Why EU subsidy schemes don't work - the evidence

In our new paper Bureaucrats or Markets in Innovation Policy? we summarise results from a five-year research program on innovation policy in Sweden.

Counter to popular beliefs among policymakers, the positive effects of support schemes are found to be very limited. In order to revitalise Europe, the newly-appointed EU Commission needs to reconsider government's role in innovation and entrepreneurship.

Overall, innovation grants have no effects on turnover, profits or number of employees.

While there are a modest effects of such grants in urban areas, these are by far offset by the negative impact seen in rural areas. These results indicate that a large part of EU regional redistribution programs are misguided as it is hard to create economic recovery without human capital in place.

Some argue that effects on innovation can only be seen in hindsight when sufficient time has elapsed.

Unfortunately, the data tells the opposite story. In the programmes we studied, the only noticeable effects are short term in the form of a 'sugar rush' when grants recipients are able to overspend on equipment and new staff. Over time, the effects fade away.

To top it off, targeted innovation often distort incentives, resulting in unfair competition and opportunistic behaviour. Such distortions are hard to measure, but in one study we show how public support results in the emergence of subsidy entrepreneurs – firms that systematically apply for public support.

The gold medal went to a firm that obtained 38 different grants from various government agencies.

Exploitation opportunities

With a wide and growing array of funding bodies, both European and national, private firms exploit all opportunities for grants. We show that these subsidy entrepreneurs in general pay higher wages to employees but have lower productivity.

Such are the results of the continuous flow of public grants firms apply for.

An explanation for the policy trend is that targeted support initiatives are easy to justify politically. Politicians appear decisive and committed to a cause when they launch a new support structure and state that billions of euros will be invested in innovation and entrepreneurship.

Beneficiaries of such policies include politicians, government agencies and the firms that thrive on these support schemes, who congeal into concentrated interest groups.

The cost, however, is distributed across a large and immobilised group in the form of taxpayers and other firms who instead concentrate their attention on serving customers and improving their operations.

Unfortunately, policies that have limited effects but strong proponents and are politically easy to justify may prevail in the long term, despite their ineffectiveness.

Conversely, escaping a trap of subsidy and privilege is difficult. It is hard to remove regulatory burden, labour market restrictions, and other barriers to innovation and entrepreneurship.

The benefits of liberalisation are distributed over large and unidentified groups. Reformers need to be deal with vested interest groups that have or think they have a lot to lose from the enactment of new policies.

The challenges facing president Emmanuel Macron's French reform agenda are but one common example.

Our research shows that reformers can have a significant positive impact on innovation and competitiveness by focusing on the obstacles to innovation and entrepreneurship: the lack of human capital and the prevalence of red tape.

Many EU member states including Sweden face a shortage of skilled labour, largely due to problems in public education with regards to quality and relevance.

Targeted support schemes and subsidies increase rather than decrease what entrepreneurs dislike the most: red tape.

It is time for European policymakers to reconsider their role. Innovation and entrepreneurship are not engineered by creating support structures funded with the same money that could have been used by firms and individuals in the first place.

At best, targeted industrial policies have limited effects. At worst, they distort incentives, create a fertile ground for subsidy entrepreneurs while distracting policymakers from dealing with tough and real problems.