Thursday, June 18, 2009

The economic consequences of subsidization

So I thought this would be a topical post, with the $1,000,000,000 "cash for clunkers" subsidization government waste provision being added to the bill funding our troops overseas (the topic of "riders" on bills will have to wait for another day, although it's probably the single most destructive problem in our government system at the moment). Instead of just saying why this bill is dumb, though (in a departure from my usual rhetoric style), I'd like to examine the effects of government subsidization programs in general, and see if the reader can surmise what I think of this latest effort.

First, let's clarify what I mean by a subsidization. In general, this is whenever the government spends money, directly or indirectly, to help offset the cost of something. Usually the government does this for policy purposes (overt or otherwise), and there are a variety of mechanisms typically used. Some examples are direct payments, tax rebates, subsidized loans, etc. So the "cash for clunkers" program will be a direct payout, whereas the housing tax credit is a tax rebate, the tax-free cap gains for sales of primary residences is a tax credit, the GSE loan rates currently are loan subsidizations, and the Fed's artificially low interest rates and lax oversight subsidized lending during the housing bubble, etc.

What's the effect of subsidization? Well, in the short term, it encourages people to do those activities, because they are effectively cheaper. However, unless the subsidizations affect only a small subset of the "buyers", the "sellers" will quickly figure out that the buyers can pay more, and normalize their prices accordingly. The amount which the sellers will raise their prices to compensate will be roughly proportional to the percentage of buyers who can qualify for the subsidy; if the percentage is small, prices won't be affected much, and if the percentage is large, prices will rise nearly equal to the subsidy.

Fortunately for the sellers, normally subsidies are available broadly, so as the appear to be fair. Moreover, in many cases the subsidy is so large as to render purchases without using the subsidy to be infeasible (see, for example, the number of people borrowing money currently for jumbo mortgages vs the number borrowing for GSE-qualified subsidized mortgages: approximately none to all). This allows the sellers to usually raise their prices to compensate entirely for the subsidy without affecting sales, or where the loss in sales (from the non-subsidized customers who can no longer afford to buy) is made up for by the increased revenue from the subsidy. Note also that in these cases, the cost to the buyers who can still buy (those who qualify for the subsidy) remains constant; the buyers are not aided by the subsidy, they are only not excluded from buying as the non-subsidized would-be buyers.

So, let's look at the end-effects in the "typical" case. The seller net profit is increased, and they are effectively being given free money from the taxpayers. At the same time, the sellers have raised prices such that people need to qualify for government handouts to purchase the items or services which they would have been able to purchase normally without the subsidy in place. The people who cannot qualify for the subsidy are excluded from purchasing, or need to spend extra money to get the same items or services.

Sound insane? Well, yeah, pretty much. Lest you think these are purely hypothetical examples, let's look at some recent actual costs which have been directly increased by the effect of subsidies: housing (loan rates and tax credits), higher education (loan rates and tax credits), and health care (tax credits and direct subsidies). Anybody think any of these are excessively cheap now? Anybody think they are more affordable now than before they were subsidized? Anybody confused about what the obvious, predictable, and inevitable effects of subsidization are?

At least with the "cash for car dealers" handout program, they're not spending the extra effort pretending that the subsidy is anything other than a handout: apparently, the "vouchers" will be issued electronically directly to the dealers. Makes me glad we are a rich country, with an extra billion dollars lying around to give to car dealers; after all, everybody thinks car dealers and dealerships are stand-up, honest, helpful institutions which deserve a "thank you" from the taxpayers for all the nice things they have done for us... right?


  1. I don’t fully understand who are the buyers and sellers in this case. You’re saying they’re subsidizing buying junky cars, and the benefit of that will go to those selling the junky cars? It seems to me that in general the benefit of a subsidy is split between the buyer and the seller, depending on the elasticity of demand and supply.

    I’m still trying to understand what Congress is even thinking by subsidizing selling junky cars. For every sale there is a buyer, right? So those cars don’t disappear. We will just have more cars in the world, which is not what we need since cars are destroying our environment.

    I think cars are one of the biggest problems are society has. They contribute to poverty, crime, and government intrusions into people’s lives. They kill 50,000 people a year. People have to struggle to create special walkable communities in the middle of cities built for machines. Any time you built a structure for x area of human use, you need 1.5 x space for their vehicles.

    One of the worse things the government could do, IMHO, is encourage people to make more of them.

  2. In this case, the sellers are the auto dealerships who are selling the buyers (who are trading in their older cars) new cars. You would expect the new cars to be marked up for those buyers, and probably all buyers during the program, by some fraction of the subsidy (depending on the number of buyer who can qualify for the subsidy). In this case, the end effect is very intentional, since the goal is not really to help the buyer at all, but rather to subsidize the auto dealerships so that they can suffer less losses during the next year; it's essentially a billion dollar gift to the auto industry (plus the extra revenue from sales for people who take advantage of it).

    The principles, however, extend well beyond this current handout. I expect the health care plan, if it passes, to be a much better example of how subsidies don't lower costs at all, but rather just make non-subsidized participants non-viable. This is essentially why a public plan would likely force all non-public plans out of existence, for example. Also per the principles, the actions of the government largely contributed to the housing bubble, are creating the prolonged downturn, and often are responsible for the dark humor in the statement "we're from the government, we're here to help".

  3. I think of this proposal as a subsidy to car dealers to purchase junky cars from people who are buying new cars. I see your model, though, since new car dealers' primary business is selling cars, not buying them.

    Anyway, I want to know what happens to the old junky cars. If they're still on the road, all this does is encourage people to purchase and produce new cars. Does some one think we do not have enough cars in the world?

  4. Nick, thank you for the comment on Left Coast Rebel's blog. This is a post from the blog I co host with KOOK that answers why I do not use the word "socialism." Your opinions are invited and welcome on KOOK's blog anytime. We like good debate and there is nothing wrong with a differing opinion so we see different perspectives. I will agree to disagree with you, yet I see and understand your point.

    Neutering the language
    I've wanted to post this one for a while but have been away: One huge way that the Obama regime has pulled the wool over the eyes of the masses is by “Neutering” our language. The true definition of neutering language is watering down lies so that they sound reasonable to the less educated masses. Those of us who understand the meanings of neutered language need to counter such language whenever and wherever it is heard. Here are some examples of neutered language.
    "Community Organizer": Communist Agtitant.
    "Cap and Trade": Energy Tax
    "Green Energy": living in the stone age with no electricity or running water
    "Man Made Disaster": Terrorist act
    "Immigration Reform": Open Borders.
    "Government/Corporate cooperation": Fascist or Communist takeover of our capitalist system
    "Tax Cut": less of a massive tax increase than those richer than you
    "Card Check": forced unionization of businesses to empower union thugs
    "Economic Stimulus": wasteful government spending in an attempt to destroy our capitalist system through forced monitery inflation
    "Climate Change": Man made destructive changes in climate made official by AlGore (PHD, Bovine Scatology)
    "God": mythological being worshipped by extreme right wing kooks. God is in same mythological class as gnomes and unicorns.
    These are just some of the Obaminations that are creeping into our language out of the white house. Those of us with common sense left must stand up and put a stop to this misuse of our language. Obama’s teleprompter will call a rattlesnake a caterpillar just so someone can get bit. If we don’t start fighting back on this front soon it will be to far gone.

  5. NIck, by the way, I reposted your comment to me from Left Coast Rebel's Blog on the blog I co-host with KOOK. I thought it worthy of debate from our readers there and will repost it here too. I am not going behind your back, or trying to be duplicitous in any way shape or form. I thought you made an honest good point, in a friendly way and it was worthy of debate.

    From KOOK's Blog:
    Really Good Debate...
    While on Left Coast Rebel's blog yesterday, discussing Obamahealthcaredestruction, I commented about my refusal to use terms "socialism" or "progressive" as I feel our language has been neutered by the so-called academia and media to push the perceived "center" to the left and make such things sound like "society" and "progress" I was engaged into a very good debate with an opposing point by Nick. I reposted my "Neutering the Language post" (see Meanings of Words section) on Nicks blog to make my point as to why I do so. Here is Nick's point:

    "To Andrew:

    I use the term 'socialism' (when I do) because it's the correct context for what I'm trying to say. The difference between socialism and communism is that communism is socialism, with the addition of a particular government and religeous structure. Socialism is only (generally speaking) the process/structure of the government running what could/should otherwise be private enterprises, interfering in private contracts, manipulating markets, and exerting control over private enterprise.

    I agree that it's unfortunate that our uninformed youth confuse the two, and/or do not appeciate the malignancies of socialism simply based on the terminology. However, I'm not going to debase my logical analysis to try to appease people who are two dumb or ill-informed to reply with anything other than the semantic equivalent of "nuh-uh" anyway; personal choice."

    I want to make clear that Nick and I are on the same side and this was a valid point and I understand his argument so there is nothing personal here. I see nothing wrong with his viewpoint, yet after reading Common Sense by Beck/Paine, I noticed that it was written in a way than anybody could understand it. Anyone with even basic reading skills could pick it up and understand every point made. I think that is important to do here. I want anyone who stumbles onto this blog to understand the points made here. Climate is a good example...I could lay out terms all day that would have most folks so confused their head would spin, but is that my goal? Was that Glen's goal in writing Common Sense? I think not. I want everybody to understand my points, whether new to politics, climate change or whatever the subject or not. Not all of us have been in this debate as long as others and I want everybody to understand my point. That's common sense.

    Nick, as I said, we are both on the same side here and just have different methods of explaining ourselves. I always try to be respectful to fellow bloggers even when we differ. I bet you and I see things eye to eye on 90% of everything else so I hope we are on good terms.

  6. I actually have what many would term an "old junky car" alongside a year old Prius. My older early 90's Honda Prelude is somewhat of a toy that I like to tune on and play with. I will keep my right to my old junky car thank you as I like it. I am sometimes asked about the Prius and saving the environment etc. I do not think the Prius is saving the environment at all but I simply wanted a gas saver with more room. It was the best car you could get at the time to do so.

  7. I've long thought that if the government's intent was truly to break America's dependence on foreign oil, the best way to do that is just to impose a tariff on the import of foreign oil, and let private industry work the rest out. Industry in America has the ability to innovate to make a more competitive product, and if oil was prohibitively costly, people would find other ways to produce power; no need for subsidies, socialized industries, power-type quota, cap and taxes, or any of the other destructive policies.

    Of course, the real reasons they don't do the simple effective solution are twofold: the current way is ripe for abuse and special favors (which is a hallmark of politicians, and especially Democrats), and increasing oil costs increases the cost of virtually everything, which amounts to a tax on all activities in the US, which people object to (and for good reason, if you don't think you should have to pay more to not use foreign oil). As people have demonstrated though, Americans will shift the products they purchase by the perceived and actual value, and if foreign oil was expensive, industry and consumers would adapt.

  8. The problem with a direct energy tax is that taxpayers will expect the money to go to road repair or other silly nonsense. By doing it this way, Washington collects the money, passes it out to "special interest groups" who pass it on to folks such as the Saudis who then slip money into pockets of the same politicians who wrote the stupid bill. Then those same politicians want to raise our taxes because D.C needs money besides the money they are printing continually. I am getting dizzy from going around in circles.