Equity and Environmental Impacts of Subsidies

Subsidies and the Poor

It is commonly argued that subsidies to basic resources should be retained because removing them would harm the poor. Similarly, particular industries must be protected, since it is the poor who work there. Subsidies simply represent transfers of wealth or risk from one party to another that occur by government action rather than by mutual market agreement. These transfers can be good or bad; they can be done efficiently or inefficiently.

Subsidizing Environmental Transition

A related issue frequently arises with respect to subsidies to polluting industries. Society, it is argued, is better off by paying a portion of the cost to retool older, polluting industries because in this way health effects can be more quickly mitigated.

There are elements of truth in both of these arguments. Provision of food to starving people is certainly a subsidy, since the recipients are not paying for what they receive. However, few would argue that such a policy should not occur. Similarly, if the choice were to pay to install emissions controls rather than force thousands of people to breath very dangerous air, the government might well be justified in stepping in. The challenge in to look at these trade-offs dynamically: what is the likely response not if the government did nothing, but rather if it intervened in a way that forced real costs through pricing, rather than subsidizing the problem away. Rather, debate would center on the most effective ways to provide that food so the costs were low and domestic farmers -- who hold the key for preventing future famines -- would have an incentive to increase food production rather than to leave farming (as sometimes occurs when markets are flooded with foreign food).

Nonetheless, some of the internal dynamics of how new subsidy policies are created and distributed suggest that much of the economic value of these policies supports more powerful groups in society, not the poor. This is common in natural resource subsidization, even for policies that appear on their face to support the poor. For example, the International Energy Agency recently pointed out that subsidies to kerosene in many developing countries ostensibly to help the poor are often helping the middle class instead. The poorest populations rely on even more basic cooking fuels such as dung, and benefit only peripherally from subsidies to kerosene.

The pattern is repeated around the world. The reason is a logical one: subsidies allocate substantial resources to subgroups of the population. When the funding is large, the recipient groups are willing to invest at least a portion of those gains to lobby for new subsidies and to protect old ones, a process referred to as "rent seeking" behavior. The need for sophistication, connections, and funds to invest in such a process means that the rich, educated, and well connected portions of society tend to be much more likely to obtain benefits in complicated political economies. Under this framework, it makes perfect sense that the bulk of the subsidies flow to the wealthier segments of the population. Political representatives often face the wrath of these segments whenever they promote any type of reform. This pattern is quite clear even in the United States. For example, while there are subsidies to heating fuels for the poor, the funding is a pittance compared to the many billions that flow primarily to corporations or wealthier investors to support new energy development.

This diversion of funds leaves fewer public resources for the real poor. Yet, the powerful interests supporting subsidization are extremely difficult to challenge. In virtually every case, the economically-efficient solution would be to let markets set commodity prices and to provide lump sum subsidies (a direct cash payment) to the poor instead. Yet in reality, many countries would be unable to implement such a system of payments. Where governments are corrupt and/or disorganized, there is no political will or infrastructure to distribute the funds, and payments for the poor would likely be diverted to other, unrelated uses. As a result, subsidies to basic commodities can transfer value that allows the poor to live, but often does so at a much higher economic cost.

The role of political power in subsidy policies suggests the need for a good deal of skepticism when evaluating new claims on public funds. Alternative mechanisms for delivering support to the poor should be evaluated. In addition, if basic goods for the poor remained subsidized while the billions flowing to wealthier interests in other forms were curbed, we would likely see a great deal of environmental improvement. We might also see many more funds available to meet the basic needs of the poor.

Regardless of how they are provided, subsidies have a similar effect on the marketplace. Subsidized activities become less expensive relative to unsubsidized activities. This can encourage overinvestment in these activities (or overconsumption of the subsidized products). Equally importantly, decisions to leave the market are slowed. As a result, newer technologies -- which are often more environmentally friendly -- face additional barriers to entering a market and growing.

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