Abstract A positive effect of government financial support on firm innovation can emerge through two different mechanisms: “additionality,” which is desirable, and “crowding-out,” which is inefficient. We attempt to disentangle these two mechanisms to understand which one likely drives empirical observations of a positive effect of government funding on firm innovation in a sample of Australian small and medium enterprises (SMEs). We use firms’ financial constraints as a moderator variable to assess which mechanism is likely to dominate on average. Our empirical analysis uses a 5-year (2011–2016) firm-level panel dataset from the Business Longitudinal Database (BLD) compiled by the Australian Bureau of Statistics (ABS), and an econometric approach that corrects for the endogeneity of both government funding and financial constraints, as well as unobserved firm heterogeneity and selection effects. Our analyses show a positive effect of government financial support on innovation. However, this effect is stronger among financially unconstrained firms than among their constrained counterparts, suggesting evidence more consistent, on average, with crowding-out or partial additionality than with full additionality.
Yeo et al. (Mon,) studied this question.