Introduction
Imagine that you are the owner of a clothing company, United for Clothing. You do pretty good business, but you’re always wary of the clothing store across town, Clothing United. Your competitor sells their products at a lower price, and you’re afraid that soon they’ll take over the market. Your products are more expensive because you prioritize eco-friendly practices and fair labor conditions for all production sources. You don’t want to compromise your morals, but how are you supposed to compete?
Explanation
Now imagine that the government has decided to incentivize socially-conscious businesses like yours and starts sending you monthly checks to offset some of your production costs. This is great news! You can now sell your clothes at a lower price than Clothing United, meaning you can finally beat your rival! This type of government assistance is known as a subsidy.
Definition of Subsidies
Subsidies are benefits given to either institutions, businesses, or individuals by the government. Subsidies can be given directly or indirectly to their intended recipients. They can come in the form of either cash payments or tax cuts, or even a guarantee that the government will buy a product. Economically speaking, subsidies are designed to relieve some sort of burden from the recipients, usually to promote a social good or stimulate economic activity.
How It Works
Subsidies have been used by various nations for hundreds of years. During the Industrial Revolution, many European countries subsidized their domestic manufacturing to maintain a competitive edge over international competition. In the United States, subsidies are common in the agricultural industry. Implemented following the Great Depression and the Dust Bowl, farm subsidies included price guarantees, incentives to keep land fallow in order to prevent overproduction, and even buying and storing overproduced goods like corn and cheese. In China, subsidies on the steel industry took the form of grants, loans, equity infusion, and tax breaks. The steel industry surged, employing over 5 million by 2016 and lowering global steel prices 57% from 2011 to 2015.
In all of these examples, subsidies were used to bolster a domestic industry for strategic and practical reasons. Strategic subsidies are intended to bolster the overall well-being and strength of a country, especially as it relates to international competitiveness, as in the Chinese steel example. Practical subsidies are designed to accomplish some sort of social policy goal, like guaranteeing a country’s food supply. In the US example, such subsidies allowed US farmers to stay in business and served as a precautionary measure against future natural disasters. Both strategic and practical subsidies generate domestic benefits.
A common criticism of subsidies is that they assist industries that may not need help. Subsidies may be implemented based on a political agenda rather than true economic need. Subsidies can create artificial market conditions by skewing supply and demand within particular industries. Additionally, subsidies can increase negative externalities that damage the public more than it helps it. For example, many critics of farm subsidies argue that overproduction of products like corn results in more usage of unhealthy ingredients like high fructose corn syrup, which is linked to higher rates of obesity and other health issues. Lastly, new subsidy programs often result in higher taxes. Subsidy programs always cost the government money, and that funding generally comes through taxes or cuts to other necessary government programs. Nevertheless, by design, subsidies are meant to accelerate economic activity that the government deems useful for the public good.
Why Care?
Subsidies can completely change the outlook of an industry. They can revitalize dying industries and create new jobs and economic activity, but they can also become an economic crutch that causes an industry to be reliant on subsidies, or in other words, the government. The most successful subsidies generate benefits not only for one particular sector, but the market, and thus the public, as a whole. When designed and carried out properly, subsidies are a useful tool for the government to regulate and manipulate markets for their people’s betterment.
