Accessible Unlicensed Requires Authentication Published by De Gruyter October 28, 2017

The Effectiveness of Public Subsidies for Private Innovations. An Experimental Approach

Julia Brüggemann and Till Proeger


The effects of public subsidies in supporting innovative activity are subject to long-standing debates. Since empirical findings remain largely inconclusive, this study adds to this debate with counterfactual evidence from a laboratory experiment. In a creative real effort task simulating the innovation process, two distinct means of allocating subsidies are compared to a benchmark treatment without subsidies to identify their effects in fostering innovativeness. Furthermore, subjects’ cooperative behavior in relation to subsidies is investigated. Overall, subsidies lead to a substantial crowding-out of private investment. While the individual revenues increase due to the subsidy, the innovative activity fails to increase and less sophisticated innovations are realized. Consequently, subsidies have no or negative effects on overall welfare, depending on the subsidy specifics. However, subsidies do not influence cooperative behavior. These findings imply that the additional costs of subsidies for innovations might not be warranted by gains from additional innovations and increased welfare.

JEL Classification: C91; H25; O31


We are grateful to Lukas Meub and Kilian Bizer for their very helpful comments on this work, as well as Sven Orzel for his assistance in programming and running the experiments. Financial support from the German Federal Ministry of Education and Research and the Hans-Böckler-Stiftung is gratefully acknowledged.


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A Instructions for all treatments

In general, the control treatment is described, which is the same in both experiments. The differences between treatments are indicated in square brackets, whereby the subsidy treatment of ExLetter is denominated as ‘extra letter’ and the subsidy treatment of ExMoney as ‘extra money’. Furthermore, the order (first, second) in which the treatments were conducted is indicated. The original instructions were in German and are available from the authors upon request.


The Game

In this game, your task is to build words using letters as in the board game “Scrabble”. By building words, you increase your payoff: for each word, you receive a payoff calculated by the sum of the values of each letter. You start the game with an endowment of 4 letters. During the course of the game, you are able to buy additional letters.

[extra letter, first: At the end of your turn, you will additionally receive one letter for free.]

[extra money, first: At the end of your turn, you will receive 4 tokens, i. e. the value of one letter, for free.]

You will play in a group of 4 players.

The Payoff

Your payoff depends on the sum of the value of your letters, which is calculated in experimental tokens. One token is converted to €0.10 at the end of the experiment. You start this part of the game with an endowment of 50 tokens. Note that it is possible to finish the experiment with less than your starting endowment.

Please note the table below, which contains all letters, their value (in tokens) and the frequency with which they occur in the game.

Table A1

List of letters.


On the next page, you will find a screenshot of the main board of the game and some explanations to gain a first overview of the game. A detailed explanation of the game ensues.

Course of a Turn

When it is your turn, a dialog pops up asking you for choices. You have 60 seconds for your decisions. You can see the remaining time at the top-left corner of the screen. If your time expires, you are subtracted 1 token from your endowment for every additional 10 seconds.

Every turn comprises five phases:

1.Word phase I

Your activity: Producing or extending words

You can use German words, their conjugations and declinations and some names of places and persons. You can test if a word is correct using the spellchecker when it is not your turn. Each letter can only be used once: after producing or extending a word, the letter will be deleted from your list.

Correct words can be built as follows:

Option 1:

  1. You can produce a word using exactly three of your letters by typing the letters on your keyboard.The payoff that you earn for creating a word is given by the sum of the value of the letters (Example: ‘pol‘: p = 4, o = 2, l = 2. This results in 4 + 2 + 2 = 8 tokens).

Option 2:

Extending a word

  1. You can extend an existing word by inserting one letter in any position in the word. For example, ‘ast’ can be extended into ‘last’, ‘rast’ and ‘aste’, and ‘last’ again into ‘laust’ and this into ‘klaust’. It is not possible to rearrange existing words (e. g. to build from ‘ast’ the word ‘star’).

Your payoff results from the sum of the value of the letters of the newly extended word. By extending e. g. ‘last’ into ‘laust’, you get l = 2, a = 1, u = 1, s = 1, t = 1, so 2 + 1 + 1 + 1 + 1 = 6 tokens. Every word can only be produced once but can subsequently be used for as many extensions as possible.

Option 3:


  1. In case you are unable to produce or extend any word, you can pass the turn to the next player.

Royalty phase I

Your activity: Setting a royalty fee

After producing a word, you have to decide whether or not to set a royalty fee that other players are required to pay when creating extensions. If you set a royalty fee, you will have to choose between 10 and 100 % of the value of the word.

If another player extends your word, the fee is automatically transferred to you.

In the following, you can find three examples for others extending your word:

  1. If you choose no license fee, the word is entirely free to use for the other players. They will receive the entire value of the word.

  2. At 100 %, you will receive the initial value of the word and the next player only receives the value of his added letter.

  3. The choice of 20 % means that the respective player has to pay 20 % of the value of the word to you. The other player will receive 80 % plus the value of their added letter.

The word and the royalty fee remain fixed during the entire game. Both appear on the list of public words on the main board and can be used by all other players. However, other players are required to pay the respective royalty fee when extending the word.

Furthermore, you will have to decide whether to set a royalty fee if you extend a word with a single letter. In this case, you only decide on the fee for your added letter.

Word phase II

After the first license phase, a second word phase ensues, in which you can produce another word following the procedure described above.

Royalty phase II

If you have produced or extended a second word, you will have to decide once again whether to set a royalty fee or not and – if so – determine the level of the royalty fee as described above.

Buying phase

Your activity: Buying letters

You can choose to buy no, one or two letters at the price of 4 tokens for each letter. The order of the letters has been randomly determined prior to the game by sampling without replacement from the list of letters shown on the table on page 1. At the beginning, you are provided four letters and 50 tokens

[extra letter, first: And in each turn one additional letter in the buying phase]

[extra money, first: And in each turn four additional tokens in the buying phase]

for free.

After that, your turn ends and it is the next player’s turn. The game is played for 12 periods.

Finally, some examples for the calculation of your payoff are provided:

Example 1: If player 1 sets a royalty fee of 90 % for the word ‘ast’ (value of the word 3 tokens: a = 1, s = 1, t = 1) and player 2 extends the word into ‘hast’ (value of h = 2), this results in the following payoffs:

Player 1: 90 % of 3 tokens = 2.7 tokens (royalty fee for player 1)

Player 2: 3–2.7 tokens (to player 1) + 2 tokens for the letter ‘h’ = 0.3 tokens + 2 tokens = 2.3 tokens

Example 2: If player 1 sets the royalty fee of 0 % for ‘ast’, player 2 receives the sum of the value of all letters for extending it into ‘hast’:

Player 1: 0 % of 3 tokens = 0 token

Player 2: 100 % of 5 tokens = 5 tokens

Example 3: After extending a word, the player has to set a royalty fee for the added letter. Player 1 sets a royalty fee of 10 % for ‘ast’ and player 2 sets a royalty fee of 50 % for the letter ‘h’ in ‘hast’. If player 3 then extends ‘hast’ into ‘haust’, this results in the following payoffs:

Player 1: 10 % of 3 tokens = 0.3 (royalty fee for player 1)

Player 2: 50 % of 2 tokens = 1 (royalty fee for player 2)

Player 3: 6 tokens for ‘haust’ – 0.3 tokens (to player 1) – 1 token (to player 2) = 4.7 tokens


Once the participants of a session had finished the first part, they were handed out the second part of the instructions:

Hereafter, you will play the game again with the following changes:

  1. You receive again 50 tokens. Your payoffs will be aggregated at the end of the experiment.

  2. The groups are matched randomly.

  3. [control, first; extra letter, second: In the buying phase at the end of your turn, you receive a free letter in each turn and you can only buy one additional letter.]

  4. [control, first; extra money, second: At the end of each turn, 4 tokens are added to your endowment, which amounts to the cost of one letter.]

[extra letter, first; control, second: In the buying phase at the end of your turn, you no longer receive a free letter anymore; instead, you are now able to buy two, one or no letters.]

[extra money, first; control, second: In the buying phase at the end of your turn, it is no longer the case that 4 extra tokens are added to your endowment.]

Apart from these changes, all parameters of the game remain constant.

B Instructions for the control task

Note: The instructions for the word task were shown to participants on the screen.


In the next screen, you will see a string comprising 9 letters.

You will be asked to create as many German words as possible using these letters within 3 minutes.

You can type the words you create in the field beneath the string of 9 letters and submit them by pressing Enter.

You can use each letter only once per word and a word cannot be shorter than 3 letters.

Longer words generate more points.

3-letter word: 3 + 2 + 1 = 6 points

4-letter word: 4+ 3 + 2 + 1 = 10 points


After 3 minutes have expired, the test will end and you will be shown your results.

As soon as you enter the next screen, the timer will start ticking.

To proceed to the next screen, please press the letter ‘R’ on your keyboard.

C Performance in the control task

To test for individual task-specific knowledge, a control task is run prior to the experiment. Therefore, the word task by Eckartz, Kirchkamp, and Schunk (2012) is implemented, in which subjects are asked to build as many words as possible out of the letterset accehhikllst within three minutes. The instructions for the control task are provided in Appendix B. For every word that they create, subjects earn points, whereby the number of points increases disproportionally with the word length: a word with three letters generates 6 points, a four-letter word 10 points, a five-letter word 15 points, etc. Overall, given the letterset, 330 different words can be generated, which are worth 5,585 points. In each session, the five subjects scoring the most points were awarded an additional 1€ to their overall payoff. The distribution of the groups’ performance across treatments as measured by the points achieved is provided in Figure 5.

Figure 5: Performance in the control task by group and treatment.

Figure 5:

Performance in the control task by group and treatment.

At the group level, there is some heterogeneity in the task-specific skills, yet no substantial differences when compared across experiments (MWU-test extra letter vs. extra money z = −1.216 and p = 0.2242). Accordingly, it can be assumed that these results are not driven by subjects’ systematically different abilities in creating words across the two experiments.

Published Online: 2017-10-28

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