The Double-Edged Subsidy Sword

Some interventions are helpful – perhaps even essential – while others are clearly destructive.

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FILE - In this Aug. 28, 2003 file photograph, a sprinkler sprays water onto a hay field near Hoxie, Kan. Continued irrigation in western Kansas has led to declining water levels in the Ogallala Aquifer.

This week, several hundred entrepreneurs, investors and others convened in San Francisco for SOCAP 2013, the annual gathering for participants in so-called "Social Capital Markets." This sold-out event aims to accelerate "the flow of capital towards social good." It attracts entrepreneurs seeking funding for business plans that combine making money with improving a social or environmental condition: for example, developing sustainable fisheries, promoting entrepreneurship in poor urban areas or facilitating the distribution of vaccines in the third world. In equal measure, the conference draws investors seeking high quality business opportunities that can provide good financial returns.

This year, the social capital crowd is turning some attention to government policy as it affects the economy. How can government policy make it easier and more profitable to do business in ways that are socially and environmentally sound? Conversely, how can government make it less attractive for businesses to take shortcuts that damage the environment, worsen inequality, and limit the opportunities for individuals to advance?

A new multinational task force was launched to explore policy solutions that would promote social investment and encourage companies that seek a measurable social or environmental benefit in addition to an attractive financial return. The effort involves representatives of each of the G-8 nations, drawing from government agencies, major corporations and leading NGO's. The initiative was announced by Matt Bannick of Omidyar Network and Jonathan Greenblatt, director of the Office of Social Innovation at the White House. A major theme will be to improve access to capital for companies engaged in social capital markets.

[See a collection of political cartoons on the economy.]

One important area for policy innovation centers on government incentives and subsidies which promote and support some economic activities over others. Subsidy, as a tool of economic policy, is a double-edged sword that causes both great harm and great benefit. Clearly, the economy does not benefit from many incentives and subsidies in place today, such as promotion of corn-based ethanol as a fuel or subsidizing the high military costs of our dependence on imported oil. Nor does the economy benefit from the implicit subsidies in the form of loan guarantees and artificially low borrowing costs offered to "too big to fail" banks.

Perhaps the largest and most destructive subsidy in our economy is how we systematically charge too little for non-renewable resources. For example, we under-price the minerals in our public lands, the clean water we use for drinking and irrigation, the soil we farm and the carbon-absorbing capacity of our air and oceans. In some cases, it is very difficult to establish a price that isn't highly debatable or arbitrary, but in other cases fair value can be easily established on the open market. When honest and realistic prices are not established, the taxpayer is deprived of a fair return on the common inheritance, and we encourage wasteful and destructive practices that undermine our prosperity for generations.

Unfortunately, each of these ill-conceived and destructive subsidies has a constituency that benefits from it. Most of them made sense when they were originally established, like farm price supports created in the 1930's to protect family farms in the depression. But once the punch bowl has been filled and put out for the guests, it is very difficult to take it away.

[See a collection of political cartoons on the budget and deficit.]

Yet, despite the damage caused by ill-conceived subsidies or those that have outlived their intended purpose, other subsidies have been crucial in making our economy as innovative and productive as it is. For example, our system of public higher education is among the best in the world, yet it required massive public investment to build it and to keep up with population growth. And the U.S. would not have built a position of world leadership in information technology without large scale subsidies from the Defense Department that supported the semiconductor and computer companies in the 1950's and 1960's. We owe much of our current prosperity to these and similar programs that provided a decisive early lead in technologies that proved to be critical.

Policy tools that shape the economy typically draw strong and predictable reactions along party lines. Conservatives and libertarians are quick to point out the dangers of government involvement in the economy and the risk of asking government to pick winners and losers. But few are bold enough to call for the withdrawal of subsidies that support established and politically connected industries. Meanwhile, liberals and progressives are quick to call for government intervention when markets fail to deliver, but they can forget how a well-intentioned rule can be subverted toward a bad end.

There are few easy answers where government interventions in the marketplace are concerned. Some interventions are helpful – perhaps even essential – while others are clearly destructive. Political platitudes rarely lead to good decisions on these issues. Careful case-by-case analysis is needed.

A good start would be to require that all incentives, subsidies and similar interventions have a specific sunset date. Let them all end after a certain number of years (no more than 10), or require that the cost of such programs be fully covered by the industry which they benefit (as, for example, highway construction receives government subsidies, but the costs are covered by taxes on gasoline). Hard deadlines would force us to periodically ask ourselves the tough questions, and help us strip away the programs that no longer benefit our economy.

David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at @davidbrodwin.

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