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public expenditure composition

Recherches Économiques de Louvain/ Louvain Economic Review (1)

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Trade integration and the destination of subsidies 1
Nelly Exbrayat, Carl Gaigné, Stéphane Riou
Journal:

Recherches Économiques de Louvain/ Louvain Economic Review / Volume 75 / Issue 4 / December 2009

Published online by Cambridge University Press:

17 August 2016, pp. 407-423

Print publication:

December 2009
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We build a model of trade and location with two countries which differ with respect to their level of productivity. Public spending has two possible allocations: a direct subsidy to immobile households or a wage subsidy to mobile firms. We show that firms receive a lower net of tax subsidy in the high-productivity country than in the low-productivity one. Despite this less generous policy, the former country can host a larger share of firms, so that its total spending for firms can be higher than in the low-productivity country when trade costs are low enough. The welfare analysis suggests that the second-best optimum requires an increase in the subsidy to households in both countries when the economies are weakly integrated or the productivity gap is low or the share of capital incomes redistributed outside the two economies is high.