Subsidy: a tool to blunt the short-term impact of FTAs

Prior to the current downturn which has prompted many countries to pursue a policy of protectionism, we used to see the word “FTA” all over the media. Each FTA (Free Trade Agreement) is usually signed by two or more countries that have agreed to eliminate tariffs, quotas and preferences on most, if not all goods and services traded between them. A successful FTA is expected to result in an increase in income and subsequently wealth and well-being for everyone in the participating countries due to specialization and division of labour. As an example, A and B each initially produce both milk and beef despite the fact that A is better than B in producing milk while B is better than A in producing beef. With FTA in place, A is expected to eventually produce only milk while B only beef.

Although simple and logical, some FTAs have not been moving in the right direction because of intense lobbying by people who are at risk of losing their jobs once FTAs are in full force. Despite knowing that job loss is nothing but just one of several short-term side effects of FTA implementation that will in time rectify itself, government has to show that it considers the sentiments of the common people and so, has resorted to providing subsidies to the affected industries with the intention of sustaining them. Too much subsidies however create the false impression that a particular industry is more competitive than its counterpart in another country when it should have been otherwise. It also allows the industry receiving subsidy to have the unfair advantage of quoting below the price of its counterparts receiving no subsidy, ultimately causing people who should not have lost their jobs to end up losing theirs.

This very implication of government subsidy has been the main contention point between countries that are engaged in talks to liberalize their market. Countries that are very confident of the ability of their industries to compete globally/regionally without any subsidy have boldly requested that subsidy elimination among participating countries be set as a pre-condition for further talks.

I personally think that fulfilling such a request is dangerous and lacking in foresight. If a country removes government subsidy for a particular industry and yet does not have proper plans in place to absorb the laid-off workers into the non-subsidized industries, it will end up increasing the unemployment rate and its related consequences such as social unrest.

One way a country in such a position could negotiate is to propose that it be allowed to continue subsidizing the industry in the spotlight but at a rate that is just right to sustain the industry and would not in any way affect the competitiveness of its counterpart in other countries. For example, if the cost of producing a liter of milk is $2 in country A and $3 in country B, country B should be allowed to give a subsidy of $1/liter to its milk industry until the industry is able to sustain itself by becoming as competitive as its counterparts if not more or until sound plans are in place to absorb the laid-off workers if the industry begins to cut jobs. Of particular concern is the potential exploitation of the subsidy system by the milk producers, i.e they will not put in any effort to boost its competitiveness and instead live off government subsidy for as long as possible. This can be easily overcome by setting a deadline where subsidy rate will drop to 0% regardless of whether the industry can fend for itself or not.