The productivity effect of public R&D in the Netherlands

Using a vector-error-correction model (VECM) with endogenous stocks for total factor productivity (TFP), domestic and foreign public and private Research and Development (R&D) as well as the GDP from which current resources are taken, we find that for the Netherlands for the period 1968-2014, extra investment in public R&D has a clear positive effect on total factor productivity growth. Taking into account the costs of these extra investments, we find that the rate of return to such a policy is positive and generally high. Including private R&D in the policy from the beginning is better than increasing public R&D alone and private R&D only following. Transitory and permanent shocks to only domestic public R&D in 1971 show positive effects on private domestic and foreign private and public R&D, total factor productivity and GDP. Under a permanent shock to the growth rate of domestic public R&D by 0.005 (an additional half percentage point on the baseline growth rate), TFP is 27.5% higher than baseline after 70 years, and the GDP is 61% higher because a higher TFP also attracts international capital one-to-one with GDP. Foreign private R&D reacts much more positively then foreign public R&D. Private R&D capital increases by up to 5.5% compared to baseline and returns to baseline in the long run. The internal rate of return is 131 percent obtained already in 1988. If domestic and foreign public R&D are increased by the same permanent shock of 0.005, there are positive effects for thirty five years in domestic private R&D but permanently so for all other variables; TFP would have been higher by 0.56% and GDP by 9.4%, much less than under the first strategy without the symmetric and simultaneous foreign policy. The rate of return is 4-6 percent for horizons 2014, 2024, and 2040 because of higher gains in later periods. If domestic and foreign public and private R&D growth get a shock of 0.0025 (each an additional quarter of a percent on baseline) TFP increases by 13 percent until 2040, GDP by 28 percent and the internal rate of return is 77%.