Effects of R&D subsidies on regional economic dynamics : evidence from Chinese provinces

We investigate the impact of research and development (R&D) subsidies on R&D inputs of large- and medium-sized firms and on additional innovation and economic activities in Chinese provinces. A panel vector autoregressive (VAR) model and corresponding impulse response function (IRF) analysis allow us to differentiate between direct and indirect effects, which add up to total effects. We find that an increase of R&D subsidies significantly decreases private R&D investments, although there is a significant positive effect on the R&D personnel employed in firms. We interpret these findings as a partial crowding-out effect because public funds substitute some private funds while total R&D inputs still increase. Complementarily, we find a positive secondary effect on the provincial patent activity, our measure of technological progress. Interestingly, we also find potentially unintended effects of R&D subsidies on increases in the investment rate in physical capital and residential buildings. Although R&D subsidies fail to incentivise private R&D expenditures, firms increase total R&D inputs, and provincial economies benefit from secondary effects on technological progress and capital deepening.