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Should Variable Cost Aid to Attract Foreign Direct Investment be Banned? A European Perspective

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  • Mario Mariniello

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    Abstract

    The purpose of this paper is to analyze the European Commission’s approach to state aid to attract foreign direct investment (FDI) in a competition policy framework. The Commission considers variable cost aid (VCA) to be more distortive than start-up or fixed cost aid (FCA). This paper addresses that issue and checks whether allowing FCA while banning VCA is an optimal strategy for a supranational Competition Authority maximizing welfare. The model shows that a domestic government maximizing welfare always prefers VCA to FCA if both the incumbent and the entrant are foreign firms and if granting VCA does not cause the incumbent firm to exit the market. The model shows that banning VCA may lead to sub-optimal equilibria where welfare is not maximized. Copyright Springer Science+Business Media, LLC 2013

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    File URL: http://hdl.handle.net/10.1007/s10842-011-0124-3
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    Bibliographic Info

    Article provided by Springer in its journal Journal of Industry, Competition and Trade.

    Volume (Year): 13 (2013)
    Issue (Month): 2 (June)
    Pages: 273-308

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    Handle: RePEc:kap:jincot:v:13:y:2013:i:2:p:273-308

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    Web page: http://springerlink.metapress.com/link.asp?id=105724

    Related research

    Keywords: state aid; competition policy; start-up aid; fixed cost aid; variable cost aid; L11; L13; L40; L53;

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    1. Brander, James A. & Spencer, Barbara J., 1985. "Export subsidies and international market share rivalry," Journal of International Economics, Elsevier, vol. 18(1-2), pages 83-100, February.
    2. Leahy, Dermot & Neary, J Peter, 2007. "Multilateral Subsidy Games," CEPR Discussion Papers 6479, C.E.P.R. Discussion Papers.
    3. Caroline Buts & Marc Jegers & Tony Joris, 2011. "Determinants of the European Commission’s State Aid Decisions," Journal of Industry, Competition and Trade, Springer, vol. 11(4), pages 399-426, December.
    4. Markusen, James R. & Morey, Edward R. & Olewiler, Nancy, 1995. "Competition in regional environmental policies when plant locations are endogenous," Journal of Public Economics, Elsevier, vol. 56(1), pages 55-77, January.
    5. Neven, Damien J. & Roller, Lars-Hendrik, 2005. "Consumer surplus vs. welfare standard in a political economy model of merger control," International Journal of Industrial Organization, Elsevier, vol. 23(9-10), pages 829-848, December.
    6. Barros, Pedro P & Cabral, Luis, 2000. "Competing for Foreign Direct Investment," Review of International Economics, Wiley Blackwell, vol. 8(2), pages 360-71, May.
    7. Feldstein, Martin, 1997. "How Big Should Government Be?," National Tax Journal, National Tax Association, vol. 50(2), pages 197-213, June.
    8. Schmalensee, Richard, 2004. "Sunk Costs and Antitrust Barriers to Entry," Working papers 4457-04, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    9. Feldstein, Martin, 1997. "How Big Should Government Be?," Scholarly Articles 3043427, Harvard University Department of Economics.
    10. Mario Mariniello, 2006. "State Aid to Attract FDI and the European Competition Policy: Should Variable Cost Aid Be Banned?," Economics Working Papers ECO2006/41, European University Institute.
    11. Collie, David R., 2000. "State aid in the European Union: The prohibition of subsidies in an integrated market," International Journal of Industrial Organization, Elsevier, vol. 18(6), pages 867-884, August.
    12. Krugman, Paul R, 1987. "Is Free Trade Passe?," Journal of Economic Perspectives, American Economic Association, vol. 1(2), pages 131-44, Fall.
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