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The Optimal State Aid Control: No Control

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Abstract

We extend a model of wasteful state aid in Dewatripont and Seabright (2006, Journal of the European Economic Association 4, 513–522) by a supranational controlling authority. The model combines moral hazard and adverse selection to show that politicians fund wasteful projects to signal their effort. Voters, unable to observe project benefits or effort, reward funding with a reelection premium that separates a high-effort politician from a low-effort politician. We examine state aid control by a benevolent authority which receives extra signals about the state of the world. We find that signals on the politician type are worthless. For signals on the project type, we derive a sufficient condition for aid control to unambiguously decrease welfare. We also prove that politicians do not respond to marginal changes in incentives. In this setup, the optimal state aid control is fairly often no control.

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Bibliographic Info

Article provided by Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies in its journal AUCO Czech Economic Review.

Volume (Year): 3 (2009)
Issue (Month): 1 (March)
Pages: 093-113

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Handle: RePEc:fau:aucocz:au2009_093

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Keywords: State aid; signaling; career concerns; aid control;

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  1. Mathias Dewatripont & Paul Seabright, 2006. ""Wasteful" Public Spending and State Aid Control," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 513-522, 04-05.
  2. Rogoff, Kenneth, 1990. "Equilibrium Political Budget Cycles," American Economic Review, American Economic Association, vol. 80(1), pages 21-36, March.
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  13. Drazen, Allan & Eslava, Marcela, 2010. "Electoral manipulation via voter-friendly spending: Theory and evidence," Journal of Development Economics, Elsevier, vol. 92(1), pages 39-52, May.
  14. Karen Helene Midelfart-Knarvik & Henry G. Overman, 2002. "Delocation and European integration: is structural spending justified?," Economic Policy, CEPR & CES & MSH, vol. 17(35), pages 321-359, October.
  15. David R Collie, 2005. "State aid to investment and R&D," European Economy - Economic Papers 231, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  16. Georges Casamatta & Caroline De Paoli, 2007. "Inefficient Public Provision in a Repeated Elections Model," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 9(6), pages 1103-1126, December.
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