Boosting innovation or entry: What increases output more?

Abstract

Governments spend substantial sums subsidising firm investment in Research and Development (R&D) with the aim of increasing output. How effective are these subsidies? Could alternative policies boost output more? I develop a quantitative model of the US economy in which heterogeneous firms choose R&D, physical capital, and debt subject to a collateral constraint distinguishing between physical capital and R&D. I find that negative spillovers from higher aggregate R&D render R&D subsidies largely ineffective at increasing output. Conversely, subsidising entry instead of R&D achieves ten times the increase in output because entry subsidies do not generate large negative R&D spillovers. My results suggest that a policymaker seeking to increase output should focus on incentivising entry rather than R&D.