How Do Government Subsidies Help an Industry?

Reviewed by Charles PottersFact checked by Katrina Munichiello

Do Subsidies Help the Economy?

Government subsidies can boost the economy, either by paying for part of suppliers’ production costs or by boosting demand among consumers for goods and services. Subsidies can take the form of direct aid, tax credits, and reimbursements, among other types of economic support.

A subsidy is often granted by a government to support critical parts of the economy that are thought to be vulnerable to external forces.

Key Takeaways

• Subsidies are payments, tax breaks, or other forms of economic support given by governments to certain industries or economic sectors.
• The goal of subsidies is to aid or support what are deemed to be key parts of the economy or national infrastructure.
• While subsidies may have a direct positive impact on the particular industry or companies involved, economists argue that subsidies work against free trade and create market inefficiencies.

Effect of Subsidies on Supply

Governments implement subsidies to encourage production and consumption in specific industries. When government subsidies are implemented on the supplier side, producers can produce more goods and services. This increases the overall supply, which increases the quantity demanded and lowers the overall price.

In this sense, when the government gives subsidies to suppliers, what results is a win-win situation for both producers and consumers. Essentially, suppliers benefit to the same extent as if the goods and services were selling at higher prices, and are able to produce more. Meanwhile, consumers get to enjoy subsidized products for relatively cheaper prices.

The government often helps suppliers through tax credits or reimbursements.

Effects of Subsidies on Demand

On the consumer side, government subsidies can also help potential consumers afford goods or services, usually through tax credits. A great example of this can be found in the transition to more renewable sources of energy. With still nascent models of green economics, the current demand to purchase new energy-saving technology is low. In order to sway consumer interest, government subsidies or tax credits may help lower an otherwise high cost of adoption. When consumers refit their houses with solar panels, the government provides tax credits to individuals and families to offset their high purchase price.

In this sense, consumer-targeted subsidies will not necessarily immediately increase supply, since producers aren’t being directly motivated or compensated to produce more. However, tax credits can offset higher prices for consumers, while ensuring that profit margins still go back to producers. In the long-run, subsidies can sustain and stabilize demand, incentivizing producers to produce more.

In the same vein, some states also provide a tax credit or subsidy for buying an electric or hybrid vehicle. This helps the renewable energy industry by allowing more consumers to purchase the products associated with that industry, without having to absorb their entire cost.

What Are Some Critiques of Government Subsidies?

Critics of subsidies claim that they interfere with free markets, and therefore can cause anomalies or inefficiencies. Critics argue that subsidies create unfair conditions that favor one set of companies over others, reducing competition. These companies can take advantage of subsidies to engage in rent-seeking, ultimately at the harm of consumers.

What Are Direct vs. Indirect Subsidies?

Direct subsidies involve cash transfers or tax breaks that immediately impact a company or industry. Indirect subsidies do not have a specific cash value or involve payments of cash. These can instead include making it easier to obtain inputs or reducing costs in other ways.

Which Industries Do the U.S. Government Subsidize?

The U.S. government heavily subsidizes the domestic agricultural sector. It also subsidizes oil and energy producers, some housing, automakers, and some healthcare, such as through Medicare.

The Bottom Line

Government subsidies can help an industry on both the supplier side and the consumer side, regardless of which end they are initially implemented on.

To pay for subsidies, governments need to raise taxes or reallocate taxes from existing budgets. Critics argue that subsidies interfere with free markets and create inefficiencies. They also argue that subsidies reduce the incentive of firms to cut costs.

Whether it’s by increasing supply through supplier-side subsidies, or helping consumers with high costs of adoption through tax credits, it’s clear that government intervention in market economics has real-life impacts on all parties.

Read the original article on Investopedia.