The Road to Ruin Is Paved with Subsidies
Government promises jobs and growth, but ends up misallocating resources and repeating the cycle of economic disruption.
Somewhere in the world a politician is promising to make people better off. A new law, tax, or subsidy will deliver jobs, better healthcare, and affordable housing. Economists, academics, and policy experts armed with economic models support the proposal.
Interventionists justify interventions as being good for society, the environment and economic growth.
If this were true, we would by now be living in paradise. Unemployment and poverty would be gone forever.
The miracle
Imagine a barter economy in which the government levies a 10% tax on production. A sheep farmer raising one hundred sheep pays tax in the form of ten sheep. The government uses the sheep to pay the politicians' and bureaucrats' salaries, and for a new road.
Assume now the government decides it needs to help struggling crop farmers. It increases the tax rate on sheep farmers to 15%. Our sheep farmer now pays fifteen sheep, instead of ten, in taxes. The government then redistributes the five extra sheep to crop farmers.
Some farmers exchange their stimulus (sheep) for ploughs to increase production. Some do not. Instead, they eat their economic stimulus. Others exchange their stimulus for chickens. Greater demand for chickens raises poultry prices, making poultry production more profitable. Poultry farmers then increase the production of chickens to meet demand. The sheep farmers lose, while chicken farmers, the unintended beneficiaries, benefit.
The government has achieved a miracle. It has turned sheep into chickens!
It does not end there. The increased tax on sheep farmers reduces meat and wool production. If the demand for sheep and wool stays constant, citizens end up paying more for meat and wool. They then have less to spend on other things, like turkeys. Turkey farmers then lower prices to get rid of the surplus turkeys. This makes turkey eaters happy, at least until the surplus ends.
How to wreck an industry
What happens when money is the medium of exchange?
Let us assume the government decides to subsidise the ailing car industry to stem job losses. To pay for the stimulus, it can introduce a new tax, borrow money, or inflate the money supply. We will ignore these actions and focus on the subsidy.
The effect of the subsidy is to keep inefficient producers in business. The production-life of cars people do not want gets extended. Manufacturers continue buying components such as windscreens and tyres from downstream suppliers. This means a part of the demand for windscreens and tyres is artificial. It stems from government subsidies and not from real consumer demand.
The subsidised manufacturers bid resources away from things for which demand is real. An example would be windowpanes needed for housing, apartments, and offices. The artificial demand for windscreen glass increases the price of windowpanes. The cost of building houses, flats and offices go up.
If the supply of subsidised cars exceeds demand, their manufacturers must lower prices. They might end up selling cars at a loss. Production cuts, job losses, and bankruptcies follow.
Subsidisation of the car industry led to more expensive houses, offices, and flats. It also ended car production. The government achieved the opposite of what it intended.
Interventionism repeats
Government intervention in the economy misallocates resources. The greater the extent of intervention, the more the unintended and unpredictable consequences.
Our politician blames the market and proposes further interventions. The cycle of economic disruption repeats.
Originally Published on The Skeptical Planner
Johan Biermann is a retired planning consultant and policy researcher and an associate of the Free Market Foundation.
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