Subsidies

Published on 5/06/21

Subsidies tend to correct market failures caused by a positive externality. By giving per unit subsidy to the manufacturers, the supply of electric cars will increase, lowering the market price and urging consumption. It is considered significantly helpful for a start-up business that lacks the financial ability to further scale up its production. States and localities in the United States have given over $13.8 billion in economic development subsidies to at least 51 electric car battery manufacturers, mainly recently. Decades of federal and state investment and policies have fueled strong growth in electric car production, thereby making the United States a pioneer in the global electric car industry. Investment in research and development (R&D) is central to driving long-term technological change and innovation, which can take the form of tax credits or immediate expenditure on relevant projects. In fact, R&D subsidies result in more obvious incentives for the R&D behavior of new energy auto companies in relation to production subsidies. Based on data from 88 listed Chinese automakers from 2001 to 2015, it is estimated that the net effect of the production subsidy stage is equal to 25.47% of the R&D subsidy stage (Shao et al.).

Benefits

1. Indirectly corrects market failure

Although in the partial equilibrium model, electric vehicles also have negative externalities as it increases carbon emissions from generating more electricity, it is true that in general equilibrium, switching to EVs will lead to fewer carbon emissions by reducing the consumption of its substitute - diesel cars - and thus the consumption of gasoline. Therefore, subsidies to the EV industry could serve as an indirect corrective mechanism to the market failure in the car industry and restore general welfare loss from the negative externalities of gasoline consumption.

2. Net social welfare gain in the long run

There are two ways that subsidies stimulate corporate investments in R&D. Direct subsidies in R&D lower the costs of initial investments and thus increase the net present value of potential projects, raising the return on investment (ROI). In addition, subsidies in the production of EVs in general increases corporate profits, which increases the amount of cash flow, thereby enabling them to invest in a greater number of projects. The increase in R&D from these two ways will lead to improvements in economic efficiency and reductions in costs in the long run, which increases both consumer and producer surpluses, resulting in a net welfare gain for society.

3. Reduces current account deficit

Subsidizing the production of electric cars will make them more competitive on the global market by making it more affordable and of higher quality than other cars on the market. It will also reduce fuel imports as electric cars run on electricity, which can be generated domestically, rather than needing to be imported from oil-rich nations through international organizations such as OPEC.

Costs

1. Crowding Out

Subsidies lead to increases in the government deficit, as the government is required to spend more on the electric car industry. Assuming that public investment is minimally curtailed in other sectors, this increase in the government deficit will compel the government to borrow money on the open market. This is best illustrated in a rightward shift of the demand for money in the Loanable Funds Market, as shown in Fig. 3. This drives interest rates upwards, which may discourage companies and individuals to borrow more money, decreasing investment. Private firms with other potential technologies may also perceive the market as being saturated with subsidized electric vehicles, which can reduce investment and stifle innovation and competition in the electric car industry.

2. Labor Market Polarization

The effects of subsidies on the labor market in the electric car industry are multifaceted. Compared to the production of traditional diesel cars, electric vehicles require less labor in their production process. For example, Ford Motor Company's CEO has estimated that building electric vehicles will require 40% fewer workers than manufacturing gasoline-powered cars and trucks (Cutler). In addition, it may lead to Labor Market Polarization, where the demand for middle-skilled workers - such as those working in the manufacturing of cars - will decrease, as their routine tasks are likely to be automated. In addition, the demand for high-skilled workers will rise following the increase in productivity. As such, subsidies may further strengthen the existing income disparity within the economy.