Edited by Dominique Foray
Chapter 15: The ‘Funding Gap’: Financial Markets and Investment in Innovation
* Bronwyn H. Hall INTRODUCTION 15.1 An important problem in the managing of technology is the financing of technological development and innovation. Even in large firms, technology managers often report that they have more projects they would like to undertake than funds to spend on them.1 There are a number of reasons for this phenomenon: low expected returns due to an inability to capture the profits from an invention, the uncertainty and risk associated with the project, and overoptimism on the part of managers. This chapter reviews these arguments in more detail and considers the evidence, both theoretical and empirical, on the extent of the problem. Economists have long held the view that innovative activities are difficult to finance in a freely competitive marketplace. Support for this view in the form of economic-theoretic modeling is not difficult to find and probably begins with the classic articles of Nelson (1959) and Arrow (1962), although the idea itself was alluded to by Schumpeter (1942 ).2 The argument goes as follows: the primary output of innovation investment is the knowledge of how to make new goods and services, and this knowledge is nonrival: use by one firm does not preclude its use by another. To the extent that knowledge cannot be kept secret, the returns to the investment in it cannot be appropriated by the firm undertaking the investment, and therefore such firms will be reluctant to invest, leading to the underprovision of research and development (R&D) and other innovation investments in...
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