Subsidies, the Shadow of Death and Labor Productivity

Journal of Industry, Competition and Trade, Vol. 15, Issue 2, pp 189-204

Our panel data from over 10,000 Finnish firms during the years 2003–2010 elucidates the effect of different business subsidies on firm productivity performance and on the relationship between firms’ lagged labor productivity and market exit. We find that none of the subsidy types have statistically significant positive short-term or longer-term impacts on the firms’ labor productivity. It appears that employment and investment subsidies, in particular, tend to be allocated to relatively less efficient companies. We further observe that declines in the firm’s lagged labor productivity levels are clearly more weakly related to the subsidized firms’ exit than to the exit of firms that have not received any subsidies. Our empirical findings thus suggest that the allocation of subsidies to relatively inefficient firms increases their liquidity, making their market exit less likely than it would be otherwise. In other words, our data indicate that subsidy allocation weakens the shadow of death phenomenon observed in the previous empirical studies and hinders the process of creative destruction in the economy.

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