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Subsidizing Firm Entry in Open Economies

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Author Info

  • Pflüger, Michael P.

    ()
    (University of Würzburg)

  • Suedekum, Jens

    ()
    (Heinrich Heine University Düsseldorf)

Abstract

Entrepreneurs who decide to enter an industry are faced with different levels of effective entry costs in different countries. These costs are heavily influenced by economic policy. What is not well understood is how international trade affects the government incentive to impact on entry costs, and how entry subsidies can be used strategically in open economies. We present a general equilibrium model of monopolistic competition with two (potentially) asymmetric countries and heterogeneous firms where government subsidizes entry of domestic entrepreneurs. Under autarky the entry subsidy indirectly corrects for the monopoly pricing distortion. In the autarky equilibrium these subsidies trigger entry, but they eventually do not lead to more but to better firms in the market. In the open economy there is another, strategic motive for entry subsidies as the tightening of domestic market selection also affects exporting decisions for domestic and foreign firms. Our analysis shows that entry subsidies in the Nash-equilibrium are first increasing, then decreasing in the level of trade openness. This implies a U-shaped relationship between openness and effective entry costs. Merging cross-country data on entry costs with international trade openness indices we empirically confirm this theoretical prediction.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4384.

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Length: 35 pages
Date of creation: Aug 2009
Date of revision:
Publication status: published in: Journal of Public Economics, 2013, 97 (1), 258-271
Handle: RePEc:iza:izadps:dp4384

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Keywords: strategic trade policy; firm entry; subsidies; heterogeneous firms; international trade; monopolistic competition; entry regulation;

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Cited by:
  1. Felbermayr, Gabriel & Jung, Benjamin & Larch, Mario, 2013. "Optimal tariffs, retaliation, and the welfare loss from tariff wars in the Melitz model," Munich Reprints in Economics 20591, University of Munich, Department of Economics.
  2. Anna Bohnstedt, 2014. "Are Public and Private R&D Investments Complements or Substitutes?," Ruhr Economic Papers 0485, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  3. Dominika Langenmayr & Andreas Haufler & Christian Josef Bauer, 2012. "Should Tax Policy Favor High- or Low-Productivity Firms?," CESifo Working Paper Series 4034, CESifo Group Munich.
  4. Bohnstedt, Anna & Schwarz, Christian & Suedekum, Jens, 2012. "Globalization and strategic research investments," Research Policy, Elsevier, vol. 41(1), pages 13-23.
  5. Christian Bauer & Ronald B. Davies & Andreas Haufler, 2011. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Working Papers 1114, Oxford University Centre for Business Taxation.
  6. von Ehrlich, Maximilian & Seidel, Tobias, 2013. "More similar firms — More similar regions? On the role of firm heterogeneity for agglomeration," Regional Science and Urban Economics, Elsevier, vol. 43(3), pages 539-548.
  7. Michael Pflüger & Stephan Russek, 2013. "Business Conditions and Exit Risks Across Countries," Open Economies Review, Springer, vol. 24(5), pages 963-976, November.
  8. Hartmut Egger & Josef Falkinger, 2013. "Limited Consumer Attention in International Trade," CESifo Working Paper Series 4166, CESifo Group Munich.
  9. Maximilian Von Ehrlich & Tobias Seidel, 2013. "Regional Implications of Financial Market Development: Credit Rationing, Trade, and Location," CESifo Working Paper Series 4063, CESifo Group Munich.
  10. Kammerer, Hannes, 2013. "Lobbying for Subsidies with Heterogeneous Firms," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79767, Verein für Socialpolitik / German Economic Association.

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