Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/83363
Authors: 
Gregor, Martin
Roháč, Dalibor
Year of Publication: 
2009
Series/Report no.: 
IES Working Paper 14/2009
Abstract: 
We extend a model of wasteful state aid in Dewatripont and Seabright (2006, Journal of the European Economic Association 4, 513-522) by a supranational controlling authority. The model combines moral hazard and adverse selection to show that politicians fund wasteful projects to signal their effort. Voters, unable to observe project benefits or effort, reward funding with a reelection premium that separates a high-effort politician from a low-effort politician. We examine state aid control by a benevolent authority which receives extra signals about the state of the world. We find that signals on the politician type are worthless. For signals on the project type, we derive a sufficient condition for aid control to unambiguously decrease welfare. We also prove that politicians do not respond to marginal changes in incentives. In this setup, the optimal state aid control is fairly often no control.
Subjects: 
state aid
signaling
career concerns
aid control
JEL: 
D72
D78
D82
H25
Document Type: 
Working Paper
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