What is a subsidy? Definition and meaning

A subsidy is a quantity of money given directly to companies, organizations or individuals by the taxpayer (government) to encourage production, boost exports, promote research, prevent a business from collapsing, reduce unemployment, or make the price of a product more affordable to consumers.

It may consist of financial assistance a government gives to help producers compete.

The most basic form of subsidy is a cash payment or grant. Grants generally refer to a time-limited payment, either linked to a specific investment, or to enable a person, company or entity to cover all or part of their general costs, or costs of undertaking a specified activity, such as research.

Agricultural subsidy typesAnnual spending in agricultural subsidies by OECD nations. (Image: Wikipedia)

According to Oxford Dictionaries, a subsidy is:

“1. A sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low. 2. A sum of money granted to support an undertaking held to be in the public interest. 3. A grant or contribution of money.”

Consumption subsidy

Consumption subsidies aim to financially aid the behavior of consumers. Most consumption subsidies are found in developing nations where the government makes the price of basic foods, utilities and education more affordable.

The Mexican Government, for example, subsidized corn tortillas for a period of 25 years. Tortillas are to Mexicans what rice is to the Chinese, potatoes to the British, or baguettes to Parisians. In 1999, the subsidies ended – a move that resulted in an angry backlash, particularly among impoverished Mexicans who relied on the staple food for half their daily diet.

Export SubsidyIf the government in Country A subsidizes the export of bananas, farmers in Country B (if they get no subsidies) will not be able to compete. Citizens in Country A will be paying more for their bananas than people in Country B.

Export subsidy

Export subsidies consist of financial support from the taxpayer for goods that are sold abroad – exported – as a means of boosting the country’s balance of payments.

According to many economists, subsidies may benefit consumers – because they pay less than the market price – but hurt the subsidizing nations.

However, China’s extensive export subsidies have helped give the country an advantage in sectors where they had previously shown no comparative advantage, such as the auto parts, paper, glass, steel and solar industries.

Industrialists in North America and Europe regularly complain that Chinese export subsidies make it virtually impossible to compete. Recently, investigative journalists have shown that export subsidy abuse in China is damaging the country.

Employment subsidy

Employment subsidies, sometimes called wage subsidies, act as incentives to get employers to provide more job opportunities, thus reducing the level of unemployment in an economy.

The taxpayer provides assistance with wages. In Australia, for example, wage subsidies are made available to employers who take on eligible job seekers including long-term unemployed individuals, mature-age workers, indigenous people, or very young employees.

According to Australia’s Department of Employment:

“Wage subsidies can help employers to expand their business and employ new staff, which will help boost the economy and create more jobs.”

Sebastian CoeSebastian Coe (Lord Coe), a British politician and Olympic gold medal winner in 1980 and 1984, once said: “When the subsidies are going out there to fund arts, I’d like to see jazz given a better shake of the dice. It attracts as many people as opera does, but not the subsidies.” (Image: Wikipedia)

Transport subsidies

Many governments across the world subsidize public transport, particularly rail, air, bus, and subway (UK: underground) transport, which decrease congestion, reduce pollution, and help create more wealth by getting people to work and to business appointments more rapidly.

Investing in transport infrastructure helps improve productivity within an economy.

European Union railways absorb €36 billion of public subsidies annually, which according to the European Commission, is nearly as much as they earn from fares.

China is a massive investor and subsidizer of rail transport and infrastructure. In 2015, China invested more than $128 billion in domestic railway construction.

Some governments see airport subsidies as unfair, because they distort the free-market, level playing field. The EU criticizes Germany for its high number of subsidized (loss-making) airports, which low-cost carriers use.

In many countries, roads and highways (UK: motorways) are paid for fully by the government rather than tolls. German railway operators say it is unfair that long-distance bus services in the country pay no tolls, while railway companies have to pay track access charges.

Agricultural subsidy

In many parts of the world, governments give subsidies to agribusinesses and farmers to supplement their income, influence the cost and supply of agricultural commodities, and help them manage their supply.

Examples of subsidized agricultural commodities include lamb, mutton, pork, beef, oil-seeds, tobacco, peanuts, rice, milk, cotton, feed grains and wheat.

While farmers think these financial incentives are great, many people criticize them. In fact, the agricultural subsidies in the United States, Canada, the European Union and Japan are one of the reasons farmers in poorer nations abandon the land and move into cities or migrate to the advanced economies to find work, many economists claim. They cannot compete with the rich nations’ subsidized goods.

Video – What is a subsidy?

This Kotak Securities video explains in simple terms what subsidies are, and how they can become a huge burden on government finances if not controlled properly.