The Problems with Prizes as Innovation PolicyOne way to focus energy on innovations that might have particular social benefits is to offer prizes. For example, Â
here's a reasonable proposal for how prizes might be focuses on certain innovations relevant to space exploration, African agriculture, vaccines for diseases of the poor, energy and climate change, and learning technologies. But B. Zorina Khan tosses some cold water on the prize perspective in "Inventing Prizes: A Historical Perspective on Innovation Awards and Technology Policy," published in the
Business History Review, Winter 2015 (89:4, pp. 631-660).  The journal isn't freely available online, although many readers will have access through library subscriptions. Also, for those with access to NBER Working Papers, a version of the paper i s available as  No. 21375, dated July 2015.)
Kahn notes that there is some stirring of enthusiasm about prizes as a tool for innovation. She writes (footnotes omitted):
By way of contrast, both academics and American policy makers today are increasingly enthusiastic about prizes. The White House urges that “history should be our guide†and “the Federal Government should… use high-risk, high-reward policy tools such as prizes and challenges to solve tough problems.†The federal government has begun to finance prizes as a means of generating new ideas and products, claiming that prizes “have a good track record of spurring innovation.†Numerous businesses have also offered large privately-funded prizes for objectives that range from specific targets to solutions for more general problems.
But it's unwise to taunt economic historians like Khan with that about how "history should be our guide." A substantial part of the article is devoted to debunking popular stories about the efficacy of prizes as a spur for past innovation. One famous example is the prize for discovering how to calculate longitude while at sea. Khan writes:
The British Parliament passed a bill in July 1714 “for providing a public reward for such person or persons as shall discover the longitude at sea.†The bill offered “10,000 pounds if the method were accurate to within 1 degree, or 60 nautical miles; 15,000 pounds if the method were accurate to within 2/3 degree, or 40 nautical miles; 20,000 pounds if the method were accurate to within ½ degree, or 30 nautical miles.†The panel of judges comprised 22 commissioners, including the astronomer royal, the Speaker of the House of Commons, and the lords of Admiralty.
A poor clockmaker named John Harrison eventually came up with a solution, but the Longitude Board was too busy fighting among its members over the prize money. Indeed, it never actually awarded the prize, although Harrison got a partial reward 47 years later from another source. Perhaps even more to the point, there had been prizes offered for a solution to the longitude problem for centuries by Spain, Venice, Holland, and others--and all those prizes had failed. Other famous historical examples of prizes turn out to be unsatisfactory in various ways, as well.
"[T]he French Academy of Sciences in 1775 offered a cash prize for the discovery of a process to create sodium carbonate from the cheaper sodium chloride. Nicolas Leblanc succeeded in finding a viable manufacturing solution, but he never received the prize and his factory was expropriated by the revolutionary government."
In other cases, a prize was offered and awarded, but the inventor made vastly more money out of patenting and selling the invention over time. Thus, it's not at all clear that the very small additional incentive provided by the prize was important. This theme applies, for example, to when Hippolyte Mège won a prize from Napoleon III  for making margarine production commercially viable, and when John Wesley Hyatt won a prize offered by the billiard table producers Phelan and Collender in 1863 for a method of making billiard balls out of something other than ivory. A policy related to prizes is to buy out the inventor's patent. A classic historical example here is when the French government in 1839 bought the rights from Louis Daguerre for his daguerrotype photographic process. Inconveniently, Khan points out that Daguerre never had a patent. Instead, he used powerful patrons to lobby with the French government for a payment, on the grounds that getting a patent was too expensive and difficult, and if the French didn't pay him for the invention, some other country would. As soon as the French paid him, he then applied for a patent in England, and tried to sell the rights to the British government--who refused to bite. Khan also considers at some length the series of 18th- and 19th-century institutions in various European countries that offered prizes for inventions, including France's Société d'Encouragement pour l'Industrie Nationale (Society to Encourage National Industry or SEIN) founded in 1801, England's Royal Society for the Encouragement of Arts, Manufactures and Commerce (commonly known as the Royal Society of Arts or the RSA) founded in 1754. But the problems of prizes were so widely recognized that these institutions largely shut down their prize operations, and instead started lobbying for a mixture of patents, research grants, and spreading technical information. Khan explains:
It is therefore not surprising that, in both England and France, the systematic institution of “inducement prizes†that had prevailed in the eighteenth and early nineteenth centuries failed to survive except for sporadic instances. In England, by the 1820s the Royal Society realized the inefficiencies associated with prizes, and instead switched to lobbying in favour of patents. ... The system of inducement prizes in France and England was typically replaced by research grants to underwrite the costs of R&D inputs into the technology production process. Both institutions also switched their mandate towards the provision of information and technical education. The RSA even refused to accept further funding from benefactors who wished to designate prizes, because such endowments hampered their desire to reform their policies away from such targeted awards and towards more productive endeavours for “the advancement of Natural Knowledge.†During the run-up to the US Constitution, there was an actual choice made between encouraging innovation through prizes or through patents. Khan says: The use of prizes and bounties was common in the colonial period, and the Continental Congress in 1783 “recommended to the Legislatures of the several states to … encourage the establishment of useful manufactures either by premiums or by such other means as they may find most effectual.†...  The framers of U.S. policies were aware of the options that had prevailed in the colonial period and in Europe, but rejected the use of “premiums†in favour of property rights in patents. ...
Whereas, the majority of organizations that had specialized in granting prizes for industrial innovations ultimately became disillusioned with this policy, and the practice of bestowing technology awards declined among both private and public institutions. As observers noted in the nineteenth century, industrial prizes faltered in part because of their lack of market-orientation, and even the democratic nature of economic institutions in the United States could not overcome such drawbacks in administered prize systems.Judges had to combine technical and industry-specific knowledge with impartiality, but even the most competent personnel could not ensure consistency; decision-making among panels was complicated by differences in standards, interpretation, capture, and risk-aversion. Such difficulties tended to lead to haphazard decisions, or were often overcome by simply making the award to the person or the firm with the most established reputation. Juries were no t immune to the effects of outright bias, capture, cognitive dissonance, lobbying, and “marketing.†Prizes tended to offer private benefits to both the proposer and the winner, largely because they served as valuable advertisements, with few geographical spillovers. Winners of such awards were generally unrepresentative of the most significant innovations, in part because the market value of useful inventions would typically be far greater than any prize that could be offered by private or state initiative.  ...
In any event, history indicates that the evolution of the institution of innovation prizes over the past three centuries serves as a cautionary tale rather than as a success story.
Khan also quotes a passage from Adam Smith on merits of patents over prizes, on the grounds that patents are more likely to reflect actual social benefits. It's from his Lectures on Jurisprudence  apparently delivered in 1763: Thus the inventor of a new machine or | any other invention has the exclusive priviledge of making and vending that invention for the space of 14 years by the law of this country, as a reward for his ingenuity, and it is probable that this is as equall an one as could be fallen upon. For if the legislature should appoint pecuniary rewards for the inventors of new machines, etc., they would hardly ever be so precisely proportiond to the merit of the invention as this is. For here, if the invention be good and such as is profitable to mankind, he will probably make a fortune by it; but if it be of no value he also will reap no benefit.
Of course, none of this means that certain kinds of carefully targeted prizes are a bad idea. But it does suggest some reasons that it comes to tools for encouraging innovation, prizes should remain a sideshow rather than taking center stage. source: conversableeconomist
