Optimal fixed cost subsidies in Melitz-type models
This paper analyzes the reallocation and welfare effects of fixed cost subsidies in a Melitz-type model. In a closed economy, the planner trades off product variety and average productivity effects. Neither subsidies on entry fixed costs nor on operating fixed costs are welfare enhancing. These results reflect the Pareto optimality of the laissez faire equilibrium. In a “small” open economy à la Demidova and Rodríguez-Clare (J Int Econ 78(1):100–112, 2009), an entry fixed cost subsidy does not enhance welfare, while a small operating fixed cost subsidy does. Only the latter affects the relative attractiveness of exporting. The average firm thus realloactes labor from export to domestic activity and operates at a smaller scale, which allows for a larger increase in domestic product variety than in the closed economy.
KeywordsMonopolistic competition Heterogeneous firms Industrial policy Subsidies
JEL-ClassificationF12 F13 H25
I thank Hartmut Egger, Gabriel Felbermayr, Wilhelm Kohler, Mario Larch, Philip Schröder, Marcel Smolka, and Jens Südekum for stimulating discussions, and participants at the Annual Meetings of the Austrian Economic Association in Vienna, the Swiss Society of Economics and Statistics in Fribourg, the European Economic Association in Glasgow, and the European Trade Study Group in Lausanne for helpful comments. All remaining errors are mine.
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