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How to select Instruments supporting R&D and Innovation by Industry

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  • Marcel J.L. de Heide

    (Erasmus University Rotterdam)

  • Amit Kothiyal

    (Erasmus University Rotterdam)

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    Abstract

    We present a theoretical framework which allows for the comparison of the effectiveness of tax measures, loans and funding, in supporting industry-oriented research. We estimate for each of the instruments the exact contribution required by a firm to decide on investing in R&D, given the costs and probability of success of the project, and the foreseen change in profit following successful implementation of the research results. We apply Prospect Theory to analyse the risk attitude of the firm. By comparing the contribution required, we identify the instrument which is most effective, and therefore preferred by a government. Our analysis indicates that there exists a critical value for the probability of success of the project for which the modality of the most effective instruments changes. For a probability of success smaller than the critical value, a tax measures offering support only in case of successful completion of the project is preferred. For a probability higher than the critical value, a loan is most effective. The value of the critical probability depends on the perception of risk and loss aversion of the firm involved in the research.

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    Bibliographic Info

    Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 11-021/2.

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    Date of creation: 03 Feb 2011
    Date of revision: 07 Feb 2011
    Handle: RePEc:dgr:uvatin:20110021

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    Web page: http://www.tinbergen.nl

    Related research

    Keywords: R&D; innovation; firms; public policy;

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    1. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
    2. Jeroen Hinloopen, 1997. "Subsidizing cooperative and noncooperative R&D in duopoly with spillovers," Journal of Economics, Springer, vol. 66(2), pages 151-175, June.
    3. Dominique Guellec & Bruno Van Pottelsberghe De La Potterie, 2003. "The impact of public R&D expenditure on business R&D," Economics of Innovation and New Technology, Taylor & Francis Journals, vol. 12(3), pages 225-243.
    4. Kenneth Arrow, 1962. "Economic Welfare and the Allocation of Resources for Invention," NBER Chapters, in: The Rate and Direction of Inventive Activity: Economic and Social Factors, pages 609-626 National Bureau of Economic Research, Inc.
    5. Eren Inci, 2009. "R&D tax incentives: a reappraisal," International Tax and Public Finance, Springer, vol. 16(6), pages 797-821, December.
    6. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    7. Jeroen Hinloopen, 2000. "More on subsidizing cooperative and noncooperative R&D in duopoly with spillovers," Journal of Economics, Springer, vol. 72(3), pages 295-308, October.
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