Back to Basics: Basic Research Spillovers, Innovation Policy, and Growth

This paper introduces a model of endogenous growth through basic and applied research. Basic research differs from applied research in two significant ways. First, significant advances in technological knowledge come through basic research rather than applied research. Second, these advances are potentially applicable to multiple industries. Since these applications are not immediate, the innovating firm cannot exploit all the benefits of basic innovations for production. We analyze the impact of this appropriability problem on firms’ basic research incentives in an endogenous growth framework with private firms and a public research sector. After characterizing the equilibrium, we estimate our model using micro level data on research expenditures by French firms. We find that the competitive equilibrium features too little basic research and too much applied research investment. In particular, we show that a uniform R&D subsidy to private firms does not improve welfare due to cross-subsidization of applied research, which is overinvested in. The optimal type-dependent policy calls for a positive subsidy to private basic research and a tax on applied research. We also find strong complementarity between the property rights of the public researcher and the optimal funding of public basic research. Our analysis highlights the need for crafting policies that directly target basic research.