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Innovation Subsidies: Misallocation and Technology Upgrade

  • Javad Sadeghzadeh

This paper examines TFP effects of size-dependent subsidies that generate misallocation but also incentivize technology adoption at the establishment-level in the context of a model with heterogeneous establishments and endogenous technology adoption. I focus on the subsidy program initiated in 2005 in Indian Iron and Steel industry which was directed to larger plants. Using plant-level data, I found that there was an acceleration of TFP growth but only among plants that used more productive technologies. Instead, I observed a larger reallocation across plants with less productive technologies after the policy change. I used a variant of the Lucas (1978) span-of-control framework with heterogeneous plants and endogenous technology choice at the establishment-level to explore if the subsidy policy contributed to the observed productivity growth. My findings indicate that size-dependent subsidies can increase aggregate TFP if the policy encourages technology adoption at the establishment-level. My calibrated model predicts that the subsidy program in India’s Iron and Steel sector accounted for 1/5 of the observed aggregate TFP growth through three direct channels: First, the subsidy introduces idiosyncracy in the prices faced by individual plants causing resource misallocation (misallocation effect: -2%), Second, the subsidized plants with standard technology switch to the more efficient technology (technology upgrade effect: 49%), and finally, plants make new decisions on occupation and technology use (selection effect: 53%).

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Paper provided by Job Market Papers in its series 2014 Papers with number psa1207.

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Date of creation: 05 May 2014
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Handle: RePEc:jmp:jm2014:psa1207
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  1. Philippe Aghion & Peter Howitt, 1990. "A Model of Growth Through Creative Destruction," NBER Working Papers 3223, National Bureau of Economic Research, Inc.
  2. Richard Rogerson & Diego Restuccia, 2004. "Policy Distortions and Aggregate Productivity with Heterogeneous Plants," 2004 Meeting Papers 69, Society for Economic Dynamics.
  3. Paul M Romer, 1999. "Endogenous Technological Change," Levine's Working Paper Archive 2135, David K. Levine.
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  10. Czarnitzki, Dirk & Hanel, Petr & Rosa, Julio Miguel, 2011. "Evaluating the impact of R&D tax credits on innovation: A microeconometric study on Canadian firms," Research Policy, Elsevier, vol. 40(2), pages 217-229, March.
  11. Aminata SISSOKO, 2011. "R&D Subsidies And Firm-Level Productivity: Evidence From France," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2011002, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES), revised 24 Oct 2013.
  12. Douglas Gollin, 2001. "Nobody's Business but My Own: Self Employment and Small Enterprise in Economic Development," Center for Development Economics 172, Department of Economics, Williams College.
  13. Xulia Gonz�lez & Jordi Jaumandreu & Consuelo Pazo, 2005. "Barriers to Innovation and Subsidy Effectiveness," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 930-949, Winter.
  14. Alain Gabler & Markus Poschke, 2013. "Experimentation by Firms, Distortions, and Aggregate Productivity," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(1), pages 26-38, January.
  15. Branstetter, Lee & Chen, Jong-Rong, 2006. "The impact of technology transfer and R & D on productivity growth in Taiwanese industry: Microeconometric analysis using plant and firm-level data," Journal of the Japanese and International Economies, Elsevier, vol. 20(2), pages 177-192, June.
  16. Claustre Bajona & Luis Locay, 2009. "Entrepreneurship and Productivity: The Slow Growth of the Planned Economies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 505-522, July.
  17. Gene M. Grossman & Elhanan Helpman, 1993. "Innovation and Growth in the Global Economy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262570971, June.
  18. Pete Klenow & Gunjan Sharma & Albert Bollard, 2011. "India's Mysterious Manufacturing Miracle," 2011 Meeting Papers 1176, Society for Economic Dynamics.
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