A subsidy is an incentive given by the government to individuals or businesses in the form of cash, grants, or tax breaks that improve the supply of certain goods and services. With subsidies, consumers are able to access cheaper products and commodities. Markets that have positive externalities, which are extra benefits to society, tend to be favored in policy to provide a greater supply of that good and service.
Basically, subsidies are provided by the government to specific industries with the aim of keeping the prices of products and services low for people to be able to afford them and also to encourage production and consumption.
Types of Subsidies
1. Production subsidy
This type of subsidy is provided in order to encourage the production of a product. In order for manufacturers to increase their production output, the government compensates for some of its parts in order to lessen their expenses while increasing their output. As a result, production and consumption grow, but the price remains the same. The drawback of such an incentive is that it may promote overproduction.
2. Consumption subsidy
This happens when the government offsets the costs of food, education, healthcare, and water.
3. Export subsidy
An obvious fact is that a country or state earns from its exports and exports help to balance its economy. That is why, to encourage exports, the government subsidizes the cost. However, this can be easily abused, especially by exporters who exaggerate the prices of their goods so that they receive a larger incentive, eventually raising their profits at the expense of taxpayers.
4. Employment subsidy
This incentive is given by the government to companies and organizations in order to enable them to provide more job opportunities.
Advantages of Subsidies
1. Lowering prices and controlling inflation
They are especially applicable in the area of production cost inputs such as fuel prices, particularly when global crude oil prices are rising. Many countries subsidize fuel costs in order to keep prices from ballooning.
2. Preventing the long-term decline of industries
There are many industries that should be kept alive and functional, such as fishing and farming because they are essential to support a population. Many new and fast-growing industries may also benefit from being subsidized.
3. A greater supply of goods
Governments want to increase the access of their population to Goods & Services such as Water, Food, and Education. They, therefore, provide an incentive that could be in the form of a tax credit or even straight up cash. Markets that have positive externalities are usually the ones that receive such benefits.
Disadvantages of Subsidies
1. Shortage of supply
Though one of the advantages of subsidies is the greater supply of goods, a shortage of supply can also occur. This is because lowered prices can lead to a sudden rise in demand that many producers may find very hard to meet. Ultimately, it can lead to very high demand that causes an increase in prices.
2. Difficulty in measuring success
Subsidies are usually effective and helpful. However, if the government were to make a report of its success in using subsidies, it would be a different story. This is because it is hard to quantify the success of subsidies.
3. Higher taxes
How will the government raise funds to use for subsidizing industries? Of course, by imposing higher taxes. So, it is the general population and corporations who provide the means to enable the government to subsidize industries.
Thank you for reading CFI’s guide to Subsidy. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below: