Study on the Effect of Government R&D Policies and Defence Procurement on Private R&D Investment: A Computable General Equilibrium Approach

Abstract

Even though there are critical views suggested by some economists on whether there is a market failure, it legitimizes the intervention of the government into private investment activities. There are two kinds of primary work that must be implemented by the government in a where it is believed that the government has to make up for the market failure. Above all, the government leads the implementation of R&D projects, which may be transferred to the private sector. In this case, the research institute established by the government may raise social welfare by carrying out the R&D tasks, of which the social rate of return is high but the private rate of return is low. Secondly, the government may implement policies that activate private investment, so that the investment is induced up to the level that is considered to be desirable by the society.

Currently, the private R&D investment accounts for a great part of total R&D investment, and the private sector is regarded as the main factor that determines the national R&D capacity. Accordingly, in order to attain the sustainable growth through technological changes, first and foremost, the government shall activate the investment activities in the private sector. In this context, the government has been implementing various policies to attract investments in the private sector.

The investment-attracting policies that are commonly implemented by most countries, including the South Korean government, include the tax incentive, subsidy, financial support, human resource support, public procurement, institutional infrastructure, technology transfer transaction, technical instruction and consultation, and so on. With the various policy instruments being used to pursue the unique purpose of policies, the discussion on how the government can allocate resources effectively, in order to activate the innovation-oriented activities of the private sector, has come to the fore.

From the viewpoint of supply-push, the state subsidy and tax incentive scheme are the most focused policy instruments. Though both the state subsidy and tax incentive scheme have similar functions in terms of supporting the innovative activities with financial resources, they have opposite characteristics from each other as the state subsidy is a direct means, in which the level of government intervention is high, but the tax incentive is an indirect means. Accordingly, it is required to establish the policies on the basis of comparative evaluation of the effects of both policy instruments in order to design the policies efficiently. However, most of existing empirical studies have analyzed each policy instrument individually, so that there is a limit to what we can suggest with regard to relatively excellent policy instruments.

On the other hand, the economists have recognized the importance of demand-pull policy through debates, however, most of governments have mainly implemented supply-push policies. However, recently, the issues regarding limitation of the supply-push policies have been raised, which are centered around the EU and member countries, calling for the introduction of demand-pull policies positively. Recognizing the importance of demand-pull policy, the South Korean government has been making efforts to supplement the institutional strategies that will be used to implement the demand-pull policies.

In this context, this study is designed to carry out a comparative evaluation of the effects of direct subsidy and tax incentive, which are regarded as the typical policy instrument to attract investments from the viewpoint of supply-push. Along with this, the effect of national defence procurement will be analyzed, which accounts for a greater part of government expenditure among the public procurement that is a typical means of the demand-pull policies.

In order to achieve the purpose of this study, the knowledge-based Computable General Equilibrium (CGE) model has been introduced. As for the model presented in this study, the knowledge is regarded as a capital, and the knowledge capital will be used as a factor of production, along with the labor and physical capital. In addition, the knowledge capital is the source of spillover effect on external economy. So, the knowledge has been capitalized according to the recommendation of System of National Accounts 2008 (SNA 2008) and OECD (2010), so that the knowledge-based social accounting matrix (SAM) could be built up by reflecting the knowledge capital formed through the capitalization in a new account.

According to the study results, both the state subsidy and tax incentive appeared to be effective in promotion of R&D investment of the private sector. However, the tax incentive appeared to be more efficient than the direct subsidy. This result suggests that an effective government intervention is the attraction of investment activities through the market-oriented decision-making. Along with this, it suggests that the government shall have a more comprehensive view of the production and investment environment of each industry in advance in order to apply the direct intervention method effectively. On the other hand, according to results of the analysis of the national defence procurement, which was divided into the general defence procurement and the special defence procurement limited to the weapon systems, both cases appeared to promote the private investment. Especially, the weapons procurement system appeared to have relatively larger effect, which was because the purchase of Defense Acquisition Program Administration (DAPA) accounted for the greatest part of the defence industry market.

This study has an academic significance as it is differentiated from the existing literature as follows. Firstly, the effects of state subsidy and tax incentive have been compared with each other and evaluated directly by using the same dataset and analysis model. Secondly, the investment-inducing effects of national defence procurement have been presented at the industry level. Thirdly, in comparison with the existing studies, in which the partial effect of investment-inducing policies was analyzed, this study has been focused on the analysis of the full effect of policies, in which the effects of knowledge spillovers have been applied according to investment activities. Fourthly, the effects of each policy instrument on innovative activities and economic growth have been analyzed. Accordingly, the degree of achievement of the ultimate goals of innovative policies has been evaluated quantitatively, which was designed to promote the economic growth through technological changes. Fifthly, the knowledge-based SAM and the CGE model will provide the foundation on which various policies can be evaluated in the future.