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On Public Financing of
Innovation
Bronwyn H. Hall
UC Berkeley, NBER, and IFS
Outline


Underinvestment?
Remedies
– and what hasn’t worked

A question
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Worldbank Conf - Barcelona
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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
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Worldbank Conf - Barcelona
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Determining the optimal
subsidy
Return
or cost
of R&D
Social return
S
Optimal
subsidy
C
Private return
RC
RS
Optimal competitive
level of R
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cost
Optimal social
level of R
Worldbank Conf - Barcelona
Level of R&D
spending
4
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
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Worldbank Conf - Barcelona
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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 corporateWorldbank
tax Conf
burden
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- Barcelona
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Why an incremental credit?
Firm increasing R&D from R0 to R1
Rate of
Return or
Cost of
R&D
Tax revenue loss
for ordinary credit
Tax revenue loss
for incremental credit
Effective cost of capital
R0
R1
Amount of R&D 
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Worldbank Conf - Barcelona
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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

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
no technology restrictions
Conf - Barcelona
other innovationWorldbank
expenditures
(diffusion)
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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 risktaking
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Worldbank Conf - Barcelona
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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
June 2005
Worldbank Conf - Barcelona
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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?
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Worldbank Conf - Barcelona
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