Optimal R&D investment tax credits under mean reversion return

This chapter presents the mean-reverting process matters for research and development (R&D) investment decisions: no matter whether the external effect is internalized or not, as the speed of mean reversion increases, the incentive to invest is raised because the long-run variance of the technology-shift factor is dampened. The incentive to invest is raised because the long-run variance of the technology-shift factor is dampened. The return to R&D capital is driven by a technological factor that follows a mean-reverting process. R&D capital also exhibits both irreversibility and externality through the learning-by-doing effect. The optimal paths for R&D capital under both the decentralized and centralized economies are derived and then compared. It is found that an equal rate of investment tax credits should be given to both costlessly reversible investments and irreversible ones, and this common rate is unrelated to the parameters that characterize the mean-reverting process. When R&D capital exhibits externality, then market outcomes will be inefficient. The role of externality is to raise the optimal stock of R&D capital.