In evaluating the effectiveness of R&D subsidies, the literature has focused on potential crowding out effects, while the possibility of misappropriation of public funds that results from moral hazard behavior has been completely neglected. This study develops a theoretical framework with which to identify misappropriation. Using Chinese firm-level data for the period 2001-2011, we show that misappropriation is a major threat. 42% of grantees misused R&D subsidies for non-research purposes, accounting for 53% of the total amount of R&D subsidies. In a second step, we study the loss of effectiveness of R&D subsidies in stimulating R&D expenditures that is due to misappropriation. We measure the loss in effectiveness by estimating the causal effect of R&D subsidies in the presence of misappropriation using an intention-to-treat (ITT) estimator and comparing it to the ideal situation (without misappropriation) using the complier average causal effect (CACE). We find that China’s R&D policy could have been more than twice as effective in boosting R&D without misappropriation. R&D expenditures could have been stimulated beyond the subsidy amount (additionality), but noncompliant behavior has resulted in a moderately strong partial crowding out effect. We find significant treatment heterogeneity by period, subsidy size, industry, and ownership. Notably, the loss in effectiveness has diminished following a policy reform in 2006. Nevertheless, the misappropriation of public funds considerably undermines the impact of R&D policies in China.

Competition from China in the Product and Input Markets and Innovation in Germany

(with L. Brandt, P. Mohnen and E. Mueller)

We analyze the effect of increasing Chinese import competition on the innovation performance of German firms. Competition takes place in both product and input markets and goods imported from China may originate in either domestically or foreign-owned firms. Using firm-level data for the time period 2000-2014 we take these dimensions of competition into account. Whereas German firms counter competition by foreign firms in the product market by spending more on own R&D, competition in the input market supports their product innovation through the provision of novel and cheaper intermediate inputs. Process innovation is only supported by Chinese competition in the input market from foreign-owned firms.