Subsidy

Subsidy

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A subsidy is an assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributors in an industry
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...

 to prevent the decline of that industry (e.g., as a result of continuous unprofitable operations) or an increase in the prices of its products or simply to encourage it to hire more labor
Wage labour
Wage labour is the socioeconomic relationship between a worker and an employer, where the worker sells their labour under a formal or informal employment contract. These transactions usually occur in a labour market where wages are market determined...

 (as in the case of a wage
Wage
A wage is a compensation, usually financial, received by workers in exchange for their labor.Compensation in terms of wages is given to workers and compensation in terms of salary is given to employees...

 subsidy). Examples are subsidies to encourage the sale of export
Export
The term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer"...

s; subsidies on some food
Food
Food is any substance consumed to provide nutritional support for the body. It is usually of plant or animal origin, and contains essential nutrients, such as carbohydrates, fats, proteins, vitamins, or minerals...

s to keep down the cost of living, especially in urban area
Urban area
An urban area is characterized by higher population density and vast human features in comparison to areas surrounding it. Urban areas may be cities, towns or conurbations, but the term is not commonly extended to rural settlements such as villages and hamlets.Urban areas are created and further...

s; and subsidies to encourage the expansion of farm
Farm
A farm is an area of land, or, for aquaculture, lake, river or sea, including various structures, devoted primarily to the practice of producing and managing food , fibres and, increasingly, fuel. It is the basic production facility in food production. Farms may be owned and operated by a single...

 production and achieve self-reliance in food production.

Subsidies can be regarded as a form of protectionism
Protectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...

 or trade barrier
Trade barrier
Trade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...

 by making domestic goods and services artificially competitive against imports. Subsidies may distort markets, and can impose large economic costs. Financial assistance in the form of a subsidy may come from one's government, but the term subsidy may also refer to assistance granted by others, such as individuals or non-governmental institutions.

Overview


A subsidy is money given by a government to help support a business or person the market does not support. In the United States, Congress can tax to provide for the general welfare. It also has the power to coin money and regulate its value. An example of subsidy is from the Middle Ages. The British Parliament took away their king’s authority to tax and gave him a tax-based subsidy to live on.

In standard supply and demand curve diagrams
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

, a subsidy will shift either the demand curve up or the supply curve down. A subsidy that increases the production will tend to result in a lower price, while a subsidy that increases demand will tend to result in an increase in price. Both cases result in a new economic equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...

. Therefore it is essential to consider elasticity
Elasticity (economics)
In economics, elasticity is the measurement of how changing one economic variable affects others. For example:* "If I lower the price of my product, how much more will I sell?"* "If I raise the price, how much less will I sell?"...

 when estimating the total costs of a planned subsidy: it equals the subsidy per unit (difference between market price
Market price
In economics, market price is the economic price for which a good or service is offered in the marketplace. It is of interest mainly in the study of microeconomics...

 and subsidized price) times the new equilibrium quantity. One category of goods suffers less from this effect: Public good
Public good
In economics, a public good is a good that is non-rival and non-excludable. Non-rivalry means that consumption of the good by one individual does not reduce availability of the good for consumption by others; and non-excludability means that no one can be effectively excluded from using the good...

s are—once created—in ample supply and the total costs of subsidies remain constant regardless of the number of consumers; depending on the form of the subsidy, however, the number of producers on demanding their share of benefits may still rise and drive costs up.

The recipient of the subsidy may need to be distinguished from the beneficiary of the subsidy, and this analysis will depend on elasticity of supply and demand as well as other factors. For example, a subsidy for consumption of milk by consumers may appear to benefit consumers (or some may benefit and the consumer may derive no gain, as the higher prices for milk offset the subsidy). The net effect and identification of winners and losers is rarely straightforward, but subsidies generally result in a transfer of wealth from one group to another (or transfer between sub-groups).

Subsidy may also be used to refer to government actions which limit competition or raise the prices at which producers could sell their products, for example, by means of tariff protection. Although economics generally holds that subsidies may distort the market and produce inefficiencies, there are a number of recognized cases where subsidies may be the most efficient solution.

In many instances, economics may (somewhat counter-intuitively) suggest that direct subsidies are preferable to other forms of support, such as hidden subsidies or trade barriers; although subsidies may be inefficient, they are often less inefficient than other policy tools used to benefit certain groups. Direct subsidies may also be more transparent, which may allow the political process more opportunity to eliminate wasteful hidden subsidies. This problem—that hidden subsidies are more inefficient, but often favored precisely because they are non-transparent—is central to the political-economy of subsidies.

Examples of industries or sectors where subsidies are often found include utilities, gasoline
Gasoline
Gasoline , or petrol , is a toxic, translucent, petroleum-derived liquid that is primarily used as a fuel in internal combustion engines. It consists mostly of organic compounds obtained by the fractional distillation of petroleum, enhanced with a variety of additives. Some gasolines also contain...

 in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

, welfare, farm subsidies
Agricultural subsidy
An agricultural subsidy is a governmental subsidy paid to farmers and agribusinesses to supplement their income, manage the supply of agricultural commodities, and influence the cost and supply of such commodities...

, and (in some countries) certain aspects of student loans.

History


In the 16th century "subsidy" referred to taxation, for example the tax introduced in England by Thomas Wolsey in 1513 based on the ability to pay.

Types of subsidies


There are many different ways to classify subsidies, such as the reason behind them, the recipients of the subsidy, the source of the funds (government, consumer, general tax revenues, etc.). In economics, one of the primary ways to classify subsidies is the means of distributing the subsidy.

In economics, the term subsidy may or may not have a negative connotation: that is, the use of the term may be prescriptive but descriptive. In economics, a subsidy may nonetheless be characterized as inefficient relative to no subsidies; inefficient relative to other means of producing the same results; "second-best", implying an inefficient but feasible solution (contrasted with an efficient but not feasible ideal), among other possible terminology. In other cases, a subsidy may be an efficient means of correcting a market failure
Market failure
Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...

.

For example, economic analysis may suggest that direct subsidies (cash benefits) would be more efficient than indirect subsidies (such as trade barriers); this does not necessarily imply that direct subsidies are bad, but that they may be more efficient or effective than other mechanisms to achieve the same (or better) results.

Insofar as they are inefficient, however, subsidies would generally be considered by economists to be bad, as economics is the study of efficient use of limited resources. Ultimately, however, the choice to enact a subsidy is a political choice. Note that subsidies are linked to the concept of economic transfer
Transfer
Transfer may refer to:* Transfer * Transfer * Transfer DNA, the transferred DNA of the tumor-inducing plasmid of some species of bacteria such as Agrobacterium tumefaciens* Transfer...

s from one group to another.

Economics has also explicitly identified a number of areas where subsidies are entirely justified by economics, particularly in the area of provision of public goods.

Indirect subsidies


Indirect subsidy is a term sufficiently broad that it may cover most other forms of subsidy. The term would cover any form of subsidy that does not involve a direct transfer.

Labor subsidies


A labor subsidy is any form of subsidy where the recipients receive subsidies to pay for labor costs. Examples may include labor subsidies for workers in certain industries, such as the film and/or television industries. (see: Runaway production
Runaway production
Runaway production is a term used by the American film industry to describe filmmaking and television productions that are "intended for initial release/exhibition or television broadcast in the U.S., but are actually filmed in another country."...

).

Infrastructure subsidies


In some cases, subsidy may refer to favoring one type of production or consumption over another, effectively reducing the competitiveness or retarding the development of potential substitutes. For example, it has been argued that the use of petroleum
Petroleum
Petroleum or crude oil is a naturally occurring, flammable liquid consisting of a complex mixture of hydrocarbons of various molecular weights and other liquid organic compounds, that are found in geologic formations beneath the Earth's surface. Petroleum is recovered mostly through oil drilling...

, and particularly gasoline, has been subsidized or favored by U.S. defense policy, reducing the use of alternative energy
Alternative energy
Alternative energy is an umbrella term that refers to any source of usable energy intended to replace fuel sources without the undesired consequences of the replaced fuels....

 sources and delaying their commercial development. However, alternative energy sources have also been subsidized by the federal and state governments, though only by a comparatively tiny amount.

In other cases, the government may need to improve the public transport
Public transport
Public transport is a shared passenger transportation service which is available for use by the general public, as distinct from modes such as taxicab, car pooling or hired buses which are not shared by strangers without private arrangement.Public transport modes include buses, trolleybuses, trams...

 to ensure Pareto improvement is attanied and sustained. This can therefore be done by subsidising those transit agencies that provide the public services so that the services can be affordable for everyone. This is the best way of helping different groups of disabled and low income families in the society.

Trade protection (import restrictions)


Measures used to limit a given good than they would pay without the trade barrier; the protected industry has effectively received a subsidy. Such measures include import quota
Import quota
An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time....

s, import tariff
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....

s, import bans, and others.

Export subsidies (trade promotion)


Various tax or other measures may be used to promote exports that constitute subsidies to the industries favored. In other cases, tax measures may be used to ensure that exports are treated "fairly" under the tax system. The determination of what constitutes a subsidy (or the size of that subsidy) may be complex. In many cases, export subsidies are justified as a means of compensating for the subsidies or protections provided by a foreign state to its own producers.

Procurement subsidies


Governments everywhere are relatively small consumers of various goods and services. Subsidies may occur in this process by choice of the products produced, the producer, the nature of the product itself, and by other means, including payment of higher-than-market prices for goods purchased.

Consumption subsidies


Governments everywhere provide consumption subsidies in a number of ways: by actually giving away a good or service, providing use of government assets, property, or services at lower than the cost of provision, or by providing economic incentives (cash subsidies) to purchase or use such goods. In most countries, consumption of education, health care, and infrastructure (such as roads) are heavily subsidized, and in many cases provided free of charge. However, these are investments rather than subsidies; both increase the economic value of the state and affect all as opposed to single groups. In other cases, governments literally purchase or produce a good (such as bread, wheat, gasoline, or electricity) at a higher cost than the sales price to the public (which may require rationing
Rationing
Rationing is the controlled distribution of scarce resources, goods, or services. Rationing controls the size of the ration, one's allotted portion of the resources being distributed on a particular day or at a particular time.- In economics :...

 to control the cost).

The provision of true public good
Public good
In economics, a public good is a good that is non-rival and non-excludable. Non-rivalry means that consumption of the good by one individual does not reduce availability of the good for consumption by others; and non-excludability means that no one can be effectively excluded from using the good...

s through consumption subsidies is an example of a type of subsidy that economics may recognize as efficient. In other cases, such subsidies may be reasonable second-best solutions; for example, while it may be theoretically efficient to charge for all use of public roads, in practice, the cost of implementing a system to charge for such use may be unworkable or unjustified.

In other cases, consumption subsidies may be targeted at a specific group of users, such as large utilities, residential home-owners, and others.

Subsidies due to the effect of debt guarantees


Another form of subsidy is due to the practice of a government guaranteeing a lender payment if a particular borrower defaults
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...

. This occurs in the United States, for example, in certain airline industry loans, in most student loans, in small business administration loans, in Ginnie Mae mortgage-backed bonds, and is alleged to occur in the mortgage-backed bonds issued through Fannie Mae and Freddie Mac. A government guarantee of payment lowers the risk of the loan for a lender, and since interest rates are primarily based on risk, the interest rate for the borrower lowers as well.

Controversy


One of the most controversial classes of subsidies, especially according to publications such as The Economist
The Economist
The Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd. and edited in offices in the City of Westminster, London, England. Continuous publication began under founder James Wilson in September 1843...

, are subsidies benefiting farmers in first-world
First World
The concept of the First World first originated during the Cold War, where it was used to describe countries that were aligned with the United States. These countries were democratic and capitalistic. After the fall of the Soviet Union and the end of the Cold War, the term "First World" took on a...

 countries.

Human-rights based non-governmental organizations like Oxfam
Oxfam
Oxfam is an international confederation of 15 organizations working in 98 countries worldwide to find lasting solutions to poverty and related injustice around the world. In all Oxfam’s actions, the ultimate goal is to enable people to exercise their rights and manage their own lives...

 describe such subsidies as dumping millions of surplus commodities (like sugar) on world markets, destroying competition from farmers in undeveloped and poor countries, especially in Africa. For example, in the past EU spent €3.30 in subsidies to export sugar worth €1. Another example of trade distorting subsidies is the Common Agricultural Policy
Common Agricultural Policy
The Common Agricultural Policy is a system of European Union agricultural subsidies and programmes. It represents 48% of the EU's budget, €49.8 billion in 2006 ....

 of the European Union
European Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...

. It represents 48% of the entire EU's budget
European Union Budget
The European Union is a union of 27 member states. The Administration of the Union has a parliament, a civil service and a judiciary that is distinct from those of the member states. These arms administer the application of treaties, laws and agreements between the member states and their...

, €49.8 billion in 2006 (up from €48.5 billion in 2005). These subsidies have remained in place even though many international accords have reduced other forms of subsidies or tariffs.

The Commitment to Development Index
Commitment to Development Index
The Commitment to Development Index , published annually by the Center for Global Development, ranks the world’s richest countries on their dedication to policies that benefit the five billion people living in poorer nations. Rich and poor countries are linked in many ways; thus the Index looks...

, published by the Center for Global Development
Center for Global Development
The Center for Global Development is a non-profit think tank based in Washington, D.C. that focuses on international development. It was founded in November 2001 by former senior U.S. official Edward W. Scott, director of the Peterson Institute for International Economics, C. Fred Bergsten, and...

, 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.

Sometimes people believe profitable companies to be 'bullying' governments for subsidies and rescue packages, an example of rent-seeking behaviour. For example, in the case with Australian rail operator Pacific National
Pacific National
Pacific National is one of Australia's largest private rail freight businesses. Originally a joint venture between Patrick Corporation and Toll Holdings; it is now a wholly owned subsidiary of Asciano Limited following the restructure of Toll Holdings....

, the company threatened the Tasmanian Government
Government of Tasmania
The form of the Government of Tasmania is prescribed in its Constitution, which dates from 1856, although it has been amended many times since then...

 with a pull-out of rail services unless a subsidization was made.

It has been suggested that American government subsidies are contributing to the country's obesity levels. So-called junk foods are made cheaper due to the subsidy programs, thus increasing consumption of such foods.

Subsidies can be less effective than projected at meeting stated economic or support goals, because some of the subsidised activity (e.g. creation of jobs) might have happened anyway, had the subsidy not been in place. Moreover, some potential recipients might not receive a subsidy, due to factors such as poor advertising, a difficult, expensive or time-consuming process to claim the subsidy, or corruption. In the worst case scenario, a subsidy could have no effect whatsoever, other than making the recipients of the subsidy financially better off than they would otherwise have been.

See also

  • Agricultural policy
    Agricultural policy
    Agricultural policy describes a set of laws relating to domestic agriculture and imports of foreign agricultural products. Governments usually implement agricultural policies with the goal of achieving a specific outcome in the domestic agricultural product markets...

  • Antidumping
  • Copenhagen Consensus
    Copenhagen Consensus
    Copenhagen Consensus is a project that seeks to establish priorities for advancing global welfare using methodologies based on the theory of welfare economics. It was conceived and organized by Bjørn Lomborg, the author of The Skeptical Environmentalist and the then director of the Danish...

  • Cross subsidy
  • Cultural subsidy
    Cultural subsidy
    A cultural subsidy is a payment to cultural industries to ensure that some public policy purpose in culture is preserved or perhaps overtly promoted as superior.They are considered a form of industrial subsidy usually by their opponents, and a form of public...

  • Constitutional economics
    Constitutional economics
    Constitutional economics is a research program in economics and constitutionalism that has been described as extending beyond the definition of 'the economic analysis of constitutional law' in explaining the choice "of alternative sets of legal-institutional-constitutional rules that constrain the...

  • Act of Entrustment
    Act of Entrustment
    An Act of Entrustment is one of four essential requirements which must be in place under European Community law, in order to ensure that the financial compensation paid to an organisation providing a public service is not treated as "State Aid" as defined by the Treaty on the Functioning of the...

  • Political economy
    Political economy
    Political economy originally was the term for studying production, buying, and selling, and their relations with law, custom, and government, as well as with the distribution of national income and wealth, including through the budget process. Political economy originated in moral philosophy...

  • Rule according to higher law
    Rule according to higher law
    The rule according to a higher law means that no written law may be enforced by the government unless it conforms with certain unwritten, universal principles of fairness, morality, and justice...


  • Direct Subsidy Scheme
    Direct Subsidy Scheme
    The Direct Subsidy Scheme is instituted by the Education Bureau of Hong Kong as a means to enhance the quality of private schools in Hong Kong at the primary and secondary levels...

  • Dirty subsidy
    Dirty subsidy
    A dirty subsidy is a payment or incentive by a government to a private corporation that encourages waste of raw materials, natural resources, energy, or results in pollution or other human health hazards....

  • Capital subsidy
  • Information subsidy
    Information subsidy
    In public relations and journalism, information subsidy is what information sources provide the news media by issuing press releases, purchasing advertising, or sending letters to the editor; this relieves the journalists from some burden of collecting information, and shortens the time to...

  • Mixed economy
    Mixed economy
    Mixed economy is an economic system in which both the state and private sector direct the economy, reflecting characteristics of both market economies and planned economies. Most mixed economies can be described as market economies with strong regulatory oversight, in addition to having a variety...

  • Party subsidies
    Party subsidies
    Party subsidies are subsidies paid by the government directly to a political party, for example in proportion to the number of seats in the parliament, or in proportion to the number of votes each party got...

  • Pigouvian subsidies
  • Price-Anderson Nuclear Industries Indemnity Act
    Price-Anderson Nuclear Industries Indemnity Act
    The Price-Anderson Nuclear Industries Indemnity Act is a United States federal law, first passed in 1957 and since renewed several times, which governs liability-related issues for all non-military nuclear facilities constructed in the United States before 2026...


External links