Free Market Institute Blog
The Allure of Subsidies
What do college tuition, health care, and housing have in common?
For decades, their prices have risen faster—much faster—than the general price level. Why?
Because each of them is too cheap.
That is the paradox, and the allure, of subsidies. We all love sales, and when the price of a good is “cheap,” we smile, and buy more. Economists tend to frown upon government subsidies because they disguise scarcity—they, in effect, tell a “lie,” and move resources to less valued uses. When tax policy and crazy low interest rates made financing houses cheaper, houses got larger and more expensive even as family sizes shrunk. And we spend more on health care partly because of a 1943 Labor Board decision allowing employers to offer tax-free health care in place of an increase in pay. It was wartime, there were price controls, and employers had a hard time getting enough workers, and they were unable to increase their pay. That is why, 80 years later, employers offer health insurance benefits and not home or auto insurance.
So we get misallocated resources. When governments make college cheaper, more students go to college, study less, earn more spurious degrees, and therefore brew more coffee as Starbucks baristas. What is really more costly can sometimes appear less costly, especially if someone else is paying. Government subsidized student loans make financing college cheaper, but increase the demand for education, increasing tuition. Dorms become nicer, programs proliferate, support services abound, and cafeteria food actually becomes tasty.
But if economists have shown us why subsidies are nearly always bad, why do they continue?
Well, perhaps no one listens to economists.
More likely, tossing free or below-cost goods at voters makes them more likely to vote for your program. Sometimes I wonder why everything isn’t subsidized.
Of course, when the cost of the subsidies becomes unmanageable, reality has a way of slapping officials in their faces. This happens frequently in developing countries, where a fuel or food subsidy becomes entrenched; budgets explode, the IMF imposes austerity as a condition for more loans, and people riot.
There’s some simple psychology here:
1—People like cheap goods.
2—Given enough time, they expect them to remain cheap. They become entitled.
3—And, if subsidies are only given to a minority of deserving people, a democracy’s middle class majority will say, “What about us?”
4—But when governments (or, for that matter, parents) take something away from a person, changing the rules and challenging their expectations, people can become positively furious, and they start looking up Molotov cocktail recipes. A recent study noted that between 2005 and 2018, there were riots over fuel in 41 countries; it dryly concluded, “When such subsidies become unsustainable, domestic price adjustments are large, often leading to riots.”
In the family version of this scenario, Junior has a temper tantrum in the candy aisle at the grocery store.
And Americans are not immune to these issues, though our wealth insulates us from social conflict, for now. Every mathematically literate American should understand how Social Security is pretty much a demographic time bomb. But if Congress were to change the rules tomorrow, telling anyone over 50 years old that they cannot receive it, elders might be sharpening their pitchforks rather than their pencils. Few politicians facing an election advocate significant cuts to Social Security or limitations on Medicare. Taken together, 37.5% of Americans are part of at least one of these programs.
Machiavelli once wrote that the Prince should dispense good news slowly and continuously, but should dispense bad news all at once. In his own words: “Therefore any cruelty has to be executed at once, so that the less it is tasted, the less it offends; while benefits must be dispensed little by little, so that they will be savored all the more.” Instituting such “cruelties”—like making community college cost money again, or slowly raising the retirement age—might be best accomplished by ripping the bandaid off really quickly, and not on “3” when you tell Junior you’ll count up to three. Being successful is partly due to both how quickly you act and how conniving you are. The balance between fairly honoring people’s expectations, and being both bold and decisive, will take some brilliant Machiavellian genius.
I hasten to add that his Italian compatriots imprisoned and tortured Mr. Realpolitik, who didn’t exactly die a hero in his native, anarchic Italy when he was 58.
It’s easy to say “we shouldn’t have subsidies at all,” but not quite so helpful. What will we do about all the promises that we’ve made?
One viable solution successfully implemented concerned closing (it was termed “realigning”) dozens of superfluous military bases. Congress assembled a bipartisan commission to formulate a plan, giving congress 45 days to overturn its recommendations to close 98 bases on an up or down vote. It didn’t, and in the end, 98 bases were closed.
Let’s not forget that when democracies cannot make hard decisions, authoritarian rulers feel that they need to step in and “get it done.” Perhaps we should get this done before we’re all cooked.
