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

Posted: 15 Jan 2002

See all articles by Leon J.H. Bettendorf

Leon J.H. Bettendorf

Erasmus University Rotterdam (EUR)

Ben J. Heijdra

University of Groningen - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

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.

Keywords: Monopolistic competition, love of variety, returns to scale, international trade, industrial policy, intergenerational welfare effects

Suggested Citation

Bettendorf, Leon J.H. and Heijdra, Ben J., Intergenerational and International Welfare Leakages of a Product Subsidy in a Small Open Economy. Available at SSRN: https://ssrn.com/abstract=296580

Leon J.H. Bettendorf (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 4081808 (Phone)

Ben J. Heijdra

University of Groningen - Department of Economics ( email )

P.O. Box 800
9700 AV Groningen
Netherlands
+31 50 363 7303 (Phone)
+31 50 363 7337 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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