A possible mechanism for partial crowding‐out of R&D subsidies in developing countries

We analyze the effectiveness of R&D subsidies on firms' R&D efforts in a developing country like Ecuador. We use the National Survey of Innovation Activities. Methodologically, we employ a structural framework that considers simultaneity and selection issues. Our results indicate that subsidies have an extensive margin effect, as they encourage firms to carry out R&D activities, and an intensive margin effect, as they increase firms' total innovation effort. However, this is compatible with partial crowding‐out of private efforts by public funds. One possible mechanism to explain this result is that, in developing countries with less developed capital markets, firms with financial constraints may divert part of the subsidy to invest in fixed capital. We find some support for this hypothesis, as the most financially constrained firms both explain the crowding‐out effect and increase their fixed capital investment when receiving a subsidy. For other firms, we observe crowding‐in, and their fixed capital investment remains insensitive to the subsidy.