The Optimal Rate of Decline of an Inefficient Industry

This paper considers the problem of the optimal time path of
contraction of an industry which has been hit by foreign
competition, and shows that in general, along the optimal path, a
production subsidy is warranted. The optimal subsidy trades off the
benefit of unemployment in speeding up the approach to the new
long-run equilibrium against the cost of lost output in the
‘inefficient’ industry. The dynamic shadow price of labour in this
industry is also derived and shown to be always positive, though
below the industry wage rate