THE FEDERALIZATION OF IDEAS A NATIONAL ENERGY DEPARTMENT JNTRODUCTION f 5x 1 I I2 President ;C.arter has characterized our national energy situ ation-as the "moral equivalent of war." Naturally, he has proposed to win this "equivalent war" by creating an "organi zational equivalent of the Pentagon the National Energy Department.

Most Congressional debates have focused on federal tax and price mechanisms to conserve current energy supplies and regu late its use. Also included in the energy bill (H.R. 6804 S. 826 is the Administration's position about the innovation of new energy sources and new conservation technologies and methods of "things that are new innovation is the same as the Defense Department's. However, Congress has paid little at tention to la r ge-scale economic distortions which this approach will causes The proposed statutory approach to the introduction Whether we are truly in a situation which is the "moral equi valent of war makes no difference the innovation of new products, supplies, serv i ces, and processes cannot be central ly financed, managed, and controlled from Washington. The reasons for thisarefound in the important differences between energy and weapons markets. Energy innovations require the democratization of ideas rather than th e federalization of ideas.

NOTE reflecting the views of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress Nothing written here is to be construed as necessarily 2 FTPI ACF DI FFFRFNCFS When the Defense Depart ment implements its innovation poli cies, it creates choices for the government's eventual in vestment and use. On the other hand, the choices that the Energy Department proposes to innovate will not be for the Department's investment and use but for nonf ederal purchase and use by city and state governments and private energy users and producers.

The National Aeronautics and Space Administration"s (NASA marketplace is the same as the Defense Department's Both NASA and the Defense Department assess their ca pabilities to responsibly perform in the future and both will, from time to time, create a demand for the innovation of new weapons, space systems, products, and services.

They are organized not only to specify the "demand for inno vation," but also to se lect, manage, and finance ideas which become investment choices to meet their own demand. They do this by performing in-house technical activities and purchasing support ,services from nongovernmental sources, such as com panies, universities, and private nonprofit organizations What is eventually chosen, with Congressional approval, is pur chased and used by these agencies to perform their statutory missions. The Defense Department and NASA legitimately prac tice the federalization of ideas they motivate a nd select ideas and provide risk capital financing to create future in vestment choices Among other important duties, the new Energy Department is also proposing to specify "demand for the innovation" of new energy sources and conservation methods. And, i t is proposed that the Department take on the responsibility of motivating and selecting ideas and manage and finance the innovative process to ''supply this demand. Thus, there is to be close corres pondence between the Defense Department, NASA, and the n ew Energy Department when new products, processes, and services must be introduced because current supply is perceived as in adequate to meet future demand I 1 S 3 Nonfederal energy buyers and users must learn about new innovations along with developers.

I f not, they will be inferior buyers. The De fense Department and NASA technical personnel learn along with developers so that what they eventually invest in and operate is a conse quence of learning about possible choices from their beginnings. While ther e may be argu ments about how efficiently the Pentagon pro curement policy operates, there is little argument about its need to perceive the demand for innovation, to manage it, and to finance the process which supplies it Also, in most cases, the Departme n t of Defense and NASA re present the sole market for the products of innovation which they have sponsored Energy must be delivered within a local frame work of price, capability, and availability goals, in a context of local operating condi tions. Each lo c ality has a different frame work :from the next, and an innovation suitable for one locality is not necessarily suitable for another. Thus, the local demand for energy delivery may be common for several localities but the constraints placed on innovation m ay be uniquely different. Different alternatives must be explored to deliver a common capability The decision to use and control "seed" or "start up" risk capital which is required to start pro ving new ideas must be decentralized. If it is centralized, s mall firms and individuals will not be able to afford the cost to create and propose their ideas for.consideration, and a sizable share of the nation's inventive and innovative resources will remain untapped.

Small firms and individuals simply cannot-,gfr ford the cost of proposing new ideas andwaithg for decisions according to federal procure ment rules. These elaborate rules have been instituted to control the large costs of large companies. They total more than 4,000 pro curement-related statutes and 3, 0 00 pages of implementing regulations. -4 NOVAT I 'G ON RFQUIRFS ADAPTIVE LFARNIh Why should federal engineers and scientists learn about new energy innovations when they are not part of eventual using organizations? Transferring what they learn to state a n d local governments, or to private buyers is certainly less effective and efficient than directly engaging even tual buyers and users from the beginning. This practice of engaging buyers and users at the beginning of innovation works well for Defense and NASA and should work equally well for nonfederal buyers and users So, why statutorily install the'l'federalization of ideas" where what is learned must go through an additional costly step of transference?

The argument that the federalization of ideas shou ld apply to tFe- new Energy Department because it has worked well in achiev ing space leadership and deterrent weaponry is an irrati6iai argument cause transferring what has been learned causes excessive and unnecesary nonproductive costs. Also, coercive m easures may be applied to force the use of whatever the Department has created. Localities and other nonfederal and private buyers will have no choice but to invest in what the federal level comes up with, even if it does not match what is needed locally I n fact, national productivity will decrease'be- i I FMOCRATI'~ATION OF- IDFAS It is imperative that private or public organizations are able to make selections and to have control over risk capital ex- penditure to commence energy innovat%i Ef ;the ke &ec tli.o.n and con trol authority is vested in one centralized public group, a group which also has the "seed" capital to commence innova tion too :nany'.of the nation's future efiergy debsstons w'i.ll..-rest 6fi."theLwi-sdorn. of l$at group' s -arbitrary ch oices. 1-deas :cOm>.e%-i SLmply buriedIi, and fiever 'heard about.

Centralized public selection authority is a key feature in the "federalization of ideas" in stark contrast to the democratization of ideas" characterized by many private idea invento rs, selectors, and risk-takers, each in competition with others give to ,tfib-s selkcted byb' fhe'.centfalized 'authsr-ities may":be 5 One of the key issues behind the solution to the energy problem is whether control over the money is decentralized or ce n tralized. Decentralized or demaer.ati-zed. control'is needed because local energy demands are unique to the locality. Competition between several "idea sponsors" is needed to drive prices down in the delivery of a common capability. The needs and unique c o nditions of localities will not be met if the selection of ideas and control over risk capital is federalized. This will lead to the intro duction of a "common" supply to meet a "common" demand; and unique, local situations and conditions will be bypassed in the process.

Friederich Hayek, the 1975 Nobel Prize winner in economics had this to say about centralized or decentralized government functions While it has always been characteristic of those favoring an increase in governmental powers to support maxi mum concentration of those powers those mainly concerned with individual liberty have generally advocated decentralization.

There are strong reasons why action by local authorities generally offer the next-best solu tion when private initiative cannot be relied upon to provide certain services and where some sort of collective action is needed; for it has many advantages of private enterprise and fewer of the dangers of the coercive action of govern ment. Competition between local authorities or between l arger units within an area where there is freedom of movement provides that opportu nity for experimentation with alternative methods which will secure most of the advantages of free growth.

It is usually the authoritarian planner who, in the interest of u niformity, governmental effi ciency, and administrative convenience, supports the centralists' tendencies The Constitution of Liberty, F. A. Hayek pages 263-264 CHNOI OG I FS I ri II ARG$ AND SMAI I II Large-scale and expensive technologies are obviously m arketed by heavily capitalized companies which have large-scale capabilities. But, most innovations which have benefited 6 private consumers where we find the energy market have not come from current producers and do not involve large scale technologies. T o name a few: Xerox was not invented by an office equipment manufacturer; the transistor was not invented by a vacuum tube producer; the ballpoint pen was not invented by a pen producer; the hydromatic auto shift ing mechanism was not invented by Detroit car manufacturers There are many other examples. Each of these privately cre ated and financed ideas has pumped billions of dollars into our private enterprise economy.

Another example of this is electric motor energy conservation.

This invention, which i s now well into the innovation stage is of particular interest not only because an electric motor producer did not invent the approach but also because govern ment research and development had nothing to do with it. The engineer/inventor mortgaged his hom e and borrowei! money to finance his idea; he did not spend his resources trying to penetrate the federal bureaucracy.

The ability to create new and beneficial ideas is independent of corporate size. Large firms tend to improve what they are currently prod ucing. All firms, large or small, which are not producing for a particular market but wish to enter:.it tend to create ideas which deliver similar capability but with pro ducts made up of different, competitive technologies.

For example, Chester Carlson, the inventor of the xerography process, approached twenty office equipment manufacturers, and was turned down. He was finally financed by a nonprofit or ganization, the Battelle Memorial Institute. Mr. Carlson was not only able to invent, he was also able to reduce the idea to practical production. His inventive/innovative talents have inserted about $1 billion into our domestic economy. He has achieved corporate growth based on competitive merit.

This is not to be construed as an argument that "bigness is bad and "smallness is good." Large federal contractors:.have con tributed significantly to attaining national goals in the past and.will continue to do so in the future. Rather, these questions must be addressed Do our federal innovation pol icies foster equal economic opportunity to create and propose ideas to nonfederal and federal sponsors alike? Do they fos ter corporate growth based on competitive merit?

D 7 The answers to these questions are of critical importance to the health and vitality of our p rivate enterprise econ omy. If federal innovation policies give unequal economic treatment favoring corporate largeness, they may be identi fied with the growth of economic concentration and oligopoly.

This would head us dangerously close to the nationalization process such as has been occurring in Britain. The "means of production" will be transferred from private to public ownership where unequal economic opportunity exists.

Current federal innovation policy, procedure, and practice Ls largely an outcom e of the Defense Department's need for new weapons since World War 11. Understandably, private risk capital has shied away from what may be characterized as a monopolistic and highly uncertain marketplace. Three decades of federally sponsored innovation t o primarily meet the Defense Department's needs have led to domestic economic distortions.

These distortions continue to be promulgated by other civil agencies and are proposed to be continued by the new Energy Department.

The fe deral government is now the "risk-taker of last resort and finances more risk capital than all private industry corn bined innovation policies and their sponsorship of risk capital research and development funding has been on the rise. In con stant dollar s , civil agencies have shown real growth while De fense and NASA research and development funding has been in de cline. The 1967-1977 rise in civil research and development in constant 1967 dollars, has been 50 percent, from $3.2 to 4.8 billion, while Defe nse Department/NASA research and develop- ment funding has'dropped 40 percent, from 13.3 to $8.3 billion.

Individuals and small firms go to private capital markets to get seed" money in order to challenge established federal constrac tors. However, private ly-sponsored risk capital is in decline and small technical firms are finding private risk capital in creasingly more difficult to obtain. A Department of Commerce report shows that small, technical firms' public stock offerings deklgned'..from $1.16 bill ion in 1969 to $16 million in 1974 a 'reduction of more than 10 to 1 over five years when infla tion is taken into account. No small, technical-firm public offerings were made between March 1974 and August 19

75. The earliest risk capital expenditure seed" or "start-up" money is almost impossible to get through new offerings Civil agencies have adopted the Defense Department's 8 In contrast, during 1975, the federal government controlled and distributed 20.8 billion of taxpayer-supplied risk capital. Fifty -four percent of the money went to organiza tions which do not pay federal taxes, the not-for-profit organizations; the remainder went to profit organizations.

This means that most of the critical beginnings of innova tion, the selection of technologies to configure into new products is notp:e'rformed within a price competitive sup plier's marketplace FFnFRAl RISK CAPITA1 MECHANISMS Government uses two mechanisms in the distribution of risk capital indirect payments by federal contract price mark ups and d irect payments by research and development contracts grants, and agency budget allocations for in-house scientific and technical work.

Eight-five percent. of the federal equivalent to private "seed or "start-up" capital was indirectly paid to ninety-nine of the largest defense contractors out of 23,875 defense suppliers.

The amount the ninety-nine received was slightly less than 1 billion while the 23,776 remaining suppliers received only an estimated $100 million.

This "start-up" risk capital is indirectly distributed according to the amount of federal contracts a contractor has or expects in the next year the more federal contracts, the more "start up" risk capital allowed in federal contract price mark-ups.

Oliv.iously, it is beneficial to be i.g in fe deral &on 7 tracting because "start-up" capital 1s more readily obtained from the federal Treasury. The corollary, however, is that individuals and firms without federal contracts will not re ceive "start-up" capital indirectly from government and, very l ikely, not from private sources either.

Federal government also makes direct risk capital payments to support innovation after indirectly paid "start-up" capital hias been spent. These direct payments are l?ecei'vei3. mainly 5y large federal contractors to create, propose, and partially prove acceptable ideas plied research" expenditures in the scientific and technical community. In 1975, out of $5 billion directly spent 3.5 billion went to not-for-profit organizations, the remainder to profit companies a d istribution of over 2 to 1 favoring organizations not obligated to pay federal taxes or perform work competitively with a profit objective These direct payments are called 'lap- The net outcome 9 of three decades of the federalization of 1 ideas, as pract i ced by the Defense Department and NASA is that their federal innovation policies foster an unequal economic opportunity to participate in federally sponsored innovation markets. Hard-to-get seed capital is mainly dis tributed to the largest defense suppli ers. Follow-on-money for applied research is mainly distributed to not-for-profit organizations; privately supplied risk capital is increasing ly difficult to come by.

This has serious long-term ecnomic consequences. The essen tial economic role of individuals and 'small. firms. is to" chal lenge ec6nomTcally-Concentrated large firms and their' economy of-scale marketplace advantages.

Equal economic opportunity to create and propose ideas should be an essential feature of federal innovation policy and prac tice, but the opposite has been the case.

These problems have not gone unnoticed, and changes are being made. It will take time to reverse accumulated policies and practices and achieve an equal economic opportunity for all qualified firms, regardless of corporate or individual wealth to participate in Defense Department and NASA innovation markets. Civil agencies have inappropriately adopted Defense Department and NASA innovation policies and are doubly ineffi cient; first.because they have a completely different market place to supply, and second becau.se they contribut_e-to-the same economic distortions as db-.the Defense'Depa.ktment, and NASA Two for important considerations should have provided the framework the new Energy Department a recognition th a t the Defense Department/NASA in novation policies and practices have led to serious distortions to our domestic economy. These dis Department. tortions should not &e' adopted.--by'th'e new 1 a recognition that the Energy Department's demand for innovatio n should open choices for nonfederal buyers, not federal buyers, and that nonfederal buyers must learn along with developers before investment decisions are made. This means that the selection and financing of ideas must be spread wider, rather than concen t rated 10 These two considerations offer opportunities to the Administration to construct innovation policies which foster equal economic opportunity for qualified indivi duals and firms of any size to create and propose ideas to nonfederal buyers. Opportu nities for competition between localities and suppliers would yield price ad vantages of ultimate benefit to.energy consumers. The Administration so far has missed -5his important opportunity.

It is also missing the opportunity to allow local de velopers, financiers, and buyers to equally learn about new innovations before large-scale investments are made.

It is not in the nation's interest that the federalization of ideas be applied to civil markets. Where it is legiti mately applied, such as the Defense Department and NASA extremely important changes are still to be made.