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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)

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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
Paper provided by Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies in its series Working Papers IES with number 2009/14.

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Length: 21 pages
Date of creation: Mar 2009
Date of revision: Mar 2009
Handle: RePEc:fau:wpaper:wp2009_14

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Related research
Keywords: state aid; signaling; career concerns; aid control;

Other versions of this item:

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

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References listed on IDEAS
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    Other versions:
  2. Candel-Sanchez, Francisco, 2007. "Incentives for budget discipline in the presence of elections," European Journal of Political Economy, Elsevier, vol. 23(4), pages 863-884, December. [Downloadable!] (restricted)
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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)
  5. Kenneth Rogoff, 1990. "Equilibrium Political Budget Cycles," NBER Working Papers 2428, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. 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. [Downloadable!] (restricted)
  7. Adi Brender & Allan Drazen, 2008. "How Do Budget Deficits and Economic Growth Affect Reelection Prospects? Evidence from a Large Panel of Countries," American Economic Review, American Economic Association, vol. 98(5), pages 2203-20, December. [Downloadable!]
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