Michigan Gov. Jennifer Granholm proposes saddling state taxpayers with $2 billion in new debt to fund research in commercially speculative technologies. California voters have authorized $3 billion in debt for government-financed embryonic and adult stem cell research. Washington’s new governor wants to borrow $1 billion to develop nanotechnology. Similar proposals are rattling around in other states.

Here’s a question for supporters of state-run investments in risky businesses: "What are the consequences for government employees if they do a lousy job selecting which entities receive the money?"

If you are a private individual who judges poorly on an investment, the consequences are severe: You lose your own money. If a mutual fund company invests other people’s money poorly, its managers know that customers may sell out and they will lose their jobs.

The success of capitalism in providing whole populations with a standard of living unimaginable just a couple centuries ago is based on billions of voluntary investment decisions in which prudence resulted from the need of individuals to balance two vivid and compelling emotions: the fear of loss and the desire for gain. If you bet too much on highly speculative investments, you might lose it all. If you avoid risk by being too conservative, you lose capital by failing to keep up with inflation.[1]

When a government employee invests money taken from taxpayers, this prudence-producing dynamic is absent. If the investment pays off, at best he gets a pat on the back. If it goes bust, at worst he gets a transfer to another department with no loss of pay. His wealth and his generous pension do not suffer by one penny.

Private investors manage their fear of loss and desire for gain with diligent research and diversification of assets. The incentive to judiciously use these tools is tremendously greater when one’s own money is at risk than if the personal rewards or punishments are minimal.

Given this, why would anyone think that government employees can do a better job at picking winning investments than private investors?

Politicians who promote these market adventures usually dodge such questions with something like, "We have strong corruption laws," or, "The program has built-in conflict-of-interest safeguards."

That's nice, but outright corruption is not the main worry – politicization and accountability for poor judgment are. The politicians’ fallback when challenged on this are wounded pronouncements about the dedication and virtue of public servants.

Later, when losses have grown to an extent that any reasonable person can see that the money was wasted, they bluster: "We’re investing for the long term. We expected some losers, but just a few 'home runs' will more than compensate." Years later, same answer. Only when the current generation of politicians has passed does history provide a definitive verdict: "Bad idea."

For some time now Michigan state government has been a leader in the corporate welfare "war between the states," and as such has provided many examples of these common-sense truths. Here are just two:

In the mid-1990s, the Michigan Renaissance Fund, a government entity with a mission similar to those now being proposed, poured $20 million into flat panel display research at the University of Michigan as part of an apparent quid pro quo agreement with Optical Imaging Systems. (OIS was a subsidiary of Guardian Industries, whose CEO regularly contributed large amounts to both political parties in the state.) In return for the government research, the results of which would be shared with the company, it would build a plant near the university.

A memo penned by the Renaissance Fund's executive secretary suggests that the diligence and fine judgment generally characteristic of private investors were absent in this case:

"Our files (are) very sparse on background material on the OIS/Flat Panel deal. Most of the deal was put together directly by the Governor, (the university president and a company official). ... We were brought in after the deal was cut to do the paperwork. ... If we had not started a Flat Panel Center at UofM, OIS would have left. ... (That is the party line anyway.)"

What was the outcome? OIS closed its doors and went bankrupt in 1999, costing Michigan taxpayers $20 million.

Here’s one more: Freed from powerful incentives for prudence that drive individual investors, bureaucrats entrusted with the public’s money are particularly subject to investment fads and "the madness of crowds." This was demonstrated during the "dot.com" bubble era when Michigan offered online grocery retailer Webvan $23.4 million in tax credits in exchange for the company's promise to build one of its 26 warehouse distribution centers in the state. Fortunately, Webvan ceased operations and filed for bankruptcy before the company could claim credits against any tax liability.

The bottom line? Unlike private investors and their fiduciaries, when the government engages in market speculation there are no penalties for bad results and no consequences for bureaucrats who make losing bets with other people's money.

One idea that could ameliorate this would be to require that the pensions of every politician and every government employee involved in these schemes be placed in the same investment pool with the public’s money. This condition would deliver a quick and merciful death to such proposals.

One final point: No prudent private investor would go into debt for the sole purpose of making speculative investments. Yet in Michigan and elsewhere, state politicians want to borrow billions of dollars with the stated purpose of making risky investments. Individual taxpayers have no choice about this, and they have no ability to "redeem" their shares. What is wrong with this picture?

Economic history shows that when government seeks to pick winners and losers in the market, the net consequences for citizens are always bad. However good the intentions, by the very nature of the activity there is no way to overcome the issues of prudence raised here. The words "I’m from the government, and I’m here to invest your money," should send a shiver through taxpayers.

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Jack McHugh is a legislative analyst for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.

[1] State-run investment promoters implicitly argue that investors are ignorant of the dangers of overly conservative investment, meaning that promising but risky ventures will starve without government capital. Countless examples from economic history, and every new business that is launched today, are proof this is not true.