Bureaucratic Bean Counting and Patent Subsidies: A Welfare Evaluation of China's Pro-innovation Program

This paper quantifies the welfare effect of the patent subsidy policy (the InnoCom program) in China. The policy encourages firms to hold more patents, but disregard the quality of patents. We provide evidence that the subsidy decreases the value of patents either through declining the quality of new granted patents or through the inefficient trade of patents. We build a structural equilibrium model, which allows three channels that the subsidy policy can change the aggregate welfare: (1) Distorting the subsidized firm’s innovations by increasing low quality new patents; (2) Reallocating patents to inefficient firms for being qualified to be subsidized; (3) Imposing a positive demand shock on the patent trade market and encouraging more low quality new patents. We find that the aggregate welfare declines substantially and the third channel is the most important one, suggesting that it is crucial to jointly consider the patent trade and the entry of new patents.