137 NTU Management Review Vol. 31 No. 2 Aug. 2021 2.2 The Effect of Government R&D Subsidies on Innovation In order to promote R&D for economic growth, the government should grant subsidies to projects with high expected social benefit but with low returns for the private sector. There are two competing theories that explain the relationship between private R&D and public expenditures such as R&D subsidies: the substitution and complementary theories.9 Theoretically, public subsidies can positively contribute to the private sector because the recipients of subsidies directly receive the profits of funds while non-recipients of subsidies indirectly obtain knowledge from R&D spillovers (David, Hall, and Toole, 2000; Özçelik and Taymaz, 2008; Chen, Chen, Liang, and Wang, 2020). Klette and Møen (2012) use the dynamic and long-run model and argue that government R&D subsidies produce positive learning-by-doing effects on private R&D. Takalo and Tanayama (2010) also use a theoretical model and suggest that government R&D subsidies directly reduce the financing constraints and can decrease the capital costs of innovative firms because the firms receiving the R&D subsidies provide informative signals to the market. Accordingly, these theoretical papers suggest that the complementary theory under which the subsidies produce additional effects for private R&D investments is the correct explanation. Although above theoretical papers support the complementary theory, empirical studies show conflicting results (David et al., 2000; Wallsten, 2000; Wu, 2005). To assure the effectiveness of government subsidies, the government should choose target projects with high social returns that private firms would not undertake on their own. However, Wallsten (2000) finds that firms which devote more R&D tend to be more easily to receive government subsidies. Further, Wallsten (2000) does not find positive influence of subsidies on innovation because he finds that federal R&D grants decrease firm-financed R&D.10 Wu (2005) and Toivanen and Niininen (2000) also find that the government direct subsidies crowd out firm R&D investments, meaning that direct subsidies substitute for private R&D expenditures. Becker (2015) argues that this crowding-out effect may result from the problem of sample selection bias. In fact, the government may favor certain 9 Substitution theory suggests that these two mechanisms replace each other: private R&D is reduced when the government infuses funds into the private sector. Complementary theory suggests that the public fund infusion of government policy ameliorates underinvestment in private R&D. 10 Wallsten (2000) posits several reasons that the government funds may provide firms with the ability to attract private funds and may allow the firms to delay refinance.
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