Answer to Question #47712 in Macroeconomics for Aditi

Question

a. Describe an export subsidy, and explain the gains and losses that might arise
from such practice.
b. Why are developing countries in Africa especially affected by export subsidies in industrial countries?

Answer 1

a. Export subsidy is a government policy to encourage export of goods and discourage sale of goods on the domestic market through direct payments, low-cost loans, tax relief for exporters, or government-financed international advertising. An export subsidy reduces the price paid by foreign importers, which means domestic consumers pay more than foreign consumers. The WTO prohibits most subsidies directly linked to the volume of exports.
Export subsidies can cause inflation: the government subsidises the industry based on costs, but an increase in the subsidy is directly spent on wage hikes demanded by employees. Now the wages in the subsidised industry are higher than elsewhere, which causes the other employees demand higher wages, which are then reflected in prices, resulting in inflation everywhere in the economy.
b. While advocates of liberalization in the economies of the developing countries have called for reduction in subsidies, the high levels of subsidies in developed countries have increased significantly especially in the OECD countries. While the Uruguay Round advocates the reduction of subsidies in most developing countries, subsidies have been on the increase in OECD countries and the United States.