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

See all articles by Dalibor Rohac

Dalibor Rohac

Legatum Institute; King's College London

Martin Gregor

Charles University, Prague

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

Rohac, Dalibor and Gregor, Martin, The Optimal State Aid Control: No Control (May 24, 2009). Czech Economic Review, Vol. 3, No. 1, pp. 93-113, 2009, Available at SSRN: https://ssrn.com/abstract=1409420

Dalibor Rohac

Legatum Institute ( email )

11 Charles Street
Mayfair, London, London W1J 5DW
United Kingdom

King's College London ( email )

Strand
London, England WC2R 2LS
United Kingdom
07585303666 (Phone)

Martin Gregor (Contact Author)

Charles University, Prague ( email )

Institute of Economic Studies
Opletalova 26
Prague, 11000
Czech Republic

HOME PAGE: http://ies.fsv.cuni.cz/en/staff/gregor

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