European Science and Technology Policy
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European Science and Technology Policy

Towards Integration or Fragmentation?

Edited by Henri Delanghe, Ugur Muldur and Luc Soete

This innovative book focuses on the most important concept underpinning current European Union research policy. It describes the history and concept of the European Research Area (ERA), analyses some of the underlying assumptions, assesses some of its achievements, and takes a brief look at its future.
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Chapter 7: The Returns to Public Research Funding

Kris Aerts and Dirk Czarnitzki


Kris Aerts and Dirk Czarnitzki Technological progress fosters economic growth and research and development (R&D) activities have become crucial for strengthening modern knowledge-based economies’ competitiveness (Romer, 1990). However, R&D entails high levels of risk and uncertainty (Dasgupta and Maskin, 1987). Moreover, knowledge creates positive externalities, that is, it can never be fully protected from free-riders (Nelson, 1959; Arrow, 1962). The public character of information leads to incomplete appropriability of investments aimed at creating knowledge. Knowledge cannot be kept proprietary – not even through today’s intellectual property rights systems. Newly created knowledge will always leak out to competitors or others and thus the social benefit will be higher than the private return. Under the assumption that companies intend to maximize profits, it will occur that some R&D projects with high social returns will never be carried out, as private costs are higher than private expected returns. This leads to underinvestment in R&D from the social point of view. Another argument refers to financing difficulties encountered by R&D projects due to asymmetric information among borrowers and lenders. Unlike investment in tangible capital, R&D investment is sunk once it has been expensed and the outcome is highly uncertain. This leads to reluctance on the side of lenders to finance R&D, resulting in financial constraints for R&D investment in the business sector (see Hall, 2005, for a survey of such studies). The arguments referring to the positive external effects of R&D and to financing constraints for...

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