David Leonhardt has a near-excellent column in the New York Times today on why prizes are 1) A great way to foster innovation, but; 2) far less popular than grants or other compensation schemes:

in the 1700s, prizes were a fairly common way to reward innovation. Most famously, the British Parliament offered the £20,000 longitude prize to anyone who figured out how to pinpoint location on the open sea. Dava Sobel’s best-selling 1995 book “Longitude” told the story of the competition that ensued, and Mr. Hastings mentioned the longitude prize as a model at that meeting back in March.

Eventually, though, prizes began to be replaced by grants that awarded money upfront. Some of this was for good reason. As science became more advanced, scientists often needed to buy expensive equipment and hire a staff before having any chance of making a discovery.

But grants also became popular for a less worthy reason: they made life easier for the government bureaucrats who oversaw them and for the scientists who received them. Robin Hanson, an economist at George Mason University who has studied the history of prizes, points out that they create a lot of uncertainty — about who will receive money and when a government will have to pay it. Grants, on the other hand, allow a patron (and the scientists advising that patron) to choose who gets the money. “Bureaucracies like a steady flow of money, not uncertainty,” said Mr. Hanson, who worked as a physicist at NASA before becoming an economist. “But prizes are often more effective if what you want is scientific progress.”....

[There] are the two essential advantages of prizes. They pay for nothing but performance, and they ensure that anyone with a good idea — not just the usual experts — can take a crack at a tough problem. Much to the horror of the leading astronomers of the day, a clockmaker ultimately claimed the longitude prize.

Grants are still crucial. (Someone has to be paying those computer scientists while they’re trying to win the Netflix prize.) But it seems pretty clear that our research system doesn’t pay for results often enough.

Just look at how both political parties have so far tried to deal with global warming. They have handed out grants and subsidies for various alternative energy sources like ethanol, even though nobody knows what the best sources will ultimately be. A much smarter approach would be to mandate that the economy use less carbon. This would effectively set up a multibillion-dollar prize — in the form of new customers — for whichever companies came up with efficient energy sources.

Beyond global warming, this approach should be used far more frequently for health care as well. Indeed, this is one of those tasks where government intervention might improve upon the market -- because the government has sufficient resources to withstand the inherent budgetary uncertainty that comes with the prospect of awarding prizes in the billions or tens of billions.

If the federal government can offer $25 million for capturing Osama bin Laden, why can't it offer a $10 billion prize for an AIDS vaccine?

I look forward to readers explain why I'm wrong.

UPDATE: Robin Hanson --cited in the above article -- elaborates on the historical switch from prizes to grants here.