Inefficient Lock-In and Subsidy Competition

37 Pages Posted: 25 Mar 2009

See all articles by Rainald Borck

Rainald Borck

Humboldt University of Berlin - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Hyun-Ju Koh

Ludwig Maximilian University of Munich (LMU)

Michael Pflüger

University of Passau; IZA Institute of Labor Economics; German Institute for Economic Research (DIW Berlin)

Date Written: March 2009

Abstract

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 inefficiently 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 relocates 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.

Keywords: agglomeration, asymmetric regions, subsidy competition

JEL Classification: F12, F15, H25, H73, R12

Suggested Citation

Borck, Rainald and Koh, Hyun-Ju and Pflüger, Michael, Inefficient Lock-In and Subsidy Competition (March 2009). CESifo Working Paper Series No. 2592, Available at SSRN: https://ssrn.com/abstract=1368115 or http://dx.doi.org/10.2139/ssrn.1368115

Rainald Borck (Contact Author)

Humboldt University of Berlin - Faculty of Economics ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Hyun-Ju Koh

Ludwig Maximilian University of Munich (LMU) ( email )

Geschwister-Scholl-Platz 1
Munich, DE Bavaria 80539
Germany

Michael Pflüger

University of Passau ( email )

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Passau, 94032
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

German Institute for Economic Research (DIW Berlin)

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Berlin, 10117
Germany

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