The Optimal State Aid Control: No Control

Martin Gregor () and Dalibor Roháč

Czech Economic Review, 2009, vol. 3, issue 1, 093-113

Abstract: We extend a model of wasteful state aid in Dewatripont and Seabright (2006, Journal of the European Economic Association 4, 513–522) by a supranational controlling authority. The model combines moral hazard and adverse selection to show that politicians fund wasteful projects to signal their effort. Voters, unable to observe project benefits or effort, reward funding with a reelection premium that separates a high-effort politician from a low-effort politician. We examine state aid control by a benevolent authority which receives extra signals about the state of the world. We find that signals on the politician type are worthless. For signals on the project type, we derive a sufficient condition for aid control to unambiguously decrease welfare. We also prove that politicians do not respond to marginal changes in incentives. In this setup, the optimal state aid control is fairly often no control.

Keywords: State aid; signaling; career concerns; aid control (search for similar items in EconPapers)
JEL-codes: D72 D78 D82 H25 (search for similar items in EconPapers)
Date: 2009
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