Jan 4, 2019

The Downsides of Receiving Government Subsidies

As Companies like GM Quickly Learn, Subsidies Often Come with a Cost
Matthew D. Mitchell Director of the Equity Initiative , Tad DeHaven Research Analyst

A poll conducted in December for The Hill asked a sample of registered voters “What action, if any, should President Trump take after General Motors announced plans to cut 15,000 jobs and potentially close four US factories.”

Here’s the breakdown of how people responded:

  • 31 percent said, “Do nothing. The President should not intervene in decisions of private businesses.”
  • 21 percent said, “Negotiate with Congress to help GM with financial incentives to help save jobs.”
  • 19 percent said, “Take away GM’s federal subsidies and tax credits.”
  • 13 percent said, “Lessen newly imposed tariffs on raw material that increase manufacturing costs.”
  • 8 percent said, “Impose tariffs on all cars manufactured outside of the U.S.”
  • 8 percent said, “Work with the United Auto Workers Union to put pressure on GM.”

Respondents could apparently only choose one answer. That’s unfortunate because it would be reasonable to support a non-interventionist approach while also supporting eliminating GM’s subsidies and tariffs. Indeed, that would be our position. It is possible, however, that some of those who said GM should lose its subsidies did so because—like the president—they want to punish the company. Regardless, it’s a positive sign that the majority of those polled supported either nonintervention or ending counterproductive policies.

We recently discussed President Trump’s response to GM’s announcement in a Washington Examiner op-ed. While the president’s ongoing attempt to centrally plan the economy from the White House is disturbing, it’s hard to feel sympathy for GM given the numerous ways it relies on the federal government for subsidies, tax incentives, and other privileges. Our takeaway is that commercial interests should think twice before striking a Faustian bargain with Uncle Sam:

“The lesson here is that with government dollars come government shackles. Though lucrative in the short run, bailouts, subsidies, and protections are no guarantee of perpetual profitability. In fact, by insulating a firm from the realities of the market, they likely encourage poor decision making. And as GM is discovering now, these privileges give politicians leverage over the firm.” 

We’d like to make a few additional points, which apply to all government-privileged firms.

Protected firms are not only unlikely to minimize costs; they are also unlikely to be as attentive to consumer desires and will tend to produce lower-quality products. Being privileged may result in both increased costs and decreased consumer benefits as consumers cut back on how much they purchase. Ironically, GM’s decision appears to be a prudent response to shifting consumer tastes, which have recently soured on GM sedans.

Government privilege is costly for society at large. But, at least for a time, it can be quite lucrative for those fortunate enough to obtain it. Commercial interests seek to curry favor with policymakers in order to obtain and maintain these profit-padding benefits, which economists refer to as “rent.” One common but subtle way to curry favor is to alter one’s business practices by making economically unwise but politically popular investments or hiring decisions (think Lockheed Martin assembling its F-35 Joint Strike Fighter in 45 states). That has been a problem with GM for decades. Note that now that GM is trying to make prudent, but politically unpopular business decisions, the president is threatening to take away its rents.

Campaign contributions and expensive lobbying operations are another way in which commercial interests attempt to obtain or maintain government-granted privileges. Indeed, GM spends millions of dollars each year on these activities. And GM’s lobbying activities have reportedly gone into “full crisis mode” in the wake up the political uproar over its plant shuttering. It’s also ramping up lobbying efforts to maintain and expand the electric vehicle tax credit that’s at the center of Trump’s retaliatory threats.

That takes us to a final point.

Entrepreneurs drive innovation, but entrepreneurs may innovate in socially unproductive ways as well. According to the late economist William Baumol, when governments hand out rents, talented people will be less likely to engage in productive entrepreneurialism and more likely to engage in unproductive or even counterproductive entrepreneurialism that results in the destruction of wealth.

The talent of the thousands of intelligent lawyers, lobbyists, and strategic thinkers engaged in such rent-seeking might instead be employed in the discovery of new ways to bring value to consumers. Instead, many of these smart and hardworking people spend their time convincing politicians to hand out privileges to their own firms or fending off attempts to hand out privileges to their competitors.

Alas, this August headline from Reuters speaks for itself: “GM Taps Former Trump Aide to Head Lobbying Efforts.”

Photo credit: Alex Wong/Getty Images

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