Tuesday, March 6, 2012

Oil subsidies

The article "Time To Put An End to Big Oil Subsidies" by Allen Greenberg, in the Northern Colorado Business Report, draws a contrast between farmers, who have stated their willingness to forgo subsidies in a time of high deficits, and oil companies, who want to keep their subsidies. While I generally agree with Greenberg's position that oil subsidies should be reduced or eliminated, there is one sentence in there that does not make much sense: "it should be easy to recognize that subsidizing a profitable business simply makes no business sense." This does not seem correct to me. The point of subsidizing something is to increase the maount of it, so it can potentially make sense to subsidize anything you want to increase the amount of - whether it is currently profitable does not enter into it. (In particular, assuming efficient markets, in an equilibrium condition any productive activity has a net profit of exactly zero on the margin - if the marginal profit was positive, people would do more of it; if the marginal profit was negative, people would be doing less of it. Putting in a subsidy makes it more profitable, which leads people to do more of it until it's not more profitable anymore.)

Also, a policy of only subsidizing activities which are currently unprofitable could easily have perverse effects. For instance, companies might deliberately try to be less efficient so that they would be "unprofitable" and thus deserving of subsidies.

EDIT: Link to article is here.


Dan Mont said...

You're right. Subsidizing things just makes them more profitable so people will do more of it.

In fact, subsidizing an unprofitable business promotes keeping resources in some place that has demonstrably been shown to be inefficient. Unless, of course, it is a young industry and you think that it could develop into a profitable one if given time to develop and that's why you are subsidizing it. But subsidizing old, dying industries (like we used to do with steel) takes away the incentives to innovate or to switch to other businesses that are more profitable.

Chilly in Calgary said...

Couldn't agree with you both more! Just a word about farming subsidies... They enable McDonald's to make big mac's and the like availabe to the public at low cost. And of course, this has public health implications...which of course has tremendous economic implications This is from Debbie