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Absorptive Capacity and R&D Tax Policy: Are In-house and External Contract R&D Substitutes or Complements?

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  • Todd A. Watkins
  • Lolita Paff

    (Department of Economics, National University of Ireland, Galway)

Abstract

Firms fund research and development (R&D) to generate commercializable innovations and to increase their ability to understand and absorb knowledge from elsewhere. This dual role and opposed incentive structure of internal R&D creates a significant question for both theory and R&D policy: Is internal R&D a complement or substitute for external R&D? We develop a model and novel technique for empirically estimating R&D substitution elasticities. We focus on bio-pharmaceutical and software industries in California and Massachusetts, where tax credit rates changed differently over time for the two types of R&D, creating a natural experiment. The effective tax prices for the two R&D types differ from type to type, firm to firm, state to state, and year to year. This allows us to examine changes in the composition of firms’ R&D budgets between in-house R&D and external basic research when the relative tax prices of each category of research changes. For a sample comprised largely of small and medium-sized firms, we find evidence of a substitute relationship.

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Bibliographic Info

Paper provided by National University of Ireland Galway, Department of Economics in its series Working Papers with number 116.

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Date of creation: 2007
Date of revision: 2007
Handle: RePEc:nig:wpaper:0116

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  1. Diewert, W E, 1971. "An Application of the Shephard Duality Theorem: A Generalized Leontief Production Function," Journal of Political Economy, University of Chicago Press, vol. 79(3), pages 481-507, May-June.
  2. Richard R. Nelson, 1959. "The Simple Economics of Basic Scientific Research," Journal of Political Economy, University of Chicago Press, vol. 67, pages 297.
  3. Arora, Ashish & Gambardella, Alfonso, 1994. "Evaluating technological information and utilizing it : Scientific knowledge, technological capability, and external linkages in biotechnology," Journal of Economic Behavior & Organization, Elsevier, vol. 24(1), pages 91-114, June.
  4. Mansfield, Edwin, 1980. "Basic Research and Productivity Increase in Manufacturing," American Economic Review, American Economic Association, vol. 70(5), pages 863-73, December.
  5. Salter, Ammon J. & Martin, Ben R., 2001. "The economic benefits of publicly funded basic research: a critical review," Research Policy, Elsevier, vol. 30(3), pages 509-532, March.
  6. Mowery, David C & Oxley, Joanne E, 1995. "Inward Technology Transfer and Competitiveness: The Role of National Innovation Systems," Cambridge Journal of Economics, Oxford University Press, vol. 19(1), pages 67-93, February.
  7. Cockburn, Iain M & Henderson, Rebecca M, 1998. "Absorptive Capacity, Coauthoring Behavior, and the Organization of Research in Drug Discovery," Journal of Industrial Economics, Wiley Blackwell, vol. 46(2), pages 157-82, June.
  8. Watkins, Todd A., 1991. "A technological communications costs model of R&D consortia as public policy," Research Policy, Elsevier, vol. 20(2), pages 87-107, April.
  9. Lolita Paff & Todd A. Watkins, 2009. "What is the After-Tax Price of R&D? An Interstate Comparison," Fiscal Studies, Institute for Fiscal Studies, vol. 30(1), pages 73-101, 03.
  10. Humphrey, David Burras & Moroney, John R, 1975. "Substitution among Capital, Labor, and Natural Resource Products in American Manufacturing," Journal of Political Economy, University of Chicago Press, vol. 83(1), pages 57-82, February.
  11. Veugelers, Reinhilde & Cassiman, Bruno, 1999. "Make and buy in innovation strategies: evidence from Belgian manufacturing firms," Research Policy, Elsevier, vol. 28(1), pages 63-80, January.
  12. 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.
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Cited by:
  1. Hagedoorn, John & Wang, Ning, 2010. "Is there complementarity or substitutability between internal and external R&D strategies?," MERIT Working Papers 005, United Nations University - Maastricht Economic and Social Research Institute on Innovation and Technology (MERIT).
  2. Ian Currie, 2011. "Government Policies to Encourage University-Business Research Collaboration in Canada: Lessons from the US, the UK and Australia," CSLS Research Reports 2011-02, Centre for the Study of Living Standards.

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