Crowding-Out Innovation

Julian Atanassov and Vikram Nanda

♦ We hypothesize that increases in federal spending financed by government borrowing crowd out innovative firms from financial markets. We find that unexpected defense spending shocks are followed by lower R&D investment and subsequent declines in scale, novelty, and economic value of corporate innovation. Consistent with a financing channel in which government borrowing displaces corporate financing, the decline is stronger for firms that are more financially constrained, more dependent on external finance, have higher short-term debt, and lower credit ratings. Unexpected defense spending is followed by higher short-term government borrowing, which in turn is associated with lower corporate innovation.

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