Does Bob Murphy misunderstand the counter-argument, or is he just avoiding it? One section of Bob's article is a real doozy and I quote it here

A lot went wrong with the specific case of Solyndra. I'm not deeply familiar with the details, but Bob provides a lot of great context in his recent article.

What I'm a little more hesitant about - stepping back from the specific case of Solyndra which is an example of corruption that could occur in any bureaucratic institution - is this section:

"Federal Loan Guarantees Inefficient, Even When a "Success"

Despite the efforts to cast Solyndra as a lone bad apple, the Department of Energy has guaranteed other renewable energy projects that later collapsed. However, even if the DOE program had always backed "winners"—meaning that no borrower ever defaulted, and so taxpayers never contributed a dime—it still would have encouraged an inefficient use of resources.

As the White House staffer's email ironically illustrated, the reason that firms such as Solyndra need government backing is that private investors think the loans are too risky. When the government comes in and, in effect, co-signs on the loan, this doesn't remove investors' original doubts. Rather, it simply leaves the taxpayer on the hook should something go wrong, while private investors get to keep their gains if everything goes right. (The Solyndra case is even more convoluted because much of the federally guaranteed loan amount came directly from the Federal Financing Bank, part of the Treasury.)

Government loan guarantees do not create more physical resources and do not (by themselves) induce individuals to save more. Consequently, when the government backstops a particular loan that would not otherwise have occurred, it draws scarce funds away from other projects that private investors originally preferred, all things considered. Unless we have some compelling reason to believe that politicians and their staffs are more careful with taxpayer dollars than private investors are with their own money, such loan guarantees will cause investment to be deployed into inferior uses. "

Every loan guarantee program is going to have some defaults. We all know this - whether the guarantor is public or private, they know this. If we didn't all know that was going to happen there would be know such thing as loan guarantees. There would be nothing to guarantee! So let's scurry past that first sentence.

Why does Bob think that the fact that private investors are not interested (not really true... in many of these cases private investors would be interested but the cost of the credit would be higher) implies that the use of resources in this way would be inefficient? He seems to act as if the counter-argument - that negative externalities associated with the production of energy and positive externalities associated with research and development - make private allocation of funds inefficient. Private investors, remember, are concerned with their evaluation of profit opportunities. Bob is simply wrong to say that these loan guarantees "would have encouraged an inefficient use of resources". No one can say that with certainty (although we can all offer educated guesses), and there's certainly nothing about the decision-making of private investors that guarantees this.

I'm also baffled by his concern about drawing away scarce funds.

But the icing on the cake is Bob's pre-condition for loan guarantees like these: the claim that we would need to expect politicians to be more careful with taxpayer dollars than private investors are. This simply isn't required for someone to back a loan guarantee program of any sort. I certainly don't expect this of politicians. What I expect is that private investors are great at looking after their own profits, which in many circumstances is the best way to guarantee what I would consider to be an ideal allocation of resources. But in the cases where it isn't, my standard for supporting a public program isn't that politicians "know better". Of course they don't. It's that I can trust that they can cautiously nudge the market in a direction that corrects for an externality. Market allocation will still prevail when loans or investments are subsidized (or taxed). Nobody is propping bad companies up like they might in a country that does do central planning. The price of capital or other inputs and outputs may be tweaked to reflect externalities, but the market still makes allocative decisions.

It's like with carbon taxes. All a carbon tax does is reflect the fact that we do not, in fact, have a guarantee of the efficiency of market allocation and we have reason to believe it is biased in a certain direction. The tax reflects that bias, but the government doesn't allocate anything. The government doesn't decide who gets gasoline and who doesn't under a carbon tax. It's not an allocater. The market allocates.

If we're going to talk about these things we should be clear about exactly what the arguments are.

UPDATE: To clarify, it's a great article. I learned a tremendous amount from it. Bob's position is also one that he can ably defend. What struck me was the discussion acted like his position was common sense and that the economics of these issues are in complete agreement with him. I understand he might not want to get into the counter-argument. That's fine. But that doesn't mean his argument is as common sense economics as it's put out there to be.

UPDATE 2: I want to re-emphasize how sincere I am in the first update. It is a good article. And the title of this post was more to motivate the discussion. Of course Bob knows about this stuff. The most problematic section is that particular section. He does raise externalities elsewhere in the article. But what he says in that section about private investors is simply not supported by anything in economics. Whether private investors will or will not invest in something tells us only one thing: their expectations of profit opportunities associated with it. That's all it tells us, period. This is wrong no matter how you cut it and no matter what else is in the article: "Unless we have some compelling reason to believe that politicians and their staffs are more careful with taxpayer dollars than private investors are with their own money, such loan guarantees will cause investment to be deployed into inferior uses". The sentence is simply untrue. I'd say "misleading", but I think that has implications of intent which I wouldn't ascribe to Bob.