Subsidizing business entry in competitive credit markets

Vincenzo Cuciniello, Claudio Michelacci () and Luigi Paciello ()
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Claudio Michelacci: EIEF
Luigi Paciello: EIEF

No 1424, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: Business creation subsidies are a means for reducing firm debt and bankruptcy risk. Do they work? To answer the question, we consider a general equilibrium model where firms are financially constrained at entry and borrow in a competitive market by issuing long-term debt. A subsidy stimulates entry and market competition, which increases the bankruptcy rate of incumbent firms. If the subsidy is paid out ex ante to finance start-up expenditures, the subsidy reduces the debt and the bankruptcy rate of start-ups; if paid out ex post as a refund for start-up expenditures, the subsidy crowds out the equity rather than the debt of start-ups and their bankruptcy rate also increases. The model is calibrated to match North-South differences across Italian provinces. The optimal subsidy in the South is paid out entirely ex ante and yields an increase in welfare equivalent to almost one percent of consumption. When the same subsidy is paid out ex post as a proportion of 60 per cent, it results in a welfare loss of a similar amount. We discuss the implications for the ‘I Stay in the South’ policy recently introduced in Italy.

Keywords: Firm dynamics; overborrowing; ratchet effect (search for similar items in EconPapers)
JEL-codes: E44 E62 G32 G33 (search for similar items in EconPapers)
Date: 2023-10
New Economics Papers: this item is included in nep-cfn, nep-com, nep-dge, nep-ent, nep-fdg, nep-inv and nep-sbm
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