What Drives Differences in R&D Across Countries? Insights from the Intensive and Extensive Margins

Abstract

The profitability, user costs and fixed costs of R&D jointly interact to determine firms' decisions on whether or not to invest in R&D and how much to invest. Which one of these three key determinants is more important at explaining differences in R&D across countries? We estimate the unobserved profitability and fixed cost distributions for a cross-section of 28 European countries by combining macro-data on the intensive and extensive margins of R&D (country level) and micro-modeling (firm level). We use the estimates to show that: 1) increases in profitability trigger sharp increases in business R&D through improvements in both the intensive and extensive margins; 2) reductions in the fixed costs generate substantial increases in business R&D through improvements in the extensive margin; 3) policy induced variation in the marginal cost through subsidies and tax credits only has a second order effect on the R&D position of a country mainly through improvements in the intensive margin; 4) while we do not establish causality, we show that profitability is associated with institutions, infrastructures, competition policy and innovation readiness while fixed costs are associated with the quality of education and exposure to trade.

Keywords: R&D, Innovation policy, Tax credits, Subsidies

JEL Classification: O30, O32, O38