Subsidy

I would define Subsidy simply as the opposite of Taxation. Whereas taxation happens when the government receives money from individuals or corporates without the payor receiving utility from it as part of the transaction, the subsidy happens whenever the government gives out money instead of taking it in, and without receiving utility for the money it gives away as part of the transaction. It is a way to redistribute wealth and affecting price points by shifting the supply-demand curve.

Most economic studies (e.g. Wikipedia, MasterClass) like to categorize subsidy in either the market or the manner that the money transaction takes place, but I like to think about subsidy as what is being incentivized. This is useful for identifying the perverse effects. When considering the perverse effects, note that utility is only created when supply exactly meets demand. When a supply is not consumed, the supply goes to waste. If a demand is unfulfilled, then it becomes poverty. Therefore, supply-demand is the most important dimension to consider for a subsidy.

Another dimension is whether the subsidy is targeted or untargeted. A targeted subsidy is designed to shift the supply-demand curve of a particular commodity (goods or services that are interchangeable with other goods or services of the same type). An untargeted subsidy is not limited to a specific market, so the perverse effect can cause collateral damages.

A supply subsidy tends to lower price but increase volume, and a demand subsidy tends to increase both price as well as volume. Having both supply and demand subsidies targeted to a specific commodity can counter the price effects while increasing volume. However, untargeted subsidy would not be effective because the scope of its perverse effect can be unpredictable.

Supply Subsidy

The supply subsidy is designed to incentivize the production of goods or services, thus increasing the supply without increasing the cost of production. This type of subsidy can cause overproduction. Overproduction happens when supply is greater than the demand, so it goes to waste. This can cause the price to decrease, or even collapse in the severe case. Supply subsidy also removes the incentive to innovate because the reduced cost of production makes it seems like a business is more efficient even if it is not.

As a production subsidy, it can take place by purchasing goods from a manufacturer, or agriculture produce from famers, at above market price and sell the goods at a loss. It can also take place as tax breaks, wages subsidy, or other employment benefits given to a company, which allows the company to lower their costs of production.

Export subsidy is a supply subsidy because the act of exporting is essentially supplying to a foreign market. Import subsidy is also a supply subsidy by virtue of lowering the cost of the import company to sell goods or services. Foreign aids or disaster relief are supply subsidies.

Oil subsidy is a supply subsidy designed to decrease the price of oil. It can take place as a production subsidy (buy high sell low) or import subsidy for foreign oil.

Public infrastructure spending can also be seen as a supply subsidy, where there would be a company, real or imagined, that manages the infrastructure without incurring the cost of construction or maintenance. Highways, roads, rail, and airports are commonly subsidized this way even though the user sometimes pays a usage fee.

Housing subsidy can be a supply subsidy if it is paid to the constructor for building homes. But subsidy paid to the landlord does not increase housing supply, so it is not a supply subsidy.

Education subsidy can be a supply subsidy if it pays for the wages of teachers.

Supply subsidy is by definition targeted: it directly affects the market for a particular commodity for which the supplier is a part of.

Demand Subsidy

The demand subsidy tries to lessen poverty condition by making goods or services more affordable to the consumer, thus increasing demand. This can cause the price to increase, which lowers the value of the goods or services received by the consumer. The value is utility per price, so lowered value is essentially inflation.

Tax rebates for the receipt of goods or services are targeted consumer subsidies, but they are less common.

Housing subsidy is a demand subsidy if it takes place as a rental subsidy paid to the renter, or vouchers given to first time home buyers to offset home-buying mortgage or expenses. Subsidy paid to the landlord only gives them more money to invest in real estate properties as buyers, so it is actually a demand subsidy.

Untargeted Demand Subsidy

Whereas targeted demand subsidies are more easily regulated to limit the perverse effect of inflation in a particular market, untargeted demand subsidy can cause broad perverse effects that are difficult to control.

Most consumer subsidies are untargeted, such as food stamps, education (scholarships or forgiven student loans), and healthcare. These are untargeted because they affect a broad category of markets, not specific to a commodity. For example, healthcare subsidies are given to a range of treatment or preventive care, even though each type of treatment require a different specialist.

Social security benefits, unemployment benefits, and universal basic income are the other untargeted demand subsidies that an individual may receive.

Other Discussion

Externalities are costs that are not captured by the price. Some examples are environmental pollution caused by resource extraction or production, or the CO2 emission caused by utilization. They are a form of market inefficiencies but not subsidies since no money changes hands. They need to be first internalized by requiring companies to restore the environment back to its pristine condition and replenish natural resources, then subsidies can be given to offset these specific costs. Without both of these two steps, it is possible to “subsidize” for externalities but without actually improving the environment.

Inflation is commonly expressed in terms of the Big-Mac index which measures supply, even though the inflation caused specifically by subsidy is mostly driven by demand subsidy as opposed to supply subsidy, so Big-Mac index may not be a good indicator for inflation. Big-Mac index is also commonly used to compare buying power of currencies, but it can be hard to compare because different countries target different markets for supply subsidies. The US, which heavily subsidizes agriculture and meat produce, will have an artificially lower Big-Mac index than other countries that don’t. The countries that don’t given out agricultural subsidies tend to be undeveloped countries, with the notable exception of New Zealand.

Due to the fact that targeted subsidies are easier to regulate for its effect on the economy, the government should favor targeted subsidies and phase out untargeted subsidies over time as a matter of policy. It should also favor supply subsidies over demand subsidies, as overproduction is an easier problem to solve than inflation. Overproduction can generally be solved by exporting the surplus. On the other hand, inflation tends to be permanent even if the superficial demand is only temporary. This means that the government should prioritize its budget on supply subsidies while removing demand subsidies.

When it comes to charity, it is better to provide food, clothing and shelter rather than money.