- Unintended consequences of offering prizes for innovation: “Suppose that you were to offer $200 million for a superior mousetrap. Your prize is surely going to attract a posse of people to try to fix your rodent problem. But at the same time, this disproportionate payment is going to have unforeseen consequences, like inducing oncologists to switch from finding cures for cancer to competing for your mousetrap payout. And of course, there is no guarantee that the invention you select is actually going to be successful in the general marketplace.” (16:37)
- Markets, not prize systems, helped develop the US economy: “It’s not hyperbole to say that the American economy has been the most successful in all of human history. The question is, how did we get to this point? … In Europe, innovation policies were the opposite of inclusive. They felt that only privileged people with wealth or status were capable of recognizing and making valuable contributions. And my data show that rewards were based primarily on the identities of inventors, rather than the productivity of their discoveries. The American model was completely different. It was based on the principle that diversity of ideas mattered most.” (25:30)
- The problem with Elon Musk’s climate innovation contest: “The central problem isn’t ignorance of ways to resolve carbon emissions. The real problem isn’t that people need to have their attention drawn to this. The real problem is that we have an absence of markets, and we have incorrect prices. We don’t need grand innovation prizes. Instead, what we need to do is the tedious job of setting up mechanisms to ensure that there are correct market prices for emissions. How to do that is not a mystery.” (29:09)
The Full Transcript
Kristin Hayes: Welcome to Resources Radio, a weekly podcast from Resources for the Future. I’m your host, Kristin Hayes. Before I introduce today’s guest, I want to start by sharing some of the context for today’s episode.
Last month—that is, February 2021—one of my colleagues and I noticed that the RFF explainer on carbon capture and sequestration—which provides an overview of the technology, along with its uses, its benefits and its drawbacks—had suddenly skyrocketed in terms of page use on the website. I mean, skyrocketed. When we did a little investigation as to what had prompted this sudden and expanded interest, we found Elon Musk’s announcement from the day prior. Mr. Musk is offering $100 million in prize money, managed through the XPRIZE Foundation, to teams that can envision, prototype, and validate scalable carbon capture and removable technology. At the end of the four-year contest period, several prizes will be awarded: $50 million for first place, $20 million for second place, and $10 million for third.
In addition, the awards program will also offer 25 six-figure scholarships to competing academic teams. According to XPRIZE officials, the $100 million on offer represents one of the largest, if not the largest, incentive prizes in history. So today’s conversation is about prizes, how they’ve been used, what we can learn from past successes and failures, and how they compare to other instruments designed to spur innovation. To talk about these fascinating issues, I’m very pleased to welcome Dr. Zorina Khan, Professor of Economics at Bowdoin College, and a member of the National Bureau of Economic Research.
Professor Khan’s research examines issues in law and economic history, including intellectual property rights, technological progress in Europe and the United States, antitrust litigation and legal systems, and corporate governance. She’s an award-winning author, and her newest book is Inventing Ideas: Patents, Prizes, and the Knowledge Economy. I’m very pleased she’s joining me today on Resources Radio to share her insights. So please stay with us.
Zorina, thank you so much for coming on Resources Radio, and for bearing with my long introduction to our episode. It’s very nice to talk with you today.
Zorina Khan: Thank you, Kristin. I’m delighted to be here, and I’m looking forward to our conversation.
Kristin Hayes: Great. Before we get to the meat of that conversation, I’d love to know a little bit more about your background and your research interests. How did you become interested in innovation and prizes, and all of this conglomeration of issues as a topic of your research?
Zorina Khan: Well, I guess you can say that I’ve engaged in a sort of educational arbitrage. I received a first class honors degree in three years from England, and an MA in economics from Canada, in one year. At that time, I was around 22 and fascinated by a lot of different topics, but I was fortunate to get a fellowship to participate in a workshop that offered a certificate in technology policy. This workshop was located in a gorgeous seaside resort, near Montego Bay, Jamaica. I have to admit that initially I viewed this as a sort of tropical vacation, but I quickly became completely captivated by the subject of technological innovation.
Soon after that, I got a Fulbright Scholarship to get my PhD in economics at UCLA. I approached Kenneth Sokoloff, a professor who was looking for a research assistant. He told me that he had lots of existing projects, but he also had a sort of vague idea for, as he said, a risky project on patents. I promptly said, “I will take the risky project on patents.” At that point, he went away on leave, and I worked for a year on the project, pretty much on my own. Now that particular project started an entirely new research area, using empirical analysis to understand the economic history of incentives for innovation. It was indeed high risk, but it has turned out to be very high return, as well. Because these sorts of very precise quantitative studies tell us a great deal about the reasons behind the success and failure of nations.
Kristin Hayes: Fantastic. Okay. So today’s conversation, as I mentioned at the outset, is about prizes and how they fit into this ecosystem of tools that are used to drive innovation. Can you share with us just a little bit of the history of using prizes to drive innovation? And it could be in the energy arena, or elsewhere. I imagine there are lessons from, from many different sectors. So lay the groundwork for us, if you would.
Zorina Khan: You could write a book on this question, and obviously, I have. Prizes of all sorts have been around for thousands of years. For instance, in ancient China, they used lotteries with prizes to fund projects and innovations. But today, we have seen a big resurgence of interest in prizes, and even the federal government proposes billions of dollars in prizes. But even when the government is analyzing these sorts of policies, they just tend to cite a few anecdotes about historical prizes. One of the reasons why my book is called Inventing Ideas is that I point out a lot of this consists of false and misleading information. To counter this misinformation, I wrote this book.
For instance, one of the canonical prizes that’s usually cited to support these kinds of policies is a prize for billiard balls that was offered in the nineteenth century. Now billiard balls, at the time, were made of ivory tusks from elephants, and this ivory was becoming very expensive. So you had a lot of inventors who were trying to find an artificial substitute. A company that made billiard balls offered a really large prize for artificial ivory. As I mentioned, this is usually pointed out as a success story, but actually, the prize was never paid out. The person who came up with the best solution was called John Hyatt, and he rejected the award because his invention had a much greater market value than the prize itself. So Hyatt instead patented his invention, started his own company, and became extremely wealthy and successful. And I should point out that he got over 200 patents over his entire career.
Instead of these misleading anecdotes, there is a clear need for systematic, empirical evidence about prizes, and about other sorts of incentives for innovation. As a result, I have spent the past 10 years scouring archives from basements in London, to concrete bunkers outside of Paris, and most exotic of all, San Francisco. The data set I put together consists of about 65,000 innovation prizes, and it covers all kinds of awards, from inducement awards to ex post recognitions, such as medals and honorary prizes and cash prizes. When combined with the data on over 100,000 people who patented inventions, all of this together allows me to draw very general conclusions about the efficacy of prize systems.
What I’d like to point out is that prizes tend to be a function of large inequality, and prizes of all sorts were very popular in elitist societies, like Britain and France. I think that elites have always mistrusted markets, and that wealth and influence tend to lead to the conviction that the insights of a favored few can outperform the common masses in the market. You can see today that there are a lot of people who think that status and celebrity are a good substitute for specialized knowledge. The French, in particular, used prizes as an integral part of their entire national science and technology policy.
Now, if we contrast that with the United States, it’s very different, especially if you look at the debates in the United States at the time of the Constitution. I’m a big fan of Alexander Hamilton, but I think he got it wrong in this case, because he lobbied for a national system of prizes like they had in Europe. In the United States, these sorts of proposals were rejected, because the delegates thought these were elitist special measures that would just benefit special interests, rather than all of society.
So instead of this sort of elitist prize system to promote innovation, the United States was unique in creating the world’s first modern patent system, and in promoting decentralized markets in ideas. These sorts of market-oriented patent policies led to what my first book called a “democratization of invention.” It was this democratization that fueled the rise of the United States as a global industrial power.
Kristin Hayes: Fascinating. Do you see prizes and patents as complements to each other? It sounds like both systems have coexisted; well, at a certain point, they started to co-exist, I guess I should say. And how do you look at them now? Are they tools that work together, or are they really substitutes for each other, in your view?
Zorina Khan: Well, this is a really important question that illustrates why historical evidence is especially valuable. Today, of course, in all countries you have patent systems. So this means that if prizes are offered, they are necessarily going to be complementary to patent awards, and it would be quite difficult, if not impossible, to disentangle the independent effect of prizes. To analyze this question, I used data from the Royal Society of Arts in London. I’ll call them the RSA. The RSA was a very elitist society that was founded in the 18th century, and it actually still exists today. It’s just around the corner from the London School of Economics. When I was on sabbatical at the London School of Economics, I would pop over to the RSA archives and go through all of their records.
The RSA were very enthusiastic about innovation prizes; at the same time, they were initially extremely hostile to patents. This is a very interesting dataset for analyzing when patents and prizes are substitutes, because they ruled that anyone who received a prize was not allowed to get a patent. The data provide a very clean way of identifying the independent effects of prize systems. And what my analysis shows is that you have a selection effect. What this means is that inventors who had ideas that were valuable in the marketplace would bypass the prize system and pursue returns from commercialization, but people with lemons, or rubbish inventions, would apply for awards from the RSA. As a result, the RSA prize system was quite irrelevant, and contributed little to technological progress. Now, eventually, even the RSA acknowledged their prize system was a complete failure. Then they switched to supporting patents, and even promoted the patent system. So the moral is that when prizes and patents are substitutes, the prize system will end up with lemons.
What about complements, that is, when inventors can get both patents and prizes? Well, in this case, we get another distortion, because inventors will be overcompensated, through what I call award stacking. The inventor is going to get a prize, and they’re also going to get a reward in the market. The incentive is for them to spend too much time chasing after additional handouts, rather than trying to invest in improvements to meet market demand, and obtain returns by satisfying consumers. I know that this is probably more information than you wanted, Kristin, but it helps to explain my personal conviction that, of course, private parties can do whatever they want, but governments at least should never use prize awards, either as a complement or as a substitute. After all, the government should be in the business of promoting overall social welfare.
Kristin Hayes: This is really fascinating. Obviously, you’ve brought in a lot of historical evidence, and it’s really nice to have these historical perspectives here on Resources Radio, but you are indeed also a professor of economics. So are there other insights? You’ve hinted at this, but are there other insights that the economics profession can offer us about the value of prizes?
Zorina Khan: Have you ever taken an econ class?
Kristin Hayes: It’s been a long time.
Zorina Khan: Well, let me apologize upfront for any unpleasant flashbacks to your principles of microeconomics classes. I think that there is obviously a lot that economics can say about prizes, but I just want to focus on three points. And the first is the distinction between a monopoly and monopsony.
Kristin Hayes: Okay.
Zorina Khan: You’re going to be tested at the end of this.
Kristin Hayes: I can’t wait, I’m taking notes.
Zorina Khan: A monopoly is a situation where you have a single seller in the market, and a monopsony is when you have a single buyer. So prize awards are actually monopsonies, where the person who’s offering the prize is the only buyer, and all of the people competing for the prize are the sellers.
Now economic theory shows that monopsonies produce economic costs. Besides this, my research finds that monopsonies also can lead to very large social costs, including arbitrary, idiosyncratic outcomes, unjust discrimination, and even corruption. Suppose that the best invention for carbon capture lowers the market value of Tesla by 50 percent. Then you can be pretty certain that that invention is not going to get their innovation prize.
The point here is that patents are different because they’re very market-oriented incentives. If an invention is valuable, the patent is going to be rewarded with profits in the market. But if the invention is useless, they’re going to get nothing. And society also benefits, because the patentee discloses all of the information to the public, which can induce additional follow-on inventions. I point out that prize awards belong to what I call administered innovation systems. These are top down arrangements, where economic decisions about rewards and values, and the allocation of resources, are going to be made by panels and by judges who will never have as much information as the market. Usually, these sorts of prize systems are very secretive. They don’t tell you how and why they arrived at their decision. And certainly, they never put in place any mechanism to reveal information to everyone in the field.
I think that administered systems are a lot like command economies, because it’s impossible for administrators to come up with the correct value. You have too low a prize, and that’s a problem. You have too high a prize, and that also creates distortions and misallocates resources. Suppose that you were to offer $200 million for a superior mousetrap. Well, your prize is surely going to attract a posse of people to try to fix your rodent problem. But at the same time, this disproportionate payment is going to have unforeseen consequences, like inducing oncologists to switch from finding cures for cancer, to competing for your mousetrap payout. And of course, there is no guarantee that the invention you select is actually going to be successful in the general marketplace.
I would conclude by pointing out that this misallocation of resources was very evident in the case of the Google Lunar XPRIZE, which was a moonshot prize of $30 million. For 10 years, this competition went on, and Google got 10 years of free publicity and insights and information from the competitors for the prize. Then Google canceled the award, amd nobody actually got the $30 million. So my take on this is that prize awards are great for the monopsonist who offers the award; markets are generally better for the rest of us. In the prize system, one person wins a prize. In the market, everyone can get a prize.
Kristin Hayes: Interesting. So this is really fascinating. It sounds like you have a fair amount of skepticism, I think it’s fair to say, about the value of prizes.
Zorina Khan (laughing): I thought I was being nuanced.
Kristin Hayes: Oh, you are, you are. I don’t mean to imply that you’re being unbalanced, but certainly it sounds like you do approach this with a critical eye. I guess I did want to ask, can you point to any cases, historically, that really have illustrated the successful use of prizes to promote innovation? And if there are some that really stick out to you, what factors have led to that success?
I can think of things, like the scale of the prize, and how well, for example, that matches with the scale of the problem. You mentioned that those are often sort of off-kilter. Maybe it was visibility, or maybe even the glamour of it, that led to some extra success, but I’m curious if there are examples you point to as real successes?
Zorina Khan: Well, economists aren’t very popular because we think there are trade-offs to everything. (At least that’s the story we try to tell ourselves, to justify our lack of popularity.) As you point out, grand innovation prizes certainly have scale and visibility and glamour. The Breakthrough Foundation, for instance, gives out millions of dollars at glitzy ceremonies that allegedly treat scientists like rock stars. There is glamour, at least for the person who offers the award, and yes, there’s glamour for the winner; but maybe not so much for all the losers who generally can’t fit on the red carpet.
Part of this answer about nuance can be illustrated by, say, a prize that was offered by Netflix. And I’m not using this example because Reed Hastings, cofounder of Netflix, was a Bowdoin graduate!
Kristin Hayes: No conflict of interest. Got it, okay.
Zorina Khan: A few years ago, Netflix offered a prize of $1 million to improve its algorithm, to predict the choices of videos. And I think this prize was successful in many dimensions. It was successful for Netflix, because they got more than $1 million of advertising and attention. And after a couple of years, they awarded the prize to the winner. This was a group that was called BellKor’s Pragmatic Chaos. (They initially wanted to call themselves “Resistance is Futile,” but they decided that that might be too aggressive.) And now, the list of economic caveats starts. By the end of this competition, the circumstances in the market had changed, so this coding innovation was no longer relevant to Netflix’s operations. So the invention itself was redundant, but the prize attracted around 20,000 teams of hopeful competitors, maybe 40,000–50,000 people. What I find is that in almost all prize competitions, the investments of time and resources on the part of the competitors generally exceed even the absolute value of the award. And it’s not irrelevant that the runner-up submitted their entry just a few minutes after the winner.
But actually, I think this whole idea of a grand innovation is itself nonsensical. Because workable, usable discoveries that ultimately benefit consumers have very little to do with visibility and glamour. I don’t know what your idea of a great invention is either. What would you say?
Kristin Hayes: Hmm. What am I going to pick? I’m going to pick the airplane.
Zorina Khan: Okay. The airplane doesn’t exist as an invention, because it consists of thousands, maybe hundreds of thousands of tiny, incremental inventions that are all buckled together to form the airplane. So my own idea of a great invention is the paper clip.
Kristin Hayes: Hmm. Okay.
Zorina Khan: I’m not referring to that annoying paper clip assistant in Microsoft Office.
Kristin Hayes: He was a great invention, too. I have to say, I really miss him.
Zorina Khan: No, no, no!
Kristin Hayes: Okay, fair enough. The tangible paper clip, yes.
Zorina Khan: I would pay money not to have that paper clip assistant.
Kristin Hayes: I’ll offer a prize for whoever can permanently get rid of that.
Zorina Khan: Paper clips don’t have much technical value, but they have enormous market value, in terms of boosting productivity and benefiting all of us. Ex ante, I very much doubt that any prize-giving authority would have come up with the idea of the paper clip, or that they would estimate the correct value in the millions of dollars.
In my view, the most successful prizes are actually non-monetary. For instance, when I completed 20 years as a Bowdoin professor, the college gave me an award. It was a check for $120. I have to confess, I was pretty outraged by this. It wasn’t that it was cash — obviously, if I received a check for $1.2 million, my outrage would vanished completely. But in the absence of the $1.2 million, I would have been happier with an award without any intrinsic value. So what my research shows is that when they’re given a choice between cash and a medal, or some sort of non-monetary award, firms typically opt for the medal. Because these sorts of non-cash awards enhance reputation, and they serve as a signal of quality in the marketplace. In that circumstance, any financial payoff is just a windfall. I mentioned the Lunar XPRIZE, which was abandoned — well, it was recently resuscitated, but as a non-cash award.
Kristin Hayes: Interesting. Is it early enough stages, that we can’t quite know at this point, whether it will be awarded? Or do you anticipate, this time, it would have a different outcome?
Zorina Khan: I think that in this circumstance, we have a case of complementarity, where the participants are going to get rewards in the marketplace. So, to some extent, whether they get the prize or not is irrelevant.
Kristin Hayes: Hmm. Interesting, very interesting. Well, I want to eventually pull this all back to the initial prize that framed all this. But before I do that, I wanted to ask just one more question, keying into something you said briefly earlier in our conversation. I think you mentioned something about prizes leading to injustice, and you had referenced how they were sort of considered to be tools of elite sections of the population. Does your research tell us anything about the relationship between innovation, and diversity or inclusion?
Zorina Khan: Today, a lot of people don’t realize how exceptional the American experience has been, and it’s not hyperbole to say that the American economy has been the most successful in all of human history. The question is, how did we get to this point? How did the United States overtake leading countries like Britain and France? I put it down largely to this relationship between diversity and innovation. As I mentioned, in Europe, innovation policies were the opposite of inclusive. Administered innovation systems were run by elites for elites. They felt that only privileged people with wealth or status were capable of recognizing and making valuable contributions. And my data show that rewards were based primarily on the identities of inventors, rather than the productivity of their discoveries.
The American model was completely different. It was based on the principle that diversity of ideas mattered most. And there was a sense that creativity was a universal human attribute, so it’s impossible, ex ante, to know where valuable ideas are going to come from. American technology policies were therefore designed to ensure open access, so everyone, as Hamilton might say, would “get their shot,” regardless of their background. My research focuses a lot on the relationship between gender and innovation. It’s very interesting to look at the very first patent statute that was passed in the United States in 1790. That statute said, and I quote, patents will be granted to any inventor “if he, she, or they” had invented any useful discovery.
Kristin Hayes: Interesting.
Zorina Khan: Now, obviously at the time, there were all sorts of barriers against women and minorities and different groups. So it’s all the more striking that we don’t see this in the realm of patent and innovation policies. Certainly in the United States, when you look at a prize system, such as those offered by the Franklin Institute, you had administrators of prizes who didn’t give out awards to women and minorities, but these relatively disadvantaged groups could, and did, become successful in the marketplace through the patent system.
I’m currently writing a book called Women in the Republic of Enterprise that elaborates on this, but overall, what these patent records show is a remarkable range of relatively ordinary people, even economists, trying to benefit from their creativity. It was this tsunami of supposedly small incremental inventions that transformed not just the United States, but the entire global economy. So if you want a pithy concluding statement, it would be that the United States’ economic success was due more to patents for paper clips than prizes for starships.
Kristin Hayes: Okay. Alright. I definitely want to close with our regular feature, but given all that you’ve researched and all that you’ve told us about today, is Elon Musk’s effort the whim of a wealthy and admittedly concerned citizen? Or is it really a critical piece of the innovation puzzle that’s aiming to tackle this very significant societal problem, of climate change?
Zorina Khan: I think I’m going to address the second part of your question first and look at the issue of climate change. Really, the central problem in this area is not ignorance of ways to resolve carbon emissions. The real problem isn’t that people need to have their attention drawn to this. The real problem is that we have an absence of markets and incorrect prices. That’s P-R-I-C-E-S.
So we don’t need grand innovation prizes. Instead, what we need to do is the tedious job of setting up mechanisms to ensure that there are correct market prices, P-R-I-C-E-S, for emissions. And how to do that is not a mystery. Bowdoin has a very strong environmental studies program, and economists in that program have long proposed policies that create incentives for lower emissions, such as carbon taxes, futures markets, carbon offset credits. In my view, the best policy would be to auction off carbon rights to firms and facilitate markets for trading in emissions.
Actually, I don’t know whether you saw this, but a few days ago, even the American Petroleum Institute says it is on board with carbon markets. It’s ironic that today the European Union is well ahead of the United States, in terms of promoting markets in carbon emissions. Going back to the question of innovation, all of my research shows that inventive activity responds to market demand. Once we have markets like these in place, any necessary technological innovations will, I have no doubt, be found.
Now, as for Elon Musk, his prize certainly attracted a lot of media attention to the problem of excessive carbon emissions. But I think he could have done this far more cheaply by turning cartwheels all the way from Mountain View to Palo Alto.
Are you familiar with Punch? It’s a London newspaper, a satirical London newspaper, and in 1906, Punch considered pretentious awards, like these moonshot prizes. The paper proposed a large prize to the first astronaut to make a round trip to Mars within a week, stipulating that the winner of the award would have to bring back, and I quote, “some tangible evidence, such as the prospectus of a Martian book club, supposing them to have any enterprise,” and they added, “a live Martian would, of course, be best.” In sum, I’m quite confident that the XPRIZEs will benefit Elon Musk more than it will the planet. But I would guess they are still likely to be more useful to the rest of us than his plans for the colonization of Mars.
Kristin Hayes: Okay. Alright. Well, these are all issues to watch, definitely. I really appreciate your perspective on these issues that I think are very relevant to the conversations happening, certainly within the environmental economics field right now, and in many, many policy discussions as well. Just having this wonderful historical context, combined with the economic insights, is great. So thank you.
We’ll close with our regular feature, Top of the Stack, and I wanted to ask you if you wanted to recommend some more good content. Of course, books are always welcome, articles, other podcasts. Let me ask you, Zorina, what’s on the top of your stack?
Zorina Khan: I really like the physical verticality of your phrase, Top of the Stack, especially when used in the context of a digital podcast.
Well, I recently read an article published in Nature, by a whole team of researchers, and it has a rather stodgy title: “Unlocking History Through Automated Virtual Unfolding of Sealed Documents Imaged by X-Ray.” But actually, this is a really captivating article. Basically, ever since olden times, senders of messages have tried to find ways to encrypt and protect their secrets. So when the cost of paper and postage was very expensive, one of the ways in which you could do this was to intricately fold your letters, so nobody could covertly read the contents. This article was describing a computer process to virtually unseal the documents without actually opening them.
This article resonated with me, for many reasons, and I’ll just mention one. I spent an entire summer in an attic in Paris, where records of a prize-granting institution were kept. I was surrounded by stacks of files on inventors who’d applied for awards. Some of these files about the French inventors were a foot high, all covered in thick dust. Now, on many occasions, I would come across envelopes with red wax seals that had never been broken, and I had permission to open them. And it was very poignant to read these handwritten pages from all sorts of French inventors. They would include drawings and samples of their discoveries. A lot of these applicants said they were in a desperate situation. They were pleading for support from the prize granting committee.
But just think about this — some administrator had just put the letter in his file, unopened, and tossed it aside. And I was the only person in 200 years who’d ever set eyes on the contents. These unsealed letters really provided to me a very moving reminder of how arbitrary prize systems are. They confirmed the conclusions of the extensive empirical analysis using data for over 160,000 individuals. My conclusion was, and is, that the best incentive for productive change is failure in the market, and the best prize is success in the market.
Kristin Hayes: Well, great. Thank you again for joining me today. I really appreciate your time.
Zorina Khan: It was my pleasure.
- “Carbon Capture and Storage 101” from Resources for the Future
- “$100M prize for carbon removal” from XPRIZE Foundation and Elon Musk
- Inventing Ideas: Patents, Prizes, and the Knowledge Economy by B. Zorina Khan
- Democratization of Invention by B. Zorina Khan