Imagine that you are the head of the state and the sugar industry on which your country depends has experienced a tank in the level of its exports. You tell your team to conduct some research, and they find out that the price of sugar in other countries is way lower. What would you do? Would you consider decreasing the tax rate at which sugar producers are taxed, or would you pay them for the difference in price? Both these policies are known as export subsidies.
Export subsidies are government policies that are implemented to incentivize local producers to export more of certain goods. These policies are usually implemented when the price of certain goods is way lower in foreign markets.
While export subsidies indeed help increase exports, there are costs associated with them. Some lose, and some win. To find out all the losers and winners, we suggest you read on and get to the bottom of this article!
Export Subsidy Definition
Export subsidy definition refers to government policies that are aimed at supporting local companies to export goods that are produced locally. Export subsidy policies are implemented when local producers can't afford to compete with foreign producers as the price of foreign goods is lower. In such a case, the government steps in and supports local companies with regulatory, monetary, or tax incentives to bring the price down to the level of foreign companies.
Exports refer to goods that are manufactured in one nation but are then sent to another nation for the purpose of sale or commercial exchange.
Exports are an important part of a growing economy as they reduce unemployment levels and contribute to an increase in a country's Growth Domestic Product (GDP).
Think about it, if companies were to export more, they would need more labor to produce the goods that they are sending outside. More labor hired means more salaries paid, which leads to more spending, which stimulates the economy.
When countries can't compete with foreign suppliers, the government makes sure to grow their export volume through export subsidies.
Export subsidies are government policies that aim to support local companies to export more goods and services.
There are four main types of policies through which governments implement export subsidies as seen in figure 1.
- Regulatory. The government can choose to regulate certain industries in a matter that makes it cheaper for companies to produce, which would enable them to compete with foreign companies and increase the level of exports.
- Direct payments. The government can choose to make direct payments for part of the production cost that a company faces, which would help lower the price of the goods they are selling, and, hence increase exports.
- Tax. The government can choose to lower the taxes paid by the companies they are aiming to support in increasing exports. This would lower the company's costs and incentivize it to export more.
- Low-interest loan. The government can also choose to extend low-interest loans to the companies which they are aiming to help export more. Lower costs loan means less interest payment, which would help decrease the price of the goods and increase exports.
The purpose of export subsidies is to stimulate the export of commodities while discouraging the sale of the same items on the local market (after all, the ultimate goal is to increase exports). When local consumers buy something, they pay more for it than customers in other countries because export subsidies lower the overseas price importers have to pay.
Example of Export Subsidy
Examples of export subsidies include regulatory changes to incentivize certain companies to export more, direct payments to companies to cover the difference between the local price and world price, changes in taxes, and low-cost loans.
For instance, the government of India has made policy changes that provide support and assistance to sugarcane farmers and sugar manufacturers in order to grow the export of these goods. In addition to that, it has provided rice exporters with a significant interest-payment subsidy.1
Another example is the United States government. Under the current legislation, the U.S government subjects U.S. multinational enterprises to a minimum tax rate of only 10.5% on their foreign earnings. 2
This is half the rate compared to the tax these multinational enterprises pay on their domestic earnings. It provides an incentive for these companies to increase the volume of their exported goods.
Difference Between a Tariff and an Export Subsidy
The difference between a tariff and an export subsidy is that a tariff makes the price of imported goods more expensive in the local market. In contrast, an export subsidy makes the price of an exported good cheaper in the world market.
Import refers to the number of goods a country buys from another country.
Tariffs refer to a tax levied on imported goods.
The main purpose of tariffs is to make foreign goods more expensive to domestic consumers.
The government resorts to tariffs to protect certain domestic industries from foreign competition. The tariff that foreign companies have to pay pushes their goods' prices up. This then leads domestic consumers to consume from local companies.
If you need to refresh your knowledge of tariffs, click here:
- Tariffs.
Effects of Export Subsidy
The effects of both export subsidy and a tariff is that they create a difference between the prices at which products are sold on the global market and the rates at which those same commodities may be bought inside a nation.
Export subsidies are government policies that aim at incentivizing local producers to increase the number of goods they export.
As export subsidy incentivizes producers to increase their exports, it is more beneficial for them to sell their goods in foreign markets rather than at home. This is, of course, for as long as the price of those goods is not higher at home. Because of this, a subsidy of this kind causes an increase in the price of items that are sold within a country.
- So, while tariffs increase the number of goods that local suppliers sell to local consumers, the export subsidy increases the number of goods local suppliers sell to foreign consumers and decreases the number of goods that local producers sell to domestic consumers.
Most of the time, the government resorts to these two policies to intervene in trade due to the distribution of income, the development of sectors deemed essential to the economy, or the maintenance of a stable balance of payments.
However, both these policies do have an impact on a country's terms of trade. That is the relative proportion of exports and imports within a country.
Terms of trade are a critical metric that measures how much a country exports and how much it imports.
Click here to find all there is about it:
- Terms of Trade.
Export Subsidy Diagram
We will construct the export subsidy diagram using relative demand and relative supply for two different goods.
Assume that there is an economy in which food and clothing are produced. This economy has not been able to export as many clothes as it can't face the world competition on clothes supply.
The government decides to provide a 30 percent subsidy value for any given cloth that is exported to another country.
How do you think this affects relative demand and relative supply for food and clothing?
Well, the immediate effect of the export subsidy is that it will increase the price of clothing relative to that of food in the domestic economy by 30 percent.
The increase in the price of clothing relative to food will push domestic producers to produce more clothing relative to food.
And domestic consumers will resort to substituting clothing for food, as food has become cheaper compared to clothing.
Fig. 2 - Export subsidy diagram
Figure 2 illustrates how an export subsidy affects the relative world supply and relative world demand for clothing, which was subject to an export subsidy.
On the vertical axis, you have the relative price of clothes in terms of food. And on the horizontal axis, you have the relative quantity of clothes in terms of food.
As the relative price of clothes in terms of food has increased, the world's relative supply of clothes shifts (increases) from RS1 to RS2. In response to the increase in the price of clothes in terms of food, the relative world demand for clothes declines (shifts) from RD1 to RD2.
The equilibrium shifts from point 1 to point 2.
Advantages and Disadvantages of Export Subsidy
Like with most economic policies, there are also advantages and disadvantages of export subsidies.
Advantages of Export Subsidy
The main advantage of the export subsidy is that it lowers the cost of production for local companies and incentivizes them to export more. Companies then will need to invest more money in infrastructure and hire more workers in order to increase the volume that is exported. This helps boost the local economy as a result of the increase in exports.
The economy of the country that exports goods are a significant contributor to the total production of that country; hence exports are quite important.
If a company's products can develop new markets or expand on ones that already exist, they may be able to increase their sales and profits by exporting.
Exporting may also provide a chance to increase their proportion of the worldwide market. In addition to this, exports help to spur the development of new employment by encouraging businesses to enlarge their existing workforce.
Disadvantages of Export Subsidy
While export subsidies help increase export volume, they can damage the economy if not done correctly. The government provides an export subsidy to the industry based on its expenditures; nevertheless, a rise in the subsidy leads to salary increases sought by workers. This might induce inflation.
Now that the salaries in the subsidized sector are greater than everywhere else, it drives other workers to demand higher pay, which is then reflected in pricing, resulting in inflation elsewhere in the economy.
Another disadvantage of export subsidy is that it makes exported goods more expensive in the local market for local customers. The main reason behind it is that export subsidies aim at only increasing the number of goods exported.
Thus, it is more profitable for firms to sell to foreign customers. This shrinks the local supply and bids the prices up. The local companies will continue to sell foreign goods for as long as the price at home is below the price they sell abroad (with the government's help).
Export Subsidies - Key takeaways
- Exports refer to goods that are manufactured in one nation but are then sent to another nation for the purpose of sale or commercial exchange.
- Export subsidies are government policies that aim to support local companies to export more goods and services.
- Tariffs refer to a tax levied on imported goods.
- The difference between a tariff and an export subsidy is that a tariff makes the price of imported goods more expensive in the local market.
References
- dfdp.gov, Sugar and SugarCane Policy, https://dfpd.gov.in/sugar-sugarcane-policy.htm
- U.S Department of the Treasury, Why the United States Needs a 21% Minimum Tax on Corporate Foreign Earnings, https://home.treasury.gov/news/featured-stories/why-the-united-states-needs-a-21-minimum-tax-on-corporate-foreign-earnings#:~:text=U.S.%20Department%20of%20the%20Treasury,-Search&text=Under%20current%20law%2C%20U.S.%20multinational,operate%20and%20shift%20profits%20abroad.
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