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A subsidy or government incentive is a form of financial aid or support extended to an economic sector (business, or individual) generally with the aim of promoting economic and social policy.[1] Although commonly extended from government, the term subsidy can relate to any type of support – for example from NGOs or as implicit subsidies. Subsidies come in various forms including: direct (cash grants, interest-free loans) and indirect (tax breaks, insurance, low-interest loans, accelerated depreciation, rent rebates).[2][3]

Furthermore, they can be broad or narrow, legal or illegal, ethical or unethical. The most common forms of subsidies are those to the producer or the consumer. Producer/production subsidies ensure producers are better off by either supplying market price support, direct support, or payments to factors of production.[1] Consumer/consumption subsidies commonly reduce the price of goods and services to the consumer. For example, in the US at one time it was cheaper to buy gasoline than bottled water.[4]

Assuming the market is in a perfectly competitive equilibrium, a subsidy increases the supply of the good beyond the equilibrium competitive quantity. The imbalance creates deadweight los

Assuming the market is in a perfectly competitive equilibrium, a subsidy increases the supply of the good beyond the equilibrium competitive quantity. The imbalance creates deadweight loss. Deadweight loss from a subsidy is the amount by which the cost of the subsidy exceeds the gains of the subsidy.[17] The magnitude of the deadweight loss is dependent on the size of the subsidy. This is considered a market failure, or inefficiency.[17]

Subsidies targeted at goods in one country, by lowering the price of those goods, make them more competitive against foreign goods, thereby reducing foreign competition.[18] As a result, many developing countries cannot engage in foreign trade, and receive lower prices for their products in the global market. This is considered protectionism: a government policy to erect trade barriers in order to protect domestic industries.[19] The problem with protectionism arises when industries are selected for nationalistic reasons (infant-industry), rather than to gain a comparative advantage. The market distortion, and reduction in social welfare, is t

Subsidies targeted at goods in one country, by lowering the price of those goods, make them more competitive against foreign goods, thereby reducing foreign competition.[18] As a result, many developing countries cannot engage in foreign trade, and receive lower prices for their products in the global market. This is considered protectionism: a government policy to erect trade barriers in order to protect domestic industries.[19] The problem with protectionism arises when industries are selected for nationalistic reasons (infant-industry), rather than to gain a comparative advantage. The market distortion, and reduction in social welfare, is the logic behind the World Bank policy for the removal of subsidies in developing countries.[16]

Subsidies create spillover effects in other economic sectors and industries. A subsidized product sold in the world market lowers the price of the good in other countries. Since subsidies result in lower revenues for producers of foreign countries, they are a source of tension between the United States, Europe and poorer developing countries.[20] While subsidies may provide immediate benefits to an industry, in the long-run they may prove to have unethical, negative effects. Subsidies are intended to support public interest, however, they can violate ethical or legal principles if they lead to higher consumer prices or discriminate against some producers to benefit others.[18] For example, domestic subsidies granted by individual US states may be unconstitutional if they discriminate against out-of-state producers, violating the Privileges and Immunities Clause or the Dormant Commerce Clause of the United States Constitution.[18] Depending on their nature, subsidies are discouraged by international trade agreements such as the World Trade Organization (WTO). This trend, however, may change in the future, as needs of sustainable development and environmental protection could suggest different interpretations regarding energy and renewable energy subsidies.[21] In its July 2019 report, "Going for Growth 2019: The time for reform is now", the OECD suggests that countries make better use of environmental taxation, phase out agricultural subsidies and environmentally harmful tax breaks.[22][23]

Although subsidies can be important, many are "perverse", in the sense of having adverse unintended consequences. To be "perverse", subsidies must exert effects that are demonstrably and significantly adverse both economically and environmentally.[1] A subsidy rarely, if ever, starts perverse, but over time a legitimate efficacious subsidy can become perverse or illegitimate if it is not withdrawn after meeting its goal or as political goals change. Perverse subsidies are now so widespread that as of 2007 they amounted $2 trillion per year in the six most subsidised sectors alone (agriculture, fossil fuels, road transportation, water, fisheries and forestry).[24]

Effects

The detrimental effects of perverse subsidies are diverse in nature and reach. Case-studies from differing sectors are highlighted below but can be summarised as follows.

Directly, they are expensive to governments by directing resources away from other legitimate should priorities (such as environmental conservation, education, health, or infrastructure),[3][13][25][26] ultimately reducing the fiscal health of the government.[27]

Indirectly, they cause environmental degradation (exploitation of resources, pollution, loss of landscape, misuse and overuse of supplies) which, as well as its fundamental damage, acts as a further brake on economies; tend to benefit the few at the expense of the many, and the rich at the expense of the poor; lead to further polarization of development between the Northern and Southern hemispheres; lower global market prices; and undermine investment decisions reducing the pressure on businesses to become more efficient.[4

The detrimental effects of perverse subsidies are diverse in nature and reach. Case-studies from differing sectors are highlighted below but can be summarised as follows.

Directly, they are expensive to governments by directing resources away from other legitimate should priorities (such as environmental conservation, education, health, or infrastructure),[3][13][25][26] ultimately reducing the fiscal health of the government.[27]

Indirectly, they cause environmental degradation (exploitation of resources, pollution, loss of landscape, misuse and overuse of supplies) which, as well as its fundamental damage, acts as a further brake on economies; tend to benefit the few at the expense of the many, and the rich at the expense of the poor; lead to further polarization of development between the Northern and Southern hemispheres; lower global market prices; and undermine investment decisions reducing the pressure on businesses to become more efficient.[4][26][28] Over time the latter effect means support becomes enshrined in human behaviour and business decisions to the point where people become reliant on, even addicted to, subsidies, 'locking' them into society.[29]

Consumer attitudes do not change and become out-of-date, off-target and inefficient;[4] furthermore, over time people feel a sense of historical right to them.[28]

Perverse subsidies are not tackled as robustly as they should be. Principally, this is because they become 'locked' into society, causing bureaucratic roadblocks and institutional inertia.[30][31] When cuts are suggested many argue (most fervently by those 'entitled', special interest groups and political lobbyists) that it will disrupt and harm the lives of people who receive them, distort domestic competitiveness curbing trade opportunities, and increase unemployment.[28][32] Individual governments recognise this as a 'prisoner's dilemma' – insofar as that even if they wanted to adopt subsidy reform, by acting unilaterally they fear only negative effects will ensue if others do not follow.[29] Furthermore, cutting subsidies, however perverse they may be, is considered a vote-losing policy.[30]

Reform of perverse subsidies is at a propitious time. The current economic conditions mean governments are forced into fiscal constraints and are looking for ways to reduce activist roles in their economies.[31]<

Reform of perverse subsidies is at a propitious time. The current economic conditions mean governments are forced into fiscal constraints and are looking for ways to reduce activist roles in their economies.[31] There are two main reform paths: unilateral and multilateral. Unilateral agreements (one country) are less likely to be undertaken for the reasons outlined above, although New Zealand,[33] Russia, Bangladesh and others represent successful examples.[4] Multilateral actions by several countries are more likely to succeed as this reduces competitiveness concerns, but are more complex to implement requiring greater international collaboration through a body such as the WTO.[26] Irrespective of the path, the aim of policymakers should be to: create alternative policies that target the same issue as the original subsidies but better; develop subsidy removal strategies allowing market-discipline to return; introduce 'sunset' provisions that require remaining subsidies to be re-justified periodically; and make perverse subsidies more transparent to taxpayers to alleviate the 'vote-loser' concern.[4]

Support for agriculture dates back to the 19th century. It was developed extensively in the EU and USA across the two World Wars and the Great Depression to protect domestic food production, but remains important across the world today.[26][30] In 2005, US farmers received $14 billion and EU farmers $47 billion in agricultural subsidies.[18] Today, agricultural subsidies are defended on the grounds of helping farmers to maintain their livelihoods. The majority of payments are based on outputs and inputs and thus favour the larger producing agribusinesses over the small-scale farmers.[1][34] In the USA nearly 30% of payments go to the top 2% of farmers.[26][35][36]

By subsidising inputs and outputs through such schemes as 'yield based subsidisation', farmers are encouraged to over-produce using intensive methods, including using more fertilizers and pesticides; grow high-yielding monocultures; reduce crop rotation; shorten fallow periods; and promote exploitative land use change from forests, rainforests and wetlands to agricultural land.[26] The

By subsidising inputs and outputs through such schemes as 'yield based subsidisation', farmers are encouraged to over-produce using intensive methods, including using more fertilizers and pesticides; grow high-yielding monocultures; reduce crop rotation; shorten fallow periods; and promote exploitative land use change from forests, rainforests and wetlands to agricultural land.[26] These all lead to severe environmental degradation, including adverse effects on soil quality and productivity including erosion, nutrient supply and salinity which in turn affects carbon storage and cycling, water retention and drought resistance; water quality including pollution, nutrient deposition and eutrophication of waterways, and lowering of water tables; diversity of flora and fauna including indigenous species both directly and indirectly through the destruction of habitats, resulting in a genetic wipe-out.[1][26][37][38]

Cotton growers in the US reportedly receive half their income from the government under the Farm Bill of 2002. The subsidy payments stimulated overproduction and resulted in a record cotton harvest in 2002, much of which had to be sold at very reduced prices in the global market.[18] For foreign producers, the depressed cotton price lowered their prices far below the break-even price. In fact, African farmers received 35 to 40 cents per pound for cotton, while US cotton growers, backed by government agricultural payments, received 75 cents per pound. Developing countries and trade organizations argue that poorer countries should be able to export their principal commodities to survive, but protectionist laws and payments in the United States and Europe prevent these countries from engaging in international trade opportunities.

Today, much of the world's major fisheries are overexploited; in 2002, the WWF estimate this at approximately 75%. Fishing subsidies include "direct assistant to fishers; loan support programs; tax preferences and insurance support; capital and infrastructure programs; marketing and price support programs; and fisheries management, research, and conservation programs."[39] They promote the expansion of fishing fleets, the supply of larger and longer nets, larger yields and indiscriminate catch, as well as mitigating risks which encourages further investment into large-scale operations to the disfavour of the already struggling small-scale industry.[26][40] Collectively, these result in the continued overcapitalization and overfishing of marine fisheries.

There are four categories of fisheries subsidies. First are direct financial transfers, second are indirect financial transfers and services. Third, certain forms of intervention and fourth, not intervening. The first category regards

There are four categories of fisheries subsidies. First are direct financial transfers, second are indirect financial transfers and services. Third, certain forms of intervention and fourth, not intervening. The first category regards direct payments from the government received by the fisheries industry. These typically affect profits of the industry in the short term and can be negative or positive. Category two pertains to government intervention, not involving those under the first category. These subsidies also affect the profits in the short term but typically are not negative. Category three includes intervention that results in a negative short-term economic impact, but economic benefits in the long term. These benefits are usually more general societal benefits such as the environment. The final category pertains to inaction by the government, allowing producers to impose certain production costs on others. These subsidies tend to lead to positive benefits in the short term but negative in the long term.[41]

The US National Football League's (NFL) profits have topped records at $11 billion, the highest of all sports. The NFL had tax-exempt status until voluntarily relinquishing it in 2015, and new stadiums have been built with public subsidies.[42][43]

The Commitment to Development Index (CDI), published by the Center for Global Development, measures the effect

The Commitment to Development Index (CDI), published by the Center for Global Development, measures the effect that subsidies and trade barriers actually have on the undeveloped 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 undeveloped 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.[44]

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