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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

Suggested Citation

  • Mario Mariniello, 2013. "Should Variable Cost Aid to Attract Foreign Direct Investment be Banned? A European Perspective," Journal of Industry, Competition and Trade, Springer, vol. 13(2), pages 273-308, June.
  • Handle: RePEc:kap:jincot:v:13:y:2013:i:2:p:273-308
    DOI: 10.1007/s10842-011-0124-3
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    References listed on IDEAS

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    1. Motta,Massimo, 2004. "Competition Policy," Cambridge Books, Cambridge University Press, number 9780521016919.
    2. 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.
    3. Feldstein, Martin, 1997. "How Big Should Government Be?," National Tax Journal, National Tax Association, vol. 50(2), pages 197-213, June.
    4. 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.
    5. Barros, Pedro P & Cabral, Luis, 2000. "Competing for Foreign Direct Investment," Review of International Economics, Wiley Blackwell, vol. 8(2), pages 360-371, May.
    6. 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.
    7. Krugman, Paul R, 1987. "Is Free Trade Passe?," Journal of Economic Perspectives, American Economic Association, vol. 1(2), pages 131-144, Fall.
    8. Dermot Leahy & J. Neary, 2009. "Multilateral subsidy games," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 41(1), pages 41-66, October.
    9. 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.
    10. Rchard Schmalensee, 2004. "Sunk Costs and Antitrust Barriers to Entry," American Economic Review, American Economic Association, vol. 94(2), pages 471-475, May.
    11. Feldstein, Martin, 1997. "How Big Should Government Be?," National Tax Journal, National Tax Association, vol. 50(2), pages 197-213, June.
    12. 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.
    13. Feldstein, Martin, 1997. "How Big Should Government Be?," Scholarly Articles 3043427, Harvard University Department of Economics.
    14. 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.
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    More about this item

    Keywords

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

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L40 - Industrial Organization - - Antitrust Issues and Policies - - - General
    • L53 - Industrial Organization - - Regulation and Industrial Policy - - - Enterprise Policy

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