A Simple Model of Corporate Bailouts in a Globalized Economy*

AuthorThierry Madiès, Nelly Exbrayat, Stéphane Riou
Publication Date01 Oct 2020
Scand. J. of Economics 122(4), 1575–1605, 2020
DOI: 10.1111/sjoe.12397
A Simple Model of Corporate Bailouts in a
Globalized Economy*
Nelly Exbrayat
Universit´e Jean Monnet, Saint-Etienne, F-42023 Saint-Etienne, France
Thierry Madi`es
University of Fribourg, 1700 Fribourg,Switzerland
St´ephane Riou
Universit´e Jean Monnet, Saint-Etienne, F-42023 Saint-Etienne, France
In this paper, we explore how globalization influences the decision of governments to rescue
inefficientdomestic fir ms whenbailouts affect firms’ markup. Wedevelop a model of international
trade in which immobile domestic-owned enterprises (DOEs) compete with foreign-owned
enterprises (FOEs) in an oligopolistic market. The decision to bail out DOEs leads to lower
corporate tax revenues if FOEs are immobile, whereas tax revenues might increase if FOEs are
mobile. Interestingly,the mobility of FOEs makes governments more prone to rescuing inefficient
domestic firms because tax competition reduces the opportunity cost of a bailout policy in terms
of public good provision.
Keywords: Bailout of manufacturing firms; firm mobility; tax competition; trade costs
JEL classification:D21; F12; F15; H25
I. Introduction
There are many examples of governments saving ailing firms from
bankruptcy in recent history. The most emblematic example of private
corporate bailout is certainly the federal bailout of the Big Three US
automakers in 2009, but many rescue plans have been decided in other
*We are grateful to participants at the 3rd SEBA GATE Workshop (Chengde), the 59th Annual
RSAI Conference (Ottawa),the 4th Lisbon Meetings in Game Theory and Applications, the GATE
Workshop on Public Policies and Spatial Economy (Lyon and Saint-Etienne), and seminars in
Dijon, Geneva, and Rennes. Jacques-Fran¸cois Thisse, Carl Gaign´e, Fr´ed ´eric Robert-Nicoud,
ecile Detang Dessendre, Maire-Laure Breuill´e, Simon Lapointe, and Stephanie F¨urer are
acknowledged for helpful comments and suggestions. We are also grateful to two anonymous
referees for providing very useful comments that have significantlyimproved our paper.
The editors of The Scandinavian Journal of Economics 2019.
1576 Corporate bailouts in a globalized economy
countries and industrial sectors over the past decades. It is not only firms
that operate in the private sector that receive bailout money; often bailouts
are offered to state-owned enterprises (SOEs). SOEs have come back to
the foreground as key players in the global economy and are often granted
advantages that can affect export competition.1
Usually, bailouts are granted to firms – public or private – with
structurally high production costs.2With regard to the 2009 US automotive
industry bailout, Goolsbee and Krueger (2015, p. 6) underline that, when
including the legacy costs of retirees, average labor costs for the Big Three
were almost 45 percent higher than for their production plants in foreign
countries. In addition, a surprisingly large share of the labor compensation
for the Big Three automakers represented a fixed cost. There is also a
long-standing body of literature which shows that SOEs are often more
labor-intensive and less efficient than foreign firms operating in the same
sectors (e.g., Dewenter and Malatesta, 2001; Gupta, 2005; Goldeng et al.,
2008). SOEs often incur high fixed costs, reflecting bureaucratic overheads
and legacy costs inherited from the past, such as the financing of civil
servant pension schemes (Kowalski et al., 2013). Finally, manufacturing
firms that benefit from rescue plans are often large firms, so their survival or
bankruptcy can result in significant distortions.3Wollman (2018) provides
empirical evidence for such distortive effects by exploring the consequences
of the 2009 rescue plan for the US automotive industry. Focusing on
data on the industry’s commercial vehicle segment, he finds that if the
government had not rescued the automakers, markup would have increased
drastically while output would have dropped.4Potential for such distortions
is also observed for ailing SOEs, given their rising importance in world
markets. As emphasized in Kowalski et al. (2013, p. 13), privately owned
enterprises frequently find themselves in competition with SOEs, both
domestically and internationally. Given that firms in international markets
are often more productive (Helpman et al., 2004), “SOE-related distortions
in contestable international markets might be associated with higher
1In the business year 2010–2011, 10 percent of the world’s largest 2,000 firms on the Forbes
Global 2000 list were identified as SOEs. These firms compete with private firms in the global
marketplace and are present in a wide range of manufacturing sectors. The manufacture of motor
vehicles in itself accounts for nearly 12 percent of world trade and its share of SOEs is as high
as 20 percent.
2Such high-cost firms are particularly vulnerable in the context of economic downturns, hence
the impetus for governments to prevent them from going bankrupt.
3In Europe, such distortions on price and market share legitimate that all state aid for rescue
and restructuring must be authorized by the European Commission, sometimes requiring
compensatory measures.
4Importantly,Wollman (2018) shows that this conclusion remains validregardless of whether the
alternative scenario was bankruptcy of the ailing firms or their acquisition by a competitor.
The editors of The Scandinavian Journal of Economics 2019.

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