On Public Financing of Innovation

1. On Public Financing of Innovation Bronwyn H. Hall UC Berkeley, NBER, and IFS

2. Outline • Underinvestment? • Remedies • and what hasn’t worked • A question Worldbank Conf - Barcelona

3. What needs fixing (in L.A.)? • underinvestment (high rates of return) in business R&D due to • financing problems • weak IP rights? • entry barriers (4 times Asian NICs as a share of GDP/capita) • lower govt support for R&D • lower quality public sector research institutions and weak links to industry Worldbank Conf - Barcelona

4. Social return S C Private return RC RS Determining the optimal subsidy Return or cost of R&D cost Optimal subsidy Level of R&D spending Optimal social level of R Optimal competitive level of R Worldbank Conf - Barcelona

5. What’s wrong with this simple graph? • Magnitude of the spillover gap varies • by country (openness, development) • by industry (appropriability) • by technology type (generic/specific) • Project ordering varies depending on whether you use social or private returns to order Worldbank Conf - Barcelona

6. Remedies for underinvestment – tax credits • Features • Accelerated depreciation - usually 100% • Allowances – amounts that can be deducted from income for tax purposes (>100%) • Credits – amounts deducted from tax liability • Firm usually chooses projects • Drawbacks for developing countries • expensive unless incremental • enforcement? • size of corporate tax burden Worldbank Conf - Barcelona

7. Why an incremental credit? Firm increasing R&D from R0 to R1 Tax revenue loss for ordinary credit Rate of Return or Cost of R&D Tax revenue loss for incremental credit Effective cost of capital R0 R1 Amount of R&D  Worldbank Conf - Barcelona

8. Remedies for underinvestment - subsidies • Public subsidies (cost-sharing) • Government usually chooses projects (although firms propose them • Sometimes targeted to collaborative research (univ-ind, govt-ind, etc) • In developing countries • successful in Finland, Israel, and some other countries (mostly more developed) • early stages of development • no technology restrictions • other innovation expenditures (diffusion) Worldbank Conf - Barcelona

9. Remedies for weak institutions/links • Successful in US development: • extension services associated with universities (funded by govt) • Taiwanese model of public research organizations (ITRI, ESRO) • with 50% cost-shared spin-offs of successful projects and engineers • downside job insurance encourages risk-taking Worldbank Conf - Barcelona

10. Some policies that seem not to have worked well • trying to create a VC industry • with insufficient private demand for capital (Chile) • with excessive govt intervention, mainly financial goals, and with downside insurance instead of upside payoff (Israel’s Inbal) • encouraging FDI via low taxes/duties/trade zones with no provision for transfer activities • Costa Rica – low links with rest of economy, most skilled labor moving from one foreign firm to another, little local R&D or tech transfer • Mexico – as local content requirements reduced, foreign firms closed R&D activities Worldbank Conf - Barcelona

11. Intellectual property policy • Asian NICs developed in an environment without a lot of patent use • now patent aggressively, partly due to changes in the ICT sector • Many (not all) infant industries did the same • Cornish pumping engine • chemicals in Germany/UK in 19C • early semiconductors/software • Does TRIPS foreclose this avenue of technology development/transfer? Worldbank Conf - Barcelona