How government stimulus works

My company is in a very immature sector. It is probably not an exaggeration to say that no company in the sector is making a profit at the moment. Those of us in the business are ploughing money into it in the belief that it will become profitable in due course, and that the position we establish and the experience we gain now will stand us in good stead when that time comes. That sort of informed bet is the essence of entrepreneurship.

To that end, we (or more precisely, our parent company) have recently invested significantly in infrastructure to service this inadequate market. Imagine my delight when I bumped into one of our competitors last week, and he told me that he had just been awarded a 100% grant for very similar equipment. He was revelling in the fact that he was able to obtain such a good grant because his business partner used to be an assessor of grant applications under this scheme, and therefore knew how to work the system. As illustration, he told us that when they received the award, they judged they had been "short-changed" by £19,000, so his partner rang his squash-partner, who still works for the assessors, and squared it so that they got all the money to which they were "entitled".

How do you compete with that? This is in a renewable-energy sector that the Government would like to be developed. Why would you bother investing capital if you faced this risk?

The result is to drive those companies who want to make a straight (i.e. competitive) profit out of the business, and leave it to those who are best at playing the political system. Being good at playing the system doesn't usually go hand-in-hand with being good at satisfying customer demands or running businesses efficiently. Consider the Soviet Union.

This is a small example. But our economy is littered with similar examples. And it is about to get worse in our sector.

I got an email from the Renewable Energy Association (REA) one evening last week. It was distributed to all the members, and read as follows:

-Dear member,-

-We have identified an opportunity to make suggestions on specific renewable energy content in the proposed recovery stimulus package. Unfortunately the time window is very short and we will need to release this in the next couple of days. We have therefore drafted the attached and would appreciate any swift feedback on major errors or omissions.-

-Treasury has suggested that this should address areas where short term stimulus can bring immediate returns (especially in the form of jobs). This response is therefore weighted towards decentralised energy and small-scale applications, though we have also suggested several early 'barrier busting' opportunities in other sectors.-

-My understanding is that it is important to put a stake in the ground now (in time for the budget), but that the detailed implementation (and funding breakdowns) can follow at a slightly later date. We are doing more work to try to firm up the figures in brackets by noon tomorrow. Any numbers you can give to help build up these funding requests would be appreciated.-

-I am sorry to allow such a ludicrously short response time on this, but would appreciate any input you are able to give.-

-Best regards,-

-[Director General of the REA]-

"The attached" contained a shopping list:

• £230m for extension of the Low Carbon Buildings Programme

• £75m for the Bioenergy Capital Grants scheme, to support biomass heat projects and 100 new anaerobic digesters

• £35m for biomethane production, cleanup and injection into the gas grid, a demonstration heat network using heat from a co-firing power station, and biogas vehicles for the 2012 Olympics

• £45m for large-scale smart-metering roll-out

• £80m for skills training for 10,000 workers in the buildings services industry, using unsold show-homes

£465m in all.

I actually have some sympathy with this, not because it makes any sense at all, but because it clearly wasn't a question of whether the Government was going to waste taxpayers' money, but who they were going to waste it on. Any sector refusing to come up with a shopping list would lose out. Even given plenty of time, there would be no way to produce a rational list, because this sort of exercise lacks precisely the information that markets provide. And in a "ludicrously short" period, these irrational figures were no less irrational than any other set of numbers they could have plucked out of thin air.

As we had under 24 hours to respond and I was in London the following day, I didn't get my comments in until too late (late the following night). Others were obviously not so busy, because the REA received over 100 responses. The version that went in to government had blossomed to £625m, plus a "Green Bond" to raise a further £2bn of government-underwritten funding for the industry. The proposals were outlined in their Press Release, and detailed in a paper submitted to Government.

It could have been worse. Within a couple of hours of the email from the REA, one of their members had posted it to an online community of which he and I are members, offering to pass any suggestions back to the REA for inclusion in their shopping list. This community is a mixed bag, with some decent energy-engineering knowledge scattered amongst its members, but almost complete economic illiteracy. Many of the members are extreme central-planners, with outrageous grand plans for government to control and improve not just the British electricity system, but a linked system incorporating the whole of Europe plus North Africa and Russia (and probably wider afield still, if given the opportunity).

The comment of the site's founder in distributing the shopping list was:

-This seems to me to be woefully inadequate - I want to see money allocated to the construction of several wind turbine factories in various locations in the UK.-

-Anyway make your input ASAP - you have only hours to react?-

I wrote to the person who invited non-members to put in their bids through him via the REA to the Government, pointing out that the REA ought to represent its members, not all and sundry. None of this group's mad-cap ideas appeared in the revised shopping list, so maybe this warning did its job. But had I not, who knows what sort of hair-brained scheme would have been promoted to the REA and through them to the Government?

In the event, the Government retreated from an immediate announcement, though they remain committed to a New Green Energy Deal, and hold out the prospect of significant announcements later. The REA reacted angrily to this false start, but nevertheless circulated their paper to other parties to try to get it adopted, even though they claimed originally that this was simply an -ad hoc- response to a short-term opportunity, and acknowledged privately that the grant mechanisms they were promoting were highly unsatisfactory and justifiable only as a stop-gap measure. The paper, which was put together in no time on the assumption that a blank cheque was about to be signed, was adopted and promoted by a group of businesses, and forwarded to a cross-party group of MPs (Elliott Morley, Tim Yeo, and Malcolm Bruce) who had adopted a similar position.

These numbers may, in this way, gradually coalesce into what appears to be a consensus view of what the industry and its supporters believe is the right way and amount for the government to provide support. And yet it relies on policies that almost no one in the industry likes, and on numbers that were near enough plucked out of thin air. That is the sort of process and information on which a centrally-planned economy routinely relies. Markets may be messy, but they are never as bad as this.