Interaction in R&D and the Case-by-Case Subsidy Rule

This paper studies the performance of government subsidy programs which fund business R&D projects. A commonly used criterion for distributing funding is the case-by-case (CbC) rule. Under the rule, project funding is decided based on the gap between a project’s social and private return. This paper finds that in the presence of pervasive complementarity in R&D activities CbC funding is socially excessive. On the other hand, in the presence of pervasive substitutability in R&D activities CbC funding is socially insufficient. Since the situation can differ greatly from one industry to the next, these findings suggest governments may be over-funding research in some industries at the expense of research in other under-funded industries.