Impact of R&D investments on the economic growth of the Czech Republic – a recursively dynamic CGE approach

Developed economies are facing a problem of declining competitiveness on a global scale. The perspectives for sustaining the world economic leadership are associated with stimulating technological progress through innovations and investments to R&D. This is a challenge for the private sector but also for governments in prioritizing their policies in line with the goal of sustaining the competitive advantage. Within the EU, the debates are often centered on the effective allocation of subsidies from the EU budget, in which certain support of policies, such as the Common Agricultural Policy, occupy a considerable part. However, the ideas of reallocation of the agricultural subsidies to the prospective sectors of the economy such as the sector of Research and Development should be supported with a thorough research, revealing possible impacts on the whole economy. Computable General Equilibrium models provide appropriate instruments in assessing the ex-ante impact of different policy scenarios. However, in the field of Research and Development, standard CGE models do not capture properly the R&D effects, due to several reasons. First of all, the national accounts usually do not explicitly involve the investments to R&D; second, the sector of R&D included in the input-output tables does not capture all investments into Research and development. Third and most important, the R&D activities are not capitalized properly to stimulate the economic growth. This paper investigates how results obtained with standard CGE models can be improved by incorporating the effects of the R&D activities in a recursively-dynamic CGE model built for the economy of the Czech Republic. The main objective of the paper is to quantify the impact of the R&D activities on the long-term economic growth of the Czech Republic in the recursively dynamic CGE framework. Furthermore, the aim is to assess the efficiency of the governmental support under different policy options. The results of this paper are part of a research grant of the Czech Science Foundation “ Evaluation of Research and Development Effects on the Economic Growth of the Czech Republic with the Use of a Computable General Equilibrium model“. Paul Romer (1990) is considered as a founder of the R&D based endogenous growth theory. His work was later conceptualized in the CGE framework by Diao, Roe and Yeldan (1999) which involved imperfect competition and forward-looking dynamization. Nevertheless, various recent practical applications of the R&D based theory of economic growth have been performed in the recursively dynamic framework. Furthermore, an extensive experience with modeling R&D activities can be found in climate change oriented CGE models, in which the investments to R&D are considered as a source of technological progress required for the mitigation of the climate change effects. Recent contributions on the R&D effects in the recursive CGE models can be found in the works of Garau and Lecca (2008), Youngchang et al. (2010), Wang et al. (2009) and Zürn et al. (2007). In these contributions, the incorporation of R&D is usually based on the accumulation of knowledge as a function of the R&D investments. Specific features can be found in Garau and Lecca, who apply this approach to a regional CGE model of Sardinia. Youngchang et al. disaggregate the Taiwanese R&D investments into public and private in order to compare their efficiency. Zürn addresses the issue of different options of subsidizing the R&D activities in a multi-region CGE model. Wang et al. draw from Zürn´s method of knowledge accounting and focus on the different mitigation commitments to reach China’s climate policy obligations. Following the recent approaches, this paper incorporates the R&D effects into a recursively dynamic CGE model built for the economy of the Czech Republic. The model follows a standard IFPRI structure (Lofgren, 2002) and is described in detail in Křístková (2010). The model is calibrated on the economy of the Czech Republic in 2008 and provides simulations until 2020. As an extension to previous approaches, different types of R&D activities are distinguished. Whereas R&D originated in private companies can be directly attributable to specific industries (such as innovations, patents etc), R&D carried out in public institutions is not easily appropriable (such as of the basic research) and can provide positive externalities to all sectors of the economy. In view of this, R&D stemming from the enterprise sector directly increases the stock of knowledge in the economy, which is modeled as an intangible production factor appropriable in each production sector. The results of the public R&D activities are capitalized in form of increasing Total Factor Productivity in all sectors of the economy. A survey of the Czech Statistical Office carried out at the companies involved in the R&D activities is used to calibrate the SAM. Furthermore, the aim is to carry out econometric estimates to properly quantify the spillover effects of the public research and development activities on the TFP. The CGE model is applied in three scenarios. The first scenario – baseline – provides the growth rates of the economy under current governmental support scheme. In particular, the attention is devoted to the dynamics of growth with the incorporation of the R&D effects, which is higher than in the model which omits the R&D effects. The second scenario focuses on comparing the impact of enterprise and public RD on the economic growth which reveals the efficiency of governmental support to both sectors. Finally, the effects of reallocation of subsidies from agriculture to both R&D sectors are analyzed. The results show that by capturing the R&D effects through knowledge accumulation and TFP growth, the reallocation of subsidies from agriculture to RD brings positive effects, as opposed to results driven from standard CGE models.