Subsidies to Poor Regions and Inequalities: Some Unpleasant Arithmetic

Abstract

This paper analyzes the effect of different regional subsidies to poor regions on industrial location, employment, income inequality and welfare in the presence of agglomeration forces when firms are mobile. The impact on location of such subsidies is stronger when trade costs are low. With mobile capital, regional subsidies such as tax breaks in the poor region lead to higher profits for firms in both regions. If financed at the national level, such subsidies given to firms in the poor region increase inequality between and within regions. Finally, with relocation costs, such regional subsidies may hurt the poor region.

JEL Classification: R0, H2, H7