Competitive selection, trade, and employment: The strategic use of subsidies

Within a heterogeneous-firms model with endogenous labour supply, intra-industry competitive selection is shown to affect the impact of wage (and entry) subsidies. Optimal uniform wage subsidies are always positive even though, by reducing industry selectivity, they lower average productivity. Due to international selection and fiscal externalities, non-cooperative policies entail under-subsidisation of wages. Targeted (domestic-only or export) wage subsidies are dominated from a welfare point of view by a uniform subsidy. Whilst always having an opposite effect on average productivity, an optimal entry subsidy is shown to be less effective than an optimal uniform wage subsidy in raising employment and welfare.