Working Paper: CEPR ID: DP3797
Authors: Micael Castanheira
Abstract: We develop a general equilibrium model that jointly considers the influence of capital accumulation constraints and of labour market frictions on the process of transition. We endogenize the economic and budgetary costs of different government policies and show that, early in transition, governments ought to subsidize state firms. Provided that inter-temporal commitment is feasible, this policy limits the initial output fall, which relaxes capital accumulation constraints, accelerates transition, and increases welfare. Moreover, by resorting to indirect — instead of direct — taxes, governments can bring the path of transition closer to the first best. Yet, political pressures may induce a policy of excessive subsidization.
Keywords: subsidies; transition
JEL Codes: H20; P20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government subsidy policy (H20) | Output levels (Y10) |
| Output levels (Y10) | Transition speed (J62) |
| Government subsidy policy (H20) | Capital accumulation constraints (E22) |
| Capital accumulation constraints (E22) | Transition speed (J62) |
| Tax policy (H29) | Transition speed (J62) |
| Political pressures (D72) | Efficiency of transition policies (J68) |
| Efficiency of transition policies (J68) | Aggregate welfare (E10) |