A Simple Model of Corporate Bailouts in a Globalized Economy*

• Author: Thierry Madiès,Nelly Exbrayat,Stéphane Riou
• Published date: 01 October 2020
• Date: 01 October 2020
• DOI: http://doi.org/10.1111/sjoe.12397

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

nelly.exbrayat@univ-st-etienne.fr

Thierry Madi`es

University of Fribourg, 1700 Fribourg,Switzerland

thierry.madies@unifr.ch

St´ephane Riou

Universit´e Jean Monnet, Saint-Etienne, F-42023 Saint-Etienne, France

Stephane.Riou@univ-st-etienne.fr

Abstract

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,

C´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.

C

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.

C

The editors of The Scandinavian Journal of Economics 2019.