The UK Government has spent hundreds of millions of pounds subsidising steel companies in the UK. This includes Tata Steel’s site in Port Talbot.
Meanwhile, other companies have been allowed to fail without intervention, such as BHS and Debenhams.
Why does the Government support some firms but not others?
This question is at the heart of what economists do.
Economists, whether in the civil service or as consultants, conduct “cost-benefit analysis”. The goal is to figure out the most worthwhile places to put taxpayer money.
What are their key considerations?
1. The wage premium argument
Suppose a firm failed. Workers may lose their jobs as a result. Would those workers be able to find another job and would that job be paid less?
If the failing firm is paying their workers low wages, the government may believe these workers are more likely to be able to find similarly paid employment, if the firm fails.
For example, governments do not routinely bail out or subsidise restaurants, yet the sector sees a relatively high rate of company failure.
What if the job being lost is a highly paid one relative to median wages? Then the workers are likely to see a large wage fall if their next job is a median wage job.
Therefore, all else equal, the government is more likely to save firms who pay their workers above median wage.
Note that this analysis assumes full employment. Specifically, that workers who, when a company fails, lose their job, will be able to find another job.
This brings us on to the state of the economy.
2. The state of the economy
Consider an economy with low unemployment, operating near full capacity. This is like the economy mentioned previously. The job market favours workers, who can more easily find another job, if they lose their current one.
Suppose instead there’s high unemployment. If a worker loses a job, they are much less likely to find another job. In this kind of scenario, intervening to protect jobs becomes more important.
Government support to prevent firm failure has a much greater effect, as the “counterfactual”. That is, the situation where the jobs are lost and the firm fails, is so much worse for the workers when there is high unemployment.
3. Market failures
This is the crux of most arguments for intervention.
In the restaurant market, there is typically not a large market failure to justify government subsidies. According to this perspective, lots of firms failing and new firms entering the market are signs of a well-functioning market.
In other markets, there may be “market failures”.
Training / education has positive externalities, knock-on positive effects on third parties.
Not only does training increase workers’ skill level, so they can go on to earn higher wages on average. Firms benefit from having more productive workers and the government benefits from tax revenue from higher-paid workers and higher-earning firms.
Even in markets like restaurants, there can be cases for intervention. The Covid-19 lockdown led to government support for the hospitality industry, for instance.
4. “Second-round effects”
Subsidising one firm helps more people and firms beyond the original firm.
Suppose the Government subsidises renewable energy. This reduces energy bills for firms and consumers who rely on that energy.
In addition, there are more funds for building solar panels and wind turbines. Thus providing higher demand for the raw materials and workers to build renewable energy generators.
In this sense, subsidies can indirectly support firms up and down the production chain.
There may also be local multiplier effects in local stores. Steel jobs in Port Talbot provide local workers an income, which they spend in local shops.
Another example is government support for electric car battery factories (also known as “gigafactories”).
A £4 billion investment by Tata Group into a gigafactory in Somerset is projected to create 4,000 direct jobs and thousands more in the wider supply chain.
The Government offers support to sectors like this, including through the Automotive Transformation Fund (ATF).
In short, how critical the firm is to the supply chain and the local economy matters. This may influence the effectiveness of any government support.
5. Inequality and regional impacts
Will subsidising a firm create new jobs in a poorer region, reducing inequality?
This could be a consideration for a government that wants to level up poorer regions of the economy.
However, cost-benefit analysis has historically been criticised for considering inequality as an afterthought. That is instead of making inequality part of the analysis itself.
Cost-benefit analysis in economics: the bottom line
As an economist, these are just some of the issues you will need to consider, when deciding whether to intervene in a market.
There are several other factors not mentioned here, that determine whether the Government supports a business or not.
For instance, the government’s budget position, security of supply concerns and more.
Moreover, cost-benefit analysis (CBA), which uses the kinds of ideas mentioned above, is subject to its own issues.
CBA tends to focus on monetised costs rather than non-monetised costs. Also it may not always consider equalities except as an afterthought.
In addition to this, CBA may only be possible in government bodies where there is the capacity to undertake it. For instance in the big government departments but not in local authorities.
Nevertheless, CBA is an important tool. Suppose we did not have a tool to value which projects are worthwhile and which are not. Then government funds would more likely be subject to vanity projects and corruption.
We can also estimate the areas of spending where taxpayers get highest value for their money. This allows a more efficient allocation of government funds.
Finally, we can tinker with the design of taxes, subsidies and regulations to improve outcomes for consumers and firms. This could include changing the conditions for getting subsidy funds. Or tweaking which products are subject to a tax.
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