R&D Subsidy and Import Substitution: growing in the shadow of protection

We study the effect of an innovation subsidy on the long-run growth of firms in a developing country. Using administrative microdata from Brazil and a quasi-experimental design that compares near-winners to near-losers of R&D subsidy applications, we find that the program had a persistent effect on firm size: fourteen years after receiving the subsidy, subsidized firms were 59% larger. The effect is strongest among small and young firms facing high borrowing costs, which is consistent with the subsidy alleviating financial constraints. This growth, however, did not come from firms developing frontier innovations. Instead, firms used the subsidy to expand their product lines into high-tariff markets, producing local versions of foreign goods.