What are subsidized prices? How do they differ from free market pricing? Where did they come from? The answers to these questions and others like them form the crux of this article.
Subsidized or governmental assistance is a form of fiscal support or financial assistance extended to an industry in general with the stated purpose of promoting social and economic policy. Subsidies may be given directly by the government or indirectly through taxation. While commonly associated with welfare programs, such as those for the disabled or the elderly, subsidies are also given to corporations and other large organizations, with the end goal being to boost growth and employment. While traditionally thought of as programs intended to help the poor, today’s subsidies come in a wide variety of forms, including government procurement contracts, student loans, tax credits, and many others. Whether or not they are given as a direct fiscal support or indirect subsidies depends on the policy goals and the nature of the recipient’s industry.
Some economists argue that direct fiscal support, such as loans and grants, are more appropriate as subsidies because they directly help people get financial assistance rather than providing a service. Such types of interventions, they argue, tend to have the best track record for raising productivity and reducing distortion in the economy. However, while they certainly can have a significant effect on the size of the economy, they do not tend to have much of a lasting effect, especially when the money spent on them is channeled into projects or areas of development that serve the poor. Indirect financial support, on the other hand, is almost never repaid. Instead, it ends up either as revenues for existing programs or as profits for the firms that receive the subsidies. While such subsidies are designed to improve the quality and quantity of public goods and services, they rarely have a direct impact on the production process or on the distribution system.
As it turns out, direct and indirect subsidies have somewhat different impacts on the economy. Direct subsidies increase aggregate demand; that is, they make people buy more items. The price elasticity of the economy means that the demand for goods and services rises as the cost increases. By removing some of the cost barriers to purchasing, such subsidies allow buyers to obtain goods and services at a higher price and/or get them at more convenient locations. This provides a boost to economic activity, but it also increases the degree of insecurity due to the associated risks of malpractice and fraud. Indirect subsidies can reduce the cost of production and thereby improve the quality of the distribution system.
Critics of subsidized industries and businesses claim that the definition of subsidized is too broad. They argue that only activities that occur without active control by the taxpayers should be labeled as subsidized. Thus, they argue, any price increases that occur without the taxpayer’s consent are not truly subsidized. However, many economists counter that a more accurate definition of subsidized would be “interdependent” – meaning that taxpayers may trade off some benefits for other values such as a larger investment base for start-up companies, better infrastructure for small businesses, or improved consumer protection.
There are four basic ways to determine whether a price or cost change is subsidized or not. First, if a firm has to recoup its investment from borrowers in the form of lower prices, then it is providing subsidies. Second, if the price level of the final goods or services sold to consumers is above the cost of production, then consumers are subsidized. Lastly, if borrowers are allowed to receive direct subsidized loans, then firms cannot raise the loan amount above the interest rate on that loan. These are the four criteria used to determine whether a price or cost change is subsidized or not.
In general, direct subsidized loans are made available to undergraduate students who meet the following conditions: do not rely on their parents to carry out the repayment, do not meet the absolute maximum period of deferment allowed, and do not demonstrate an exceptional financial need. The direct subsidized loans that are made available to undergraduate students must be repaid within the maximum period of deferment allowed, while maintaining timely payment of all prior debts. Students who are not eligible for the Federal Perkins Loan program can still receive federal student loans in the form of subsidized loans.
For students who fall into the other two financial need subgroups – those with the least half-time income and those with the least half-time academic achievement – they are not eligible for these loans. For both groups, unsubsidized loans are awarded. These loans have interest rates slightly higher than those offered on subsidized loans because unsubsidized loans are awarded on a first-come, first-served basis. There are also certain provisions that apply to undergraduate students who do not meet the third criteria, i.e., the minimum payment does not cover the entire interest on the loan.