Green industrial policy, information asymmetry, and repayable advance

Abstract

The energy transition requires the deployment of risky research and development programs, most of which are partially financed by public funding. Recent recovery plans, associated with the COVID‐19 pandemic and the energy transition, increased the funding available to finance innovative low‐carbon projects and called for an economic evaluation of their allocation. This paper analyzes the potential benefit of using repayable advance: a lump‐sum payment to finance the project that is paid back in case of success. The relationship between the state and innovative firms is formalized in the principal‐agent framework. Investing in an innovative project requires an initial observable capital outlay. We introduce asymmetric information on the probability of success, which is known to the firm but not to the state agency. The outcome of the project, if successful, delivers a private benefit to the firm and an external social benefit to the state. In this context a repayable advance consists in rewarding failure. We prove that it is a superior strategy in the presence of pure adverse selection. We investigate under what conditions this result could be extended in the presence of moral hazard. Implications for green industrial policy are discussed.

The Political Economy of Industrial Policy

“…Meunier and Ponssard (2024) show that when firms and public agencies have symmetric information about the probability of a project's success, rewarding success is optimal, whereas the opposite is true under asymmetric information where only the firm knows its probability of success; failure should be rewarded, as it mitigates the windfall profit that arises when an agency subsidizes projects that would have received financing absent the subsidy. Meunier and Ponssard (2024)'s insights speak directly to the experience of the French Agency for Ecological Transition (ADEME), a public agency monitoring innovative activities for the energy transition funded by the Investments for the Future Programme. At the outset, ADEME used flat subsidies, but evidence of windfall profits quickly became apparent with some projects.…”