Firms’ location decisions, supply chain disruptions and government subsidies: A dynamic game

Abstract

This paper develops a dynamic game to study the interaction between firms’ production location decisions and a government subsidy policy. On the one hand, firms consider the cost of shielding their production capacity from (potential) supply chain disruptions. On the other hand, the government is interested in curbing production offshoring to increase domestic tax revenues. The location decision of each firm is affected by the government subsidy policy and the location choices of other firms, while the share of firms producing domestically influences the government’s decision on whether and to what extent to provide subsidies to firms. We show that government subsidy policy must target a sufficiently large number of firms to encourage production reshoring and achieve the Pareto-efficient equilibrium. However, a subsidy policy providing a high number of low subsidies is likely to be ineffective in increasing domestic production, highlighting the importance of careful fine-tuning of the policy. Finally, in some scenarios, industrial policy becomes crucial to increase the resilience of domestic supply chains and foster reshoring.