Joel Achenbach's piece on government-sponsored awards for innovation, both as a concept and as a history is really quite good. He points out that there are large advantages to a prize-based approach, but cautions that the contests have to be structured appropriately:
Last September, the Obama administration released the Strategy for American Innovation, which called on agencies to use prizes and challenges. The obvious advantage of the prize approach is that the government pays only for results. The competitors invest their own money in research and development.
"You can't just ask, 'invent for me antigravity'-type of questions. Or 'cure cancer,' " said Karim Lakhani, assistant professor of management at Harvard Business School, who has written extensively on open innovation.
To me, the diversity argument for prize competitions is probably the strongest. An individual may be able to create something great, but completely unable to get attention for it through the normal procurement process. But in contests like this, merit will out as long as you've got the right judges.