Do government innovation policies actually work?

Does all the federal government funding for research and development, direct and indirect subsidies, tax credits and other tax benefits, such as deductibility of research expenses, actually boost economic growth and American prosperity? The Minneapolis Fed tried to find out—and discovered it couldn’t really come to a conclusion. Here is the problem:

In particular, the idea that innovative activity by firms has “spillovers” that promote the wider diffusion (intentional or inadvertent) of new innovations and knowledge created at just one location, firm, or industry is central in justifying government subsidies for innovation. As a result, we want to know how important these spillovers are for the economy as a whole.

And since measuring spillover effects is difficult, evaluating the effectiveness of innovation policy is also tricky (bold is mine):

The response of economic welfare and GDP over the long run to changes in innovation policy is highly sensitive to the size of innovation spillovers; welfare gains could vary between virtually no change and a 50 percent increase in equivalent consumption, depending on spillover size.

Unfortunately, we cannot accurately measure these long-run effects without accurate estimates as to the magnitude of innovation spillovers. Results from our model indicate, however, that even under ideal conditions, it should be very difficult to measure spillovers using data on medium-term response of the macroeconomy from changes in innovation policy. That is, evidence from the medium term is not likely to help differentiate long-run effectiveness because all policies have similar medium-term outcomes regardless of the size of spillovers.

What does this imply for policy?

The clearest implication of our research is that to the extent that policymakers choose to subsidize innovative activity by firms, they should consider the full set of tax and regulatory policies that impact aggregate innovation through firm profitability. Taxing corporate profits or enacting regulations that make it more costly for firms to start up or operate has a significantly negative influence on innovation, undercutting the stimulative impact of R&D subsidization. The net effect may be to depress, rather than encourage, innovation by firms.

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