Conditional R&D subsidies

This paper introduces a new type of R&D subsidy, which is conditional on the success of the R&D project. In a three-stage model, the government chooses a subsidy(ies), a monopolist chooses R&D effort which determines the size or the probability of success of the R&D project, and the firm chooses output. It is found that conditional subsidies can yield the same level of innovation and welfare as unconditional subsidies. However, when the probability of success is sufficiently low (be it endogenous or exogenous), conditional subsidies yield suboptimal levels of innovation and welfare. When the firm chooses the probability of success, conditional subsidies reduce the expected cost of the subsidy to the government as well as profits. The simultaneous use of conditional and unconditional subsidies is considered. Finally, subsidies conditional on failure are studied. It is found that they yield the same level of innovation and welfare as unconditional subsidies but increase expected subsidy costs and profits.