Alta Devices: Finding a Solar Solution

Looking to enter a highly ­competitive solar market, Alta Devices hopes to use a combination of technological advances and manufacturing savvy to succeed where many others have crashed and burned.

• By David Rotman

Suited up: CEO Christopher Norris holds a gallium arsenide wafer used in making Alta’s solar cells. Behind him is a custom-designed reactor used to grow thin layers of the semiconductor. Credit: Gabriela Hasbun

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Alta Devices is a small but well-funded startup located in the same nondescript Silicon Valley office building that once served as the headquarters for Solyndra, the infamous solar company that went bankrupt last year after burning through hundreds of millions of dollars in public and venture investments. Whether the location has bad karma is still not clear, jokes Alta's CEO, Christopher Norris. But Norris, a former semiconductor-industry executive and venture capitalist, does know that the fate of his company will hinge on its ability to navigate the risky and expensive process of scaling up its novel technology, which he believes could produce power at a price competitive with fossil-fuel plants and far more cheaply than today's solar modules.
On a table in Alta's conference room, Norris lays out samples of the company's solar cells, flexible black patches encapsulated in clear plastic. They look unremarkable, but that's because the key ingredient is all but invisible: microscopically thin sheets of gallium arsenide. The semiconductor is so good at absorbing sunlight and turning it into electricity that one of Alta's devices, containing an active layer of gallium arsenide only a couple of micrometers thick, recently set a record for photovoltaic efficiency. But gallium arsenide is also extremely expensive to use in solar cells, and thin films of it tend to be fragile and difficult to fabricate. In fact, Alta's innovations lie not in choosing the material—the semiconductor has been used in solar cells on satellites and spacecraft for decades—but in figuring out how to turn it into solar modules cheap enough to be practical for most applications.
The company, which was founded in 2007, is based on the work of two of the world's leading academic researchers in photonic materials. One of them, Eli Yablonovitch, now a professor of electrical engineering at the University of California, Berkeley, developed and patented a technique for creating ultrathin films of gallium arsenide in the 1980s, when he worked at Bell Communications Research. The other, Harry Atwater, a professor of applied physics and materials science at Caltech, is a pioneer in the use of microstructures and nanostructures to improve materials' ability to trap light and convert it into electricity. Andy ­Rappaport, a venture capitalist at August Capital, teamed up with the two scientists to found Alta, recruiting fellow Silicon Valley veteran Bill Joy as an investor and, with the other cofounders, building a management team that included Norris. The goal: to make highly efficient solar cells, and to make them more cheaply than those based on existing silicon technology.
It is at this point that many solar startups have gone wrong, rushing to scale up an innovative technology before understanding its economics and engineering challenges. Instead, Alta spent its first several years in stealth mode, quietly attempting to figure out, as Norris puts it, whether its process for making gallium arsenide solar cells was more than a "science experiment" and could serve as a viable basis for manufacturing.

Flexible power: Alta’s solar cells can be made into bendable sheets. In this sample, a series of solar cells are encapsulated in a roofing material. Credit: Gabriela Hasbun

Remnants of the science experiment are still visible in the modest lab at the back of Alta's offices. Small ceramic pots sit on electric hot plates—relics of the company's early efforts to optimize ­Yablonovitch's technique of "epitaxial liftoff," which uses acids to precisely separate thin films of gallium arsenide from the wafers on which they are grown. Elsewhere in the lab the equipment gets progressively larger and more sophisticated, reflecting the scaling up of the process. Near a viewing window that allows potential investors to peer into the lab without donning clean-room coverings is one of the jewels of the company's development efforts: a long piece of equipment in which batches of samples are processed to create the thin-film solar cells. It's convincing evidence that the early work with pots and hot plates can be transformed into an automated process capable of the yields necessary for real-world manufacturing.
SOLAR LIFTOFF
When Bill Joy, a cofounder of Sun Microsystems and now a leading Silicon Valley venture capitalist, first saw the business plan for what became Alta Devices, he and his colleagues at Kleiner Perkins Caufield & Byers were already looking for high-efficiency thin-film solar technology. Joy keeps a running list—currently about 12 to 15 items long—of desirable technologies that he believes he has "a reasonable chance of finding." Solar cells that are highly efficient in converting sunlight and that can be made cheaply in flexible sheets could provide ways to dramatically lower the overall costs of solar power. Gallium arsenide technology was a natural choice for efficiency, but Alta's economics were what really interested the investors. "Their core competency was how to make it manufacturable," says Joy, who joined Rappaport as an investor within a few months.
Gallium arsenide is a nearly ideal solar material, for a number of reasons. Not only does it absorb far more sunlight than silicon—thin films of it capture as many photons as silicon 100 times thicker—but it's less sensitive to heat than silicon solar cells, whose performance dramatically declines above 25 °C. And gallium arsenide is better than silicon in retaining its electricity-producing abilities in conditions of relatively low light, such as early in the morning or late in the afternoon.
Key to reducing its manufacturing costs is the technique that Yablonovitch helped figure out decades ago. The semiconductor can be grown epitaxially: when thin layers are chemically deposited on a substrate of single-crystal gallium arsenide, each adopts the same single-crystal structure. Yablonovitch found that if a layer of aluminum arsenide is sandwiched between the layers, this can be selectively eaten away with an acid, and the gallium arsenide above can be peeled off. It was an elegant and simple way to create thin films of the material. But the process was also problematic: the single-crystal films easily crack and become worthless. In adapting Yablonovitch's fabrication method, Alta researchers have found ways to create rugged films that aren't prone to cracking. And not only do the thin films use little of the semiconductor material, but the valuable gallium arsenide substrate can be reused multiple times, helping to make the process affordable.
Research by Alta's founding scientists has also led to techniques for increasing the performance of the solar cells. Photovoltaics work because the photons they absorb boost the energy levels of electrons in the semiconductor, freeing them up to flow to metal contacts and create a current. But the roaming electrons can be wasted in various ways, such as in heat. In gallium arsenide, however, the freed electrons frequently recombine with positively charged "holes" to re-create photons and start the process over again. Work done by ­Yablonovitch and Atwater to explain this process has helped Alta design cells to take advantage of this "photon recycling," providing many chances to recapture photons and turn them into electricity.

Thus Alta's efficiency record: its cells have converted 28.3 percent of sunlight into electricity, whereas the highest efficiency for a silicon solar cell is 25 percent, and commonly used thin-film solar materials don't exceed 20 percent. Yablonovitch suggests that Alta has a good chance of eventually breaking 30 percent efficiency and nearing the theoretical limit of 33.4 percent for cells of its type.
The high efficiency, combined with gallium arsenide's ability to perform at relatively high temperatures and in low light, means that the cells can produce two or three times more energy over a year than conventional silicon ones, says Norris. And that, of course, translates directly into lower prices for solar power. Norris says a "not unreasonable expectation" is that the gallium arsenide technology could yield a "levelized cost of energy" (a commonly used industry metric that includes the lifetime costs of building and operating a power plant) of seven cents per kilowatt-hour. At such a price, says Norris, solar would be competitive with fossil fuels, including natural gas; new gas plants generate electricity for around 10 cents per kilowatt-hour. And it would trounce today's solar power, which Norris says costs around 20 cents per kilowatt-hour to generate.
Such numbers are tantalizing. But Norris is quick to bring up another: it costs roughly $1 billion to build a manufacturing facility capable of producing enough solar modules to generate a gigawatt of power, which is roughly the output of several medium-sized power plants. "I don't see any scenario where we would do this on our own," he says.
GHOST OF SOLYNDRA
Silicon Valley has been infatuated with clean tech since the mid-2000s, but it has yet to figure out something crucial: who will supply all the money necessary to scale up energy technologies and build factories to manufacture them? Venture investors might be skilled at picking technologies, but few of them have the deep pockets or the patience required to compete in a capital-intensive business such as the manufacturing of solar modules. The collapse of Solyndra, which built a $733 million factory in Fremont, California, is just the most recent reminder of what can go wrong.
Alta's lead investor Andy Rappaport says he usually stays away from investments in clean tech, including photovoltaics. Many investors in solar, he suggests, have bet that a startup could lower the marginal costs of manufacturing and thus "capture some market share." That's "a recipe for failure," he says, because "you need to spend hundreds of millions to build a factory before you know if you have anything of value." The strategy is especially risky now, because photovoltaics are becoming an increasingly competitive commodity business and prices continue to plummet, creating a moving target for new production. But rather than trying to create value by building manufacturing capacity, Rappaport says, Alta can profit from its intellectual property: "We have said simply and consistently that we can scale capacity faster and build a much stronger company by leveraging partnerships rather than raising and spending our own capital to build factories."
Current investors in Alta include GE, Sumitomo, and Dow Chemical, which recently introduced roofing shingles that incorporate thin-film photovoltaics (see "Can We Build Tomorrow's Breakthroughs?" January/February 2012). Though these companies have invested in several rounds of funding—Alta has so far raised $120 million—eventually Norris would like to see deals, such as licensing agreements or joint ventures, in which manufacturers build capacity to produce Alta's solar cells or use the solar technology in their products. To do that, he says, Alta first needs to "retire the risk" of the production technology, demonstrating to prospective partners that the gallium arsenide solar modules can in fact be produced in an economically competitive way.
Less than a mile from its headquarters, Alta is gutting and renovating a building where Netflix used to warehouse DVDs, turning it into a $40 million pilot facility to test its equipment. Though the facility is far smaller than a commercial solar factory, it is still no small or inexpensive undertaking. Norris warily eyes the new columns required to reinforce the roof, which will need to hold heavy ventilation and emission-control equipment. But the Alta CEO becomes more buoyant as he approaches the nearly completed back section of the facility. There, in several white rooms, are the large custom-designed versions of the lab apparatus used to make the solar cells.
Whether Alta succeeds will depend chiefly on how well these manufacturing inventions perform. The cost of the pilot facility might pale next to the price tag for a commercial-scale solar factory, but it is still a critical investment for the startup. And even as Alta is busily trying to get the facility up and running by the end of the year, Norris says, it is taking a deliberate, methodical approach to the process of scaling up. That contrasts sharply with earlier solar startups that spent hundreds of millions in venture investments to build factories as fast as possible. But Alta's cautious approach should not be confused with a lack of ambition. The goal, says Norris, is to make this a "foundational, transformative technology."

David Rotman is Technology Review's editor. 

Foundation Medicine: Personalizing Cancer Drugs

Foundation Medicine is offering a test that helps oncologists choose drugs targeted to the genetic profile of a patient's tumor cells. Has personalized cancer treatment finally arrived?

• By Adrienne Burke

It's personal now: Alexis Borisy (left) and Michael Pellini lead an effort to make DNA data available to help cancer patients. Credit: Christopher Harting

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Michael Pellini fires up his computer and opens a report on a patient with a tumor of the salivary gland. The patient had surgery, but the cancer recurred. That's when a biopsy was sent to Foundation Medicine, the company that Pellini runs, for a detailed DNA study. Foundation deciphered some 200 genes with a known link to cancer and found what he calls "actionable" mutations in three of them. That is, each genetic defect is the target of anticancer drugs undergoing testing—though not for salivary tumors. Should the patient take one of them? "Without the DNA, no one would have thought to try these drugs," says Pellini. 
Starting this spring, for about $5,000, any oncologist will be able to ship a sliver of tumor in a bar-coded package to Foundation's lab. Foundation will extract the DNA, sequence scores of cancer genes, and prepare a report to steer doctors and patients toward drugs, most still in early testing, that are known to target the cellular defects caused by the DNA errors the analysis turns up. Pellini says that about 70 percent of cases studied to date have yielded information that a doctor could act on—whether by prescribing a particular drug, stopping treatment with another, or enrolling the patient in a clinical trial.
The idea of personalized medicine tailored to an individual's genes isn't new. In fact, several of the key figures behind Foundation have been pursuing the idea for over a decade, with mixed success. "There is still a lot to prove," agrees Pellini, who says that Foundation is working with several medical centers to expand the evidence that DNA information can broadly guide cancer treatment.
Foundation's business model hinges on the convergence of three recent developments: a steep drop in the cost of decoding DNA, much new data about the genetics of cancer, and a growing effort by pharmaceutical companies to develop drugs that combat the specific DNA defects that prompt cells to become cancerous. Last year, two of the 10 cancer drugs approved by the U.S. Food and Drug Administration came with a companion DNA test (previously, only one drug had required such a test). So, for instance, doctors who want to prescribe Zelboraf, Roche's treatment for advanced skin cancer, first test the patient for the BRAFV 600E mutation, which is found in about half of all cases.
About a third of the 900 cancer drugs currently in clinical trials could eventually come to market with a DNA or other molecular test attached, according to drug benefits manager Medco. Foundation thinks it makes sense to look at all relevant genes at once—what it calls a "pan-cancer" test. By accurately decoding cancer genes, Foundation says, it uncovers not only the most commonly seen mutations but also rare ones that might give doctors additional clues. "You can see how it will get very expensive, if not impossible, to test for each individual marker separately," Foundation Medicine's COO, Kevin Krenitsky, says. A more complete study "switches on all the lights in the room."
So far, most of Foundation's business is coming from five drug companies seeking genetic explanations for why their cancer drugs work spectacularly in some patients but not at all in others. The industry has recognized that drugs targeted to subsets of patients cost less to develop, can get FDA approval faster, and can be sold for higher prices than traditional medications. "Our portfolio is full of targets where we're developing tests based on the biology of disease," says Nicholas Dracopoli, vice president for oncology biomarkers at Janssen R&D, which is among the companies that send samples to Foundation. "If a pathway isn't activated, you get no clinical benefit by inhibiting it. We have to know which pathway is driving the dissemination of the disease."
Cancer is the most important testing ground for the idea of targeted drugs. Worldwide spending on cancer drugs is expected to reach $80 billion this year—more than is spent on any other type of medicine. But "the average cancer drug only works about 25 percent of the time," says Randy Scott, executive chairman of the molecular diagnostics company Genomic Health, which sells a test that examines 16 breast-cancer genes. "That means as a society we're spending $60 billion on drugs that don't work."
Analyzing tumor DNA is also important because research over the past decade or so has demonstrated that different types of tumors can have genetic features in common, making them treatable with the same drugs. Consider Herceptin, the first cancer drug approved for use with a DNA test to determine who should receive it (there is also a protein-based test). The FDA cleared it in 1998 to target breast cancers that overexpress the HER2 gene, a change that drives the cancer cells to multiply. The same mutation has been found in gastric, ovarian, and other cancers—and indeed, in 2010 the drug was approved to treat gastric cancer. "We've always seen breast cancer as breast cancer. What if a breast cancer is actually like a gastric cancer and they both have the same genetic changes?" asks Jennifer Obel, an oncologist in Chicago who has used the Foundation test.
The science underlying Foundation Medicine had its roots in a 2007 paper published by Levi Garraway and Matthew Meyerson, cancer researchers at the Broad Institute, in Cambridge, Massachusetts. They came up with a speedy way to find 238 DNA mutations then known to make cells cancerous. At the time, DNA sequencing was still too expensive for a consumer test—but, Garraway says, "we realized it would be possible to generate a high-yield set of information for a reasonable cost." He and Meyerson began talking with Broad director Eric Lander about how to get that information into the hands of oncologists.
In the 1990s, Lander had helped start Millennium Pharmaceuticals, a genomics company that had boldly promised to revolutionize oncology using similar genetic research. Ultimately, Millennium abandoned the idea—but Lander was ready to try again and began contacting former colleagues to "discuss next steps in the genomics revolution," recalls Mark Levin, who had been Millennium's CEO.

Levin had since become an investor with Third Rock Ventures. Money was no object for Third Rock, but Levin was cautious—diagnostics businesses are difficult to build and sometimes offer low returns. What followed was nearly two years of strategizing between Broad scientists and a parade of patent lawyers, oncologists, and insurance experts, which Garraway describes as being "like a customized business-school curriculum around how we're going to do diagnostics in the new era."
In 2010, Levin's firm put $18 million into the company; Google Ventures and other investors have since followed suit with $15.5 million more. Though Foundation's goals echo some of Millennium's, its investors say the technology has finally caught up. "The vision was right 10 to 15 years ago, but things took time to develop," says Alexis Borisy, a partner with Third Rock who is chairman of Foundation. "What's different now is that genomics is leading to personalized actions."
One reason for the difference is the falling cost of acquiring DNA data. Consider that last year, before his death from pancreatic cancer, Apple founder Steve Jobs paid scientists more than $100,000 to decode all the DNA of both his cancerous and his normal cells. Today, the same feat might cost half as much, and some predict that it will soon cost a few thousand dollars.
So why pay $5,000 to know the status of only about 200 genes? Foundation has several answers. First, each gene is decoded not once but hundreds of times, to yield more accurate results. The company also scours the medical literature to provide doctors with the latest information on how genetic changes influence the efficacy of specific drugs. As Krenitsky puts it, data analysis, not data generation, is now the rate-limiting factor in cancer genomics.
Although most of Foundation's customers to date are drug companies, Borisy says the company intends to build its business around serving oncologists and patients. In the United States, 1.5 million cancer cases are diagnosed annually. Borisy estimates that Foundation will process 20,000 samples this year. At $5,000 per sample, it's easy to see how such a business could reward investors. "That's ... a $100-million-a-year business," says Borisy. "But that volume is still low if this truly fulfills its potential."
Pellini says Foundation is receiving mentoring from Google in how to achieve its aim of becoming a molecular "information company." It is developing apps, longitudinal databases, and social-media tools that a patient and a doctor might use, pulling out an iPad together to drill down from the Foundation report to relevant publications and clinical trials. "It will be a new way for the world to look at molecular information in all types of settings," he says.
Several practical obstacles stand in the way of that vision. One is that some important cancer-related genes have already been patented by other companies—notably BRCA1 and BRCA2, which are owned by Myriad Genetics. These genes help repair damaged DNA, and mutations in them increase the risk of breast or ovarian cancer. Although Myriad's claim to a monopoly on testing those genes is being contested in the courts and could be overturned, Pellini agrees that patents could pose problems for a pan-cancer test like Foundation's. That's one reason Foundation itself has been racing to file patent applications as it starts to make its own discoveries. Pellini says the goal is to build a "defensive" patent position that will give the company "freedom to operate."
Another obstacle is that the idea of using DNA to guide cancer treatment puts doctors in an unfamiliar position. Physicians, as well as the FDA and insurance companies, still classify tumors and drug treatments anatomically. "We're used to calling cancers breast, colon, salivary," says oncologist Thomas Davis, of the Dartmouth-Hitchcock Medical Center, in Lebanon, New Hampshire. "That was our shorthand for what to do, based on empirical experience: 'We tried this drug in salivary [gland] cancer and it didn't work.' 'We tried this one and 20 percent of the patients responded.'"
Now the familiar taxonomy is being replaced by a molecular one. It was Davis who ordered DNA tests from several companies for the patient with the salivary-gland tumor. "I got bowled over by the amount of very precise, specific molecular information," he says. "It's wonderful, but it's a little overwhelming." The most promising lead that came out of the testing, he thinks, was evidence of overactivity by the HER2 gene—a result he says was not picked up by Foundation but was found by a different test. That DNA clue suggests to him that he could try prescribing Herceptin, the breast-cancer drug, even though evidence is limited that it works in salivary-gland cancer. "My next challenge is to get the insurance to agree to pay for these expensive therapies based on rather speculative data," he says.
Insurance companies may also be unwilling to pay $5,000 for the pan-cancer test itself, at least initially. Some already balk at paying for well-established tests, says Christopher-Paul Milne, associate director of the Tufts Center for the Study of Drug Development, who calls reimbursement "one of the biggest impediments to personalized medicine." But Milne predicts that it's just a matter of time before payers come around as the number of medications targeted to people's DNA grows. "Once you get 10 drugs that require screening, or to where practitioners wouldn't think about using a drug without screening first, the floodgates will open," he says. "Soon, in cancer, this is the way you will do medicine."
Adrienne Burke was founding editor of Genome Technology magazine and is a contributor to Forbes.com and Yahoo Small Business Advisor.

The fallout of Rupee depreciation and fuel price increase

  

Subsidies? Well, yes, but make them smart subsidies

Nigeria: Subsidising 

the neighbours

Nigeria’s Central Bank Governor, Sanusi Lamidi Sanusi, had a problem. In a recent live interview with the Aljazeera TV, he said that his country had to raise the retail prices of all petroleum products to match the rising international prices, despite the violent and massive public protests against that move. That was because Nigeria could not afford to subsidise them anymore though Nigeria is a leading petroleum-producing country and a net exporter of that commodity.

“We had fixed the retail prices of petroleum prices in Nigeria when the international price of crude oil was $ 50 a barrel,” he said. “But the international prices are around $ 110 a barrel now and we still supply petroleum products at the original prices” Then, he came out with his problem, a problem which he raised as an economist and not as a politician. “This was a huge burden on the Nigerian government’s budget because that money could have been used for developing the basic infrastructure of Nigeria which is now far from desired. But the major problem was something else. In all the neighbouring countries where the petroleum prices were at the current international level, it became a very profitable business for some groups to buy those products at the subsidised prices in Nigeria and smuggle the same to those countries and sell still at a lower price than the international prices. So, the demand for petroleum products in Nigeria was higher than their normal level. The government’s subsidy requirements were therefore higher than what it would have otherwise been. Worst was that the Nigerian government was subsidising the petroleum consumers of neighbouring countries as well”

Governor Sanusi’s explanation was the official justification of the government’s decision to raise the retail prices of petroleum products in the market and response to the massive and bloody protests that had brought Nigeria’s economy to a halt.

Sri Lanka: Making money by selling subsidised rice

Nigeria is not alone in this predicament. In all the countries where unmanaged and uncontrolled subsidies have been extended by governments in good public spirit, there had been similar unintended consequences and wastage of scarce resources of the countries concerned. In Sri Lanka, prior to 1977, every citizen of the country, irrespective of the income level, had been supplied with two measures of rice, equal to about two kilograms, at a highly subsidised price. The objective of the government in doing so was noble: Eliminate hunger amongst the poor by supplying them with their staple food. But this system engendered a thriving underground market in which traders started to buy subsidised rice from the franchise holders by making a payment to them and supply the same to hotels in the city where there was a high price for rice in the open market. So, both the poor and the rich got the opportunity of earning an additional income through the subsidy scheme which economists call ‘earning a rent’ meaning that it was earned not by making a worthwhile contribution to the economy but by using the available control and regulatory systems. So, the government wanted people to consume rice. Instead, they made money out of it and spent on other needs.

Fishermen’s demand: Reduce prices or no fishing anymore

After the fuel prices were increased by a significant margin in Sri Lanka recently, there were spontaneous agitations calling for reducing them to the original price levels. The fishermen on the North Western coast of Sri Lanka refused to accept the subsidy that was offered to them by the government on the fear that that subsidy was a temporary measure to placate them and would not be continued. They refused to take their boats to sea until the government met their demand. Similar demands were made by others like three-wheeler taxi men, lorry owners and school van operators. This was not what they were supposed to do because, if their costs had increased due to the fuel price hike, they should have hiked the prices of their individual products as well to compensate for the cost increases. The objective of the fuel price increase by the government was to discourage the excessive use of petroleum products by both consumers and producers and thereby check on the growth of the fuel bill of the country. Economists call this allowing a ‘pass-through’ of the price increase to the rest of the economy forcing everyone to make a painful but necessary adjustment to their consumption pattern. This adjustment is exactly what is needed in Sri Lanka today where everyone, including the government, is notorious for over-consuming beyond their means. Both the private bus operators and the Ceylon Electricity Board in the very first instance and lorry owners subsequently made this pass through by raising bus fares, electricity tariffs and lorry hiring charges, respectively, in line with the increase in the fuel prices.

A price pass-through is not necessarily inflationary

Many have feared that such a pass through will raise the cost of living and contribute to high future inflation. This argument is both right and ill-conceived. It is right because a fuel price increase raises the consumer prices and shrinks the basket of goods and services which a person could buy out of a given income. It in fact puts the poor and those earning fixed incomes to innumerable misery because they are now forced to tighten their belts beyond the minimum consumption needed to maintain them and their families. So, the painful adjustment which the price increase expects everyone to make falls squarely on them. However, this argument of long term inflation is ill-conceived because the initial increase in the cost of living will fizzle out pretty soon if the central bank does not increase money supply and allow the economy to increase its total aggregate demand through a liberal credit expansion. All other groups will be forced to accommodate the initial price increase through an improvement in productivity in the long run. This process which should naturally occur in the economy as per the objective of increasing fuel prices will short-circuit if the central bank allows credit to expand liberally, ostensibly to force-track economic growth beyond the country’s true growth potential. Such a liberal credit expansion, in the opinion of economists, is a subsidy to be extended by the central bank to the economy which a central bank is neither capable of doing nor supposed to do. It is not capable of doing it because merely through money creation it cannot influence people to work hard and deliver prosperity; it is not supposed to do so because it delays the adjustment needed and makes its own life painful.

Offer smart subsidies

to the poor Economists generally agree that the ultra-poor and the vulnerable need support in such an event to wade through the adjustment process successfully. Such support is generally delivered to them through a subsidy scheme, not just a general subsidy system, but a ‘smart subsidy system’.

The general subsidy schemes are not endorsed by economists due to several weaknesses inherent in them. A smart subsidy system is one that eliminates or minimises those inherent weaknesses.

What are the weaknesses in general subsidy systems?

Avoid unintended consequences

First, they generate unintended consequences throughout the economy. A subsidy is not free but paid for by someone else in the economy. For instance, if the government extended a cash subsidy to fishermen or, as demanded by them, reduced the prices of fuel to their original levels without a compensating reduction in costs in the Ceylon Petroleum Corporation or the Indian Oil Company, there are losses to be made by these suppliers. The Indian Oil Company can close shop and go home if these losses are mounting. But the Petroleum Corporation, being a public monopoly, cannot do so easily. It could for some time continue to operate by financing losses by borrowing from banks, especially from state banks. But sooner or later, the loss levels will become too high even for the banks to bear. At that stage, its losses have to be borne by ‘someone else’ and this someone else in this case is the government as its owner. The government has to pay for those losses by increasing taxes, or by cutting expenses elsewhere or by printing money or by increasing public debt. In the past, the government did so by taking over the debt of the Petroleum Corporation by issuing Treasury bonds to the two state banks which is a combination of both printing money (because it increases net credit to government by banks) and by raising public debt (because it adds to the total public debt of the country). Whatever the method of financing, it is an unintended consequence because in the first instance, it reduces the credit granting capacity of state banks to other customers and when the government takes over the debt later, it causes future inflation. A central bank cannot be happy about the Petroleum Corporation running at losses or its losses being financed through bank borrowing or, eventually, those losses being taken over by the government.

The Moral Hazard

Problem: Give subsidies and corrupt them too

Second, subsidies lead to a problem known as the ‘moral hazard problem’ in an economy. A moral hazard is simply a situation where, when one is supported by another without a commensurate sacrifice by the first one, the supported person has no incentive to work for gaining capacity for standing on his own feet one day and, in the absence of this quality, will become a greater burden to the person who chooses to support him. A good example is the case of a child whose home assignments are done by his mother out of pure love for him. But the child does not learn to do it by himself and, as a result, the mother will have to continue to do his assignments at a great burden to herself. This problem is not a new one and had been known for long. As preached by the Buddha in the Chakkavatthi Seehanada Sutra in the Dheegha Nikaya, a king, on being advised by his Ministers that people in his kingdom had resorted to theft and looting because they did not have enough money to undertake their own enterprises, had given them, out of sympathy, free capital from his treasury. After sometime, people had realised that they could get more money from the king if they engaged themselves in more theft and looting. So, instead of theft and looting subsiding, they had proliferated in his kingdom. So, uncontrolled subsidies, instead of helping people, perpetuate their misery and become a huge burden to the subsidy provider.

Adverse selection: Bad guys get together to be selected

Third, subsidies generate another problem called the ‘adverse selection’ problem by promoting people to flock to get the subsidy though they may not deserve to receive such a subsidy. If fishermen are given a ration of fuel, many will join the bandwagon of fishermen to get the benefit of the subsidy for them. The wrong signal given by the subsidy collects an underserving group together and the selection of that group by the government for granting the subsidy is adverse to the government right from the beginning. That is because the government comes under constant pressure by this group for enhancement and continuation of the subsidy. The subsidy is paid with a good intention, but it does not generate the expected results because it is used by people who have been adversely selected.

Have a timeline for exiting the subsidy

Fourth, subsidies, once granted, have the tendency of becoming a permanent feature in the system and at a later date, when it is no longer necessary to grant that subsidy, it will be difficult for the government to withdraw the same. One good example is the fertiliser subsidy granted to farmers in Sri Lanka. The advocates of the subsidy had justified it on the ground that it is not a waste of resources but an investment because it helps farmers to raise output by reducing their cost of production. However, the unlimited and untargeted subsidy ballooned when the international prices of fertiliser too ballooned since 2007. Accordingly, the fertiliser subsidy which was around Rs 3.6 billion in 2004 shot up to Rs 11 billion in 2007 and further to Rs 26 billion in 2008. It has remained around that level since then draining a significant portion of the country’s scarce resources for the subsidy. Hence, even if the government wants to curtail or eliminate the subsidy now, it is not possible to do so without facing severe resistance from the recipients. Hence, a smart subsidy should have clearly thought out this problem right at the outset and introduced a dateline for exiting the subsidy when it has delivered the desired results.

Have a fall back strategy to hang on when things go wrong

Fifth, subsidies can go wrong due to factors beyond the control of authorities. One possibility is the cost escalation due to increase in the international prices. Sri Lanka’s fertiliser subsidy is a casualty of this adverse development. At the time the open and unrestricted fertiliser subsidy was designed in 2005, the international prices of petroleum products including that of fertilisers were at an affordable level and therefore the authorities could talk very safely of fertiliser subsidy as ‘an investment’ because the total cost was to rise only from Rs 3.6 billion in 2004 to Rs 4.2 billion in 2005. This marginal increase was within the resources of the government. However, the year 2006 ended up with a total subsidy level of Rs 12 billion due to cost escalations. The authorities still stuck to the original plan and continued with their so called ‘investment’ in the agriculture sector. But in 2008, fertiliser prices increased sharply raising the cost of the subsidy to Rs 26 billion and in 2009 to Rs 27 billion. When such mishaps occur, there should be a ‘fall-back strategy’ designed and built into the subsidy model so that the authorities could easily move out of the subsidy for a better alternative. But this has not been there in the fertiliser subsidy and as a result the subsidy levels have remained every year at above Rs 25 billion throughout since 2008.

Offer smart subsidies

So, subsidies could be extended to help those vulnerable groups in the case of a sudden price increase due to international price increases. But those subsidies should necessarily be smart subsidies with clear targeting of the beneficiary groups, avoiding unintended consequences, free from moral hazard and adverse selection issues, an announced timeline for exiting the subsidy after the desired results have been attained and a clearly thought-out fall back strategy in the event of the subsidy becoming untenable.

The general subsidies with no smartness built into them are doomed to failure though they are very much desired by politicians and the public at large.

(W.A. Wijewardena could be reached at waw1949@gmail.com )