The subsidy game

If you’re so smart, why aren’t you subsidized?

The market economies of Central Asia are a quarter of a century old, and their first blushes of ardor for Adam Smith are fading. Expo 2017 illustrates the new paradigm: When in doubt, subsidize – particularly when the subsidized will back you politically in return.

What’s wrong with subsidies? One urban legend argues that the subsidized lose money. This confuses cause for effect: Losers qualify for subsidies. The real problem is that subsidies divert resources – men, machines and ideas – to an industry where they are less valuable than they had been in their original. 

To see why, begin with an economy that already maximizes value.  This condition connotes that the value of another labor hour is the same in all industries; had it instead been worth, say, $10 in Industry A and $9 in Industry B, then we could have raised the economy’s value by $1 by moving one hour from B to A, so the economy must not have been at a max.

Subsidies move inputs in the wrong direction, from A to B.  Consider what happens. In the beginning, another labor hour was worth $10 in both A and B.  Now a subsidy to A enables an employer there to lure away a labor hour from B.  Since workers have only so much machinery to work with, adding another worker to an industry congests its capital, raising its value of production by a diminishing amount.  (Try baking more pizzas when you add the tenth cook to your one oven.) Let’s say that the additional labor hour in A is worth only $9.  Since it had been worth $10 in B, the subsidy slashes the value of total production by $1.

Of course, the honcho in A is delighted to accept the subsidy, because it boosts his profits.  Suppose that the subsidy is $3.  To hire the labor hour away from B, he will need to pay the worker $11 (since she had been receiving $10, the value of her product, in B).  That hour is worth only $9 to the A boss, so he loses $2 by purchasing it.  But the subsidy is $3, so the boss comes out ahead by $1. It’s just the economy that loses. Analysts who argue that subsidies must be good because they enable the subsidized industry to survive, are missing the point.

Of course, subsidies are not always odious.  They may give us what we want when the producer cannot collect enough value to cover costs although the former does exceed the latter. The textbook example in Almaty is clean air; since it cannot be bottled, the producer cannot confine its consumption to payers, so he doesn’t bother to supply it. The government could stimulate its supply by paying auto owners in Almaty to install devices on their vehicles that control pollution (or, in what amounts to the same thing, by taxing car owners who fail to install the equipment).

The music industry offers a more complex example. A song may cost $10,000 to record but $0 to distribute via the Web. The musician must charge enough to cover the fixed cost -- $1 per listener if he has 10,000 fans; but because the song costs nothing to provide, he should instead give it away to all who yearn to hear it. One solution is to have the government pay the $10,000. The problems in this approach are evident -- Astana may favor dreary pro-government tunes – but the example does show the brighter side of subsidies. –Leon Taylor tayloralmaty@gmail.com