INCREMENTAL R-AND-D SUBSIDIES

An Incremental Incentive Scheme (IIS) encourages some activity by rewarding an agent for overachieving a base level determined by past performance but not penalizing underachievement. We examine an IIS R&D subsidy in a dynamic model due to Grossman and Shapiro (1986). We show that the firm's optimal R&D path either cycles around the no-subsidy path or follows a ''ratchet'' pattern of small increases in R&D relative to the no-subsidy path. A simple condition determines which type of behavior occurs. Furthermore, we show that an IIS may be an inefficient method of encouraging R&D compared to a flat-rate subsidy.