This paper uses a general equilibrium model with financial frictions and competitive credit markets to analyze the optimal subsidy for the creation of new businesses and how it influences the financing choices of those businesses. In addition to fostering economic activity and business creation, subsidies, depending on how they are paid out, can also lead to the excessive indebtedness of companies and, therefore, to a higher number of failures. The model uses parameters estimated using the administrative data of Italian firms.
This analysis shows that the optimal subsidy to support the creation of new businesses is one that is paid out ex ante. Thus, the initial indebtedness of the companies is reduced, making it less likely for them to fail, with significant benefits in terms of social welfare. Conversely, a subsidy paid out ex post increases leverage and the risk of failure.
Forthcoming in: Journal of Political Economy.
