Lesson 3

Part 1

THE ROLE OF GOVERNMENT IN MICROFINANCE

SUBSIDIES

What Is a Subsidy?

A subsidy is a benefit given to an individual, business, or institution, usually by the government. It can be direct
(such as cash payments) or indirect (such as tax breaks). The subsidy is typically given to remove some type of
burden, and it is often considered to be in the overall interest of the public, given to promote a social good or an
economic policy.

A subsidy is a direct or indirect payment to individuals or firms, usually in the form of a cash payment from the
government or a targeted tax cut.

In economic theory, subsidies can be used to offset market failures and externalities to achieve greater economic
efficiency.

However, critics of subsidies point to problems with calculating optimal subsidies, overcoming unseen costs, and
preventing political incentives from making subsidies more burdensome than they are beneficial.

How a Subsidy Works

A subsidy is generally some form of payment—provided directly or indirectly—to the receiving individual or
business entity. Subsidies are generally seen as a privileged type of financial aid, as they lessen an associated
burden that was previously levied against the receiver or promote a particular action by providing financial support.

Subsidies have an opportunity cost. Consider the Great Depression-era agricultural subsidy described later in this
story: It had very visible effects, and farmers saw profits rise and hired more workers. The invisible costs included
what would have happened with all of those dollars without the subsidy. Money from the subsidies had to be taxed
from individual income, and consumers were hit again when they faced higher food prices at the grocery store.

Types of Subsidies

A subsidy typically supports particular sectors of a nation’s economy. It can assist struggling industries by lowering
the burdens placed on them or encourage new developments by providing financial support for the endeavors.
Often, these areas are not being effectively supported through the actions of the general economy or may be
undercut by activities in rival economies.

Direct vs. Indirect Subsidies

Direct subsidies are those that involve an actual payment of funds toward a particular individual, group, or industry.
Indirect subsidies are those that do not hold a predetermined monetary value or involve actual cash outlays. They
can include activities such as price reductions for required goods or services that can be government-supported.
This allows the needed items to be purchased below the current market rate, resulting in savings for those whom
the subsidy is designed to help.

Government Subsidies
There are many forms of subsidies given out by the government. Two of the most common types of individual
subsidies are welfare payments and unemployment benefits. The objective of these types of subsidies is to help
people who are temporarily suffering economically. Other subsidies, such as subsidized interest rates on student
loans, are given to encourage people to further their education.

With the enactment of the Affordable Care Act (ACA), some U.S. families became eligible for subsidies, based on
household income and size. These subsidies are designed to lower the out-of-pocket costs for insurance premiums.
In these instances, the funds associated with the subsidies are sent directly to the insurance company to which
premiums are due, lowering the payment amount required from the household.

Subsidies to businesses are given to support an industry that is struggling against international competition that has
lowered prices, such that the domestic business is not profitable without the subsidy. Historically, the vast majority
of subsidies in the United States have gone toward four industries: agriculture, financial institutions, oil companies,
and utility companies.

Advantages and Disadvantages of Subsidies

Different rationales exist for the provision of public subsidies. Some are economic, some are political, and some
come from socioeconomic development theory. Development theory suggests that some industries need
protection from external competition to maximize domestic benefit.

Technically speaking, a free market economy is free of subsidies; introducing one transforms it into a mixed
economy. Economists and policymakers often debate the merits of subsidies and, by extension, the degree to
which an economy should be mixed.

Advantages

Pro-subsidy economists argue that subsidies to particular industries are vital to helping support businesses and the
jobs that they create. Economists who promote a mixed economy often argue that subsidies are justifiable to
provide the socially optimal level of goods and services, which will lead to economic efficiency.

In contemporary neoclassical economic models, there are circumstances where the actual supply of a good or
service falls below the theoretical equilibrium level—an unwanted shortage, which creates what economists call a
market failure.

One form of correcting this imbalance is to subsidize the good or service being undersupplied. The subsidy lowers
the cost for the producers to bring the good or service to market. If the right level of subsidization is provided, all
other things being equal, then the market failure should be corrected.

In other words, according to general equilibrium theory, subsidies are necessary when a market failure causes too
little production in a specific area. They would theoretically push production back up to optimal levels.

Some theories of development argue that the governments of less-developed countries should subsidize domestic
industries in their infancy to protect them from international competition. This is a popular technique seen in China
and various South American nations at present.

Some say goods or services provide what economists call positive externalities. A positive externality is achieved
whenever an economic activity provides an indirect benefit to a third party.
However, because the third party does not directly enter into the decision, the activity will only occur to the extent
that it directly benefits those directly involved, leaving potential social gains on the table.

Many subsidies are implemented to encourage activities that produce positive externalities that might not
otherwise be provided at the socially optimal threshold. The counterpart of this kind of subsidy is to tax activities
that produce negative externalities.

Disadvantages

Meanwhile, other economists feel free market forces should determine if a business survives or fails. If it fails,
those resources are allocated to more efficient and profitable use. They argue that subsidies to these businesses
simply sustain an inefficient allocation of resources.

Free market economists are wary of subsidies for a variety of reasons. Some argue that subsidies unnecessarily
distort markets, preventing efficient outcomes and diverting resources from more productive uses to less
productive ones.

Similar concerns come from those who suggest that economic calculation is too inexact and that microeconomic
models are too unrealistic to ever correctly calculate the impact of market failure. Others suggest that government
spending on subsidies is never as effective as government projections claim it will be. The costs and unintended
consequences of applying subsidies are rarely worth it, they claim.

Another problem, antagonists point out, is that the act of subsidizing helps corrupt the political process. According
to political theories of regulatory capture and rent seeking, subsidies exist as part of an unholy alliance between big
business and the state. Companies often turn to the government to shield themselves from the competition. In
turn, businesses donate to politicians or promise them benefits after their political careers.

Even if a subsidy is created with good intentions, without any conspiracy or self-seeking, it raises the profits of
those receiving beneficial treatment, thus creating an incentive to lobby for its continuance, even after the need or
its usefulness runs out. This potentially allows political and business interests to create a mutual benefit at the
expense of taxpayers and/or competitive firms or industries.

DONATIONS

A donation is a gift for charity, humanitarian aid, or to benefit a cause. A donation may take various forms,
including money, alms, services, or goods such as clothing, toys, food, or vehicles. A donation may satisfy medical
needs such as blood or organs for transplant.

Voluntary Giving: Donations are given willingly and without any coercion. It's a voluntary act of contributing to a
cause or organization.

Altruism: Donations are typically motivated by a desire to help others, support a cause, or make a positive
difference in the world.

Financial or In-Kind: Donations can be in the form of money, goods, services, or even time. People can contribute in
various ways based on what they have to offer.

Tax Deductibility: In many countries, donations to registered nonprofits or charities can be tax-deductible,
providing an additional incentive for giving.
Impact: Donations are meant to create a positive impact on the recipients—whether it's aiding a community,
funding research, supporting education, or addressing various needs.

Transparency and Accountability: Reputable organizations maintain transparency by sharing information about
how donations are used and ensure accountability by demonstrating the impact of the contributions.

Philanthropy: Donations are often a part of a broader philanthropic approach, involving strategic giving to create
long-term societal improvements.

Fundraising: Many organizations engage in fundraising efforts to encourage donations, using various methods like
campaigns, events, or online platforms to reach a wider audience.

THE ROLE OF SUBSIDIES AND DONORS

The Role of Subsidies

For the accomplishment of microfinance administrations, maintainability is the essential for a microfinance
organization.

The Role of Donors

“The pro-poor growth agenda has important implications for the way donors support partner countries. It is not a
“business as usual” agenda, and “more of the same” will not be sufficient.”

Donors in the pro-poor growth agenda

"Benefactors should concentrate on supporting in-nation forms that are comprehensive of poor people

Upgrading foundation's effect on expert helpless development which is addressing the requirements with suitable
administrations and duty levels and profiting by cooperative energies between various kinds of framework.