Subsidies

Arguments against Subsidies

Critics argue that competing for jobs through generous subsidies to firms is a waste of scarce public resources and degrades the efficiency of markets. Local government officials under pressure to attract business investment may “overpay” for jobs, giving up tax revenues or making expenditures exceeding the economic benefits to residents. Moreover, incentives encouraging firms to select inferior locations can distort natural investment patterns, leading to a loss in allocative efficiency.

Education and training subsidies to individuals are generally seen to produce more virtuous economic and human development outcomes (e.g., large subsidies for public education). However, individual training programs, especially those geared to improve opportunities for “disadvantaged” workers, have been criticized for not providing skills demanded in the market or training workers for jobs that do not exist. For example, under the Federal Job Training Partnership Act (recently renamed the Workforce Investment Act) some local agencies have contracted with private training providers to train workers in jewelry making, truck driving, or generic or outdated computer skills where there were few real job opportunities for program graduates.

Benefits of Subsidies

Nevertheless, the case against subsidies is not clear-cut. Under certain conditions, subsidies can yield net benefits for individuals, communities, and the nation, and they can lead to improvements in the distribution of opportunities and income to local citizens. Such gains are most likely in cases of market failure. Involuntary unemployment or underemployment, underinvestment in human capital and research and development, and undervaluation of dynamic benefits such as agglomeration economies are examples of market failures that can affect regional economies. Specific incentives can be justified if they overcome these market failures and yield new economic activity that would not be forthcoming without such public-sector intervention. For example, if an incentive convinced a firm to locate in an area, and the firm then paid good wages to formerly [Page 1351]unemployed local workers, the net benefit-to-cost ratio could be positive for that jurisdiction.

Government Actions for Community Welfare

The debate over subsidies primarily reflects disagreements over the ability of governments to act rationally and competently to improve residents' welfare. Governments lack information about market and industry dynamics, the location preferences of firms, the skills the market is demanding, and how much subsidy (if any) is needed to secure a specific investment. On the other hand, the political benefits of inducing firms to relocate or expand locally are hard to resist. The real challenge is to develop regulations or decision rules that encourage governments to act with greater fiscal integrity in the granting and structuring of subsidies. For specific incentive deals to yield net benefits for local residents, a number of conditions must be met.

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