Dundee Discussion Papers in Economics 296: Selection, Trade, and Employment: The Strategic Use of Subsidies

We study how the interaction between economic openness and competitive selection affects the effectiveness of employment and entry subsidisation. Within a heterogeneous-firms model with endogenous labour supply, optimal employment subsidies are shown to have pro- or anti-competitive effects on industry selection depending on whether the economy is open or not. Selection effects resulting from international competition and fiscal externalities imply that non-cooperative policies may entail under-subsidisation of employment. Entry subsidies always have pro-competitive selection effects on the industry, but are shown to be less effective in raising employment and welfare than employment subsidies.