Furthermore, they can be broad or narrow, legal or illegal,
ethical or unethical. The most common forms of subsidies are those to
the producer or the consumer. Producer/production subsidies ensure
producers are better off by either supplying market price support,
direct support, or payments to factors of production.
Consumer/consumption subsidies commonly reduce the price of goods and
services to the consumer. For example, in the US at one time it was
cheaper to buy gasoline than bottled water.
Whether subsidies are positive or negative is typically a normative judgment. As a form of economic intervention, subsidies are inherently contrary to the market's demands. However, they can also be used as tools of political and corporate cronyism.
Whether subsidies are positive or negative is typically a normative judgment. As a form of economic intervention, subsidies are inherently contrary to the market's demands. However, they can also be used as tools of political and corporate cronyism.
Types
Production subsidy
A
production subsidy encourages suppliers to increase the output of a
particular product by partially offsetting the production costs or
losses.
The objective of production subsidies is to expand production of a
particular product more so that the market would promote but without
raising the final price to consumers. This type of subsidy is
predominantly found in developed markets. Other examples of production subsidies include the assistance in the creation of a new firm (Enterprise Investment Scheme), industry (industrial policy) and even the development of certain areas (regional policy).
Production subsidies are critically discussed in the literature as they
can cause many problems including the additional cost of storing the
extra produced products, depressing world market prices, and
incentivizing producers to over-produce, for example, a farmer overproducing in terms of his land's carrying capacity.
Consumer/consumption subsidy
A consumption subsidy is one that subsidises the behavior of consumers. This type of subsidies are most common in developing countries
where governments subsidise such things as food, water, electricity and
education on the basis that no matter how impoverished, all should be
allowed those most basic requirements.
For example, some governments offer 'lifeline' rates for electricity,
that is, the first increment of electricity each month is subsidized. This paper addresses the problems of defining and measuring government
subsidies, examines why and how government subsidies are used as a fiscal policy
tool, discusses their economic effects, appraises international empirical evidence
on government subsidies, and offers options for their reform. Evidence from
recent studies suggests that government expenditures on subsidies remain high in
many countries, often amounting to several percentage points of GDP.
Subsidization on such a scale implies substantial opportunity costs.
There are at least three compelling reasons for studying government subsidy
behavior. First, subsidies are a major instrument of government expenditure
policy. Second, on a domestic level, subsidies affect domestic resource allocation
decisions, income distribution, expenditure productivity
Export subsidy
An
export subsidy is a support from the government for products that are
exported, as a means of assisting the country's balance of payments. Usha Haley and George Haley identified the subsidies to manufacturing industry provided by the Chinese Government and how they have altered trade patterns.
Traditionally, economists have argued that subsidies benefit consumers
but hurt the subsidizing countries. Haley and Haley provided data to
show that over the decade after China joined the World Trade Organization
industrial subsidies have helped give China an advantage in industries
in which they previously enjoyed no comparative advantage such as the
steel, glass, paper, auto parts, and solar industries.
Export subsidy is known for being abused. For example, some
exporters substantially over declare the value of their goods so as to
benefit more from the export subsidy. Another method is to export a
batch of goods to a foreign country but the same goods will be
re-imported by the same trader via a circuitous route and changing the
product description so as to obscure their origin. Thus the trader
benefits from the export subsidy without creating real trade value to
the economy. Export subsidy as such can become a self-defeating and
disruptive policy.
Import subsidy
An
import subsidy is support from the government for products that are
imported. Rarer than an export subsidy, an import subsidy further
reduces the price to consumers for imported goods. Import subsidies
have various effects depending on the subject. For example, consumers
in the importing country are better off and experience an increase in
consumer welfare due to the decrease in price of the imported goods, as
well as the decrease in price of the domestic substitute goods.
Conversely, the consumers in the exporting country experience a decrease
in consumer welfare due to an increase in the price of their domestic
goods. Furthermore, producers of the importing country experience a
loss of welfare due to a decrease of the price for the good in their
market, while on the other side, the exporters of the producing country
experience an increase in well being due to the increase in demand.
Ultimately, the import subsidy is rarely used due to an overall loss of
welfare for the country due to a decrease in domestic production and a
reduction in production throughout the world. However, that can result
in a redistribution of income.
Employment subsidy
An
employment subsidy serves as an incentive to businesses to provide more
job opportunities to reduce the level of unemployment in the country
(income subsidies) or to encourage research and development.
With an employment subsidy, the government provides assistance with
wages. Another form of employment subsidy is the social security
benefits. Employment subsidies allow a person receiving the benefit to
enjoy some minimum standard of living.
Tax subsidy
Government can create the same outcome through selective tax breaks as through cash payment.
For example, suppose a government sends monetary assistance that
reimburses 15% of all health expenditures to a group that is paying 15%
income tax. Exactly the same subsidy is achieved by giving a health tax
deduction. Tax subsidies are also known as tax expenditures. Tax subsidies are one of the main explanations for why the American tax code is so complicated.
Tax breaks are often considered to be a subsidy. Like other
subsidies, they distort the economy; but tax breaks are also less
transparent, and are difficult to undo.
Transport subsidies
Some
governments subsidize transport, especially rail and bus transport
which decrease congestion and pollution compared to cars. In the EU, rail subsidies are around €73 billion and in China they reach $130 billion.
Publicly owned airports can be an indirect subsidy if they lose
money. The European Union for instance criticizes Germany for its high
number of money losing airports that are used primarily by low cost carriers, characterizing the arrangement as an illegal subsidy.
In many countries roads and highways are paid for through general
revenue rather than tolls or other dedicated sources only paid by road
users creating an indirect subsidy for road transportation. For instance
the fact that long distance buses in Germany do not pay tolls has been
called a subsidy by critics pointing to track access charges for
railways.
Oil subsidies
An
oil subsidy is one aimed at decreasing the overall price of oil.
Oil subsidies have always played a major part in U.S. history. These
began as early as World War I and have increased in the following
decades. However, due to changes in the perceptions of the environment,
in 2012 President Barack Obama ended the subsidies to the oil industry,
which were, at the time, $4 billion.
Housing subsidies
Housing
subsidies are designed to promote the construction industry and
home ownership. As of 2018, housing subsidies total around $15 billion
per year. Housing subsidies can come in two types; assistance with down
payment and interest rate subsidies. The deduction of mortgage
interest from the federal income tax accounts for the largest interest
rate subsidy. Additionally, the federal government will help low-income
families with the down payment, coming to $10.9 million in 2008.
Removing energy subsidies is viewed as a necessary measure to combat
greenhouse gas emissions as it helps decrease energy consumption.
Environmental externalities
As
well as the conventional and formal subsidies as outlined above there
are myriad implicit subsidies principally in the form of environmental externalities.
These subsidies include anything that is omitted but not accounted for
and thus is an externality. These include things such as car drivers who
pollute everyone's atmosphere without compensating everyone, farmers
who use pesticides
which can pollute everyone's ecosystems again without compensating
everyone, or Britain's electricity production which results in
additional acid rain in Scandinavia.
In these examples the polluter is effectively gaining a net benefit but
not compensating those affected. Although they are not subsidies in the
form of direct economic support from the Government, they are no less
economically, socially and environmentally harmful.
A 2015 report studied the implicit subsidies accruing to 20
fossil fuel companies and found that, while highly profitable, the
hidden economic cost to society was also large.
The report spans the period 2008–2012 and notes that: "for all
companies and all years, the economic cost to society of their CO2 emissions was greater than their after‐tax profit, with the single exception of ExxonMobil in 2008."
Pure coal companies fare even worse: "the economic cost to society
exceeds total revenue (employment, taxes, supply purchases, and indirect
employment) in all years, with this cost varying between nearly $2 and
nearly $9 per $1 of revenue."
Categorising subsidies
Broad and narrow
These
various subsidies can be divided into broad and narrow. Narrow
subsidies are those monetary transfers that are easily identifiable and
have a clear intent. They are commonly characterised by a monetary
transfer between governments and institutions or businesses and
individuals. A classic example is a government payment to a farmer.
Conversely broad subsidies include both monetary and non-monetary subsidies and is often difficult to identify.
A broad subsidy is less attributable and less transparent.
Environmental externalities are the most common type of broad subsidy.
Economic effects
Competitive
equilibrium is a state of balance between buyers and suppliers, in
which the quantity demanded of a good is the quantity supplied at a
specified price. When the quantity demand exceeds the equilibrium
quantity, price falls; conversely, a reduction in the supply of a good
beyond equilibrium quantity implies an increase in the price.
The effect of a subsidy is to shift the supply or demand curve to the
right (i.e. increases the supply or demand) by the amount of the
subsidy. If a consumer is receiving the subsidy, a lower price of a good
resulting from the marginal subsidy on consumption increases demand,
shifting the demand curve to the right. If a supplier is receiving the
subsidy, an increase in the price (revenue) resulting from the marginal
subsidy on production results increases supply, shifting the supply
curve to the right.
Assuming
the market is in a perfectly competitive equilibrium, a subsidy
increases the supply of the good beyond the equilibrium competitive
quantity. The imbalance creates dead-weight loss. Dead-weight loss from a
subsidy is the amount by which the cost of the subsidy exceeds the gains
of the subsidy.
The magnitude of the dead-weight loss is dependent on the size of the
subsidy. This is considered a market failure, or inefficiency.
Subsidies targeted at goods in one country, by lowering the price
of those goods, make them more competitive against foreign goods,
thereby reducing foreign competition.
As a result, many developing countries cannot engage in foreign trade,
and receive lower prices for their products in the global market. This
is considered protectionism: a government policy to erect trade barriers
in order to protect domestic industries. The problem with protectionism
arises when industries are selected for nationalistic reasons
(Infant-Industry), rather than to gain a comparative advantage. The
market distortion, and reduction in social welfare, is the logic behind
the World Bank policy for the removal of subsidies in developing
countries.
Subsidies create spillover effects in other economic sectors and
industries. A subsidized product sold in the world market lowers the
price of the good in other countries. Since subsidies result in lower
revenues for producers of foreign countries, they are a source of
tension between the United States, Europe and poorer developing
countries.
While subsidies may provide immediate benefits to an industry, in the
long-run they may prove to have unethical, negative effects. Subsidies
are intended to support public interest, however, they can violate
ethical or legal principles if they lead to higher consumer prices or
discriminate against some producers to benefit others.
For example, domestic subsidies granted by individual US states may be
unconstitutional if they discriminate against out-of-state producers,
violating the Privileges and Immunities Clause or the Dormant Commerce
Clause of the United States Constitution.
Depending on their nature, subsidies are discouraged by international
trade agreements such as the World Trade Organization (WTO). This trend,
however, may change in the future, as needs of sustainable development
and environmental protection could suggest different interpretations
regarding energy and renewable energy subsidies.
Perverse subsidies
Definitions
Although subsidies can be important, many are "perverse", in the sense of having adverse unintended consequences.
To be "perverse", subsidies must exert effects that are demonstrably
and significantly adverse both economically and environmentally.
A subsidy rarely, if ever, starts perverse, but over time a legitimate
efficacious subsidy can become perverse or illegitimate if it is not
withdrawn after meeting its goal or as political goals change. Perverse
subsidies are now so widespread that as of 2007 they amounted $2
trillion per year in the six most subsidized sectors alone (agriculture,
fossil fuels, road transportation, water, fisheries and forestry).
Effects
The
detrimental effects of perverse subsidies are diverse in nature and
reach. Case-studies from differing sectors are highlighted below but can
be summarized as follows.
Directly, they are expensive to governments by directing
resources away from other legitimate should priorities (such as
environmental conservation, education, health, or infrastructure).
Indirectly, they cause environmental degradation (exploitation of resources,
pollution, loss of landscape, misuse and overuse of supplies) which, as
well as its fundamental damage, acts as a further brake on economies;
tend to benefit the few at the expense of the many, and the rich at the
expense of the poor; lead to further polarization of development between
the Northern and Southern hemispheres; lower global market prices; and
undermine investment decisions reducing the pressure on businesses to
become more efficient.
Over time the latter effect means support becomes enshrined in human
behavior and business decisions to the point where people become
reliant on, even addicted to, subsidies, 'locking' them into society.
Consumer attitudes do not change and become out-of-date, off-target and inefficient; furthermore, over time people feel a sense of historical right to them.
Despite governments being responsible for the creation and (lack of)
termination of subsidies, it is ironic that perverse subsidies are not
tackled more rigorously, particularly as the above highlight their
contradiction to the majority of governments' stated policies.
Implementation
Perverse
subsidies are not tackled as robustly as they should be. Principally,
this is because they become 'locked' into society, causing bureaucratic
roadblocks and institutional inertia. When cuts are suggested many argue (most fervently by those 'entitled', special interest groups and political lobbyists) that it will disrupt and harm the lives of people who receive them, distort domestic competitiveness curbing trade opportunities, and increase unemployment. Individual governments recognize this as a 'prisoner's dilemma'
– inasmuch that even if they wanted to adopt subsidy reform, by acting
unilaterally they fear only negative effects will ensue if others do not
follow. Furthermore, cutting subsidies, however perverse they may be, is considered a vote-losing policy.
Reform of perverse subsidies is at a propitious time. The current
economic conditions mean governments are forced into fiscal constraints
and are looking for ways to reduce activist roles in their economies.
There are two main reform paths: unilateral and multilateral.
Unilateral agreements (one country) are less likely to be undertaken for
the reasons outlined above, although New Zealand, Russia, Bangladesh and others represent successful examples.
Multilateral actions by several countries are more likely to succeed as
this reduces competitiveness concerns, but are more complex to
implement requiring greater international collaboration through a body
such as the WTO. Irrespective of the path, the aim of policymakers should be to: create
alternative policies that target the same issue as the original
subsidies but better; develop subsidy removal strategies allowing
market-discipline to return; introduce 'sunset' provisions that require
remaining subsidies to be re-justified periodically; and make perverse
subsidies more transparent to taxpayers to alleviate the 'vote-loser'
concern.
Examples
Agricultural subsidies
Support
for agriculture dates back to the 19th century. It was developed
extensively in the EU and USA across the two World Wars and the Great
Depression to protect domestic food production, but remains important
across the world today. In 2005, US farmers received $14 billion and EU farmers $47 billion in agricultural subsidies.
Today, agricultural subsidies are defended on the grounds of helping
farmers to maintain their livelihoods. The majority of payments are
based on outputs and inputs and thus favour the larger producing
agribusinesses over the small-scale farmers. In the USA nearly 30% of payments go to the top 2% of farmers.
By subsidizing inputs and outputs through such schemes as 'yield
based subsidization', farmers are encouraged to: over-produce using
intensive methods including using more fertilizers and pesticides; grow
high-yielding monocultures; reduce crop rotation; shorten fallow periods; and promote exploitative land use change from forests, rainforests and wetlands to agricultural land. These all lead to severe environmental degradation including adverse effects on: soil quality and productivity including erosion,
nutrient supply and salinity which in turn affects carbon storage and
cycling, water retention and drought resistance; water quality including
pollution, nutrient deposition and eutrophication
of waterways, and lowering of water tables; diversity of flora and
fauna including indigenous species both directly and indirectly through
the destruction of habitats, resulting in a genetic wipe-out.
Cotton growers in the US reportedly receive half their income from the government under the Farm Bill of 2002.
The subsidy payments stimulated overproduction and resulted in a record
cotton harvest in 2002, much of which had to be sold at very reduced
prices in the global market.
For foreign producers, the depressed cotton price lowered their prices
far below the break-even price. In fact, African farmers received 35 to
40 cents per pound for cotton, while US cotton growers, backed by
government agricultural payments, received 75 cents per pound.
Developing countries and trade organizations argue that poorer countries
should be able to export their principal commodities to survive, but
protectionist laws and payments in the United States and Europe prevent
these countries from engaging in international trade opportunities.
Fisheries
Today, much of the world's major fisheries are over-exploited; in 2002, the WWF
estimate this at approximately 75%. Fishing subsidies include "direct
assistant to fishers; loan support programs; tax preferences and
insurance support; capital and infrastructure programs; marketing and
price support programs; and fisheries management, research, and
conservation programs." They promote the expansion of fishing fleets,
the supply of larger and longer nets, larger yields and indiscriminate
catch, as well as mitigating risks which encourages further investment
into large-scale operations to the disfavor of the already struggling
small-scale industry. Collectively, these result in the continued overcapitalization and overfishing of marine fisheries.
There are four categories of fisheries subsidies. First are
direct financial transfers. Second, are indirect financial transfers
and services. Third, certain forms of intervention and fourth, not
intervening. The first category regards direct payments from the
government received by the fisheries industry. These typically effect
profits of the industry in the short term and can be negative or
positive. Category two pertains to government intervention, not
involving those under the first category. These subsidies also affect
the profits in the short term but typically are not negative. Category
three regards intervention that results in a negative short-term
economic impact, but economic benefits in the long term. These benefits
are usually more general societal benefits such as the environment.
The final category pertains to inaction by the government, allowing
producers to impose certain production costs on others. These subsidies
tend to lead to positive benefits in the short term but negative in the
long term.
Others
The US National Football League's (NFL)
profits have topped records at $11 billion, the highest of all sports.
The NFL had tax-exempt status until voluntarily relinquishing it in
2015, and new stadiums have been built with public subsidies.
The Commitment to Development Index (CDI), published by the Center for Global Development,
measures the effect that subsidies and trade barriers actually have on
the undeveloped world. It uses trade, along with six other components
such as aid or investment, to rank and evaluate developed countries on
policies that affect the undeveloped world. It finds that the richest
countries spend $106 billion per year subsidizing their own farmers –
almost exactly as much as they spend on foreign aid.
