Should foreign producers oppose domestic state aid?

Abstract

Can subsidies to domestic producers, de facto, be subsidies to foreign producers? If so, state aid may distort competition to the advantage of the foreign producers. At the same time, governments often oppose subsidies elsewhere, claiming that their industry is hurt. The possibility that governments fight subsidies on these grounds, although the effects are to the contrary, constitutes what is called ‘the state aid paradox’ that is discussed throughout the paper. The dispute over regionally differentiated payroll tax rates between Norway and the surveillance authority of the European Free Trade Association (ESA) is used as a motivating example. The dispute is analysed by means of a simple general equilibrium model. The approach is partly analytical and partly numerical. There are three regions represented in the model: the assisted periphery, the assisting core, and the world outside, interpreted here as the European Union (EU). It will be demonstrated that although the assisted periphery will be losing market shares if state aid is ended, so will possibly EU in all markets.