My econ prof said the other day that subsidies were needed to solve externalities. For his example he said that there was a positive externality problem with teaching hospitals because they teach doctors who leave very quickly and then benefit the rest of society. To make up for this, he claimed, the government had to provide subsidies to the hospital to ensure enough doctors get trained.
Now, I understand the debate about negative externalities, but I really don't understand how anyone can support subsidies to solve positive externalities. Do any of the big government folks want to take up the cause? Can you name a +ve externality situation that desperately needs to be fixed?
I specifically want to talk about positive externalities in this thread, not negative ones.
FWIW, these are my objections to subsidies for +ve externalities:
1. It removes the incentive for an entrepreneurial solution to the problem. When there is a perceived market failure, most people will not be able to see the solution and as such will be likely to support subsidies to "correct" the problem. The thinking with the first railways in the 19th century was that there was a big positive externality issue and that it would be impossible to build a railroad privately. As it turned out, it was possible to build a transcontinental railroad without government subsidies (see the great northern railroad
http://tinyurl.com/2zmmvd ). In fact, the JJ Hill was so successful as a railway entrepreneur that he was targeted by General Sherman's antitrust act. My point is this: if it weren't for the availability of a separate northern market, we would never have known that a free market solution existed to the perceived problem.
In most cases, the subsidy will mean we *never* find a free market solution.
2. Not only is the entrepreneurial incentive removed from the subsidized company but potential competitors are crowded out of the marketplace. It becomes economically infeasible to compete with the subsidized company.
3. The provision of subsidies encourages rent-seeking. Instead of trying to find a free market solution, it makes more sense to spend time and money lobbying politicians to provide you with subsidies and to take subsidies away from your competitors. There is a huge opportunity cost associated with this activity. There was an economist whose name I forget who likened such rent seeking behavior to two sumo wrestlers fighting over the contents of a china store, by the time they're done, the store is destroyed and all the winner gets is one teapot.
4. Often times the subsidies can lead to bizarre behavior on the part of the subsidized. To return to the railway example - the union pacific and central pacific railroads were subsidized with a land grant and low interest rate loan on each mile of track that they built. So what did they do? There was never any focus on finding the shortest route, they often built winding circuitous routes and the focus was on speed not workmanship.
5. Allowing subsidies creates a perverse incentive for politicians. The most effective politicians are the best vote maximizers, by definition. Allowing subsidies allows politicians to effectively buy votes to keep themselves in office.
6. My last objection is that providing a subsidy is not a free market solution, it is - by definition - not a free choice. Subsidies are essentially plunder of your fellow citizens. I receive no benefit from the Gravina Island Bridge (
http://tinyurl.com/2s6jpk ), yet I am forced to pay for it. Even if I could receive benefit from it, I might have chosen not to use it.