The political economy of interregional competition for firms

Hopp Daniel, Kriebel Michael

Abstract

This paper studies interregional competition for firms when the bidding is decided upon majority voting. We model the competition as an auction under full information between two asymmetric regions inhabited by low- and high-skilled individuals. We derive two results: First, the location decision is inefficient in most cases, especially when the median voter is high-skilled. Second, winning the auction is harmful for the region if the political process and a strong competition lead to subsidies which exceed the surplus createdby a firm's location. This implies that restricting interregional competitionfor firms, e.g. regulating subsidies, may enhance welfare. Furthermore, our model shows that countries with high redistributive taxes and a low-skilled majority have an advantage to attract foreign firms.