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Subsidy Competition, Imperfect Labor Market, and Endogenous Entry of Firms

Tadashi Morita (), Yukiko Sawada and Kazuhiro Yamamoto

Discussion papers from Research Institute of Economy, Trade and Industry (RIETI)

Abstract: This paper constructs a model of subsidy competition for manufacturing firms under the existence of labor market imperfection. Because subsidies affect the distribution of firms, they also affect unemployment rates, the number of firms, and welfare. In our model, governments invariably give inefficiently high rates of subsidy to manufacturing firms. When the labor market friction is large, subsidy competition is beneficial, although subsidies under subsidy competition are inefficiently high. We show that the increase in the labor market friction invariably lowers welfare, while trade liberalization always improves welfare. Finally, we study the effect of the increase in labor market friction in a country. The rise of labor market friction in a country raises the equilibrium subsidy rate, raises or lowers the unemployment rate, and lowers the welfare of this country.

Date: 2016-10
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