Edited by Harry Bloch
Chapter 11: Existence of Equilibrium in Models of Internationally Competitive Public Policy
Perry Shapiro and Jeff Petchey INTRODUCTION Features of the emerging global economy include the expanded importance of regional unions of countries that share common markets for the free flow of goods, capital and workers, and the increased international mobility of these factors of production. While ceding certain powers to some supra-regional authority, the countries that make up regional unions, such as the European Union, have retained sufficient sovereignty over their public expenditure and taxes to allow them to compete with one another to attract mobile factors. In some regions, this competition has led to ‘fiscal wars’ in which states aggressively use tax and spending subsidies to attract mobile firms and workers from neighbouring jurisdictions. A recent example of this has occurred in Brazil and Argentina.1 A popular view is that the effect of such competition is pernicious in the sense that it leads to inefficient public policy, inefficiency in the geographic allocation of mobile resources and damage to regional harmony and cooperation over matters of common interest. These views arise, in part, from conclusions reached using economic models developed to examine regional tax and public spending competition in a globalizing world. One, the so-called ‘fiscal competition’ model, has certain general features. It supposes that there are two countries or states, each endowed with a concave production technology with at least two factors of production, identical immobile citizens (workers) and a second factor (capital or labour) that is mobile between states, and also between the region and the world economy. States...
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