Subsidies (or subventions) are forms of financial assistance, economic concessions, or privileges granted by government to a company, businesses, segment of an industry, or industry for the purpose of encouraging their continued existence, growth, development, and profitability (subsidies may also be granted by government to individuals as a redistribution of income, and to local governments by central governments to promote public policy objectives). Subsidies are often “hidden” due to their various types, inherent objectives, and complex economic effects. It is, however, ultimately a political decision to grant a subsidy. When government grants a subsidy, it is ostensibly in the public interest that a company, business, or industry continues as a viable entity and provides needed business activities in the domestic economy.
In general, there are two forms of subsidies: direct subsidies involve a direct cash transfer to an economic entity, while indirect subsidies are forms of government subventions that usually do not involve direct money transfers. From a purely economic perspective, the use of subsidies may be inefficient as compared to not offering any subsidies or another policy instrument for achieving similar socioeconomic results or, contrarily, an efficient means of correcting a market failure and providing a public good. Furthermore, direct subsidies, that is, cash transfers, are considered more efficient than indirect subsidies, for example, trade barriers sought by domestic industries seeking protection from international competition.
The economic impact (total costs) of a subsidy is explained through the application of supply-and-demand curves and the concept of elasticity of supply and demand, that is, the subsidy per unit times the new equilibrium quantity. For example, a subsidy that encourages a business’s production will tend to lower the product’s price, that is, it shifts the supply curve downward along the demand curve; contrarily, a subsidy encouraging demand tends to increase a product’s price, that is, it shifts the demand curve upward along the supply curve. Public goods tend to be less impacted by elasticity of demand, given that there is sufficient supply of such public goods and the total costs of subsidies remain constant (regardless of the volume of consumers). An exception to this public good tendency is when the number of suppliers of this good rises (reflecting a rise in demand for this subsidy “benefit”) and increases cost.
Direct subsidies are considered preferable to indirect subsidies, as they allow for greater transparency in the political process. This political transparency can result in the opportunity for government representatives to eliminate economically inefficient “hidden” government subsidies benefiting rent-seeking business entities. In the United States, these so-called pork barrel federal subsidies, that is, unnecessary or wasteful subsidies, are popularly referred to as “corporate welfare” by government reform nonprofit organizations that publish lists of such pork barrel projects for public scrutiny.
Subsidies take many different forms and are best described by the means by which the subsidy is distributed to the business entity:
- Labor: A business receives a government payment to help cover employment costs and/or training expenses.
- Tax: A company receives a tax credit or deduction, accelerated depreciation (applied against business income) for equipment, or an outright exemption from a sales tax.
- Production: An industry will receive direct cash payments to encourage manufacture of a specific product or provision of a service.
- Procurement: As a consumer, a government may pay higher-than-market prices for goods or services it purchases.
- Consumption: A government may simply give away a good or service, offer the use of a government-owned asset or service at a price lower than production cost, or provide direct cash incentives to a business for the purchase of a good or service.
- Infrastructure: The public provision of infrastructure for a restricted number of business entities is a form of an indirect production subsidy provided by taxpayers.
- Regulatory Preferences. A public policy may directly or indirectly favor a class of products, company, segment of an industry, or industry over competitors, thus reducing a potential input into production costs.
- Trade Protection: Import limitations, such as a quantity limit, offer a hidden subsidy for a domestic industry.
- Export: To promote domestic industries in their bid to be competitive in a global market, certain tax measures are offered to encourage trade promotion.
In the arena of international trade, the World Trade Organization (WTO) enforces the Agreement on Subsidies and Countervailing Measures. The agreement is designed to regulate two areas of international trade: first, it circumscribes the use of subsidies by a national government, and second, it regulates the actions that a national government can take to counteract the negative effects of subsidies. Under the agreement, a country may use the WTO’s dispute settlement procedure to obtain the removal of the subsidy or its adverse effects on a nation’s domestic industry, or the national government may initiate its own investigation into the prohibited use of a subsidy and, if the evidence supports the action, charge a countervailing duty on the subsidized import.
There are two categories of subsidies defined under the agreement: prohibited and actionable. Prohibited subsidies require companies or industries to meet government-prescribed export targets, or to use domestic inputs in the manufacturing process rather than imports, and are intended to negatively influence the free trade environment. With actionable subsidies, an aggrieved nation must provide evidence that the government-supplied subsidy has an adverse effect on its domestic industry or the subsidy is allowable. While so-called dumping is when a company exports a product and charges a price below what it charges in its domestic market, subsidies are offered only by government.
- Dirk Czarnitzki and Andrew A. Toole, Business R&D and the Interplay of R&D Subsidies and Market Uncertainty (Wirtschaftsforschung, 2006);
- C. Hufbauer and J. Shelton-Erb, Subsidies in International Trade (MIT Press, 1984);
- David N. Hyman, Public Finance: A Contemporary Application of Theory to Policy With Economic Application (Cengage Learning, 2004);
- Malgorzata Kurjanska and Mathias Risse, Fairness, Export Subsidies, and the Fair Trade Movement (Harvard University, 2006);
- New Zealand, An Employer’s Guide to the Subsidies We Offer (Work and Income, 2007);
- Office of Fair Trading (UK), Public Subsidies: A Report by the Office of Fair Trade (Office of Fair Trade, 2004);
- Anna Purinton, The Policy Shift to Good Jobs: Cities, States and Counties Attaching Job Quality Standards to Development Subsidies (Good Jobs First, 2003);
- Volker Reinthaler and Guntram B. Wolff, The Effectiveness of Subsidies Revisited: Accounting for Wage and Employment Effects in Business R&D (ZEI, 2004);
- World Trade Organization, “Anti-Dumping, Subsidies, Safeguards: Contingencies, etc.,” www.wto.org (cited March 2009).
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