Investment Subsidy

Abstract

Just as it may be optimal to regulate firms that produce negative externalities, it may be optimal to provide subsidy to firms that produce positive externalities. This paper studies the optimal provision of subsidy to maximize the value of these externalities, and also whether there are policy measures that can enhance the welfare of investment subsidy. We consider both first-mover advantages in the market for subsidy (often associated with FDI subsidy) and free riding (often associated with green investment subsidy). We study the factors that influence the timing of investment subsidy, which in our model explains the activity in a given investment subsidy market. If the subsidy is offered early we expect there will be high activity, and conversely if the subsidy tends to be deferred to a later stage we expect there will be low activity. There are policy implications of the model, in particular we discuss an international "taxation" scheme which recovers welfare losses arising from too high or too low activity in the investment subsidy markets.