The Intangible Borrowing Constraint of Entrepreneurship

With quantity-based innovation targets and subsidy programs launched since the mid-2000s, China has seen a patent surge, accounting for 46% of the world’s total patent applications in 2020; however, the overall patent quality has been steadily declining over time. This paper develops a Schumpeterian growth model featuring innovating firms’ quantity-quality trade-off between radical and incremental innovations, and decomposes subsidies’ aggregate impact into quantity and quality channels. We calibrate the model to Chinese firm-level R&D data in the early 2010s. Our quantitative analysis shows that the quality channel effects are negative and dominant, and quantity-based subsidies in that period reduce the TFP growth rate and welfare by 0.3% and 9%, respectively. We evaluate welfare gains under a constrained planner’s problem, and propose a quality-biased subsidy — subsidizing the human capital accumulation — which effectively recovers the optimal allocation.