The Role of Subsidies1
The Role of Subsidies1
Stabilisation would not have been possible without fairly extensive use of subsidies to prevent unavoidable cost increases from impinging on prices and finding their way, directly or indirectly, into the Wartime Prices Index.
However, government policy was to restrict their use to a minimum. Before a subsidy was approved in a particular case, a close and searching examination was to be made of the ability of a business to bear further cost increases and of its efficiency in production. Sellers or manufacturers or those providing services might be required to institute economies through standardisation, rationalisation and similar methods, as a condition for receiving assistance. No subsidy would be paid to maintain inefficient units2 or merely to maintain profits at their former level.
Subsidies to farmers included-payments to hold major farm costs and provide assistance to those who had lost their pre-war markets, particularly orchardists. The wheat subsidy was an example of an incentive payment intended to increase production.
1 Parts of this discussion are taken from The New Zealand Economy, 1939–1951. (Parliamentary Paper B–5, 1951.)
2 Criteria of efficiency were not clearly defined, but judgments would be made on the basis of comparisons with other units in the same industry.
The declared purpose of many of the producer subsidies was to offset increased costs which would otherwise have entered into the prices of essential commodities. While the cost of a subsidy was usually met by the community as a whole, to the same degree as if an original price increase had been permitted,1 secondary spirals2 of an unpredictable amount were avoided. The coal subsidies, for example, were primarily intended to enable coal to be produced and sold at stabilised prices in the face of increased costs and a wartime shortage of imported coal. They not only held down the price of coal to household consumers, but helped to hold costs in the gas industry, dairy factories, meat freezing works, and in the railways. Various transport subsidies similarly limited the spread of increased costs through the community.
Costs at 15 December 1942 were used as a base for decisions on producer subsidies to offset cost increases. However, the full increase in costs above the basic level was not always covered by subsidy. In many cases, a part of the increased cost had to be borne by the industry concerned, either at the source of the increased cost or at some later stage in the distribution of goods and services.
The most important producer subsidies were the coal subsidies and those paid to farmers.
By 1945–46 subsidy payments were equivalent to over 2 ½ per cent of the national income and had become a significant component of the New Zealand pattern of financial transactions. They needed careful consideration in deciding government financial policy. The direct cost of subsidies was partly offset by the fact that, in the absence of subsidies, costs, prices and wages would all have risen more, and government expenditure in many avenues—salaries, works schemes, defence purchases, railways—would have been much greater.
1 Being met from general revenue, it was borne by a rather different group of people from that which would have been affected by the price increase.
2 The most common use of the word spiral by economists is to describe a situation where price increases justify a wage increase, which in turn leads to further price increases, then another wage increase, and so on. A variety of other types of spiral can occur, many of them more intricate than this. High profits, for example, or extra investment or new consumption expenditures can initiate spirals. Many spirals move more quickly in potentially inflationary situations, where goods and services generally are tending to be in short supply.
Consumer subsidies, where demand was elastic, could have had a considerable effect on expenditure patterns. In practice most consumer subsidies were on items for which demand was inelastic.3 All subsidies interfered with the normal working of the price mechanism in the economy. Producer subsidies, by creating false price relationships, could lessen the incentive to get rid of inefficiencies in the subsidised industries and to seek suitable substitute commodities to replace those which had become too costly.4 Subsidy proposals therefore needed a most critical examination and frequent review. In practice, subsidy payments were made only as a last resort.
In spite of shortcomings in subsidies as a stabilisation expedient, they were an integral part of the comprehensive scheme. To condemn their use in time of war would be to underestimate seriously the importance of stabilisation and the magnitude of the task of achieving it.
1 Not quite true of cases where the subsidy was used to offset a rise in price of imports. The position here is that extra internal purchasing power was mopped up in paying for the imports. The subsidy payments restored an equivalent amount of purchasing power.
2 Recent discussions among economists assess the probability of a ‘cost-push‘, as distinct from a ‘demand-pull‘, inflation. If their views are accepted, one might alter the text to say that the effect of stabilisation subsidies would be to avoid cost-push inflation at the risk of inducing demand-pull inflation, and that, where subsidies are accompanied by sufficient extra taxation or internal borrowing, it might be possible to avoid both types of inflation.
3 Elasticity of demand refers to the degree of response of demand to a given price change, both being expressed as percentage changes.
4 It could be argued that, with the degree of price, wage and other controls operating in time of war, the price mechanism could not have worked effectively in any case.