Here’s why governments should avoid tit-for-tat subsidy wars

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Appeared in the Ottawa Sun, May 31, 2023
Here’s why governments should avoid tit-for-tat subsidy wars

According to Premier Doug Ford, Ontario will put “more money on the table” to keep the Stellantis electric vehicle (EV) battery plant in the province, in addition to the $500 million the government already promised. This adds to the overall Ontario taxpayer commitment to EV battery production, given an earlier financial pledge to Volkswagen to build an EV plant in St. Thomas. Meanwhile, taxpayers across Canada will be on the hook for federal government subsidies to the two EV battery facilities including an eye-watering $13 billion commitment to Volkswagen.

The apparent justification for this orgy of corporate welfare is that the Biden administration is offering hundreds of billions of dollars in government subsidies to firms involved in green technologies such as EVs and the batteries that power them. So, if the federal and Ontario governments do not match U.S. government subsidies, Canada will be shut out of the green technology value chain, and high-paying jobs in Canada’s motor vehicle industry will disappear. As Premier Ford said, the subsidies are all about creating great paying jobs and giving people the quality of life they deserve in southwestern Ontario.

There are several problems with the approach.

Firstly, even if it were beneficial for the overall Canadian economy, Canada likely couldn’t afford to match U.S. government subsidies to any sector including green technology. Although, if attracting green technology production facilities through government subsidies accelerated Canada’s economic growth, the subsidies would ultimately expand the government’s tax base and borrowing capacity such that the “affordability” issue would be moot. In any case, given that Canada’s federal gross debt was around $1.6 trillion in 2021, capital markets would hardly notice an additional $30 billion in corporate welfare financed by government borrowing.

But the salient economic argument against governments in Canada engaging in tit-for-tat subsidy wars with other governments is fundamentally the same argument for governments eschewing tit-for-tat retaliation against tariffs on exports. Such actions make the retaliating country’s economy less efficient and therefore poorer. Government subsidies and tariffs encourage increased production in subsidized or protected sectors of the economy at the expense of other sectors since the former sectors must bid away labour and other inputs (machinery and equipment, for example) from the latter. In economic speak, if increased production requires taxpayer subsidies or protective tariffs, the true economic costs of the inputs utilized will likely exceed the economic value of the increased output.

That other governments implement policies that make their economies less efficient is not a reasonable justification for the Canadian government to duplicate those policies. As famous British economist Joan Robinson (a colleague of John Maynard Keynes) said, “Even if your trading partner dumps rocks into his harbour to obstruct arriving cargo ships, you do not make yourself better off by dumping rocks into your own harbour.”

To be sure, shareholders of companies that receive corporate welfare, and some portion of the workforce, will benefit—or at least avoid economic damage. And some local workers will be hurt by the protectionist policies of foreign governments. But rather than waging tit-for-tat retaliation, governments should improve the investment and labour market environments across industrial sectors and locations. In Canada, that means making business and personal income taxes more competitive, reducing the costs of excessive regulation particularly for small and medium-sized companies, improving housing affordability by changing zoning processes, and eliminating interprovincial barriers to trade and labour mobility.