State aid and tacit collusion

Christoph Bertsch, Claudio Calcagno and Mark Le Quement

No ECO2009/36, Economics Working Papers from European University Institute

Abstract: Both literature and policy debate on State aid or government subsidies have focused on the trade-off between the potential ine¢ ciencies caused by state intervention (inefficient allocation of resources, moral hazard) and the potential gains from intervention (whether related to the resolution of market failures or to the achievement of some dimension of social equity). The debate however has ignored another important negative e¤ect of State aid: governments, by setting up aid schemes to ailing firms, may increase the likelihood of (tacit) collusion in an industry characterised by idiosyncratic shocks. Indeed, in a repeated-game setting, a systematic bailout regime increases the expected profits of a firm from cooperation and simultaneously raises the probability that competitors will still be in business to carry out punishment against cheaters. Despite the generality of the model and of its key insight, we study this problem through an application to the banking sector, as it has recently been subject of much attention within the context of the ongoing economic crisis.

Keywords: Subsidies; dynamic oligopoly; government policy; banking (search for similar items in EconPapers)
JEL-codes: D43 G21 K21 L41 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-com and nep-mic
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