Government Intervention, Innovation, and Entrepreneurship

We study how government intervention affects innovation and entrepreneurship, using a model in which two agents (e.g., one entrepreneur and one venture capitalist) engage in teamwork to launch a new business in which a moral hazard problem may persist for both parties. One feature of our model is that the government's financial support (grant) may have (positive) externalities on the teamwork of both parties, but is also constrained by budget costs. We compare two major forms of government intervention: indirect intervention and hybrid intervention. Contrasted to the case without government intervention, indirect government intervention always raises the efforts of both parties and promotes social surplus (welfare) while hybrid government intervention may not always raise the efforts of both parties or promote social surplus. Hybrid government intervention may, however, deliver even higher social surplus than indirect government intervention when the government's share in the enterprise is dominant and its marginal contribution to the project is sufficiently high.