Subsidizing Firm Entry in Open Economies

35 Pages Posted: 15 Oct 2009

See all articles by Michael Pflüger

Michael Pflüger

University of Passau; IZA Institute of Labor Economics; German Institute for Economic Research (DIW Berlin)

Jens Suedekum

Heinrich-Heine-University Duesseldorf, Duesseldorf Institute for Competition Economics (DICE); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Institute for the Study of Labor (IZA)

Abstract

Entrepreneurs who decide to enter an industry are faced with different levels of effective entry costs in different countries. These costs are heavily influenced by economic policy. What is not well understood is how international trade affects the government incentive to impact on entry costs, and how entry subsidies can be used strategically in open economies. We present a general equilibrium model of monopolistic competition with two (potentially) asymmetric countries and heterogeneous firms where government subsidizes entry of domestic entrepreneurs. Under autarky the entry subsidy indirectly corrects for the monopoly pricing distortion. In the autarky equilibrium these subsidies trigger entry, but they eventually do not lead to more but to better firms in the market. In the open economy there is another, strategic motive for entry subsidies as the tightening of domestic market selection also affects exporting decisions for domestic and foreign firms. Our analysis shows that entry subsidies in the Nash-equilibrium are first increasing, then decreasing in the level of trade openness. This implies a U-shaped relationship between openness and effective entry costs. Merging cross-country data on entry costs with international trade openness indices we empirically confirm this theoretical prediction.

Keywords: firm entry, subsidies, heterogeneous firms, international trade, monopolistic competition, entry regulation, strategic trade policy

JEL Classification: F12, F13, H25, L11

Suggested Citation

Pflüger, Michael and Südekum, Jens, Subsidizing Firm Entry in Open Economies. IZA Discussion Paper No. 4384, Available at SSRN: https://ssrn.com/abstract=1489207

Michael Pflüger (Contact Author)

University of Passau ( email )

Innstrasse 27
Passau, 94032
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

German Institute for Economic Research (DIW Berlin)

Mohrenstrasse 58
Berlin, 10117
Germany

Jens Südekum

Heinrich-Heine-University Duesseldorf, Duesseldorf Institute for Competition Economics (DICE) ( email )

Universitaetsstr. 1
Duesseldorf, NRW 40225
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Institute for the Study of Labor (IZA)

P.O. Box 7240
Bonn, D-53072
Germany

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