The Optimal State Aid Control: No Control
Czech Economic Review, Vol. 3, No. 1, pp. 93-113, 2009
21 Pages Posted: 25 May 2009 Last revised: 3 Jan 2012
Date Written: May 24, 2009
Abstract
We extend a model of wasteful state aid in Dewatripont and Seabright (2006, Journal of the European Economic Association 4, 513-522) by a supranational controlling authority. The model combines moral hazard and adverse selection to show that politicians fund wasteful projects to signal their effort. Voters, unable to observe project benefits or effort, reward funding with a reelection premium that separates a high-effort politician from a low-effort politician. We examine state aid control by a benevolent authority which receives extra signals about the state of the world. We find that signals on the politician type are worthless. For signals on the project type, we derive a sufficient condition for aid control to unambiguously decrease welfare. We also prove that politicians do not respond to marginal changes in incentives. In this setup, the optimal state aid control is fairly often no control.
Keywords: state aid, signaling, career concerns, aid control
JEL Classification: D72, D78, D82, H25
Suggested Citation: Suggested Citation
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