Friday, September 27, 2013

27/9/2013: Incumbent Subsidies v Innovation: US evidence on R&D subsidies

I wrote about R&D tax credits before and the fact that some recent research has been throwing a spanner in the works of the Governments around the world actively subsidising R&D and innovation. You can read my musings on the subject here:

New research on the same just out from the Bank of Finland.

"Innovation, Reallocation and Growth" is a paper recently published by the Bank of Finland (Discussion Papers 22, 2013 authored by Daron Acemoglu, Ufuk Akcigit, Nicholas Bloom and William Kerr.

From the abstract (emphasis mine):

"We build a model of firm-level innovation, productivity growth and reallocation featuring endogenous entry and exit. A key feature is the selection between high- and low-type firms, which differ in terms of their innovative capacity. We estimate the parameters of the model using detailed US Census micro data on firm-level output, R&D and patenting. The model provides a good Öt to the dynamics of firm entry and exit, output and R&D, and its implied elasticities are in the ballpark of a range of micro estimates."

"We find industrial policy subsidizing either the R&D or the continued operation of incumbents reduces growth and welfare. For example, a subsidy to incumbent R&D equivalent to 5% of GDP reduces welfare by about 1.5% because it deters entry of new high-type firms."

"On the contrary, substantial improvements (of the order of 5% improvement in welfare) are possible if the continued operation of incumbents is taxed while at the same time R&D by incumbents and new entrants is subsidized. This is because of a strong selection effect: R&D resources (skilled labor) are inefficiently used by low-type incumbent firms. Subsidies to incumbents encourage the survival and expansion of these firms at the expense of potential high-type entrants. We show that optimal policy encourages the exit of low-type firms and supports R&D by high-type incumbents and entry."

Or put differently, let the creative destruction work. Or even incentivise the creative destruction working (not my preference, though)...
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