Knowledge And Decisions

Information about the availability of goods is distorted in the opposite direction when the government subsidizes goods. Some of the people consuming a subsidized good would be unwilling to pay the cost of it if that cost were accurately conveyed to them in the price. Instead, third parties are forced to pay part of the cost in taxes, regardless of their evaluation of the good and even regardless of whether they ever used it.

Sometimes subsidies are more subtly arranged, without explicit taxation. Where there is a government-run monopoly (such as the Post Office) or a government-regulated industry where competition is kept out by force of law (public utilities), then the prices that are set by government cause some users to subsidize other users. Force is applied, not to those users but to potential competitors, who are not allowed to enter the industry and offer lower prices to those consumers who are subsidizing others. Users of first-class mail pay more postage than is necessary to cover the cost of delivering such mail, while senders of “junk mail” pay less than its cost. The economic system in this case conveys distorted information, making junk mail seem cheaper to deliver than it is, and thereby causing more of it to be sent than if its true cost was conveyed to the senders in prices. Resources that would be more valuable to other people in other uses are used to move junk mail, because its bids for those resources include not only the assets voluntarily sacrificed on the basis of the value of that mail to the sender but also assets which nonsenders of junk mail had to surrender as the price of their own first-class mail — thereby becoming involuntary bidders for resources they neither want nor use.

In an ideally functioning political system with zero costs of knowledge, the extra-payers would have as much ability to end this cross-subsidy as the special interests have to create it. In the real world, however, special interests are — almost by definition — groups with lower costs of knowledge. They know individually what it is that they have in common so that they can contact and organize each other as people or organizations similarly affected by government policy. Their greater political weight then enables them to forcibly take economic resources from others.

As in all systems of price discrimination, cross-subsidy works only as long as competitors can be kept out, and usually only the government has sufficient force to do that effectively. Where price discrimination is attempted in a competitive market, those who are paying more than their own costs can be served more cheaply (and profitably) by firms charging each set of customers according to their own respective costs. Price discrimination under these conditions quickly becomes attempted price discrimination, as overcharged customers find other firms to transact with. This has happened, for example, in the railroad industry as it lost its original monopoly with the development of trucking and airlines. Those kinds of freight which had been overcharged to subsidize other kinds of freight simply began being shipped by trucks, planes, or barges.

Given that a monopolistic market is essential for cross-subsidizing (or other forms of price discrimination), it is not surprising that cross-subsidy prices are common in the postal service, public utilities, and other enterprises either run or directly controlled by the government. The cross-subsidization of mail occurs not only as between first-class and junk mail. It also occurs as between users in large cities and those in remote places. The huge volume of mail between New York and Chicago tends to make the cost per letter very low, while the low volume of mail to remote villages makes their cost per letter much higher. In an uncontrolled, competitive market, the respective prices would tend to reflect these large cost differences. In a government market, however, all the costs are lumped together and all the users pay the same postage without regard to how much each contributed to those costs. The knowledge conveyed by the uniform prices is therefore a distortion of the real costs in terms of the resources used up by the economy in directing mail to different places. To the extent that other government controlled prices similarly distort the cost of delivering electricity, water, and other services to rural locations, the whole cost of living in isolated towns or villages is understated to those who are deciding where to locate.