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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://www.bgpe.de/texte/DP/070_koh.pdf
File Function: First version, 2009
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Paper provided by Bavarian Graduate Program in Economics (BGPE) in its series Working Papers with number 070.

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Length: 33 pages
Date of creation: Mar 2009
Date of revision:
Handle: RePEc:bav:wpaper:070_koh
Contact details of provider: Web page: http://www.bgpe.de/
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