OVER-subsidizing or UNDER-subsidizing

In the case of market-based solutions for external benefit in productions, which one is more problematic? OVER-subsidizing or UNDER-subsidizing?

A subsidy is a financial assistance given by the government to encourage production. It is difficult to impose the correct amount of subsidy as the measuring of the exact value of external benefit is a very difficult task.

In the case of over-subsidising, large amount of taxes may be required. This causes disincentive effects on work and investment as people do not feel the need to work hard since the “extra” money that they earn will go to paying for the taxes. This will cause adverse effects on economic growth.

However, in the case of under-subsidising, producers may not want to produce the goods as they do not find themselves benefiting much from the subsidies. Therefore this defeats the purpose of the government implementing subsidies in the first place. However, the government can actually increase the subsidies if the producers are not responsive to the subsidies, this will encourage producers who lack the capital at first to enter the market with the increase in subsidies.

In the case of market based solutions for external benefit in productions, over-subsidising is more problematic compared to under-subsidising as over-subsidising will cause negative effects on other industries which are affected by the overwhelming taxes. On the other hand, under-subsidising will only affect the industry itself, and perhaps those that are related to it. The negative effects of under-subsidising are not as problematic as those due to over-subsidising.

- Vivian