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Are Subsidies to Business R&D Effective?

15. 5. 2023 New study "Are Subsidies to Business R&D Effective? Regression Discontinuity Evidence from the TA CR ALFA Programme" examines the impact of government subsidies for corporate research and experimental development (R&D).

Summary:

• Governments subsidise business research and experimental development (R&D) to promote development of the economy, because externalities and information asymmetries inherent to the innovation process make private funding of these activities fall short of what is socially desirable. Nevertheless, how effective such subsidies are and whether they achieve their goals is an open question that needs to be studied empirically.
• This study leverages the state-of-the-art method of regression discontinuity (RD) that allows us to come very close to making causal inferences about the effects of subsidies, to find out whether the Technology Agency of the Czech Republic’s (TA CR) ALFA programme stimulated new business R&D inputs, outputs, and positive economic impacts that would not have happened otherwise.
• Our results show that the subsidies significantly stimulated R&D expenditures in small and medium size enterprises (SMEs), but not in large ones. In SMEs, the effect is strongly positive on both publicly and privately funded R&D, both during a subsidised project and afterwards, so there is evidence of persistent crowding in. For large firms, in contrast, the subsidy appears to have only changed the structure of R&D expenditure during the project – increasing funding from public sources at the expense of private ones and capital expenditures at the expense of current expenditures – and the effects largely fizzle out after the project expires.

• When looking at R&D outputs and economic performance, our results do not provide any evidence of significant effects of the subsidies on patenting, employment, sales, or labour productivity of the firms regardless of their size category either during or after a project. However, given the limited size of our sample and the typically small amount of a subsidy relative to the size of the recipient, these subsidies making a recognizable difference in the overall economic performance of their recipients would require an annual rate of return to the additional R&D expenditure generated by the subsidies in the order of hundreds of percent, which is not feasible. Furthermore, it should be pointed out that, using this methodology, we are only able to pin down direct impacts of the subsidies on the economic performance of their recipients, whereas their broader impacts on the economy as a whole through knowledge spillovers – positive externalities that are crucial for justifying the subsidies – remain hidden to us.
• Overall, the results indicate that similar programmes, including the follow-up ALFA programmes, could potentially become more efficient by reallocating funding from large firms to SMEs, for which positive additionality effects on R&D inputs have been identified. It is also noteworthy that some of the most prominent programmes abroad, such as R&D subsidies in the Small Business Innovation Research (SBIR) program in the United States and the Small and Medium Enterprise Instrument (SMEI) of the European Commission, target not only small but specifically young innovative firms (median age 5 years in both programmes),
  whereas their Czech counterparts support relatively more established firms (median age 19 years in ALFA). Because small and young firms are also more likely to be credit constrained, policymakers should seriously consider shifting the focus of support to these groups of firms.
• Given the universal design of similar programmes, spreading subsidies relatively thinly over many firms, it is extremely hard to test empirically whether they deliver positive impacts on economic performance and on the competitiveness of the economy, on which grounds they are primarily justified. Admittedly, this should be acknowledged ex-ante when funding for these programmes is considered by the government.