When Do R&D Subsidies Boost Innovation? Revisiting the Inverted U-Shape

We show theoretically that a proportional Ramp;D subsidy accelerates innovation activity at all degrees of competition in the modern Schumpeterian growth model, but less so at high degrees of competition. We then use company-level data on patenting activity, product market competition and Ramp;D subsidies of Finnish firms during 1990-2001 to test the theoretical prediction. The empirical findings can be summarized as follows. Firstly, we find relatively strong evidence in favour of the inverted U-shape between competition and innovation. Secondly, we find some evidence that a direct Ramp;D subsidy increases innovative activity at all but very high degrees of competition. This can be interpreted so mean that the Ramp;D subsidy reinforces the Schumpeterian effect due to the negative cross-effect of Ramp;D subsidy and competition. This is evident from the finding that an increase in the Ramp;D subsidy steepens the inverted U relationship when competition is fierce