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Picking losers

The Department of Energy, acting under authority provided in the stimulus package of February 2009, may try to push through up to $5 billion in loan guarantees to green energy projects before month’s end (i.e., in the next 48 hours).

This same program loaned Solyndra $535 million before the company eventually filed for bankruptcy.

Given the Solyndra debacle and other “investments” made through this program, officials and policymakers should pause and admit to the serious structural problems associated with government investments that try to pick winners in the market.

The first problem is venality. With so much money at stake, there is genuine temptation for unsavory influence peddling.

Solyndra’s high-profile donors to President Barack Obama’s election campaign, its access to the White House and the pressure from the White House to expedite Solyndra’s loan guarantee were not unrelated. Whenever we give officials the power to pick winners, would-be winners will find ways to woo officials.

The second problem is how this kind of government intervention distorts feedback from the market that could improve management decision-making.

A recent Wall Street Journal article titled “Loan Was Solyndra’s Undoing” documents how the infusion of government money allowed Solyndra to double down on a bet that increasing the scale of its production plant and equipment would help it lower its per-unit costs. That bet failed to reduce costs. Ironically, had Solyndra maintained its pre-government loan infrastructure – all that the market would have allowed – it might have more nimbly responded to rapid changes in the solar-panel marketplace.

A final problem is how government investments are skewed by purely political considerations.

An October 2010 memo to Obama from then-White House economic advisor Larry Summers specifically outlined problems with this loan guarantee program – the potential for “double dipping” from other government incentives, too little skin in the game from private investors and the potential to use taxpayer money in programs that would proceed without government assistance.

The memo documents how these three concerns all come together in a wind farm project called Shepherds Flat in Oregon. The project also failed to meet the program’s environmental outcome standards. Dispassionately analyzed just on the basis of economics and outcomes, the government loan should never have been approved.

But $1.3 billion in loan guarantees were approved. Why? According economist Alex Tabarrok at George Mason University, because the hundreds of turbines to be used would be manufactured in South Carolina and Florida, critically important states in presidential politics.

Since the project was “double dipping” from other government incentives and would have proceeded without other government help, Shepherds Flat will not turn into a bankruptcy scandal. Instead it will make a lot of money for its highly leveraged investors from taxpayer dollars that were misallocated for political reasons.

When customers choose winners and losers in the marketplace, capital is allocated efficiently. When government chooses winners and losers, capital is allocated politically. It’s time to let customers call the shots.