Liberalization of Markets

Governments subsidize, taxpayers suffer

With a federal election in sight, the issue of subsidies to the aeronautical industry needs to be revisited.

It is true that most, if not all, large airplane manufacturers in the world are subsidized, directly or indirectly, by their governments. It is certainly true for Embraer, the Brazilian manufacturer, and for its main competitor, Bombardier. I think we can discuss this issue without taking sides in the subsidy dispute, and siding instead with the taxpayer and, indeed, with both these great private firms. Bombardier and Embraer have come to where they are not because of government subsidies but because they are great companies in of themselves.

Economists generally believe subsidies should not be available to businesses, including in the aeronautical industry. The basic reason is simple: Economics is primarily interested in the welfare of consumers and taxpayers, not so much in the welfare of producers per se. It can be shown that, even when consumers benefit from subsidies to businesses (through lower prices), they ultimately lose more as taxpayers than they gain as consumers.

Moreover, the availability of subsidies generates a wasteful competition for them. Private firms risk becoming more efficient at this “rent seeking” (as public choice economists call the process) than at producing goods and services that consumers want and are willing to pay for at the real market price.

A subsidy is a subsidy. If government loans and loan guarantees did not include a subsidy component, if they were truly granted at market conditions, they would be offered by private financial institutions, and government help would be redundant. Thus, the fact that a loan or loan guarantee is offered by a public institution shows it is not provided at market conditions.

The argument that loans or loan guarantees do not impose a cost to taxpayers is, of course, economically false, for they carry a cost in terms of risk. This is why the lenders or loan guarantors take provisions for credit losses. In 2003, for example, Export Development Canada globally added $644-million to its provision for losses on loans, loan commitments and loan guarantees, and wrote-off impaired loans for $98-million. That being said, the loans or type of investments made by governments directly to Bombardier all seem to have been reimbursed (capital and interest), so far.

Another false argument is that technological subsidies generate net economic benefits. This forgets the fact that what is invested in certain economic sectors, or in “national champions,” is not invested in other technologies or in other industries. And certainly, the market is more efficient than bureaucrats and politicians in deciding where investments should be made. Moreover, by being forced to subsidize businesses, taxpayers become involuntary investors.

A good case can be made that the availability of subsidies hurts not only the system of free enterprise in general, but also the businesses that get the subsidies. At the end of the day, the competition for subsidies and the call for a level playing field hurt the beneficiaries and their shareholders.

The argument is the following. Although it is in the interest of each producer to try and get subsidies, competition for them does not benefit businesses compared with a situation where there would be no subsidy for anybody. This can be modeled in terms of the well-known prisoner dilemma. Each producer has an interest in getting subsidies whether or not his competitors get them. But when all producers get subsidies, it is, from a competitive point of view, as if nobody got them. Consequently, everybody ends up in a non-preferred situation. The best solution from the point of view of a producer would be that governments be (constitutionally, politically or fiscally) incapable of granting subsidies.

It is true that foreign subsidies to foreign competitors are very frustrating for our own enterprises. But by duplicating such subsidies here, we contribute to the problem, not to its solution. If taxpayers in country A are forced to subsidize industry X in their own countries, it is not a sufficient reason to force taxpayers in country B to subsidize industry X in their own country. If the taxpayers of B just run with the subsidies from A’s taxpayers (by flying in their subsidized planes), the latter may not continue paying for long.

More generally, if an industry can only survive with subsidies, it means that it should not survive.

This is not to say that business taxes should not be lowered. Everybody’s taxes should be lowered, and government expenditures cut. At any rate, it is not efficient to tax businesses and return to (certain of) them part (about a third, in Canada) of what they paid through subsidies. If politicians want to be useful, they should promise an end to this absurd and economically inefficient system.

 


Michel Kelly-Gagnon is president of the Montreal Economic Institute.

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