Government subsidized R&D, project screening, and firms’ innovation: evidence from China

Abstract

The effects of government subsidies to corporate R&D on firms’ innovation outputs still remain inconclusive in existing studies. Moreover, little is known how the screening system of the public R&D programs influences the effect of such programs. This study examines the effects of Innofund (one of the largest Chinese government programs supporting corporate R&D activities) on firms’ innovation outputs in China. In particular, the project screening mechanism was changed due to policy amendments in 2005. This exogenous policy shock allows us to estimate how the project screening system affects the influence of public R&D subsidies. Based on a panel dataset of Chinese manufacturing firms, we find Innofund-backed firms outperform their non-Innofund-backed counterparts in innovation, measured by the number of patents, new product sales, and the volume of exports after they gained funding. The magnification effects of Innofund are larger after 2005, when the project-screening scheme became more decentralized indicating that decentralized screening functions better in public R&D investment. Finally, the effects of Innofund and the effects of the decentralized screening system that occurred in 2005 vary substantially across markets. The more economically and institutionally developed the market is, the stronger the Innofund effects and the project selection decentralization effects appear. The identification problems are handled by using the propensity score matching approach and the instrumental variable approach.