6.1.4 Subsidies

Subsidies are grants from the state given to market participants. They can be interpreted as negative taxes. When comparing a sales tax paid by the seller with a subsidy received by the producer, we see that in the case of the tax, the seller keeps a lower amount (net price) than is shown by the market price (gross price). The difference is the tax: Tax = Pgross Pnet. In the case of the subsidy, this is reversed. The seller receives a premium for each unit sold, thus: Subsidy = Pnet Pgross. A subsidy also generates a welfare loss. This arises not, as with the tax, from the fact that market participation decreases, i.e. fewer individuals than possible benefit from the market, but from the fact that too many actors participate in the market because the government supports them to do so. The costs of the state for each market participant are higher than their individual benefit, so that there is an overall loss of welfare for society. Here too, of course, external effects have to be considered. For example, subsidies are paid to maintain a sufficiently high production capacity to secure supply (e.g., electricity market, agriculture), short-time allowances are paid to prevent company bankruptcies or mass layoffs, or payments are made to achieve environmental and nature conservation effects (e.g., set-aside bonuses and requirements in agriculture). Hence, policymakers clearly weigh the costs (monetary and economic) against the potential benefits (social or political).

Reasons that often lead to economic and/or societal welfare losses from subsidies mostly arise from four points of conflict:

  1. Much of the costs and benefits will be realized at some point in the future. By then, the estimation of developments and the expectations of the actors may differ or may be plain wrong, so that suboptimal outcomes are realized.
  2. A large part of the costs and benefits are not monetary and difficult to weigh up against each other. Similarly, the discount factors of actors may differ, resulting in different evaluations of the outcome. An outcome that is optimal for person or group A is bad from group B’s perspective. In the absence of a market, the possible coordination mechanisms are often opaque and not very flexible.
  3. Often, subsidies serve primarily to generate or maintain political power, so that decision-makers accept the economic/societal costs at the expense of others.
  4. Ultimately, however, it is often the case that only a few benefit greatly from subsidies, but the costs are passed on to the population as a whole, so that each individual is burdened only slightly. Thus, the incentives are clearly distributed: The few that profit from it will advocate very much for the subsidy or invest sufficiently much in lobbying, while the broad masses mostly care very little.

(c) by Christian Bauer
Prof. Dr. Christian Bauer
Chair of monetary economics
Trier University
D-54296 Trier
Tel.: +49 (0)651/201-2743
E-mail: Bauer@uni-trier.de
URL: https://www.cbauer.de