This paper introduces a new type of R&D subsidy, which is conditional on the success of the R&D project. In a threestage model, the government chooses a subsidy(ies) in the first stage; in the second stage, a monopolist chooses R&D effort which determines the size or the probability of success of the R&D project; in the last stage, the firm chooses its output. It is found that conditional subsidies can yield the same level of innovation and welfare as unconditional subsidies. However, when the probability of success is sufficiently low (be it endogenous or exogenous), conditional subsidies yield suboptimal levels of innovation and welfare. When the firm chooses the probability of success, conditional subsidies can have the advantage of a lower expected cost of the subsidy to the government. I consider the simultaneous use of conditional and unconditional subsidies, and show that different combinations of the two can lead to the same levels of innovation and welfare as unconditional subsidies alone. Finally, reverse conditional subsidies, which the firm gets only if the project fails, are considered. It is found that they yield the same level of innovation as unconditional subsidies, except when the probability of success is sufficiently high. Comparing conditional subsidies with reverse conditional subsidies, conditional subsidies yield higher (lower) welfare when the probability of success is high (low).
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Paper provided by University of Ottawa, Department of Economics in its series Working Papers with number
0702E.
Find related papers by JEL classification: L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies L52 - Industrial Organization - - Regulation and Industrial Policy - - - Industrial Policy; Sectoral Planning Methods O31 - Economic Development, Technological Change, and Growth - - Technological Change - - - Innovation and Invention: Processes and Incentives O38 - Economic Development, Technological Change, and Growth - - Technological Change - - - Government Policy
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