According to modern growth theory, product market competition is the prime factor in the comparative growth performances of different countries as well as for individual countries over time. Product market competition also seems to play a prominent role in international economic and political discourse, not least because the benefits of globalization – perhaps the most significant manifestation of more intense competition – are currently a hot topic for debate in various circles around the world. The issue of the effects of public sector R&D subsidies on entrepreneurial innovation incentives and opportunities is an integral part of the debate and a frequent topic of research and analysis on private-sector R&D activity. Do public sector interventions stimulate R&D markets by boosting private innovation and hence contributing to the country's technological progress? Although economists appear to be in broad agreement that product market competition – at least within limits – is conducive to economic growth, opinions vary more on the potentially beneficial effects of public sector intervention on entrepreneurial incentive to innovate. Once we put this issue into the context of Schumpeterian endogenous growth theory, the key aspect of the effects of public R&D policy on private innovation incentives appears to be whether such policy can influence innovators' incremental rents, ie the difference between post- and pre-innovation rents, or the difference in rents obtained by a successful versus an unsuccessful innovator. Moreover, the theoretical possibility that the effects of R&D policy may depend on the degree of product market competition makes this issue particularly interesting. Empirical evidence seems to support the increasingly popular theoretical notion that entrepreneurial incentives for innovation are weakest under monopoly and perfectly competitive markets; hence the relationship between degree of product market competition and innovation intensity is humped or inverse-u shaped. Any potential effects of public R&D policy on the relationship between innovation intensity and degree of product market competition can be best scrutinized through further high quality research on the issue.
In their forthcoming BoF discussion paper, 'When do R&D subsidies boost innovation? Revisiting the inverted U shape', Juha Kilponen and Torsten Santavirta study the effects of a proportional R&D subsidy on entrepreneurial incentives to innovate at different degrees of product market competition. Their model combines aspects of the literature on the relationship between competition and economic growth with research on the impact of public intervention on firms' R&D activity, which enables them to explore theoretically how subsidies affect the relationship between private innovation intensity and product market competition. More precisely, the theoretical inquiry into the effects of product market competition on private incentive to innovate is cast in terms of a modern Schumpeterian model of endogenous growth. The Schumpeterian approach is based on the idea that the prospect of earning incremental rents drives firms to innovate. The Kilponen-Santavirta model incorporates a channel through which direct R&D subsidies from the public sector influence these incremental rents and hence the entrepreneurial incentive to innovate. The authors derive interesting theoretical results from the model. To begin with, they show that (except under conditions of extremely intense competition) a proportional R&D subsidy stimulates firms' innovation activity, whatever the degree of product market competition. Consequently, this result lends support to the Schumpeterian mechanism in which product market competition impacts entrepreneurial incentives to innovate: firms are willing to innovate in order to escape competition with neck-and-neck rivals or, alternatively, firms that are imitated face stronger incentives to innovate because they are now in neck-and-neck competition with technologically-equal rivals and will remain so until they innovate again. On the other hand, the specific R&D subsidy analysed by Kilponen and Santavirta does not seem to change the relative positions of different market structures or degrees of product market competition in terms of the intensity of innovation: the market structure that sustains the highest innovation intensity is apparently not affected by the R&D subsidy.
Kilponen and Santavirta proceed to test the key implication of their model, ie that the R&D subsidy strengthens entrepreneurial incentives to innovate in the context of all but extremely high degrees of product market competition. They use data for 1990-2001 on firm and plant-specific patents, indicators of product market competition, and R&D subsidies to Finnish firms. R&D subsidies are measured by the direct product subsidies dispersed by the National Technology Agency of Finland (Tekes). Direct product subsidies are the cornerstone of Tekes' subsidies, accounting for some 40% of its total budget. To control for possible endogeneity bias, Kilponen and Santavuori complement their data with case-by-case analyses of decisions taken by the Finnish Competition Authority on possible distortions or biases in product market competition as well as some privatization decisions. On first glance, the empirical results seem to support the theoretical observation that innovation intensity peaks at market structures falling between monopoly and perfect competition. On the other hand, these results also indicate that R&D subsidies increase firms' innovation intensity at all but extremely high degrees of product market competition. The empirical evidence is strongest for market structures that give firms the strongest incentives to innovate to escape competition. These results are interesting not only for validating the key implications of the theoretical model but also more generally. Clearly, they provide additional motivation to expend resources for digging deeper into the growth effects of competition and different market structures. In addition to opening up the possibility of constructing new and innovative theoretical models, this theme invites researchers to introduce new data sets and methodologies to test the implications of their theoretical models. Consequently, all the important ingredients for producing significant research are put on the table. |