Growth Promotion Policies When Taxes Cannot Be Raised

This paper examines the growth effects of R&D subsidies and public-funded basic research in an R&D-based endogenous growth model when political constraints do not allow the government to increase its revenue. If individuals have enough life-cycle saving motives and R&D productivity is sufficiently high, the growth rate becomes higher than the interest rate in equilibrium, and the government can finance expenses while perpetually rolling over the debt. Given this situation, debt-financed R&D subsidies always enhance short-run growth. However, they increase long-term growth only when R&D productivity exceeds another threshold. Our estimates suggest that this condition holds for most advanced countries, including the United States, but not for low-growth countries such as Japan and Italy. In contrast, enhancing public-funded basic research is effective for economic growth even in low-growth economies. However, such policies reduce the upper bound in the debt-to-GDP ratio, beyond which the economy cannot recover to a steady state.