Industrial Policy
State aids

Models of policy-making based on the `public interest' and `Leviathan' approaches maintain respectively that governments intervene only to address particular market failures or to pursue their own goals while subject to capture by interest groups. Real world outcomes involve both motivations, however. In Discussion Paper No. 945, Programme Director Damien Neven investigates the pattern of state aids to manufacturing in the European Union and relates them to the characteristics of political institutions and regimes. If politicians seek to retain the support of the constituencies with which they are associated, `right-wing' governments may be expected to grant more state aids than `left-wing' ones, which may also tend to rise before elections and when the ruling government is relatively weak. While theories of government emphasizing politicians' incentives and the role of institutions tend to focus on the `supply' side of government policies, the characteristics of the interest groups also matter, so a higher concentration of firms should be associated with more effective lobbying and a higher level of state aids. If transparency in decision-making reduces the scope for political capture, state aids may be higher when the procedures governing their allocation are relatively opaque.

Neven evaluates these presumptions by estimating regressions in which the intensity of state aids depends on the weakness of governments, their ideological orientation, the concentration of industry and the timing of elections. His results indicate that fractionalization of political parties, `right-wing' governments and higher concentrations of firms' interests are all associated with higher state aids. The timing of elections appears not to matter in general, although there are significant effects in individual countries; evidence on the transparency of allocation and control procedures in certain countries suggests that they may also enhance scope for capture. While this simple approach may be criticized on a number of grounds, it is striking that these characteristics of political institutions and regimes account for some 90% of the variance in the sample, which suggests that politics significantly determine the allocation of state aids.

The Political Economy of State Aids in the European Community: Some Econometric Evidence
Damien Neven

Discussion Paper No. 945, April 1994 (IO)