DP1986 Industrial Policy and Firm Heterogeneity
Our concern is about a firm-specific industrial policy. When R&D subsidies or taxes are differentiated among firms, the question arises which firms in an industry should receive such support. We analyse a situation where firms differ in their R&D technologies in two distinct ways: they differ both in the costs of performing R&D activities and in the output obtained from such activities. The introduction of several domestic firms creates a corrective motive for government intervention with the firms' R&D activities in addition to Spencer and Brander's strategic motive. We find that the optimal firm-specific industrial policy is affected differently by the two sources of firm heterogeneity. Moreover, a change in a firm's R&D productivity has an ambiguous effect on the optimal policy towards the firm.
