Why Avoiding Deindustrialization via Subsidies May Trigger a Subsidy Trap and Slow Down Green Investments

To counter the threat of deindustrialization due to soaring energy prices and facilitate a green transition, policymakers have devised new subsidy schemes such as the "bridge electricity price" (BEP). To analyze this, we develop a model, where the principal introduces a subsidy program to prevent the agent from exiting and facilitate green investments, which would end the agent's reliance on the subsidy. We demonstrate that, while successfully mitigating deindustrialization, the subsidy can lead to unintended consequences. First, the principal's commitment problem can lower investment incentives and lead to the subsidy program being everlasting. Second, it can induce a "subsidy trap'", drawing non-targeted agents into the subsidy scheme. Lastly, it can reinforce the exit problem it intended to solve by encouraging opportunistic investments. When applying our results to the BEP, we conclude that the fiscal costs of this subsidy could, therefore, far exceed initial projections.