Subsidies may be: (a) export or credit subsidies to promote growth through more efficient allocation of resources by encouraging the private sector to undertake activities that generate external benefits; (b) subsidies to provide income support, including food or housing subsidies and subsidies to state owned enterprises to support government-imposed price controls. Clearly some subsidies - for food, health or education, for example - can be justified because of their social benefits.
Although subsidies can contribute to efficiency, to relief of poverty and to growth, their benefits must be weighed against their substantial costs, which are likely to rise faster than benefits, these benefits needing careful targeting. If a government's revenue-raising capacity is severely constrained by administrative limitations, as is true in many developing countries, using scarce revenues to subsidize private activities will mean that fewer resources are available for other uses. In such cases, the investment or spending on operation and maintenance forgone must be seen as a major cost of subsidies. In cases where a government's revenue-raising capacity is not so limited - as in more advanced countries - a major cost of subsidies is the burden incurred in raising the revenue to finance them. Subsidies also induce changes in private sector behaviour. For example, credit subsidies designed to spur investment can actually cheapen capital relative to labour and lead to excessive capital-labour ratios in production, thus increasing unemployment. In Thailand credit subsidies to agriculture in the late 1970s encouraged excessive mechanization and have since been scaled back. Subsidies on particular foods or forms of energy can lead to overconsumption, waste and inefficient use of the subsidized product. The private sector may divert its attention from productive pursuits to lobby for a share in the subsidy and, in addition, subsidies may lead to harmful environmental effects.
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