Author(s)
Source
Working Paper, Stanford University, 2011; presented at the 2011 TNIT Conference
Summary
The authors use a model to suggest which sorts of industrial subsidies encourage growth.
Policy Relevance
Supporting new firms and subsidizing research costs will effect economic growth, but broadly providing subsidies to existing firms will decrease an economy’s efficiency.
Main Points
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Many countries provide subsidies to large incumbent firms.
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In the aftermath of the 2008 recession, the US spent $82 billion dollars to prevent GM and Chrysler from collapsing.
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EU nations often support large “national champions” with enormous subsidies.
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It’s hard to predict from theory whether subsidies will increase growth rates.
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Maybe subsidies will encourage existing firms to invest in research and capital goods like factories, and to hire or retain workers.
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On the other hand, subsidies to existing firms might prevent the emergence of efficient new firms and insulate existing firms from the need to innovate to stay competitive.
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The authors create a mathematical model of the U.S. economy with diverse firms that make investment decisions. Then, they impose different subsidy policies and report how the economy reacts.
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A 10% subsidy to new firms increases the economy’s growth rate from 3.3% annually to 3.5%, as more-efficient firms are able to get a foothold in the market.
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A 10% subsidy to the research expenditures of existing firms increases the economy’s growth rate from 3.3% to 3.8%, but is much more expensive than subsidizing new entrants.
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Subsidizing the fixed costs—the costs incurred by firms that are necessary for the firm to operate, and usually unrelated to research—reduces growth rates and lowers the quality of firms in the economy.
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The poor performance of fixed cost subsidies is a consequence of inefficient firms being protected from competition.