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The Sunday Paper – Can Investment Incentives Crowd Out Innovation? Evidence from China

You’re a government that wants to encourage output (and what government doesn’t?). There are two way you can do this; stimulate investment or innovation.

In 2004 China decided it wanted to encourage the latter and chose six metal-bashing industries in the notoriously metal-bashing-centric provinces of Heilongjiang, Jilin and Liaoning as experiments for a pilot reform of VAT that’d end up giving them more money.

Being already heavily invested in fixed assets it was hoped they’d use the windfall for innovation. What actually happened is an important lesson for not only Chinese policymakers but other developing economies.

The extra money went into new kit which not only had the effect of crowding out innovation but also reduced the labor input. The effect wasn’t small either (as measured by quality patents filed firms in the affected areas); innovation was reduced over the period by a whopping 9.5%.

My two-pennyworth. This finding seems to chime with the observation that countries ‘blessed’ with an abundance of natural resource are, in fact, often very far from blessed; and what might this imply about the progress of innovation at the world’s cash-rich tech leviathans?

Only time will tell on that point but the paper reminds that resource isn’t a reliable wellspring of innovation and there’s still useful wisdom in the old saying about necessity being the true mother of invention.

The work, by Shaowe Ke (et. al.) from the University of Michigan at Ann Arbor, can be accessed in full via the following link Can Investment Incentives Crowd Out Innovation?.

Happy Sunday.

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