According to neoclassical economics, subsidies are a solution to correct for the existence of externalities in consumption or production.

What is the economic rationale/justification for such subsidies in the EU? Which are the externalities subsidies are correcting for? Or are subsidies justified by other motives, e.g. political?

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    $\begingroup$ They are essentially political, but one other justification given is food security $\endgroup$
    – Henry
    Jan 16 '17 at 20:32
  • $\begingroup$ ...And it is not just the EU. US for example reportedly provides yearly around 25 billion USD in subsidies to farm businesses. $\endgroup$ Jan 16 '17 at 20:53
  • $\begingroup$ food security is one aspect. another is to motivate the switch to sustainable agriculture $\endgroup$
    – Yorgos
    Jan 16 '17 at 22:34
  • $\begingroup$ A comprehensive answer, perhaps based on official documents to support the claims, would be ideal. $\endgroup$
    – luchonacho
    Jan 17 '17 at 9:28

Markets are extremely poor at pricing events that have very low probability and catastrophic impacts. In part because we're very bad at estimating low-probability events: by definition, they're rare. And in part because the catastrophic impacts fall on pretty much all the population, so any single purchase has very widely-spread potential negative externalities.

And there are strongly asymmetric risks here - if civilisation collapses, it can take centuries to rebuild it. If one country falls under the control of another, it becomes extremely expensive and messy to reverse this.

As such, societies decide - in order to avoid those catastrophic impacts - to pay a kind of insurance premium. A high risk of some market distortion is an acceptable premium to pay, in order to avoid catastrophic loss.

Food is probably the most obvious market where a dramatic loss of supply could lead to catastrophic failure. (the carbon market is another) By subsidising farmers, we ensure the continuity of the domestic supply of food: this helps ensure the availability of food locally, so the population gets fed; and reduces the strategic international risks that would arise from high imports of essential foods.

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    $\begingroup$ But, without subsidies, would there not be enough farming? Or is it that prices would be too high? what would that land be used for? Is not protectionism a cheaper approach? I think the proper counter-factual needs to be accounted for. All that money could have been used for something else. $\endgroup$
    – luchonacho
    Jan 17 '17 at 15:39

The governments want to ensure that there is enough food for their people even if international food trade breaks down (for example due to trade war, war, or famine).

A secondary objective is that they want low food prices to make food affordable to people with low/medium income. Politicians that drive up food prices for the masses are less likely to get reelected.

Finally there is the effect on the outside world. This has not been of high concern, but in recent years the issue has been raised by various groups that promote equal rights for developing countries.

But, without subsidies, would there not be enough farming?

Less would be produced in the EU, more would be imported. So the decrease in the EU production would picked up by other countries.

Or is it that prices would be too high?

That is the second concern.

what would that land be used for?

Some land would be used for crops that are less labor-intensive. Land that isn't appropriate for such crops would be disused. Example: grape vineyards situated on steep hills could be disused or become grazing for sheep/goats.

Is not protectionism a cheaper approach?

It probably would be. It would not meet the objectives, though. With protectionism, the prices will drop sharply as soon as there is a surplus in production. With a surplus, the EU price will equal the world market price. With a shortage, the EU price will equal world market price + trade tariffs. For subsidies there is no such sharp drop at the equilibrium point. Thus, the EU food production will be lower under protectionism than under subsidies.

I think the proper counter-factual needs to be accounted for. All that money could have been used for something else.

It is clear that the cost (=price + subsidy) of food is increased. By a fairly large amount. Some of that money is being spent for political reasons, because some of the products that receive subsidies aren't really vital to avoid starvation or malnutrition.


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