Centralized R&D Subsidy Policy in an NEGG Model: A Welfare Analysis

Using a two-country NEGG (New Economic Geography and Growth) model with localized spillovers, we show that a centralized R&D subsidy policy can reach the objectives of both higher efficiency and lower inequalities. Indeed, by reducing the cost of R&D, the policy increases the investment in R&D and therefore the aggregate growth rate. We suppose that the policy is funded by a proportional tax on the profits of industrial firms so that the policy reduces the value of capital and therefore the capital revenue of consumers. As we suppose that country a holds initially more capital than country b, it follows that the policy reduces the revenue inequality. The location framework of our model exihibits the famous Home Market Effect meaning that location of industrial firms depends on revenue inequality. As the policy reduces revenue inequality, industrial firms have less incentive to locate in the bigger market so that the spatial concentration of industrial sector in country a decreases.