You can define corporate welfare in a number of way, but the most common revolves around Government subsidies — and other forms of unearned support — to private businesses. I don’t have a problem with this definition. But I’d like to cast it in a different light.
I think of corporate welfare as one symptom of Arnold Kling’s generalized observation that Government restricts supply and subsidizes demand. For example, building new homes is highly restricted in many cities while at the same time home-buyers are offered financial assistance. Or Government restricts healthcare supply through the prices it reimburses and while subsidizing the health insurance cost of the patients. This results in higher costs being consumed by the privileged firms — cost disease.
Here’s the way I’m playing with this idea in analogy terms: Restricting supply is to corporate welfare as subsidizing demand is to social welfare.
But what do I mean by this?
Let’s start with subsidizing demand.
Most often, demand subsidies go to the public to help them buy houses, afford groceries, receive medical care, and so forth. Certainly that is associated with social welfare. When subsidies are given to the public and it reflects their basic needs, it will create new patterns of specialization and trade, for sure, but it will not ensure the profits of one firm or any other.
When home-buying subsidies start and that creates a step-increase the number of new homes demanded, there will be a one-time benefit to the incumbent home builders. But the rising demand and profits will signal other firms to enter the home-building market. As new entrants join the competition, they compete away profits from the incumbents. No single builder gets unfair access to the Government subsidies. Each supplier must compete by bringing value to the consumers being subsidized.
Restricting Supply leads to Corporate Welfare.
Competition between suppliers to earn the consumers’ business is the force that drives lower prices and innovation. When there is competition, suppliers can’t afford to operate inefficiently or they’ll be driven out of the market. But when there are barriers to entry, the suppliers can operate wastefully and continue to reap profits.
The various subsidies provided to business all work to restrict supply: Cash handouts provide advantages over potential entrants who do not receive them; Government absorbs the risk of certain companies from defaulting on their obligations, but not others; tax breaks are doled out for special cases unattainable by competitors; and pressures from international trade are dampened to prop up inefficient domestic suppliers.
The end result is more a concentrated industry. The subsidies provide an advantage to certain firms, and the advantage perpetuates itself. New firms looking to compete have to be so much more efficient as to hurdle all the various privileges received by incumbents, not to mention their head start.
Regulations also restrict supply.
When firms grow large, they usually look to protect their market position by influencing regulations. Most times regulations look to serve the public’s interest. Licensing laws ensure that only qualified people are performing a risky job; financial reporting and other business standards safeguard shareholders; and lengthy contract procedures provides oversight to Government spending.
But in several markets, these regulations taken as a whole provide a huge barrier to entry. A new firm would need massive amounts of capital to afford all the compliance officers, auditors, business consultants, and other costs associated with the regulations. And of course, a new entrant would need lobbyists of its own.
In many cases, regulatory capture ends with the rules of the game favoring the incumbents precisely because they had the loudest voice in the language of the regulations. The firms supply critical information supporting their position, which then primes the regulators toward certain technical or economic solutions to the public’s problem. That boxes out new and innovative firms who might have viable — if unexpected — solutions.
Conclusion.
The cause of corporate welfare is supply restriction which raises barriers to entry for competing firms. In most cases, the increased barriers protect the public, making them worth the cost of restricting supply. However, Government officials writing regulations are often captured by the regulated industry. Industry is provides the most feedback to the wording of the language, and they use it to protect themselves from competition.
In upcoming posts, I’ll describe what corporate welfare looks like in the defense industry.
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