Should certain industries be subsidized

Subsidies

What are subsidies? Don't worry, here you will get a definition, get to know different types of award and also find out why subsidies are criticized every now and then.

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Subsidies definition

According to the economic definition, subsidies are publicly funded services to companies. The benefits include both direct cash payments and indirect benefits such as tax reductions and exemptions. The basic aim of subsidies is to promote the economy. Subsidies thus represent an economic policy instrument that can be used by states or associations of states such as the EU. As a rule, the grants are made without market-economy consideration by the recipient.

aims

The decision of the state to support a particular company or industry is mostly related to political and social goals. Often an incentive for certain market behavior of the recipient is to be created. There are basically three different backgrounds for subsidizing companies:

Objective of the subsidyExplanationexample
advancementDevelopment of new economic fieldsEstablishing a company in economically important future industries (e.g. artificial intelligence)
AdaptationAdaptation of companies to new economic and social formsrenewable energies, capacity reduction in the steel industry
conservationProtection of structures with cultural or social significanceAgriculture, mining

In the case of promotional subsidies as well as adaptation subsidies and maintenance subsidies, the cushioning or slowing down of structural change in a society is often an important factor in granting the benefits. Without state aid, many companies are unable to adapt to new circumstances and position themselves in the competition. Examples include various federal and state subsidy programs designed to help medium-sized companies take advantage of the opportunities offered by digitization and Industry 4.0. In addition, creating or maintaining jobs is another aspect to consider when deciding on subsidies.

Award types

However, one subsidy is not always the same as another. There are different types of award with financial differences. Let us establish definitions of various terms:

  • grants: Grants are paid directly to companies and do not result in anything in return. This is the classic and most common type of award.
  • loan: Here the state offers cheap loans so that companies do not have to rely on private sector interest. Often such loans are given to projects to improve infrastructure, for housing construction or for energy saving opportunities.
  • Guarantees: In the event that there is no collateral for private sector loans, the public sector offers guarantees. The main application here is export credit insurance.
  • Real funding: When awarding public contracts, the state foregoes the cheapest price and accepts additional costs for a political goal. In addition, the sale of material assets at a price that is not customary in the market also counts as real subsidies (e.g. the sale of land to a non-profit housing association).
  • Tax subsidies: Tax reductions or exemptions take the form of indirect subsidies.
  • Excessive prices: The producer receives higher prices than usual for the market. An example of this would be the feed-in tariff in energy policy.

Impact and Criticism

Of course, subsidies offer many advantages for the recipient. However, not everyone benefits from the distribution of the grants. That is why subsidies are often criticized from different perspectives.

  • A big point of contention is that active intervention in the market economy. This mainly concerns legal problems, as financial aid is generally prohibited in legally secured free trade zones (e.g. within the EU). However, this prohibition is overridden by numerous exemptions. From the point of view of free competition, subsidies create advantages for recipients and thus automatically disadvantages for non-beneficiaries. This can lead to the crowding out of competitive companies that are not subsidized.
  • The lack of transparency in political decisions is also a problem. Often the reasons are questionable as to which industries are supported and which are not. In addition, there is a lack of regular performance reviews that would help justify subsidies. The possible abolition of existing subsidies is also a challenge. If a company receives regular payments from the state, it is not easy for the state to justify the suspension of these payments. This is why many companies and industries are still funded when the political purpose is no longer given. For example, a subsidy was introduced for freight forwarders in 2002 to relieve them of the then new truck toll. This subsidy came under fire because, among other things, on-board refrigerators, comfort cockpits and laptops were approved for a large number of shipping companies.
  • If there is no information about the purpose of the money, the taxpayer often takes the subsidies as unjust true. This perception is also caused by the fact that the general public has to bear the benefits of individual companies.
  • Finally, there is a risk that a Subsidy mentality solidified. This means that companies get used to financial aid in order to adapt to structural changes in an economy. This means that companies lose their own initiative and structural change can be delayed. This would have negative consequences for economic growth and employment figures.

The effects of subsidies do not necessarily have to result in disadvantages. For example, the market price of housing can be reduced if the state promotes housing construction with rental price control. It depends on the perspective. With many effects it is not obvious whether they are positive or negative. For example, the state creates an incentive for nationally subsidized companies not to relocate abroad. This has advantages for employment within the country, but creates additional costs for the state budget and the taxpayer. Whether these costs are greater than the benefits of a high employment rate is difficult to calculate.

Subsidies Examples

A big topic in the context of the media is EU subsidies in agriculture. Using this example, we break down the objectives, the type of award and the effects of subsidies.

EU subsidies

In the EU, agricultural subsidies are based on both market failures and the interests of farmers, businesses and consumers. The aim was to supply the population with affordable food through stable agricultural markets and to create an adequate income for farmers. In the meantime, the EU also bases its subsidies on the multifunctionality of agriculture. This means that the farmers receive a cultural landscape, for example, but are not paid for it. The subsidies should compensate for this in the form of direct payments. Agricultural policy plays an extremely important role in the EU. The annual expenditure amounts to almost 60 billion euros, which corresponds to around 114 euros per EU citizen.

Agricultural subsidies

Despite the high expenditure, there is a lack of transparency regarding the use of the funds. Only the amount of direct payments to the recipient is given, not the land area affected. Another point of criticism is that external effects are not taken into account. For example, excessive fertilization of the fields causes an accumulation of phosphate in the groundwater, which in the long term promotes harmful plant growth. From an economic point of view, exporting countries of agricultural products (e.g. Canada) in particular suffer from EU subsidies. Within the EU, the subsidies have a positive effect on production volumes and employment in agriculture.

Conclusion

As can be seen from the example of EU agricultural policy, subsidies can offer both opportunities and risks. Weighing up the advantages and disadvantages is not always easy and should be carefully considered in view of the amount of the payments. The goal of long-term economic development should never be disregarded over the period of subsidy payments.

  • Subsidies are publicly funded services to companies
  • The aim is to promote the economy
  • Important aspects such as structural change and the number of employees must be taken into account when granting subsidies
  • There are different types of subsidies with financial differences
  • Criticisms of subsidies are mainly the interference in the market and a lack of transparency in political decisions