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State aid and tacit collusion

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  • Christoph Bertsch
  • Claudio Calcagno
  • Mark Le Quement

Abstract

Both literature and policy debate on State aid or government subsidies have focused on the trade-off between the potential ine¢ ciencies caused by state intervention (inefficient allocation of resources, moral hazard) and the potential gains from intervention (whether related to the resolution of market failures or to the achievement of some dimension of social equity). The debate however has ignored another important negative e¤ect of State aid: governments, by setting up aid schemes to ailing firms, may increase the likelihood of (tacit) collusion in an industry characterised by idiosyncratic shocks. Indeed, in a repeated-game setting, a systematic bailout regime increases the expected profits of a firm from cooperation and simultaneously raises the probability that competitors will still be in business to carry out punishment against cheaters. Despite the generality of the model and of its key insight, we study this problem through an application to the banking sector, as it has recently been subject of much attention within the context of the ongoing economic crisis.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2009/36.

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Date of creation: 2009
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Handle: RePEc:eui:euiwps:eco2009/36

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Keywords: Subsidies; dynamic oligopoly; government policy; banking;

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  1. Perotti, Enrico C & Suarez, Javier, 2001. "Last Bank Standing: What Do I Gain if You Fail?," CEPR Discussion Papers 2933, C.E.P.R. Discussion Papers.
  2. Mathias Dewatripont & Paul Seabright, 2006. "Wasteful public spending and state aid control," ULB Institutional Repository 2013/9635, ULB -- Universite Libre de Bruxelles.
  3. Martin Stephen & Valbonesi Paola, 2008. "Equilibrium State Aid in Integrating Markets," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 8(1), pages 1-39, August.
  4. Repullo, Rafael, 2004. "Capital requirements, market power, and risk-taking in banking," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 156-182, April.
  5. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  6. 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.
  7. Franklin Allen & Douglas Gale, 2004. "Competition and financial stability," Proceedings, Federal Reserve Bank of Cleveland, pages 453-486.
  8. Timothy Besley & Paul Seabright, 1999. "The effects and policy implications of state aids to industry: an economic analysis," Economic Policy, CEPR & CES & MSH, vol. 14(28), pages 13-53, 04.
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