REPLY TO SUBSIDIES, ADDITIONALITY AND FINANCIAL CONSTRAINTS

In Wren (1994) I find that industrial subsidies have significantly gre ater employment effects in small firms, and interpret this as arising from the poorer access that these firms have to private funds. Holden and Swales (1996) criticize this interpretation, arguing that financia l constraints typically limit the effectiveness of subsidies. In this paper I show that their results arise from the particular properties o f the homogeneous production function. More generally, I show that the effectiveness of assistance increases with the marginal cost of priva te funds and is greater in those firms facing financial constraints. A s such, differential access to private funds can explain the greater e ffectiveness of assistance found in small firms.