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Intergenerational and International Welfare Leakages of a Product Subsidy in a Small Open Economy

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  • Leon Bettendorf
  • Ben Heijdra

Abstract

A dynamic overlapping-generations model of a small open economy with monopolistic competition in the goods market is constructed. Lump-sum tax-financed product subsidization boosts output and employment both in the impact period and in the new steady state. The real exchange rate depreciates in the long run but the impact effect is ambiguous. If the labour supply effect is weak and the economy is not very open, the exchange rate appreciates at impact. The policy has important intergenerational distribution effects. Old existing generations gain more than younger existing generations as well as future generations. The bond policy which neutralizes the intergenerational inequities allows the computation of an optimal product subsidy which depends positively on the extent of the domestic scale economies and negatively on the degree of openness of the economy. Copyright Kluwer Academic Publishers 2001

Suggested Citation

  • Leon Bettendorf & Ben Heijdra, 2001. "Intergenerational and International Welfare Leakages of a Product Subsidy in a Small Open Economy," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 8(5), pages 705-729, November.
    • Handle: RePEc:kap:itaxpf:v:8:y:2001:i:5:p:705-729
    DOI: 10.1023/A:1012891110164
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    Cited by:

    1. Ben J. Heijdra & Ward E. Romp, 2008. "A life-cycle overlapping-generations model of the small open economy," Oxford Economic Papers, Oxford University Press, vol. 60(1), pages 88-121, January.

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