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There Ain’t No Such Thing As A Free Subsidy

An argument that protectionists — both the greedy variety and the uninformed variety — frequently raise goes like this:

Foreign governments often subsidize or otherwise give special advantages to their domestic firms, especially to their domestic firms that produce for export.  It’s unfair for our firms to compete against artificially advantaged foreign rivals.  So when such subsidizing and protecting by a foreign government is detected, our own government should respond in kind — or at least by protecting our domestic firms from having to compete against these artificially advantaged firms.

A full book would be required to unpack all of the many errors that infect the above reasoning.  I here, though, focus on only one of these errors, namely, the fact that there is no such thing as a free subsidy.  Resources used to subsidize industry A (or industries A, B, and C) must come from somewhere; such subsidies might enable their recipient industries to expand output farther than otherwise and to sell at lower prices than otherwise, but these same subsidies will artificially raise the costs born by other industries in the country.

Dwight Lee and I wrote about this error, in October 2003 at Tech Central Station, in an article entitled “Trade Grade.”  Now I expand the argument a bit.

Imagine the Carpenter family.  Headed by Mr. “Ruler” Carpenter, a determined patriarch, the Carpenters have four teenage sons: Abe, Bill, Carl, and Dave.  Abe is the only one of the boys who wants to follow the family tradition by becoming a carpenter but, well, he’s not very good at it.  He’s awkward swinging a hammer, and has already cut off a couple of his fingers while using a radial-arm saw.

Bill, Carl, and Dave want to become chefs.  And each has a great deal of natural talent in the kitchen.

“Ruler” knows that he can’t force Bill, Carl, and Dave to become carpenters.  But he is determined to do all that he can to ensure that Abe earns a living at carpentry.  So “Ruler” announces to his sons that he will not pay for Bill, Carl, and Dave to go to cooking school and he will take all the money that he’d set aside for their college education and devote it to Abe’s carpentry career.

With these funds, “Ruler” hires several skilled helpers to assist Abe in his work – helpers who enable the work of “Abe’s Carpentry” to be quite passable.  “Ruler” also promises to supplement Abe’s income with a $20,000 gift each year, knowing that Abe, even with his helpers, is unlikely to survive on carpentry alone.

With these subsidies from “Ruler,” Abe might well be able to work and compete as a carpenter.

But the welfare of the entire Carpenter family is surely reduced.  Because of these subsidies to Abe, “Ruler” and his wife have less money to save for their retirement and for other family matters.  Importantly, brothers Bill, Carl, and Dave have fewer resources with which to pursue their dreams of becoming chefs; they are hindered at developing skills that would make each one of them as productive (and, hence, as prosperous) as possible.

“Ruler” surely does his family no favors by subsidizing Abe’s carpentry career, and he likely also makes life more difficult for other, competing carpenters.  But “Ruler’s” subsidies to Abe, do note, also make life for chefs — ones against whom Bill, Carl, and Dave would otherwise have competed — easier than otherwise.


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