Working Paper No. 494 Government Subsidized R&D and Innovation Outputs: An Empirical Analysis on China’s Innofund Program

This study examines the effects of the Innovation Fund for Small and Medium Technology-based Firms (Innofund), one of the largest Chinese government programs that support corporate R&D activities on corporate innovation outputs. We study the general effects of Innofund on innovation. By exploring institutional variations over time and across regions, we also examine the effect of institutions on this government R&D program on firms’ innovation outputs. Based on a panel dataset of Chinese manufacturing firms, we find, in general, Innofund-backed firms outperform their non-Innofund-backed counterparts in terms of innovation, measured by the number of patents, new product sales, and the volume of exports. Moreover, innovation outputs are significantly increased after Innofund-backed firms gained funding. The magnification effects of Innofund on innovation are further increased after 2005, when the project-screening scheme became more decentralized, which indicates that decentralized screening functions better in public R&D investment. Finally, we find that the effects of Innofund and the effects of the decentralized screening system that occurred in 2005 vary substantially across markets. The more economically and institutionally developed the market is, the stronger the Innofund effects and the project selection decentralization effects appear. The identification problems are handled using the propensity score matching approach and the instrumental variable approach.