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Subsidizing research programs with "if" and "when" uncertainty in the face of severe informational constraints

Subsidizing research programs with "if" and "when" uncertainty in the face of severe informational constraints
Subsidizing research programs with "if" and "when" uncertainty in the face of severe informational constraints
We study government optimal subsidy policies for research programs in the face of servere information asymmetry---when firms have private information about the likelihood of project viability but the government cannot form a unique prior belief about this likelihood. The paper makes two contributions. First, we show that the way in which R&D is subsidized matters. Under both monopoly R&D (i.e., a single firm conducts R&D in isolation) and R&D competition, different types of subsidies (e.g., earmarked, unrestricted subsidies, and pure matching subsidies) have significantly different effects on firms' R&D investment incentives. Second, we show that a simple subsidy scheme works even when the government is unable to form a unique prior belief about the firm's private information on project viability. If the shadow cost of public funds is zero, under monopoly R&D, there exists a pure matching subsidy that induces the firm to follow the first-best R&D policy irrespective of its prior beliefs about the viability of the project, meaning it is a (belief-free) ex post equilibrium policy; under R&D competition, the first-best outcome can also be achieved through a simple combination of a matching subsidy and an unrestricted subsidy. If the shadow cost of public funds is positive, an ex post equilibrium in general does not exist either under monopoly or competition. We then consider two alternative policy decision criteria that are appropriate for belief-free games: rationalizability and max-min criteria. We argue that the max-min criteria is preferable in our context, and by way of doing so establish that the set of max-min subsidy policies under either monopoly or competitive R&D consists entirely of simple pure matching subsidies. We further establish that allowing firms to form an R&D consortium reduces the matching rate for the highest max-min subsidy, suggesting that cooperative R&D has the potential to economize on the shadow costs of public funding of subsidies.
0966-4246
1605
University of Southampton
Besanko, David
f883b3af-f490-4125-b05e-5a047a56d8e2
Tong, Jian
8109179b-ff1d-483e-9ee0-bf3f96cda71b
Wu, Jianjun
b5d3072d-431a-4650-9d04-9ce11d7c3a93
Besanko, David
f883b3af-f490-4125-b05e-5a047a56d8e2
Tong, Jian
8109179b-ff1d-483e-9ee0-bf3f96cda71b
Wu, Jianjun
b5d3072d-431a-4650-9d04-9ce11d7c3a93

Besanko, David, Tong, Jian and Wu, Jianjun (2016) Subsidizing research programs with "if" and "when" uncertainty in the face of severe informational constraints (Discussion Papers in Economics and Econometrics, 1605) Southampton, GB. University of Southampton 57pp.

Record type: Monograph (Discussion Paper)

Abstract

We study government optimal subsidy policies for research programs in the face of servere information asymmetry---when firms have private information about the likelihood of project viability but the government cannot form a unique prior belief about this likelihood. The paper makes two contributions. First, we show that the way in which R&D is subsidized matters. Under both monopoly R&D (i.e., a single firm conducts R&D in isolation) and R&D competition, different types of subsidies (e.g., earmarked, unrestricted subsidies, and pure matching subsidies) have significantly different effects on firms' R&D investment incentives. Second, we show that a simple subsidy scheme works even when the government is unable to form a unique prior belief about the firm's private information on project viability. If the shadow cost of public funds is zero, under monopoly R&D, there exists a pure matching subsidy that induces the firm to follow the first-best R&D policy irrespective of its prior beliefs about the viability of the project, meaning it is a (belief-free) ex post equilibrium policy; under R&D competition, the first-best outcome can also be achieved through a simple combination of a matching subsidy and an unrestricted subsidy. If the shadow cost of public funds is positive, an ex post equilibrium in general does not exist either under monopoly or competition. We then consider two alternative policy decision criteria that are appropriate for belief-free games: rationalizability and max-min criteria. We argue that the max-min criteria is preferable in our context, and by way of doing so establish that the set of max-min subsidy policies under either monopoly or competitive R&D consists entirely of simple pure matching subsidies. We further establish that allowing firms to form an R&D consortium reduces the matching rate for the highest max-min subsidy, suggesting that cooperative R&D has the potential to economize on the shadow costs of public funding of subsidies.

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Published date: 13 July 2016
Organisations: Economics

Identifiers

Local EPrints ID: 404611
URI: https://eprints.soton.ac.uk/id/eprint/404611
ISSN: 0966-4246
PURE UUID: 077cb102-e636-460e-b0d0-f6ecf363fd11
ORCID for Jian Tong: ORCID iD orcid.org/0000-0001-9367-4853

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Date deposited: 13 Jan 2017 14:02
Last modified: 04 Oct 2018 00:33

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