Why Avoiding Deindustrialization via Subsidies May Trigger a Subsidy Trap and Slow Down Green Investments

Markus Dertwinkel-Kalt, Anna Ressi and Christian Wey

No 12012, CESifo Working Paper Series from CESifo

Abstract: To counter the threat of deindustrialization due to soaring energy prices and facilitate a green transition, policymakers have devised new subsidy schemes such as the "bridge electricity price" (BEP). To analyze this, we develop a model, where the principal introduces a subsidy program to prevent the agent from exiting and facilitate green investments, which would end the agent's reliance on the subsidy. We demonstrate that, while successfully mitigating deindustrialization, the subsidy can lead to unintended consequences. First, the principal's commitment problem can lower investment incentives and lead to the subsidy program being everlasting. Second, it can induce a "subsidy trap'", drawing non-targeted agents into the subsidy scheme. Lastly, it can reinforce the exit problem it intended to solve by encouraging opportunistic investments. When applying our results to the BEP, we conclude that the fiscal costs of this subsidy could, therefore, far exceed initial projections.

Keywords: deindustrialization; bridge electricity price; electrification; green transition; subsidy trap (search for similar items in EconPapers)
JEL-codes: D04 L11 L50 (search for similar items in EconPapers)
Date: 2025
New Economics Papers: this item is included in nep-cta
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_12012

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