Market failures and the additionality effects of public support to private R&D: Theory and empirical implications

We extend the theoretical basis of the empirical literature on the effects of R&D subsidies by providing an estimable model of strategic interaction among subsidy applicants, and public and private sector R&D financiers. Our model incorporates fixed R&D cost and a cost of external finance. We derive the optimal support rule. At the intensive (extensive) margin the costs of external funding reduce (increase) the optimal subsidy rate. We also establish necessary and sufficient conditions for the existence of additionality. It turns out that additionality at the intensive margin is less likely with higher spillovers. Our results suggest that the relationship between additionality and welfare may not be straightforward. •We build a structural econometric model of the R&D subsidy process.•We incorporate spillovers, cost of finance and fixed costs of R&D.•An increase in spillovers always lead to higher subsidies.•An increase in cost of finance or fixed cost may lead to higher or lower subsidies.•Additionality may or may not be a necessary condition for a welfare improvement.