Government interventions to promote research and development in industry

Abstract

The market failure and transaction costs approach to R&D suggests that industry will tend to invest less in R&D than the socially efficient level. The primary causes of this underinvestment are risk and uncertainty, indivisibility and nonappropriability and such transaction costs as arise from bounded rationality and costs arising from principal-agent relationships. Transaction costs can be understood as the costs that are associated with the exchange of goods and services and which establish constraints on the efficient workings of markets. Governance structures within which R&D is conducted can be used to minimise but not eliminate the transaction costs associated with R&D. However, more direct government intervention to encourage industrial R&D is appropriate where the likely social returns to R&D exceed both the private returns and the alternative uses of the investment government makes through its intervention, and where the social benefits of the intervention exceed the costs. The level and nature of R&D in industry is influenced by such factors as firm size, market structure, industry sector, past human capital investments and technological opportunity. Firms use R&D as a strategic tool through new product and process development. This in turn involves the creation of barriers to entry to and exit from markets, and allows economic profits to be earned. Government broadly influences R&D in industry through its human capital investments, the provision of government funded research and through its macroeconomic and regulatory policies. Against this background, government can also influence industrial R&D through a range of more direct and targeted interventions. The Government can lower the intramural cost of R&D inputs, for example through tax incentives and grant schemes which lower the costs of intramarginal R&D projects and make possible extramarginal projects which would not have proceeded without subsidy. It is also possible to convey to industry demand side signals to induce increased R&D investment, for example through offset and procurement policies. The Government can also target particular weaknesses in the industrial research system, for example the supply of venture capital to R&D based firms and the type and strength of intellectual property rights protection. It can also facilitate institutional structures, such as collective research mechanisms, that provide the framework for increased R&D investment. The effectiveness of interventions can be measured through the impact of an intervention on: - the total quantum of industrial R&D investment; - the allocative efficiency of the investment in R&D; - the production efficiency of the conduct of R&D; - the sustainability of any increased industrial R&D effort; - the extent to which the R&D is embodied in commercial applications; - the extramarginality of the R&D investment, that is, the extent to which it is over and above what the firm or industry group would invest in the absence of the intervention; - the technical quality of the R&D. A large amount of evidence has been gathered internationally on the effect of interventions to promote R&D and while the resulting policy implications are not always relevant to countries like New Zealand, they allow some conclusions to be drawn. The interventions that appear to lead to economic benefits that exceed the costs when measured against the criteria include: 1. Selective grants targeted at small firms and to parts of the R&D process that are subject to especially high transaction costs, risk or uncertainty; 2. The direct public provision of equity and loan capital to support R&D based innovation on a risk sharing basis; 3. Encouragement of collective research, including through the provision of establishment and seed finance capital for research consortia and associations, and the enactment of facilitating legislation; 4. Output oriented collaborative research programmes jointly funded by the public and private sectors; 5. Reducing the costs of establishing intellectual property rights, and promoting the diffusion of technical information held by agencies such as the Patents Office; 6. Limited public procurements for new R&D based products and processes that have been identified through an industry priority setting process. An interactive, "hands on" approach to the management of most of these interventions is generally an important factor in their success.