Entry Policy and Entry Subsidies

Authors:
James D. Reitzes and Oliver R. Grawe
Working Paper:
212

This paper provides a theory that explains why government allow free entry and selectively promote entry under certain conditions and deter entry under other conditions. The analysis also identifies conditions under which optimal policy requires that large-scale entry is freely permitted and small-scale entry is deterred. In our model, policymakers use entry policy to strategically shift rents away from foreign producers toward domestic producers and consumers.  Since it may be socially beneficial to subsidize entry by both domestic and foreign firms, we explore the optimal means of promoting entry under complete and incomplete information concerning the entrant's marginal and fixed costs. Under complete information, welfare can be maximized by a two-part subsidy mechanism consisting of a per-unit output subsidy in combination with a lump-sum subsidy or tax. Under incomplete information, the policymaker has incentive to treat domestic and foreign entry differently in setting an optimal entry subsidy. With respect to domestic entry, the policymaker can eliminate any potential welfare losses due to incomplete information if the entrant can be induced to act as a Stackelberg leader. Otherwise, the policymaker may undersubsidize domestic entrants with high marginal costs and oversubsidize entrants with low marginal costs. In the case of foreign entry, the presence of incomplete information implies that entry is undersubsidized.