The Optimal R&D Policy: Patents, Public Funding, or Both?

Abstract

It is well known that frictionless markets fail in providing incentives to invest in RD 14]. Two widely used solutions to this problem are patents, which temporarily assign successful researchers property rights to their discoveries, and research contracting, where R&D is publically funded. A hybrid solution is to subsidize private R&D and provide more limited patent protection. Patents can provide only a second-best solution since they lead to noncompetitive pricing. There are also excess social costs associated with the public funding of R&D. One such cost is raising revenue to finance public funding, which entails excess burdens. There is also the moral hazard that researchers will pocket publically provided funds since their private returns (ex post receiving public funds) will be below normal. Hence, there will be costs associated with monitoring publically funded researchers. This paper analyzes the second-best R&D policy where the excess social costs of patents and public funding are considered.

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