The U.S. Government as Venture Capitalist: Why Go There?

04/25/2013 11:32 am ET | Updated Jun 25, 2013

I had a rousing debate on Kudlow tonight about the Fisker story that's got a lot of folks like Larry K crying "Solyndra squared!"

Not so fast, dude. Brad Plumer covers the details here, but Fisker Automotive is a small company that has been trying to break into the electric car market but now teeters on the edge of bankruptcy. So... it happens, right? Not every pony finishes the race. What's the big deal here?

No electric vehicle initiative backed by Washington seems more of a debacle than Fisker, which was given a $529 million federal loan in 2009 to advance the project. Two years later, after Fisker repeatedly missed production targets and other deadlines, the Energy Department suspended the loans.

Private investors also sunk about $1 billion into the company, but it's the loan by the U.S. government that a) genuinely rankles free marketeers like Kudlow, and b) provide a juicy talking point for Obama admin critics.

To be clear, the Energy Dept. froze the loan after $192 million back in June of 2011, and seized $21 million from the company's reserves on Monday. Also, as Plumer notes:

The Obama administration... stressed that Fisker was an anomaly. Nicholas Whitcomb, who directed the Energy Department's advanced-vehicle loan program until recently, testified (pdf) that $8.4 billion in advanced-vehicle loans have been given out to five auto companies so far. While Fisker has performed poorly, he said, loans to firms like Ford, Nissan, and Tesla have helped build factories and are all scheduled to be repaid.

Whitcomb also noted that Congress explicitly provided a $10 billion credit subsidy to cover losses and bad loans, thereby acknowledging the "inherent risks of funding new and innovative technologies.

One might also note, as an administration official did during testimony today, that about 2 percent of the government's loans have defaulted, and there's of course no venture capital firm out there that would come anywhere close to that level of success (if they bat 500, they're doing great).

But putting aside all the political BS, the case raises good questions: Why should the U.S. government provide venture capital? And if there's a rationale, how much should they provide, and on what terms? What is an acceptable failure rate? Is it zero, as Kudlow et al would argue?

The question of should the government backstop investments in new areas of research is actually an odd one, because it's been doing so since before we were even a nation (the provisional government subsidized machine tools for weaponry to fight the British -- in fact, much of what followed grew out of defense spending). As I stressed on the Kudlow show, you simply cannot find an economically transformative innovation, from railroads to transistors to lasers to fracking to the Internet, GPS, nanotech, and so on, that doesn't have a government fingerprint on it somewhere.

There are numerous reasons for this history. Absent early investment support, not enough private capital will be willing to risk early support of an unproven technology. Scale is prohibitive when contemplating the railroads, the internet, or the smart grid. Credit can disappear at critical moments, as in the financial meltdown out of which the electric automotive loan program arose.

Our international competitors understand this, and they're far less squeamish about it. Public/private partnerships are prevalent in Germany for example, where manufacturing policy is an explicit area of intervention.

So, does all that mean taxpayers have to live with the occasional failure in order to reap the benefits of transformative innovations like those listed above? Probably so, but while I'm clearly a believer in public investment, I don't love the idea of the federal government picking this firm over that one. The record shows that doing so is not anywhere near as problematic as critics maintain, but let's be real... there's just a lot of ways in which that's asking for trouble.

Perhaps a better way is some sort of arm's length arrangement, where national policy picks broad areas of innovation to support where markets will underinvest, but assigns the choice of specific firms to groups of private experts and investors who will also have their own skin in the game. Needs work, but that's the idea.