Industrial Policy and the Climate Challenge

The 21st century is increasingly being defined by the need to respond to major social, environmental, and economic challenges. These “grand challenges” include climate change, demographic challenges, and promotion of health and well-being. The challenge of generating sustainable and inclusive growth, like other major policy challenges, is complex, systemic, interconnected, and urgent, requiring insights from many perspectives. For example, poverty cannot be tackled without attention to the interconnections between nutrition, health, infrastructure, and education—as well as more traditional approaches such as redistributive tax and transfer policy. “Grand challenge” thinking is being applied across the world, with some of the most interesting experiments around sustainability being driven by the needs of emerging economies.

Both the rate and direction of investment and innovation are critical to all these challenges. Innovation and the finance that supports it are not neutral: The role and characteristics of finance in innovation influence the shape and success of investments.

A green-directed transition thus requires lining up policies to fuel radical changes in production, distribution, and consumption. This cannot be achieved through initiatives in separate silos and discrete approaches, but rather requires a new lens for economy-wide green growth. This has to be underpinned by long-term, patient finance, which is willing to take risks and able to mobilize and “crowd in” other investors. Business investment reacts to the perception of where future opportunities lie: The climate crisis can be both carrot and stick to create new economic possibilities at home and globally.

An Economy-Wide Reorientation: Harnessing Industrial Strategy

A green transition will not happen on its own. Reliance on pure market pricing has led to a catastrophic overinvestment in carbon and an underinvestment in needed public systems and renewable-energy sources.

The conventional view of what the state should do to foster innovation is simple: It has to fix different types of market failures—taking care of positive and negative externalities due to pricing failures—and then get out of the way. At best, supposedly, governments merely facilitate the economic dynamism of the private sector; at worst, their lumbering, heavy-handed, and bureaucratic institutions actively inhibit it. The fast-moving, risk-loving, and pioneering private sector, by contrast, is what really drives the type of innovation that creates economic growth.

Yet a patchy approach did not get us the IT revolution—nor will it get us a green one. In fact, as I argued in The Entrepreneurial State, in Silicon Valley the state did not just “fix” private markets; rather it took active risks, investing in all the radical technologies that fuel our “smart” products today: the internet, GPS, touch screen, and even Siri. The interaction with the private sector was dynamic and directed: Help us solve a problem—whether to get the satellites to communicate (internet was the answer) or to aim missiles better (GPS was the solution). Today we have the opportunity to use this same level of strategic investment and dynamic partnering for social, not only technological, problems. And this is harder but just as urgent.

A key lesson is that government often needs to take risks precisely because business is risk-averse and reacts to opportunities. This means investments across the entire innovation chain, from basic research (e.g., National Science Foundation), to areas that fuel science-industry linkages (National Nanotechnology Initiative), to the provision of long-term finance (e.g., through the Small Business Innovation Research program, but also through the CIA’s public venture capital fund In-Q-Tel). And further downstream through the ambitious use of procurement and demand-side policies, including those related to suburbanization back a century ago, which is what allowed mass-produced products to get fully deployed. Why not think about green today as a demand-side pull for the IT revolution?

This kind of public spending has proved transformative, creating entirely new markets and sectors, including the internet, nanotechnology, biotechnology, and clean energy. It strikes at the heart of the neoclassical economic theory taught in most economic classes, which takes the view that the goal of government policy is simply to correct market failures.

Green growth is more than just a carbon transition; climate change impacts are felt from the financial sector to the creative economy, and from conservation to health care.

Industrial strategies are having a revival around the world: Increasingly developed by governments at the national and local level, they are one antidote to the market-failure approach that keeps the public sector insulated from the private sector, and from the role of market creation. Today’s industrial strategies must be about directing economies toward green growth through innovation and investment, toward new “techno-economic paradigms,” as innovation economist Carlota Perez describes it.

Rather than ending up as a static list of sectors to support, industrial strategy must be about outlining the key problems a country is facing—those related to clean growth, health, and mobility—and steering investment-led growth across many different sectors. This means changing the way that procurement, grants, and loans work to be less about handouts to those that ask to be helped or bailed out. It means picking not the “winners” but the “willing”—those companies willing to transform toward a green form of growth. This was recently seen in Germany, where the Energiewende mission saw the steel sector receive support only if it lowered its material content. Which it did.

Direct help to companies ready to commit to green growth needs to be coupled with taxation and regulatory strategies to deter carbon-based energy. Vital infrastructure systems—energy, transport, digital communications, water, and waste—which generate interdependent, long-term, high-investment, and high-employment projects—must be designed to direct economic activity toward green growth, and must be aligned with a cross-sectoral sustainable industrial strategy. And taxation can be used to tax material more than labor, and reward long-term investors rather than those making billions from millisecond trades.

Green growth goes well beyond a carbon transition; climate change is felt from the creative economy to the financial sector; it affects public health and health care. And of course, conservation is central. Nor can a green transition happen in one isolated economy; it requires coordinated shifts in global value chains. With global production chains, even products that are “greener” at point of use, such as electric cars, require nonrenewable elements such as cobalt and lithium—often extracted in countries with weak or nonexistent child labor and human rights laws. Private-sector owners of these supply chains and public regulators must co-design the new system.

Policies aimed at big societal challenges require confronting the direction of growth—to become more inclusive and sustainable. But this is very hard to do within the traditional framework that sees policy as simply fixing market failures or simply de-risking and facilitating value creation. Challenge-led growth requires a new tool kit—one that is more based on market shaping and market co-creating. Industrial policies have always been composed of both a “horizontal” and a “vertical” element. Horizontal policies have historically been focused on skills, infrastructure, and education; while vertical policies have focused on sectors like transport, health or energy, or technologies. These two traditional approaches roughly embody differing schools of economics: neoclassical economics–inspired horizontal policies focusing on supply-side factors and inputs; and evolutionary economics–inspired policies putting emphasis on demand-side factors and systemic interactions.

Although certain sectors might be more suited for sector-specific vertical strategies, the grand challenges expressed in societal goals like the Sustainable Development Goals are cross-sectoral by nature. Hence we cannot simply apply sectoral or vertical approaches to such challenges. The idea of structural renewal through directing innovation found an original expression in Albert Hirschman’s idea of development through unbalanced growth. Hirschman argued that consciously keeping development unbalanced—meaning letting some economic activities develop faster than others—keeps development momentum going as it enforces cross-sectoral learning and experimentation. Given that firms often base their investments on the perception of future growth opportunities, vertical or “unbalanced growth” policies can help to drive future business investment and, as Hirschman argued, induce cross-sectoral positive-feedback loops.

In this view, innovations are economy-wide learning and self-discovery processes that help companies hedge their balance sheets, and provide analytical linkages between macroeconomic financial stability and microeconomic firm behavior. If firms are confident about future technological and market opportunities, they will invest and seek to innovate; if they are not confident, or see few market opportunities, they will not invest or innovate. This requires both direct investments, such as those provided by ARPA-E in the Department of Energy, fueling new innovations in areas like battery storage, and then the certainty provided by government-led energy-pricing strategies, such as feed-in tariffs (guaranteed prices paid to green-energy producers), which then give private companies the confidence to expand renewable-energy capacity. Therefore, any industrial strategy should not only seek to improve the conditions under which firms invest, but also aim to stimulate demand and increase business expectations about where future growth opportunities might lie. It is interesting that a company like Tesla has benefited from supply-side strategies of the U.S. government (receiving a $500 million guaranteed loan from the Department of Energy) and demand-side policies in Scandinavia, where a large percentage of the cars are sold (due to taxation regimes that favor the use of electric cars).

Climate innovation approaches need to be cross-sectoral, harnessing supply and demand, innovation and procurement, and public and private actors. A Green New Deal cannot operate only within sectors like renewable energy, through focusing purely on decarbonizing automobiles, or with any other sector-specific initiatives in a vacuum. Instead, we require innovative transformations across all sectors, one of the largest shifts ever attempted by humans. Markets will not find the green direction on their own. Only when there is a stable and consistent direction for investment will regulation and innovation converge along a green trajectory. Business does not invest unless it sees an opportunity for growth—so turning mitigation into opportunities for investment and innovation is key. This requires more than tax incentives or public subsidies: It requires bold investments like those witnessed in Roosevelt’s New Deal in the wake of the Great Depression.

Policy and People-Centered Approaches in the United States

When President Obama bemoaned in 2011 that “we live and do business in the Information Age, but the last major reorganization of the government happened in the age of black-and-white TV,” he was pointing out a lack of bold institutional innovations over the last half-century. It is not a coincidence that the Information Age was heralded and funded by the U.S. government. More specifically, what makes our modern devices “smart” was bold government investment into missions—specific urgent problems that need to be solved.

In Democracy in America (1835), Alexis de Tocqueville famously admired American townships “whose budgets are neither methodical nor uniform.” De Tocqueville valorized then-innovative governance institutions (such as elected officials) for their power to constantly rejuvenate communities.

One of humankind’s greatest feats occurred when imagination, common purpose, and a systematic approach to problem solving won out over siloed thinking and anxiety about where the money would come from.

At the heart of green growth is the role of citizens. The questions of “who” —who will benefit from the green-growth outputs; who takes on the “transition risk”—are key. The cross-sectoral, systemic, supply-and-demand-side change needed means that we have an opportunity for inclusive, sustainable economic growth that brings everyone along with it, including traditionally overlooked groups, working in poor-quality jobs. Those working in the old carbon economy should not simply be displaced, but be re-skilled as part of the transition. Unions should be at the negotiating table, thinking in forward-looking ways to make sure the green economy is co-created and co-shaped rather than handed down from above.

Inclusive growth requires understanding the deeply embedded nature of markets, both at the national level and in a “place-based” manner. Markets are embedded in institutions and norms—and incumbent policy processes help shape the kind of outcomes that result. To strengthen and reform the institutions and the rules at play requires ambitious innovation in the policies themselves, in the institutional configuration, in the instruments that are used on the ground, and in new metrics that capture the dynamic effects of policies. There is a need to address all four dimensions:

• Ambitious, “moon shot” policy frameworks for inclusive growth;
• New institutional configurations needed for such policies;
• Dynamic organizational capabilities; and
• New metrics to understand and monitor the dynamic effects of missions.

This does not only happen at a national level, or through international direction and agreements. States and cities are catalysts of green growth, helped by civil-society support. In the U.S., where the Trump administration has defaulted, 3,629 leaders, including governors, tribal leaders, faith leaders, and business executives signed the “We Are Still In” pledge to support climate action.

The institute I founded and direct at University College London—the Institute for Innovation and Public Purpose (IIPP)—has been working with national industrial strategies and local officials in different cities including Manchester, U.K., which is aiming for carbon-neutrality by 2038—one of the most rapid timelines in Europe, to develop a mission road map with a cross-sector model that delivers a citizen-centric, bottom-up approach. This has become part of the city region’s Local Industrial Strategy, one of the first “trailblazing” strategies of this type in the U.K.

Sharing Risks and Rewards

For the green transition, we need entirely new, flexible, agile, and open-minded institutions and structures to take on uncertain innovation challenges. There are several examples of these institutions in the U.S. Successful mission-oriented organizations include DARPA in the Department of Defense and ARPA-E in the Department of Energy. DARPA is an excellent example of public funding bringing about innovation: The progenitor of the internet was ARPANET, a program funded by DARPA in the 1960s. It was “an absurdly high-powered team of brainiacs” that started at the Advanced Research Projects Agency-Energy (ARPA-E) in the mid-2000s. That agency was specifically designed as a “DARPA clone,” bringing mission-oriented investment to the energy sector. The Intelligence Advanced Research Projects Activity (IARPA) was launched with an intelligence tech mandate in 2006.

AP Images

President Kennedy takes a close look at the nation’s moon program during a visit to Cape Canaveral, Florida, November 16, 1963.

ARPA-E takes on the same organizational mindset of DARPA—both expecting and tolerating failure. Like DARPA, ARPA-E does not set its own research agenda at “top-down” level—instead it draws on the priorities set by industry experts and academics who are working on high-risk, cutting-edge technical solutions.

If the public sector takes risks, it will of course also make mistakes. Any venture capitalist will have to accept failures for every success. To naysayers, the failure of public funding, for any reason, is often considered indicative of an inability to “pick winners” or “distortion” of (otherwise optimal) markets. Yet many of the successes go unnoticed and even result in public rewards being privatized.

The Department of Energy attracted criticism for providing a guaranteed loan of $535 million to the solar power startup Solyndra, which went bankrupt once the price of silicon chips fell dramatically, leaving taxpayers to pick up the bill. However, few critics acknowledged that a similar guaranteed loan ($465 million) supported Tesla for the development of the Model S electric car, which led to success. Even fewer have ever questioned why the government accepted early payment of the underlying loan (earning $12 million back) instead of negotiating stock options that could have been worth almost $1.4 billion, according to some estimates. Had the Energy Department chosen the stock options, the royalties retained could have covered the Solyndra losses many times over and continued to fund promising ventures; this shows the importance of government’s high-risk funding for achieving renewable-energy technologies.

This example also sheds light on the set of strategic decisions that policymakers face regarding the selection of profit-sharing mechanisms suitable for each context. Profit-sharing mechanisms may include repayable grants with profit-sharing via royalties on sales or equity stakes, public venture capital funds enabling royalties on equity, debt financing convertible into equity, and other sorts of funding mixing elements of equity and debt. Hence, besides the timing for the public sector to reap any rewards, a critical distinction concerns the revenue basis upon which public and private actors agree to share; ranging from low-end intellectual property to high-value (capital gains), as the Solyndra versus Tesla case illustrates. The state of California is developing a regional-level mechanism for sharing the profits of the tech sector: In 2016, an investment fund was created to be owned by all citizens, with or without pensions, and with the potential over time to invest into housing, infrastructure, and other state priorities.

The Need for a Climate Moon Shot

Last July was the 50th anniversary of the first lunar landing. The moon shot, one of humankind’s greatest feats, was a triumph of imagination, common purpose, and a systemic approach to problem solving. President John F. Kennedy’s resolve won out over anxiety about where the money would come from and siloed thinking. Greening the economy is not a question of picking a series of outcomes that are worthwhile only for some market participants, to the disadvantage of others: Climate orientation must be a win-win strategic approach for all participants. Public, private, and civil actors alike need to take on the mindset of long-run outcomes and profits, rather than short-term gains, particularly against the background of financial-stability and transition risks that make up the landscape of climate change. Industrial strategies don’t just need grand challenges: We require moon shots.

Imagine having leaders who would proudly declare, in the spirit of John Kennedy: “We choose to fight climate change in this decade not because it is easy, but because it is hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win.”