Deciphering the Innovation Subsidy Puzzle: Government Choices amid Supply Chain Encroachment

Although the impact of government subsidies on private innovation has been widely recognized and researched in numerous studies, few have considered the increasingly prevalent phenomenon of supply chain encroachment in their analysis. This paper explores this phenomenon through a game-theoretic model that takes into account a government entity, a supplier, and a manufacturer. The primary aim is to understand how the government can make optimal subsidy decisions when the supplier moves into the supply chain. Several interesting conclusions have been drawn: (1) under governmental innovation subsidies, the supplier will raise the price of the new technology to obtain more potential revenue, which is termed the inverse wholesale price effect; (2) different kinds of innovation subsidies are shown to have varied effects on R&D, production, and consumption behavior; and (3) different subsidy strategies are made compatible with the characteristics of innovative activities to maximize social welfare as much as possible. These findings shed light on inconsistent results surrounding the impacts of government subsidies on private innovations in the existing literature, providing municipalities with helpful guidance when encouraging private innovation initiatives amid supply chain encroachment.