Question

In: Economics

Economists have provided a model to explain how an export subsidy may benefit the local economy....

Economists have provided a model to explain how an export subsidy may benefit the local economy. Without providing the details of the model, present the intuition of how an export subsidy may benefit the imposing country. Explain also why the model and the analysis have been criticized in terms of (in each of the following cases): (a) the presence of local consumers; (b) the presence of many firms in the industry; (c) the existence of many industries that deserve export subsidies; (d) political economy

Solutions

Expert Solution

Export subsidy is the policy by the government of a country to encourage export of goods and discourage their sale in the domestic market. They are the devices to influence international trade in favour of a country's exporters through direct payments, low cost loans, tax relief for exporters, government financed international advertising, low interest loans to foreign buyers for stimulating exports etc.,

The export subsidies increase the domestic price of the commodity and decrease it's international price. Hence the export subsidies benefits the domestic exporters. Their gain exceeds the small welfare loss in the domestic consumer's side and that is why the governments adopt the policy of export subsidy. The increase in producersproducer for domestic exporters ultimately leads to an increase in output, employment and profits.

But there are a number of reasons due to which the policy of export subsidy is highly criticised.

A) Presence of Local consumers

When there are local consumers for a good which has been given export subsidy this leads to a loss in consumer surplus for them. Because when export subsidy is given the domestic price of the particular good increases and consumer surplus decreases. Hence there occurs a welfare loss. As said above export subsidy increases domestic price and this may lead to inflation also .

B) Many firms in the industry

When there are many firms in the industry and export subsidy is given there arises a huge competition which is not healthy for none of the firms. There won't be much benefit from the export subsidy to the producers as there arisr a situation similar to perfect competition and price will depend solely on demand and supply

C) existence of many industries that deserves export subsidy

This issue actually leads to the generation of inflation in the domestic economy which will without any doubts affect the economy adversely. Because when there are many industries that are given export subsidies , domestic prices of a of their products increase. This will lead to an overall increase in the price level which is inflation.

Another issue related with this is the problem faced by government regarding the financing of export subsidies. When there are many industries that deserve export subsidy the government will have to find a way to finance it because a huge amount of fund is needed for financing that.

D) Political economy

The government is suposupp to pay the subsidy to the exporters. This payment must come from the general budget of the government. That means the payment will be made most probably from the tax revenue. Another way to finance subsidies is through borrowing funds. If subsidy is paid usinf tax revenue, that means the ultimate burden is upon the tax payers of the country. If the payment is done using the borrowed funds the tax payers do not have to take the burden immediately. But in future as the borrowed funds are to be paid back with interests there also the ultimate burden will be on the domestic tax payers.


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