Equilibrium Effects of Firm Subsidies

Abstract

Subsidy programs have two countervailing effects on firms: direct gains for eligible firms and indirect losses for those whose competitors are eligible. In 2006, India changed the eligibility criteria for small-firm subsidies, and the sales of newly eligible firms grew by roughly 35 percent. Competitors of the newly eligible firms were affected, with almost complete crowd-out within products that were less internationally traded, but little crowd-out for more-traded products. The newly eligible firms had relatively high marginal products, so relaxing the eligibility criteria for subsidies increased aggregate productivity by around 1−2 percent. Targeting different firms could have led to similar gains. (JEL D22, D24, H25, L25, L52, L60, O14)