A subsidy (also known as a subvention) is a form of financial assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributors in an industry 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 (as in the case of a wage subsidy). Examples are subsidies to encourage the sale of exports; subsidies on some foods to keep down the cost of living, especially in urban areas; and subsidies to encourage the expansion of farm production and achieve self-reliance in food production.
Subsidies can be regarded as a form of protectionism or trade barrier 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.
In standard supply and demand curve diagrams, 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. Therefore it is essential to consider elasticity when estimating the total costs of a planned subsidy: it equals the subsidy per unit (difference between market price and subsidized price) times the new equilibrium quantity. One category of goods suffers less from this effect: Public goods 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.
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.
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 transfers 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 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.
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).
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, and particularly gasoline, has been subsidized or favored by U.S. defense policy, reducing the use of alternative energy sources and delaying their commercial development.
In other cases, the government may need to improve the public transport 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.
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 quotas, import tariffs, import bans, and others.
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.
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.
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. 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 to control the cost).
The provision of true public goods 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.
Another form of subsidy is due to the practice of a government guaranteeing a lender payment if a particular borrower defaults. 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.
Human-rights based non-governmental organizations like Oxfam describe such subsidies as dumping millions of surplus commodities (like sugar) on world markets, destroying opportunities for farmers in developing and poor countries, especially in Africa. For example, the EU is currently spending €3.30 in subsidies to export sugar worth €1. Another example of trade distorting subsidies is the Common Agricultural Policy of the European Union. It represents 48% of the entire EU's budget, €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, published by the Center for Global Development, measures the effect that subsidies and trade barriers actually have on the developing 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 developing 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.
The Austrian School of economics and other free-marketers hold the view that subsidies generally do more harm than good by distorting economic signals.
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, the company threatened the Tasmanian Government with a pull-out of rail services unless a subsidization was made.