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The Optimal State Aid Control: No Control

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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.

Suggested Citation

  • Martin Gregor & Dalibor Roháč, 2009. "The Optimal State Aid Control: No Control," Czech Economic Review, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, vol. 3(1), pages 093-113, March.
    • Handle: RePEc:fau:aucocz:au2009_093
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    More about this item

    Keywords

    State aid; signaling; career concerns; aid control;
    All these keywords.

    JEL classification:

    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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