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Subsidies put the R&D horse before the innovation cart

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The logic behind subsidies for research and development (R&D) activities seems straightforward enough: R&D creates new ideas and new technologies. These new technologies can then be used to increase productivity, wages and incomes. A casual glance at the data would seem to confirm the link: high levels of R&D are generally associated with dynamic, fast-growing economies. If government can help this process along, then it should.

But what if this story is simply confusing cause and effect? What if the real reason that firms in a dynamic, growing economy invest so much effort into R&D is that they are reacting to the market signals that a dynamic growing economy provides?

For firms operating in a dynamic environment, the advantages of investing in R&D are clear enough: it is more profitable to be at the leading edge of a fast-growing economy. And the costs of not doing R&D are equally clear: dominant firms who skimp on R&D don't stay on top for long. For firms in these dynamic economies, R&D is not only a source of new profits, it's also a matter of survival.

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Let's think now of a less-than-dynamic economy where firms in difficulty can often count on a government bail-out to keep them going, where government procurement policies shield them from foreign competitors (or even from competitors from another province or city) and where there is a rich kaleidoscope of government programs that offer a wide range of opportunities to obtain public funding. In short, an economy not entirely unlike Canada's.

Investing in R&D wouldn't do much to ensure survival in this economy. Instead, firms would find that it is much more important to invest in lobbying and consultant services in order to fully exploit the opportunities for government funding. Adding R&D subsidies to the mix would simply add another playing field for this game.

People respond to incentives. If the government gets into the business of giving money to firms that undertake activities that the government deems "close enough to R&D to get public funding", then that money won't be left on the table. But if the reason for carrying out R&D-like activities is the availability of public funding, then actual innovation ends up being more of a coincidence than an objective.

If high levels of R&D are the effect of a dynamic economy and not their cause, we shouldn't be surprised that R&D subsidies aren't producing the desired results.

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About the Author

Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative. More

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