ROGER MARTIN, A KEMPER | HARVARD BUSINESS REVIEW

SO WHAT WENT WRONG? The problem, we believe, is that reconciling the two theories is treated as an exercise in compromise: I will give a nod to restraint if you give one to growth, and we’ll hope to get a bit of each. Many policy makers implicitly recognise that we need approaches derived from both theories to deal with the environmental crisis.

But few have actually gone beyond that assumption when making policy or strategy.

Go beyond it we must. For if both theories are valid if they provide a compelling description of the world and have predictive power then other factors must exist that determine when each best applies. As consumers, companies, or governments, we have some power to influence those factors, and thus a choice about whether a Malthusian or a Solovian dynamic will play out. But first we need moreprecise information about what warrants which strategy.

How To Make Innovation The Answer The most obvious requirement for radical, technologically disruptive innovation is access to risk capital for relatively unspecified investment.

Alta Devices, a classic Silicon Valley start-up, believed that gallium arsenide could increase the efficiency of photovoltaic cells by about 30 percent over the upper limit of silicon technology. To find out whether and how this could be done at a commercially feasible price, it needed to invest $72 million in speculative R&D. Investment of this kind on this scale is typically provided by venture capitalists or the corporate venturing arms of large corporations.

But before parting with large amounts of capital for such a project, investors have to believe that solving the problem will generate high and sustained revenues in the future. The most productive context for Solovian innovation features a stable, high price for either the problematic resource or its substitute.

Failure to recognise these preconditions explains what went wrong with the US government’s policy on ethanol. After the oil crisis of the 1970s, Congress passed a tax credit for the production of ethanol, which remains in place to this day. After a new spike in oil prices, President George W Bush reinforced its effect by signing the Energy Policy Act of 2005, which mandates the blending of renewable fuels into gasoline and precipitated a major investment in ethanol production capacity.

The idea, of course, was and is to reduce reliance on a nonrenewable fuel (gasoline) by replacing it with a renewable one (ethanol) and to reduce dependency on Middle Eastern oil. In addition, the government slapped a tariff on ethanol imported from Brazilian producers in order to promote domestic production.

Naturally, US0 ethanol production capacity increased.

Setting aside the pros and cons of ethanol as a fuel, the policy was doomed from the start because the government could not deliver stable, high gasoline prices. They have, in fact, been extremely volatile tracking the international oil price and often very low, and the profitability of and level of investment in ethanol production have been equally variable as a result, putting Solovian innovation out of reach. The expansion of production capacity with existing technologies has driven up domestic corn prices and thus increased food prices. As the failure of the policy becomes evident, the government has signaled that it may reverse itself, but that would mean writing off the investments already made in ethanol production and suggesting to investors that the federal government will not be a reliable partner when it comes to other green technologies.

Consider, in contrast, the German government’s solar energy policy. Germany’s Renewable Energy Act was adopted in 2000 with the aim of encouraging investment in solar energy. The problem was that a serious, large-scale investment in delivering solar power required that producers get high prices for the power they generated.

Consequently, the government required grid operators to purchase solar at five times the cost of conventional power a price that would decline only slowly over time, in a carefully planned way creating an environment that simulated a very high price for fossil fuel used to generate power. This policy meant that investors could justify the high capital cost of investing in solar power technology. As a result, Germany had installed nearly twice the expected solar capacity by 2010. This fastgrowing capability was leveraged by German companies, which started to sell turnkey photovoltaic production facilities to Chinese companies.

The Chinese, in turn, scaled up production and dramatically reduced the price of solar arrays.

(To Be Continued)