The collapse of global trade, murky protectionism, and the crisis:

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firms with and without strings attached. Some of the conditions relate to production
and employment levels, operations of foreign subsidiaries, and executive compensation.
In the automobile sector it has been reported recently that Italy and Spain plan
on joining France in conditioning financial support on commitments to retain
domestic employment levels. Italy is also said to have demanded that its financial
support to car producers be used to pay suppliers on time. 21
Other subsidies have related to the financing of firms 22 , including loan guarantees,
access to below-market rates of interest, and lenient default policies. Yet another
important form of subsidy relates to wages and employment. Germany, for example,
subsidises the wages of over a quarter of a million workers that the crisis prevents
working full time. Finally, stimulus packages have included taxation and expenditure
provisions of particular interest to a given sector.
The harm done by subsidies at home and abroad
What makes bailouts such a useful vehicle for murky protectionism is that there are
circumstances under which certain subsidies can improve national economic performance
and resource allocation. Blanket condemnation of subsidies is, therefore,
inappropriate. Much turns on how the discretion given to public officials in designing
bailouts is employed and whether in fact the principles for the design of effective
subsidies (that economists have articulated over the years) have been employed during
this crisis. The strong combination of private interests and political imperatives
can ride roughshod over the proper design of bailouts and, without much information
in the public domain, the beneficiaries can still claim those principles were
applied.
Subsidies can have three types of welfare-reducing effects. First, they can distort the
recipient firm's incentives. When firms expect to receive a subsidy in case of bad outcomes,
they are less likely to bear the cost necessary to avoid sub-standard performance.
Likewise, their incentive to restructure and become more efficient diminishes.
The mere expectation of a bailout can adversely hit cost competitiveness and productivity
growth.
Second, when some firms are subsidised and other firms in the same market are
not, the subsidised firms benefit from an artificial advantage. Competition is no
longer solely "on the merits" (good products or services, low costs, etc) and more efficient
competitors may contract and, in the limit, leave the industry. Firms can also
use the subsidies that they receive to engage in anticompetitive practices, such as
predatory pricing and to fund competition-reducing acquisitions.
A third problem with many subsidies is that they only indirectly affect the ultimate
objective set by the government. If job loss is the state's real concern, then subsidies
to production costs or reduced cost of credit will only influence employment decisions
through their impact on other aspects of firm performance. The best subsidy is
the one that targets precisely the private sector decision in question (employment in
21 See "EU and France ease protectionism row on summit eve," Agence France Press, 28 February 2009.
22 For example, the UK government is reported to have asked beneficiaries of its Asset Protection
Scheme for banks to "pledge" to lend more to UK mortgage holders and small and medium-sized businesses.
See "The biggest insurance policy in history," The Independent, 25 February 2009. Similarly,
the Australian government is said to be creating a A$4 billion fund to assist investors in commercial
property that cannot refinance foreign debts when they come due; see "Homeward Bound," The
Economist, 7 February 2009.
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