Preventing Deindustrialization through Energy Price Subsidies: A Principal-Agent Model

Abstract

To counter the threat of deindustrialization due to soaring energy prices and facilitate a green transition, German politicians are deliberating on the implementation of a novel subsidy termed the "bridge electricity price" (BEP)-a capped electricity price for large-scale industrial companies. To analyze such policies, we develop a principal-agent model, where the principal (government) introduces a subsidy program to prevent the agent (firm) from exiting the domestic market. At the same time, it wants the agent to invest in a green transition, which would end the agent's reliance on the subsidy. We demonstrate that, while successfully mitigating the threat of deindustrialization, the subsidy can lead to unintended consequences. First, the principal's commitment problem can frustrate investment incentives and lead to the subsidy program being everlasting. Second, it can induce a "subsidy trap", drawing non-targeted agents into the subsidy scheme. Lastly, it can reinforce the exit problem it intended to solve by encouraging opportunistic investments. When applying our results to the BEP, we conclude that the fiscal costs of this subsidy could, therefore, far exceed initial projections.

Keywords: JEL-Classification: D04, L11, L50 Principal-agent model, deindustrialization, bridge electricity price, electrification, green transition, subsidy trap

JEL Classification: D04, L11, L50