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How to select Instruments supporting R&D and Innovation by Industry

Author

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  • Marcel J.L. de Heide

    (Erasmus University Rotterdam)

  • Amit Kothiyal

    (Erasmus University Rotterdam)

Abstract

We present a theoretical framework which allows for the comparison of the effectiveness of tax measures, loans and funding, in supporting industry-oriented research. We estimate for each of the instruments the exact contribution required by a firm to decide on investing in R&D, given the costs and probability of success of the project, and the foreseen change in profit following successful implementation of the research results. We apply Prospect Theory to analyse the risk attitude of the firm. By comparing the contribution required, we identify the instrument which is most effective, and therefore preferred by a government. Our analysis indicates that there exists a critical value for the probability of success of the project for which the modality of the most effective instruments changes. For a probability of success smaller than the critical value, a tax measures offering support only in case of successful completion of the project is preferred. For a probability higher than the critical value, a loan is most effective. The value of the critical probability depends on the perception of risk and loss aversion of the firm involved in the research.

Suggested Citation

  • Marcel J.L. de Heide & Amit Kothiyal, 2011. "How to select Instruments supporting R&D and Innovation by Industry," Tinbergen Institute Discussion Papers 11-021/2, Tinbergen Institute, revised 07 Feb 2011.
  • Handle: RePEc:tin:wpaper:20110021
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    File URL: http://papers.tinbergen.nl/11021.pdf
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    References listed on IDEAS

    as
    1. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    2. Kenneth Arrow, 1962. "Economic Welfare and the Allocation of Resources for Invention," NBER Chapters,in: The Rate and Direction of Inventive Activity: Economic and Social Factors, pages 609-626 National Bureau of Economic Research, Inc.
    3. Han Bleichrodt & Jose Luis Pinto & Peter P. Wakker, 2001. "Making Descriptive Use of Prospect Theory to Improve the Prescriptive Use of Expected Utility," Management Science, INFORMS, vol. 47(11), pages 1498-1514, November.
    4. Eren Inci, 2009. "R&D tax incentives: a reappraisal," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 16(6), pages 797-821, December.
    5. Richard R. Nelson, 1959. "The Simple Economics of Basic Scientific Research," Journal of Political Economy, University of Chicago Press, vol. 67, pages 297-297.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    R&D; innovation; firms; public policy;

    JEL classification:

    • D04 - Microeconomics - - General - - - Microeconomic Policy: Formulation; Implementation; Evaluation
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • O38 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Government Policy

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