Notes from

Wei, Shang-Jin, Jianhuan Xu, Ge Yin, and Xiaobo Zhang. 2023. “Mild Government Failure.” https://www.nber.org/papers/w31178 (May 4, 2023).

The paper argues that a mild form of government failure, where bureaucrats can count but do not differentiate quality, can have substantial implications for the efficacy of the subsidy program—China’s largest pro-innovation industrial policy.

Unintended responses from firms Link to heading

1. The subsidy program primarily incentivizes firms to produce more low-quality patents, rather than encouraging the creation of high-quality patents that have a positive productivity effect.
2. The subsidy program does not differentiate between in-house and purchased patents. This lack of differentiation may lead firms to engage in activities that maximize their chances of receiving subsidies, such as purchasing patents from external sources.

Source of welfare losses Link to heading

1. The subsidy program incentivizes firms with a low initial patent count to allocate resources towards producing low-quality innovations
2. Even firms that are not eligible for a subsidy may allocate resources towards producing low-quality innovations with the hope of selling them to subsidy-eligible firms.
3. High-quality patents may be sold by higher-value users who are not eligible for a subsidy to lower-value users who are eligible for a subsidy