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Inefficient Lock‐In And Subsidy Competition

  • Rainald Borck
  • Hyun‐Ju Koh
  • Michael Pflüger

This paper shows that subsidy competition may be efficiency enhancing. We model a subsidy game among two asymmetric regions in a new trade model, where capital can freely move among regions, but capital rewards are repatriated. We study subsidy competition, starting from an equilibrium where the industry core is ineffi- ciently locked in to the smaller region. When regions weigh workers' and capitalists' welfare equally, the core region will set its subsidy low enough that the industry re- locates to the larger region, restoring an efficient allocation. When workers' welfare is weighted more heavily, the core may pay subsidies that are high enough to prevent a relocation of industry.

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File URL: http://hdl.handle.net/10.1111/j.1468-2354.2012.00716.x
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Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 53 (2012)
Issue (Month): 4 (November)
Pages: 1179-1204

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Handle: RePEc:wly:iecrev:v:53:y:2012:i:4:p:1179-1204
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