The Effect of Subsidies on R&D Investment and Success – Do Subsidy History and Size Matter?

Governments employ different instruments to support private R&D activities in order to increase firms’ R&D efforts and innovative performance. The most important measure used by the German Federal Government to fund R&D in private businesses is the so-called Direct R&D Project Funding (DPF). This paper contributes to the discussion of the effects and effectiveness of DPF as an innovation policy instrument by empirically analyzing the impact of DPF grants on firm’s R&D input as well as on R&D output. In the analysis I allow for heterogeneous effects to a certain extent in two dimensions: firm’s DPF history and DPF grant size. Previous research reveals that the subsidization of firms via the DPF scheme shows a certain level of continuity. I investigate whether this rather stable pattern of program participation has an impact on the effectiveness of the scheme, i.e. whether the continuity of funding can be justified by its higher impacts. A second focus is set on the role of the grant size. Previous research for Ireland shows that the effects of grants on R&D input vary by grant size. This relationship is analyzed for the DPF grants in Germany. In addition, the effects on R&D output are examined to verify whether the public money is translated successfully into new products. The empirical analysis is based on an annual innovation survey which is the German part of the Community Innovation Survey (CIS). This data is merged with a database comprising of information on subsidized projects in order to identify a firm’s subsidy status for each year. The sample consists of over 8,500 firm-year observations covering the manufacturing and knowledge-intensive service sectors in the time period from 1994 to 2005. A non-parametric matching approach with multiple treatments is employed in the first step to provide insights into the impact of R&D grants on firm-financed R&D inputs, namely private R&D expenditures. In the second step the effect on R&D output, namely sales with products new to the market is examined, distinguishing the effect with respect to firm’s DPF history and DPF grant size. Overall a positive effect of DPF grants on R&D input and also on output is found. Thus the main policy goal of the DPF scheme i.e. to increase private investment in R&D is being achieved. However, not every grant has the same effect. The analysis provides evidence that (at least) the effect varies with firm’s history of subsidies and grant size. Besides the necessity of a minimum grant size, the effect of private R&D increases with the frequent receipt of grants. For analyzing the effects of public grants on a firm’s R&D output, R&D expenditures are disentangled in R&D which would have been spent in the absence of the grant and publicly induced R&D, including the grant and the effect on private R&D expenditures. Basically both types of R&D are equally productive in terms of the generation of products and services new to the market. In addition, subsidy-based R&D is used equally efficiently by first time and frequent participants for generating innovative output. For the statement that a rather stable pattern of program participation leads to a lower effectiveness of the instrument no evidence has been found.

Aschhoff, Birgit (2009), The Effect of Subsidies on R&D Investment and Success – Do Subsidy History and Size Matter?, ZEW Discussion Paper No. 09-032, Mannheim.