Do Incentives for Innovation work? Evidence from the Italian Manufacturing Sector

Understanding and estimating the impact of fiscal incentives on innovation are crucial elements for policy evaluation. This is so because innovation- be it of the product or the process type- is able to move the production frontier and hence, ultimately, enlarge societys consumption possibilities (as shown by the endogenous growth literature). However, despite the fact that innovation is the final goal of public policy, most studies look at the relationship between R&D expenses and fiscal policy, perhaps considering that the relationship between innovation and R&D is strong and deterministic. However, there exists evidence that such a relationship is neither strong nor deterministic. In fact, if the innovation is a process to which many factors contribute (including R&D), from our perspective the interesting policy question becomes: do fiscal incentives designeddirectly or indirectly (i.e. through R&D) to promote innovation - work? Hence, the main purpose of this study is to investigate the impact that fiscal incentives have on firms innovative performance. For this, we use data from the 7th, 8th and 9th waves of the Indagine sulle Imprese Manifatturiere Italiane by Unicredit (previously managed by Capitalia-Mediocredito Centrale), which contains information on both product and process innovation by manufacturing firms, on the amount of resources invested in R&D (if such amount is positive) and it is also informative of the existence of forms of fiscal incentive for R&D and investment in innovative activities. This information is crucial for our study since it permits us to link firms innovation (the dependent variable in our exercise) to fiscal incentives. In our work, we use different techniques. First we look at Average Treatment Effects, under the assumption of selection on observables, implying that the econometrician has access to all the variables affecting the likelihood of being treated (i.e. have access to incentives for innovative activities). In this part of the report, we just want to verify whether- everything else remaining constant (i.e. for a given value of the propensity score obtained with the conditioning variables) - there is evidence that firms that have access to fiscal incentives tend to innovate more. In the second part of our study, we cast some doubts on the plausibility of the selection on observables assumption and we look in more depth at one specific case of fiscal incentive: the one provided by Law 140/1999 to firms located in depressed areas (as defined by the law itself). We focus on this law because it is particularly important from a policy perspective within the Italian dual economy, but also because it allows us a more precise estimate of the treatment effect in a situation where treatment status (i.e. access to the incentive) is likely to depend on the same (unobserved) factors that affect the innovation outcome. In such a situation, OLS estimated are biased and inconsistent and we have to use instrumental variable estimation. We choose to instrument treatment using the eligibility rules for treatment and we find that an endogeneity issue does indeed exist and that its effects are stronger the weaker the impact of the treatment is on the outcome variable.