Fiscal Competition and Regional Differentiation.pdf

Fiscal Competition and Regional Differentiation? Moshe Justman? Jacques-Franc?ois Thisse? Tanguy van Ypersele§ 30 April 2001 Abstract Regions can benefit by offering infrastructure services that are dif- ferentiated. Competiton between regions over potential investors is then less direct, allowing them to realize greater benefits from exter- nal investors. The two polar cases of full and incomplete information about investors’ needs are studied. In both cases, there is regional dif- ferentiation. However, fiscal competition is efficient in the former case but not in the latter. Finally, it is shown that free entry in the location market calls for some regulation because of the excessive number of competing regions that would prevail in equilibrium. Keywords: fiscal competition, regional development, infrastructure, hor- izontal differentiation. JEL Classification: R58, R12, H73, O38. ?We thank P. Pestieau for helpful discussions. We are also grateful to the Ministe?re de l’e?ducation, de la recherche et de la formation (Communaute? franc?aise de Belgique), Convention 00/05-262, for funding. ?Department of Economics and Monaster Center for Economic Research Ben Gurion University of the Negev Beer Sheva, Israel ?CORE, Universite? catholique de Louvain, Belgium CERAS, Ecole nationale des ponts et chausse?es, France and CEPR. §The University of Namur, CREW and CORE, Belgium. 1 1 Introduction The globalization of trade and investment has increased competition among regions vying to attract outside investments that create jobs, boost local income and raise property values, forcing them to compete internationally. Such competition often takes the form of tax reductions or subsidies. In one recent example, Israel successfully outbid Ireland and other rival loca- tions in persuading Intel to locate a new fabrication plant in a struggling development town, by awarding the company a specially earmarked subsidy of $600 million.1 Subsidies like this are often augmented by local