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The Optimal State Aid Control: No Control

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Author Info
Martin Gregor () (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
Dalibor Roháč () (University of Oxford, Department of Economics, Oxford, United Kingdom)

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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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Publisher 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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Related research
Keywords: State aid; signaling; career concerns; aid control;

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Find related papers by JEL classification:
D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Models of Political Processes: Rent-seeking, Elections, Legislatures, and Voting Behavior
D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy-Making and Implementation
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

References listed on IDEAS
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    Other versions:
  4. 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. [Downloadable!] (restricted)
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