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State Aid to Attract FDI and the European Competition Policy: Should Variable Cost Aid Be Banned?

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Listed author(s):
  • Mario Mariniello

Abstract

The purpose of this paper is to analyze the European Commission's approach to state aid for foreign direct investment in a competition policy framework. The Commission shows to consider 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 a first-best strategy for a rational Authority maximizing welfare. The model shows that a rational forward-looking government maximizing domestic welfare always prefers VCA to FCA if both the incumbent and the entrant are foreign firms and if granting VCA does not cause to the incumbent firm to exit the market. On the other hand, a VCA which causes the incumbent firm to be crowded out by the entrant never occurs at the equilibrium. The model shows that the Commission's approach may lead to sub-optimal equilibria where market competition and consumers.welfare are not maximized.

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Paper provided by European University Institute in its series Economics Working Papers with number ECO2006/41.

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Date of creation: 2006
Handle: RePEc:eui:euiwps:eco2006/41
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Keywords: state aid; competition policy; start-up aid; variable cost aid;

Find related papers by 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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  1. Motta,Massimo, 2004. "Competition Policy," Cambridge Books, Cambridge University Press, number 9780521016919, November.
  2. Fumagalli, Chiara, 2003. "On the welfare effects of competition for foreign direct investments," European Economic Review, Elsevier, vol. 47(6), pages 963-983, December.
  3. 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.
  4. Markusen, James R. & Venables, Anthony J., 1999. "Foreign direct investment as a catalyst for industrial development," European Economic Review, Elsevier, vol. 43(2), pages 335-356, February.
  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. Rchard Schmalensee, 2004. "Sunk Costs and Antitrust Barriers to Entry," American Economic Review, American Economic Association, vol. 94(2), pages 471-475, May.
  8. David R Collie, 2005. "State aid to investment and R&D," European Economy - Economic Papers 2008 - 2015 231, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
  9. 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.
  10. David Collie, 2002. "Prohibiting State Aid in an Integrated Market: Cournot and Bertrand Oligopolies with Differentiated Products," Journal of Industry, Competition and Trade, Springer, vol. 2(3), pages 215-231, September.
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Cited by:

  1. Kolesnikova Irina, 2010. "State Aid for Industrial Enterprises in Belarus: Remedy or Poison?," EERC Working Paper Series 10/01e, EERC Research Network, Russia and CIS.
  2. 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.
  3. Kolesnikova, Irina, 2010. "State Aid for Industrial Enterprises in Belarus: Remedy or Poison?," MPRA Paper 22403, University Library of Munich, Germany.

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