The Case for Eliminating Subsidies to Industries
On a previous post about subsidizing industries, a Show-Me Daily reader poses the following question:
So it would be better to not subsidize these programs and allow them to not exist? It’s not worth it to let them become proven while working toward the longer-term goal of eliminating the subsidies?
The writer introduces infant industry argument, which supporters of subsidies commonly use. The argument implies that emerging industries need to be protected temporarily in order to develop the economies of scale that established companies and industries possess.
My answer is an emphatic yes. For reasons that I am about to describe, it would be better if the state did not subsidize these programs.
If these subsidies were eliminated, many groups would be better off. Consumers represent one group that would certainly benefit. Protecting industries hurts consumers because it: (1) restricts new suppliers from entering the market (which restricts supply and increases the price to the consumer); (2) removes the incentive for existing suppliers to innovate (which decreases product quality); and, (3) restricts their access to consume non-protected competitive products. Furthermore, eliminating subsidies to particular industries will not restrict the variety of goods and services available to consumers. When industries focus production according to their comparative advantage and then trade with others, Missourians will still be able to consume in the absence of subsidy.
Taxpayers would be better off in the absence of such subsidies, as well. The subsidies distort relative prices, which consequently distorts the mix of goods and services available for consumption. A firm that receives a subsidy from the government can charge a lower price to consumers, who consequently have an incentive to consume a greater quantity of it. Additionally, if the subsidies were eliminated, taxpayers would be able to keep a greater percentage of their earnings that they can save, invest, and/or spend on the goods and services that they naturally prefer in the private sector, rather than the goods or services that happen to have artificially lower subsidized prices.
Another group that would benefit from the elimination of subsidies is businesses and industries that do not currently receive subsidies. The government places this group at an artificial competitive disadvantage by dispensing political favors to its competitors.
Milton and Rose Friedman disputed the infant industries argument in their book Free to Choose: A Personal Statement. They wrote:
[T]he “infant industry” argument [is] advanced, for example, by Alexander Hamilton in his Report on Manufactures. There is, it is said, a potential industry that, if once established and assisted during its growing pains, could compete on equal terms in the world market. A temporary tariff is said to be justified in order to shelter the potential industry in its infancy and enable it to grow to maturity, when it can stand on its own feet. Even if the industry could compete successfully once established, that does not of itself justify an initial tariff. It is worthwhile for consumers to subsidize the industry initially–which is what they in effect do by levying a tariff–only if they will subsequently get back at least that subsidy in some other way, through prices lower than the world price or through some other advantages of having the industry. But in that case is a subsidy needed? Will it then not pay the original entrants into the industry to suffer initial losses in the expectation of being able to recoup them later? After all, most firms experience losses in their early years, when they are getting established. That is true if they enter a new industry or if they enter an existing one. Perhaps there may be some special reason why the original entrants cannot recoup their initial losses even though it may be worthwhile for the community at large to make the initial investment. But surely the presumption is the other way.
Additionally, subsidized industries have difficulty weaning themselves off government assistance. I have previously discussed this in the context of film tax credits. When a state protects a particular industry and/or provides financial aid, the industry tends to remain dependent on that protection or subsidy. Furthermore, industries that are subsidized do not have an incentive to innovate because they are not subject to the same competitive pressures as those that are unsubsidized.
More often than not, when an industry refers to itself with the “infant” term, it’s simply seeking rent through legislative favoritism. Milton and Rose Friedman also discussed this concept in Free to Choose: A Personal Statement. They wrote:
The infant industry argument is a smoke screen. The so-called infants never grow up. Once imposed, tariffs are seldom eliminated. Moreover, the argument is seldom used on behalf of true unborn infants that might conceivably be born and survive if given temporary protection; they have no spokesmen. It is used to justify tariffs for rather aged infants that can mount political pressure.
