Thursday, 5 April 2018

Business of Politics

Politics is as inevitable as the cold season in Finland. Don't get me wrong, I like to discuss politics quite often but when it comes down to business, I don't think that politics and business make a good cocktail.

Motivated by the news of the government of Finland pouring billions and billions of euros as subsidies for different companies in different industries I started to wonder the most fundamental reasons and theories behind subsidies. What are the arguments for and against corporate subsidies?

Subsidies are used as a form of government intervention to support different industries and companies. There might be various reasons to this. Either the government want to support domestic production (and employment) or make different services or goods more affordable to the consumers, for instance. For example subsidies to energy are quite familiar to ensure affordable energy for the consumers and households in the economy.

This is the goal, but not the reason for subsidies.

If we take a look at what subsidies really are for the companies, subsidies are money (what they want). That money is then used to operations and investments (or dividends). During my analysis I've seen many companies who stay profitable just because of a subsidy. Taking the subsidy out of the income statement, these mentioned companies would have made losses for the past 10 years and perhaps gone out of business.

This is one reason why subsidies are given. The government may have different opinions on the importance of that one particular company for the economy. If for example one shipping company is considered as important in terms of security of supply or employment or government income, this company can be put on a life supply. But is this wise?

Figure below illustrates the situation where subsidies are given to a company. If we presume that initially the market is in competitive equilibrium, the subsidy moves the supply curve to the right. Now with the subsidy it is possible to produce "more with less". This causes a market failure and a deadweight loss indicated by the grey area in the graph. Meantime the quantity supplied increases from Q* to Qs and the equilibrium price falls from P* to Ps.
So we can agree that government intervention in subsidies should disturb the free markets and decrease social welfare. This is one reason why the World Bank is against subsidies in the developing countries.

Giving free money to a company distorts competition. It reduces the incentives of a business to be more efficient and to invest in its operations to increase its profitability. If the corporations are hold on to a life supply, the markets aren't perfectly competed.

But corporations enjoy this. They get free cash to run their business. So it is quite understandable that big companies try to hang in this money as hard as they can. And the causation of this is lobbying.

Lobbyist know their stuff. They know the right strings to pull and the adequate threats to give. Their only purpose is to get the government to give money for their company. Lobbyists try to think all kinds of reasons and threats from which they achieve their goal. For example they can threat to take their production (thus tax income and employment) abroad if they don't receive the subsidies they want. Also in the negotiation the terms are settled as such that subsidies are promised to grant for tens of years to come so that they cannot be cancelled immediately by the next government.

Also the incentive to grant subsidies increases if politicians face projects from their hometown or something that they are familiar with. In these cases it must be evaluated that the subsidies aren't granted for the wrong reasons.

Subsidies increase efficiency and competitiveness only if they are used to create more value for the company and the production. Because of the lobbyists it is hard to distinguish what is the real key motive of getting money from the government. Is it to increase value or is it just a matter keeping the business as such.

I also have to admit that some companies are important in terms of employment and welfare in an individual worker level. But when considering the big picture, subsidies (like any other government intervention) create disturbances and inefficiencies to the market.

But in the end, I don't think that it's fair that the tax payers have to pay the subsidies to the corporations for the sake of corporations staying in business.

If you are interested more about subsidies, I'm visiting my friends' podcast soon where you can hear more discussion about corporate subsidies. I'll add a link as soon as it is in the air.

Text: SW
Pictures don't belong to me