Picking 'winners' in China: Do subsidies matter for indigenous innovation and firm productivity?

- This paper studies the relationship between state subsidies, the innovation process and productivity in China.
- Correcting for selection, state subsidies promote firm innovation, but only in high-tech industries, despite reducing TFP.
- Successful innovator firms that received (no) prior state support exhibit lower (higher) TFP.
- The findings bring into question whether the social payoff from picking 'winners' justifies the cost.

This paper examines the effects of public subsidies across several dimensions of the innovation process and the implications for productivity. As an identification strategy, panel data is used to estimate a structural innovation model that controls for unobserved heterogeneity combined with matching techniques that help ensure comparability between subsidized and non-subsidized firms. The findings reveal that public subsidies reduce firms' economic performance in lower and higher technology industries despite promoting indigenous innovation in the higher technology industries. Policymakers may tolerate lower average efficiency if they expect that some of the state-backed firms will eventually become successful innovators that go on to generate significantly large social welfare payoffs. Although the findings do not support such an expectation, thus bringing into question whether the social payoff from China's so-called picking 'winners' strategy justifies the cost.