Too Much of a Good Thing? The Economics of Investment in R&D

Research and development is a key determinant of long-run productivity and welfare. A central issue is whether a decentralized economy undertakes too little or too much R&D. We develop an endogenous growth model that incorporates parametrically four important distortions to R&D: the surplus appropriability problem, knowledge spillovers, creative destruction, and duplication externalities. Calibrating the model, we find that the decentralized economy typically underinvests in R&D relative to what is socially optimal. The only exceptions to this conclusion occur when the duplication externality is strong and the equilibrium real interest rate is simultaneously high.     

Endogenous fluctuations with procyclical R&D

The literature on endogenous growth cycles predicts the countercyclical allocation of resources to R&D. However, this prediction is not supported by empirical studies. This study considers the R&D-based growth model with endogenous fluctuations introducing population growth and a negative externality that affects the productivity of R&D. We show that this simple modification makes R&D investment procyclical along sustained business cycles using both an overlapping generation framework and an infinitely-lived agent framework.     

R&D policy with layers of economic integration

This paper examines whether the optimal unilateral R&D policy for an open economy is a subsidy or a tax. It constructs a general equilibrium model with three successive layers of international integration: (a) trade in goods, (b) trade in technologies with international R&D spillovers and (c) internationally-coordinated R&D policy. Trade in technologies introduces the possibility that an R&D subsidy will have such strong, negative terms-of-trade effects that it harms domestic welfare. Numerical simulations of the OECD show this is a possibility for the US and Japan. With international R&D spillovers a domestic R&D subsidy may reduce domestic innovation.     

Effectiveness versus Efficiency: Growth-Accelerating Policies in a Model of Growth without Scale Effects

Abstract. Recent R&D growth models without strong scale effects imply that long-run growth rates depend only on parameters that are usually taken to be exogenous. However, integrating human capital accumulation into models of this type, Arnold (2002) demonstrates that subsidizing education accelerates growth. The present paper addresses welfare issues in Arnold's model. The main theoretical finding of the paper is that a system of subsidies that implements the optimal balanced growth path as a decentralized equilibrium includes zero subsidies to education, while R&D activity should be either subsidized or taxed. To shed further light on the latter result, the model is calibrated and it turns out that along the balanced growth path, the decentralized economy underinvests in R&D, i.e. R&D activities should be subsidized.     

University patents,R&D competition,and social welfare

Although university patenting has increased dramatically over the past three decades, debates persist regarding the broad economic implications of the phenomenon. This article examines the social welfare implications of university patenting in a model of R&D competition in which firms develop innovations on the basis of the disclosure of a university invention. When such disclosure does not preempt the patenting of downstream innovations, university patenting enhances social welfare only if a regime of open access to university inventions is characterized by excessive aggregate R&D from the viewpoint of social welfare. When the university invention disclosure preempts patenting on firms’ innovations, the nature of the open access equilibrium in the R&D market depends on the threat of imitation ex post. Only when the threat of imitation is sufficiently strong firms will not invest in downstream R&D in the open access regime. In this case, university patenting promotes R&D investment and increases social welfare.     

Rent-seeking distortions and fiscal procyclicality

Recent research has demonstrated that while government expenditures are countercyclical in most industrialized countries, they tend to be procyclical in developing countries. We develop a dynamic political-economy model to explain this phenomenon. In the model, public expenditures provide insurance to uninsured households, and optimal fiscal policy is countercyclical. The introduction of a political friction, in which successive governments disagree on the desired distribution of public spending, can lead to procyclical fiscal policies. Numerical simulations of the model allow us to compare quantitatively the relative role of common explanations for fiscal procyclicality. We conclude that political distortions in the fiscal process can explain fiscal procyclicality better than other common explanations, such as borrowing constraints and macroeconomic volatility.     

Climate change mitigation options and directed technical change: A decentralized equilibrium analysis

The paper considers an endogenous growth model with climate change as well as three R&D sectors dedicated to energy, CCS (Carbon Capture and Storage) and backstop efficiency. First, we characterize the set of decentralized equilibria: a particular equilibrium is associated with any vector of policy instruments including a carbon tax and a subsidy to each R&D sector. Second, we show that it is possible to express any equilibrium as the solution of a maximization program. Third, we solve the first-best optimum problem and thereby deriving the optimal instruments. Finally, we illustrate the theoretical model using calibrated functional specifications. In particular, we investigate the effects of various combinations of policy instruments (including the optimal ones) by determining the deviation of each corresponding equilibrium from the “laisser-faire” benchmark. We find notably that introducing an R&D subsidy hardly affects emissions when a carbon tax is already implemented, thus revealing a complementary effect between these two policy instruments.     

R&D subsidies in a model of growth with dynamic market structure

This paper presents the effects of an R&D subsidy in a Schumpeterian general equilibrium model with rich industry dynamics. R&D subsidies raise the long-run growth rate, but they also raise the level of industry concentration. In the model firms compete for market share through process R&D endogenously determining the market structure within and across industries. Endogeneity of the market structure allows for analysis of changes in the moments of the firm size distribution in response to policy. R&D subsidies primarily benefit large incumbent firms who increase their innovation rates creating a greater technological barrier to entry. Concentration increases with fewer firms and a higher variance in the market shares. In general equilibrium, the greater distortions in the product market cause the wage rate to fall which leads to increased turnover rates. In addition, the analysis demonstrates that the model captures a large number of empirical regularities described in the industrial organization literature, but absent from most endogenous growth models. These features, such as entering firms are small relative to incumbents, the hazard rate of exit is negatively related to firm size, and large firms spend more on R&D than small firms play important roles in understanding the impact of R&D subsidies on the economy.     

International R&D Rivalry with Spillovers and Policy Cooperation in R&D Subsidies and Taxes

Abstract

We have investigated non-cooperative and jointly optimal R&D policies in the framework of Spencer & Brander (1983) in the presence of R&D spillovers. When R&D activities are strategic substitutes and the R&D game exhibits a positive externality, the result of Spencer & Brander (1983) reverses: the non-cooperative policy is a tax while the jointly optimal policy is a subsidy. Moreover, when R&D activities are strategic complements, the usual result of the prisoners' dilemma in the strategic subsidy game does not hold, implying that a welfare intervention is preferable over laissez-faire. When spillovers are sufficiently large, the joint welfare increases with subsidies being higher than those under non-cooperation.     

A computational analysis of R&D support programs

We compare two common government R&D support programs, R&D tax credits and direct R&D grants. To study their effectiveness and the extent to which their design matters, we analyze these programs within a dynamic equilibrium model of imperfectly competitive industries. Adopting comprehensive welfare measures that take into account government, producer and consumer surpluses, we find that both schemes exhibit positive social returns. Mid-range R&D-intensive sectors exhibit higher social returns than either high or low R&D-intensive sectors. Both incentive schemes generate positive measures of R&D input additionality of magnitudes consistent with empirical R&D research. However, R&D grants that require firms to allocate subsidy funds to R&D spur less R&D than a more flexible R&D tax credit. Subsidy schemes can even induce competing firms to over-spend on R&D, generating negative producer surplus and possibly negative social returns.     

Optimal patent length and breadth in an economy with creative destruction and non-diversifiable risk

In this paper, I examine the optimal patent shape in an economy in which R&D firms innovate and imitate, households face non-diversifiable risk and there is externality in production and R&D. With non-diversifiable risk, a household’s consumption and investment decisions are interlinked. This economy contains industries of two kinds: monopoly industries with an innovator only, and duopoly industries with an innovator and an imitator. I define patent length as the expected time in which an innovation is imitated, and patent breadth as the innovator’s profit share in an industry after a successful imitation. The government can control patent length by the requirements for accepting a substitute for a patented good, and patent breadth by imposing compulsory licensing and royalties for the patentee after a successful imitation. I show that the stronger the externality in production relative to R&D is, the slower the optimal growth rate, the larger the optimal proportion of duopoly industries, and the longer and narrower the optimal patent.     

Cyclicality of fiscal policy and the shadow economy

A survey of recent literature on cyclical properties of fiscal policy reveals that fiscal policy is procyclical in many developing countries whereas it is countercyclical in developed ones. However, there is no consensus on what drives the difference in this specific cyclical property of fiscal policy. Using cross-section and panel data sets for 78 countries we document that procyclicality of fiscal policy is more pronounced in countries with a larger size of the shadow economy. We also show that policies reducing the size of the shadow economy lead to a less (more) procyclical (countercyclical) fiscal response to shocks.     

Strategic Rivalry With Spillovers Within Segmented Versus Integrated Markets

We consider a two-stage game with firms investing in R&D in the first stage while competing [a] la Cournot in the second stage. The firms are located in two countries, which are either segmented or integrated. R&D spillovers occur between firms located in the same country as well as between firms located in different countries.

We first examine the consequences of market integration on the impact of national and international R&D spillovers on innovative efforts, effective R&D, profits and total welfare. Comparing the resulting equilibrium levels, we subsequently conclude that market integration always leads to higher R&D investments and output if international R&D spillovers are limited, while the welfare consequences are ambiguous. Finally, we also analyze the welfare maximization problem of a ‘constrained social planner who can only decide on the level of R&D spillovers.     

R&D policy in a vertically related industry

In this paper, we analyze the effectiveness of public policy aimed to stimulate business-performed R&D in a vertically related market. We examine the role of an R&D active upstream supplier in a four-stage R&D model, where we incorporate public funding. The considered policy instrument is direct funding of firms’ R&D efforts. We calculate the optimal policies and show that they have a positive impact on firms’ R&D investments. From a welfare point of view, it is optimal to differentiate the subsidy rates between the upstream and the downstream markets. Competition in the product market leads to a higher subsidy rate to the upstream supplier than to the downstream firms. When concentration is high in the downstream market, the optimal solution is an R&D subsidy for these firms, otherwise the optimal solution is an R&D tax for the downstream firms.     

Timing of innovation policies when carbon emissions are restricted: An applied general equilibrium analysis

This paper studies the timing of subsidies for emissions-saving research and development (R&D) and how innovation policy is influenced by a carbon tax. We develop a dynamic computable general equilibrium (CGE) model with both general R&D and specific emissions-saving R&D. We find two results that are important when subsidizing emissions-saving R&D in order to target inefficiencies in the research markets. First, the welfare gain from subsidies is larger when the carbon tax is high. This is because a high carbon tax raises the social value of the emissions-saving technology and that this increase in value is not fully appropriated by the private firms. Secondly, the welfare gain is greater when there is a falling time profile of the rate of subsidies for emissions-saving R&D, rather than a constant or increasing profile. The reason is that knowledge spillovers are larger in early periods.     

Research Joint Ventures with Asymmetric Spillovers and Symmetric Contributions

The paper proposes a new type of R&D cooperation between firms endowed with asymmetric spillovers, which we call symmetric Research Joint Venture (RJV) cartelization, based on reciprocity in information exchange. In this setting, firms coordinate their R&D expenditures and also share information, but such that the asymmetric spillover rates are increased through cooperation by equal amounts. It is found that this type of cooperation reduces R&D investment by the low spillover firm when its spillover is sufficiently low and the spillover of its competitor is sufficiently high. But it always increases the R&D of the high spillover firm, as well as total R&D (and hence effective cost reduction and welfare). A firm prefers no cooperation to symmetric RJV cartelization if its spillover rate is very high and the spillover rate of its competitor is intermediate. The profitability of symmetric RJV cartelization relative to other modes of cooperation is analyzed. It is found that symmetric RJV cartelization constitutes an equilibrium for a very wide range of spillovers, namely, when asymmetries between spillovers are not too large. As these asymmetries increase, the equilibrium goes from symmetric RJV cartelization, to RJV cartelization, to R&D competition, to R&D cartelization.     

The refoundation of the symmetric equilibrium in Schumpeterian growth models

We provide a refoundation of the symmetric growth equilibrium characterizing the research sector of vertical R&D-driven growth models. We argue that the usual assumptions made in this class of models leave the agents indifferent as to where targeting research: hence, the problem of the allocation of R&D investment across sectors is indeterminate. By introducing an “?-contamination of confidence” in the expected distribution of R&D investment, we prove that the symmetric structure of R&D investment is the unique rational expectations equilibrium compatible with ambiguity-averse agents adopting a maxmin strategy.     

Equal treatment and socially optimal R&D in duopoly with one‐way spillovers

This paper examines the standard symmetric two‐period R&D model with a deterministic one‐way spillover structure: know‐how flows only from the high R&D firm to the low R&D firm (but not vice versa). Though firms are ex ante identical, one obtains a unique asymmetric equilibrium (pair) in R&D investments, leading to interfirm heterogeneity in the industry. R&D cooperation by means of a joint lab is considered and compared to the non cooperative solution. The main part of the paper provides a second‐best welfare analysis in which we show that the joint lab yields a socially optimal R&D level subject to an equal treatment (of firms) constraint, which also coincides with the noncooperative solution in the absence of spillovers. We also investigate the welfare costs of this equal treatment constraint and find that they can be quite significant.     

Optimal growth when environmental quality is a research asset

We advance an original assumption whereby a good state of the environment positively affects labor productivity in R&D such that deteriorating environmental quality negatively impacts R&D. We study the implications of this assumption for the optimal solution in an R&D-based model of growth, where the use of a non-renewable resource generates pollution. We show that in such a case, it is socially optimal to postpone extraction, as opposed to the situation in which the environment has no effect on productivity in R&D. Furthermore, insofar as environmental quality declines and subsequently recovers, we find that it is optimal to re-allocate employment to R&D in line with productivity changes. If environmental quality recovers only partially from pollution, R&D effort optimally begins above its long-run level, then progressively declines to a minimum and eventually increases to its steady-state level.     

Innovation or imitation? The effect of spillovers and competitive pressure on firms’ R&D strategy choice

In this paper a firm’s R&D strategy is assumed to be endogenous and allowed to depend on both internal firm characteristics and external factors. Firms choose between two strategies, either they engage in R&D or abstain from own R&D and imitate the outcomes of innovators. This yields three types of equilibria, in which either all firms innovate, some firms innovate and others imitate, or no firm innovates. Firms’ equilibrium strategies crucially depend on external factors. We find that the efficiency of intellectual property rights protection positively affects firms’ incentives to engage in R&D, while excessive competitive pressure has a negative effect. In addition, smaller firms are found to be more likely to become imitators when the product is homogeneous and the level of spillovers is high. Regarding social welfare our results indicate that strengthening intellectual property protection can have an ambiguous effect. In markets characterized by a high rate of innovation a reduction of intellectual property rights protection can discourage innovative performance substantially. However, a reduction of patent protection can also increase social welfare because it may induce imitation. This indicates that policy issues such as the optimal length and breadth of patent protection cannot be resolved without taking into account specific market and firm characteristics.