Despite recent failures in the oil sector, not all government investment is bad

This column is an opinion from Sara Hastings-Simon, an assistant professor in the School of Public Policy at the University of Calgary. For more information aboutCBC's Opinion section, please see theFAQ.

With a string of high profile, troubled public investments in the oil sector, from the "bitumen boondoggle" to oil-by-rail and Keystone XL, there is a temptation to generalize to a view that all government investments are bad.

At the same time there is a big push for investment in carbon capture and storage, with requests for future government capital in the tens of billions of dollars.

If the only lesson taken from the failures is the risk in government involvement, then it will be all too easy to see mistakes repeated again. Instead, it is critical to get clarity on what government's role is, what differentiates good public investments from those that become boondoggles, and how to approach government investment to maximize outcomes and avoid costly mistakes.

The theory of government intervention

Even neoclassical economic theory concedes there are "market failures," or gaps where things go wrong in markets and government intervention is required.

For example, private companies will under-invest in research and development because they only get a portion of the benefits of the resulting innovation, since other companies can copy the unpatentable innovation and reap the benefits without having to make the investment up front. There may also be challenges around the development of infrastructure to deploy new technologies at scale the "chicken and egg" issue for electric vehicles and charging infrastructure.

Other schools of thought see an even larger role for government in enabling innovation and economic growth, including direct support for radical technical innovations that solve a clearly defined problem.

Governments can't stay out of markets because markets are not naturally occurring, rather they are created and shaped by the choices governments make through laws and regulations.

The role of government in the private sector isn't just a theory. It can be seen repeatedly through history.

In Alberta, one of the clearest examples of government's role is in the development of the in-situ extraction technology for the oilsands, where critical investments in the development of a facility and in testing were 100 per cent government funded. Similarly in the fossil energy sector, the shale gas revolution can be traced back to over 25 years of U.S. government programs and funding.

Critical government funding for technology development and deployment can be found behind everything from agriculture to the smartphone or computer you are reading this story on.

However, the cliches about public investment "governments shouldn't be in the business of business" and "governments shouldn't pick winners" in fact hold kernels of truth in how to invest wisely.

Don't be in the business of business

Government funding shouldn't take the place of private capital, doing so at best just contributes profits to a private project. Instead, governments should look to do things the private sector can't. For example, dividing up the risk in a project and assigning it to the entity government or private sector that can best manage it and enable investment and economic development that wouldn't happen otherwise.

The key is to ensure the right risks go to the right player.

Governments are well placed to manage or hedge policy risk in their jurisdiction because they directly control future policy changes, making it natural to take actions like monetizing future increases in carbon pricing today. They can also better hedge overall price risks in an economy-wide market, for example where low electricity prices might challenge individual generators but benefit the economy as a whole.

On the flipside, governments have little control over policy risks in other jurisdictions, such as the decision of the U.S. government on a pipeline permit. Similarly, the risk of cost overruns for project construction that is managed in the private sector is outside of government control, as is the case with the Sturgeon refinery.

The appropriate division of risks should be matched with a fair sharing of rewards to avoid creating windfalls with public money.

The Alberta Electric System Operator's renewable energy procurement process successfully kept any market upside with the government that took the market risk, while leaving the construction management and associated upside with the developers. Ensuring the potential upside is fairly distributed can also help keep government out of the role of business if companies truly need government support, they will be more willing to give up some upside in exchange.

Don't pick winners

Many of the recent investments that have run into trouble are cases where governments did directly pick a "winner" by supporting a specific company, project, or approach, outside of a transparent, competitive process to find the best solution to a clearly defined problem.

Politicians can avoid this trap by sticking to defining a clear goal or mission direction that government supports. Framing the challenge to the market in terms of desired end goals then allows the private sector to respond with a broad range of options across technologies and approaches, rather than government presupposing the outcome.

Those within the government bureaucracy responsible for evaluating and comparing options should be insulated from politics and supported by external experts that can provide technical advice.

Learn from business

There are some lessons governments can apply from the private sector. Two important ones are in structuring deals to limit the overall downside risk as the oil-by-rail case illustrates, the contracting details matter and being willing to walk away and accept some losses. Just as no private investor has a 100 per cent success rate, government investments must be judged on a portfolio basis where big wins should more than cover losses.

The recent string of issues with Alberta government investments calls public investments into question, but rather than generalizing around government investments writ large, each case holds key lessons on how to ensure future public investments benefit the public.

As stewards of the public purse charged with ensuring a healthy economy, governments must ensure they are playing the right role based on what they have to offer, define clear goals that are pursued with transparent metrics that are fair to the public for their investment, and set up systems and structures to keep the politics out of investment decisions.

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