DP1887 | Venture Capital: A Case for Investment Promotion

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Venture capitalists provide risk capital and valuable monitoring services that are essential for the success of upstart companies. The financial sector?s expertise in monitoring investment proposals may increase with the accumulated experience in funding such projects. In the other direction, the productivity gains from learning lower the cost of venture capital finance and reinforce start-up investment. Since learning depends on aggregate investment, the effect is external to individual agents. The paper demonstrates how the nature of the externality depends on the state of financial sector development, and how the appropriate tax/subsidy policy should be tailored to it.