Repairing the R&D market failure: Public R&D subsidy and the composition of private R&D

We examine the role of government subsidy in addressing market failure in research and development (R&D). Prior studies have shown that allocating market resources for R&D is not socially optimal due to the expected market failure in private R&D investment. Using Korean pharmaceutical industry data, we analyze the relationship between public R&D subsidy and private R&D investment. We also investigate the impact that public R&D subsidy has on the composition of private R&D expenditures. We find that the government’s R&D subsidy stimulates rather than crowds out private R&D activities of small biotechnology venture firms. This finding provides additional empirical evidence that government R&D subsidy can successfully address market failure in private R&D investment. Yet, the empirical evidence that the R&D subsidy program stimulated the biotechnology venture firms to expand their new product R&D activities is found to be rather weak. Consequently, the idea that the Korean government’s R&D subsidy program successfully addressed the underinvestment in R&D below the socially optimal level by inducing small venture firms to expand their R&D activities in new product R&D areas is only partially supported. Limitations of this study, the extent to which the test results can be generalized in other industries, qualitative assessments in a broader context, and areas for further study are also discussed.