Subsidizing public inputs

If production–cost savings associated with successful research and development are freely disseminated to other firms as soon as they are realized, too few resources may be allocated to this activity. Subsidies to this activity, a public input, can lead to optimal input use. The effectiveness of four alternative subsidy instruments in stimulating firms’ R&D spending are examined. Two are incremental subsidies and two are level subsidies. One of the incremental subsidies and one of the level subsidies crudely capture characteristics of incentive mechanisms used in many countries. A laboratory implementation of these instruments confirms that incremental subsidies are inferior to level subsidies.