Innovation policy:

(How) Should Priorities be Chosen?

Jim Watson
Sussex Energy Group

TIPS/SPRU Workshop, Berlin, 27-28 November 2007

Sussex Energy Group

SPRU - Science and Technology Policy Research
Innovation Policy
How Should Priorities be Chosen?

1 Rationales for public support

2 Why make choices?
3 How might choices be made?
4 Conclusions

Sussex Energy Group

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Rationales for public support
for low carbon innovation

Traditional market failures:

• Social returns from R&D cannot be fully captured by private
firms, so they will tend to under invest
• Environmental externalities (particularly social cost of carbon)
justify market support for deployment
System failures
• The need to build capacity and skills, and develop new networks
(e.g. micro-generation installers; electricity network R&D)
• Lock-in of existing technologies, institutions create ‘passive
barriers’ to innovation (e.g. centralised infrastructure)

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But should government stay out
of technology choice?

A prime consideration must be to create the right framework which

will reward the best, most cost-effective technologies and
encourage their development. This means a policy that is not about
picking winners, but which allows the market to provide appropriate
incentives.
Interdepartmental Analysts Group: Long Term Reductions in
Greenhouse Gas Emissions in the UK. February 2002

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 Why make Choices?

Sussex Energy Group

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Why make choices?
1. Failures as learning

• Picking winners is a great idea if it can be achieved

• Perhaps avoiding picking losers is more accurate – this leads to an
understandable aversion to overt priority setting
• But failure is a learning process – learning by doing not learning
by speculating (e.g. CCS costs and performance is uncertain until
you build a full scale plant)
• Processes of review must be in place to avoid dependency; allow
support to be withdrawn as likelihood of success diminishes

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Why make choices?
1. Failures as learning

Uncertainty over the economies of scale and learning-by-doing

means that some technological failures are inevitable. Technological
failures can still create valuable knowledge, and the closing of
technological avenues narrows the investment options and
increases confidence in other technologies.
Stern Review Report, Chapter 16

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Why make choices?
2. Governments vs markets

• The idea that government cannot pick winners and that the market
is better placed to make choices is a caricature
• Government have backed failures in the past (supersonic
passenger aircraft, fast breeder reactors)
• Government spending has also had positive outcomes, e.g.
– Cost reductions in global PV market
– CCGT technology (source of UK carbon emissions reductions)
• Market mechanisms are predisposed to pick options that are
nearer to commercial readiness – e.g. the UK’s Renewables
Obligation and wind power

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Why make choices?
3. Resource Constraints

800
700 UK Energy R&D Spending
Spending (2004 £s)

600
500
400
300
200
100
0
1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004
Conservation Oil & Gas Coal Renewables
Nuclear Power & Storage Other

Sussex Energy Group Source: IEA

SPRU - Science and Technology Policy Research
Why make choices?
3. Resource Constraints

9000
8000
Spending (2005 $)

7000

6000
5000

4000
3000

2000
1000

0
1974 1979 1984 1989 1994 1999 2004

UK USA Japan France Germany

Sussex Energy Group Source: IEA

SPRU - Science and Technology Policy Research
Why make choices?
3. Resource Constraints

But data from IEA don’t cover everything. Some UK funding not
included in these figures, e.g.
• Funding for agencies like the Carbon Trust
• Funding for technology deployment (e.g. £1bn on Renewables
Obligation by 2010; new Environmental Transformation Fund)
Also misses out private sector funding:
• US and EU data show falls in private sector funding for energy
R&D since late 1980s; also falling patent activity
• Multinationals are key in many areas of energy system, but can
their spending be analysed accurately?

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 How might choices be made?

Sussex Energy Group

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How might choices be made?
Four issues

• Policy analysis of economics of low carbon technologies is

important, but often neglects financial risks
• Stage of development of different technologies can influence type
of mechanism that is most appropriate
• Diversity is a good strategy, but how should it be put into
practice?
• Industrial policy has been out of fashion in the UK since the 1970s,
but it is often a factor in other countries’ decision making

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How might choices be made?
Need to consider costs and risks

4.00

Old nuclear New offshore wind New Coal

3.50
Old coal New Nuclear
DTI 2000 mix
Generating Cost (p/kWh)

3.00 Old hydro DTI 2010 mix

Old Gas
Old wind
2.50 DTI 2020 mix

2.00 New Gas

New onshore wind
1.50

1.00

0.50
Source: Awerbuch, Jansen et al, 2005
0.00
0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18 0.20
Risk (standard deviation)

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How might choices be made?
Experience curves can bring costs down

Source: Watanabe et al, 2000

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How might choices be made?
Experience is sometimes unhelpful

2000
Capital Costs ($1996 / kW)

1500

1000

500

Source: Watson, 1997

0
1965 1970 1975 1980 1985 1990 1995 2000

CCGT Conventional Coal

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How might choices be made?
Stage of development is important

‘valley of death’
Source: Carbon Trust
Funding

Stage 1 (R&D) Stage 2 (early Stage 3 (refinement Stage 4 (early

demonstration) & cost reduction) commercialisation)

Current Policy Framework Ideal Profile

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How might choices be made?
Stage of development and funding
Possible Mechanisms

Capital grants Performance

R&D funding
incentives
Performance (e.g. carbon
Tax breaks
incentives price)

Stage 1 (R&D) Stage 2 (early Stage 3 (refinement Stage 4 (early

demonstration) & cost reduction) commercialisation)

Current Policy Framework Ideal Profile

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How might choices be made?
Diversity in practice

• Diversity seen almost universally as a good idea, but what does it

mean?
– Variety (number of options in a portfolio)
– Balance (relative shares of these options)
– Disparity (how different options are from each other)
• Resource constraints may mean supporting all options is not
desirable or possible
• Technologies might interact and should not be considered in
isolation from each other
– In the UK, risk that new nuclear programme will divert political
and economic resources from other options

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How might choices be made?
Energy policy & industrial policy

In the past the steam engine, the internal combustion engine, the
micro-processor transformed not just technology but the way our
society has been organised and the way people live.
Now we are about to embark, I believe, on a comparable
technological transformation to low carbon energy and energy
efficiency and this represents an immense challenge for Britain, but
it is also an opportunity.
Gordon Brown, 19th November 2007

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How might choices be made?
Energy policy & industrial policy

[T]he first programmes of the £1 billion public/private Energy

Technologies Institute … will be focused on R and D in offshore
wind, in wave and tidal stream energy, and the new £370 million
domestic environmental transformation fund will help bring these
technologies to the marketplace, creating businesses and jobs.
Gordon Brown, 19th November 2007

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 Conclusions

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Conclusions

• Pricing carbon and is necessary but not sufficient – should be

complemented by technology-specific measures
• Energy R,D,D & D funding needs to be increased and rebalanced
(Manhattan Project comparisons are perhaps simplistic)
• These prescriptions mean that government needs to take more
risks (e.g. risks of being captured by lobbies, risks of failure)
• To deal with these increased risks, the following may help:
– Plural institutions to guard against ‘policy capture’ by lobbies
and to deal with complex issues
– More transparency in process of priority setting
– More systematic evaluation of current / past policies with
willingness to cut funding to losers
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Conclusions
How is UK policy doing?

• Still too much emphasis on EU emissions trading scheme, but

increasing number of specific measures (e.g. on CCS)
• Significant increases in funding for R&D and deployment, but still
question of ‘valley of death’
• Government still very risk averse and obscured by ‘picking
winners’ debate. Would rather analyse costs of new technology
programmes than implement them.
– Complex, plural institutions – though unclear how they all fit
together or where gaps are
– Lack of transparency on selection process – though some
priorities clear (CCS, offshore renewables, nuclear?)
– Evaluations are hidden or missing; support to new industries
cut before they have got going
Sussex Energy Group
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 Thanks

http://www.sussex.ac.uk/sussexenergygroup

Sussex Energy Group

SPRU - Science and Technology Policy Research