy innovation.”10
2. Energy R&D Takes Much Longer to Payoff
Many have pointed to the Information Technology boom as providing an antecedent to the clean tech revolution. But while IT can offer important lessons for clean energy development, there are major differences in maturity of the respective industries, scale of infrastructure needed, and initial capital required for clean tech today versus IT twenty years ago. King among these factors, of course, is cash. Existing companies and the private capital markets are not investing sufficient amounts in clean energy R&D and innovation because of the enormous upfront costs and the absence of current market demand in the U.S.
Compared to many other technologies, especially IT, innovating in clean energy is the equivalent of sailing into a hurricane. For example, IT capacity doubles every 18 to 24 months. It has taken on average 30 years for a new energy innovation to go from the drawing board to capturing just 1% of the market.11 And an IT entrepreneur can follow the path of Hewlett-Packard and Google and literally develop a new Internet or computer innovation in the garage. That is not possible with solar panels, next-generation nuclear power, or transmission. Clean energy innovation requires large capital investments in facilities, projects that can last for years at a time, research experts, and scalable demonstration projects.
Other sectors, particularly healthcare and defense, where there is similar national interest and potentially a long time between research and commercialization, receive consistent government investment. This has helped fuel economic growth. The defense sector has enjoyed 4% growth from 1998-2010 and the healthcare sector 5%. The energy sector lagged far behind at 2.3%. Neither the health nor defense sectors faced the rollercoaster of federal investment uncertainty faced by energy. Over the past two decades, the government has invested $52 billion in energy, compared to $452 billion in health research and $1.3 trillion for defense.12 Public energy innovation funding dipped then flat-lined beginning in 1998 while investment in health and defense increased by an average of $167 million a year.
3. International Competitors Are Moving More Aggressively
Without some other external driver, like the national policies in Europe and Asia, there is little incentive to spend money on the expensive pursuit of energy innovation. Our international competitors recognize these challenges and are tackling them head-on. In July 2010, China announced that it will invest a total of $738 billion over the next ten years in clean energy research, development, deployment, and associated infrastructure.13 China is also putting a very modest but real price on carbon in some sectors of its economy in 2011,14 and mandating a 45% reduction in the energy intensity of the Chinese economy.15 The Australia-based Climate Institute calculated that these policies taken together add up to an implicit $14.20 per ton price on carbon.16 This has helped China attract more clean-tech financing this year than Europe and the United States combined,17 and the Worldwatch Institute warns that, based on this trend, China will become the “undisputed global leader” in clean energy within two years.18
Japan will invest $30 billion over the next five years in clean energy technologies.19 South Korea is investing heavily, $84 billion over five years, on a “Green New Deal”20 to develop and utilize clean energy and to improve their IT infrastructure.21 This is 9% of the country’s gross domestic product (GDP),22 comparatively dwarfing the U.S., which spends only a small fraction of 1% of GDP on energy innovation.23 Investors in the European Union (EU) will also outspend the U.S. on clean energy development, spending $38.5 billion per year,24 on top of the EU’s existing carbon price25 and a multinational 20% renewable electricity standard that will take effect in 2020.26
Clean energy technology is the domain of the private sector. But in the face of clear market failures—an absence of capital, long lead times for development, and commercializing new technologies and international competitors with a head start—American companies simply are not able to compete on their own. The payoff of a smart public investment, however, is enormous. As Chairman Bernanke points out, “The location of R&D activity can matter.”27 Countries that are the home of innovation get the benefits of economic growth, job creation, and expanded revenues. In the face of huge deficits and sluggish job growth, that is what a successful CEO would do. It is exactly what the United States needs to do today.