Optimal Subsidy Policy for Innovation: Technology Push and Demand Pull

Government plays a critical role in the development and adoption of new technology with social benefits. While there are many policies available under different forms and names, the two most popular subsidy policies are a technology-push policy, which awards manufacturers for R&D efforts, and a demand-pull policy, which directly awards customers. We study how the government should utilize a mix of push and pull subsidies to maximize the benefit from new technology and increase customer adoption when there are multiple manufacturers in the market. In particular, we examine how technology spillovers influence the optimal subsidy and resultant market outcomes. We provide a complete characterization of an optimal subsidy policy as a function of the technology benefit and derive the resultant equilibrium outcomes. We find that while the government will spend more for a more beneficial technology, the push and pull subsidies themselves change non-monotonically in technology benefit. For instance, the optimal push subsidy does not always decrease in benefit and the optimal pull subsidy given to early adopters does not always increase in benefit. We find that the level of technology spillover critically affects the firm's incentive to invest and the optimal subsidy. On the contrary to the conventional wisdom that an increase in the spillover level will discourage a firm's R&D investment, we find that the spillover can induce more firms to invest in R&D. Using analytical and numerical results, we examine when it is most beneficial to use a mix of push and pull subsidy policies.