The Government appears to accept that Rio Tinto's announcement that it plans to wind-down and close the Tiwai Point aluminium smelter is final.
On Thursday Rio Tinto said it planned to close the smelter in August 2021. More than 1000 people are directly employed at the smelter with another 1600 jobs indirectly affected, the company claims.
In a statement more than two hours after Rio Tinto made the surprise decision, the Government gave no signal that it is trying to convince the mining giant to change its mind, saying there was "a degree of inevitability" about the move...
Energy Minister Megan Woods said the smelter was receiving large subsidies under the emissions trading scheme while transmission pricing plans released recently would also have lowered the smelter's transmission costs.
"This is a blow for the people of Southland and I feel for them, but we need to look to the future," Robertson said.
Woods said there was "a clear understanding" that direct subsidies were not on the table. The smelter wanted a "prudent discount" on transmission pricing. However a formal application had not been put in.
Regular readers of this blog may recall that the prospect of continuing subsidies for Rio Tinto got me pretty angry last year. My ECONS102 class covered subsidies this week, so it is worthwhile recapping why a subsidy is not good, in terms of economic welfare, and why it is even worse in the case of Rio Tinto.
To keep things simple, let's assume that the government subsidy is a direct subsidy on aluminium production (rather than a subsidy on purchased electricity, or a subsidy in the form of below-cost carbon credits under the Emissions Trading Scheme), and that it is a constant value per unit of production. Let's also assume no international trade (although I'll revisit this later in the post). We'll also assume no negative externalities of this production (which, if we included them, would simply make the subsidy even less defendable in terms of economic welfare).
The market for aluminium is shown in the diagram below. Without the subsidy, the market would operate in equilibrium, where supply meets demand, with an equilibrium price of PA, and an equilibrium quantity of aluminium traded of QA. The subsidy is paid to Rio Tinto (a seller in this market), and that acts sort of like lowering their costs of production (in fact, it is exactly like lowering their costs of production if the subsidy is in the form of lower energy costs). This is demonstrated in the diagram by the new curve S-subsidy. The lower costs mean that the sellers can sell at a lower price to consumers PG, and receive a higher effective price PF, once we factor in the value of the subsidy. The quantity of aluminium produced increases to QS, and so does the quantity of aluminium demanded.
Now let's consider what happens in terms of economic welfare. Consumer surplus is the difference between what consumers are willing to pay for the service (shown by the demand curve) and the price they actually pay. In the diagram above, without the subsidy the consumer surplus is the area FGPA. With the subsidy, the consumer surplus increases to the area FJPG. Aluminium consumers are better off as a result of the subsidy.
Producer surplus is the difference between the price that the producers receive and the producers' costs (shown by the supply curve). In the diagram above, without the subsidy the producer surplus is the area PAGH. With the subsidy, the producer surplus increases to the area PFKH. Aluminium producers (i.e. Rio Tinto) are better off as a result of the subsidy.
All sounds great so far, right? Not so fast. The taxpayer contributes into this market the value of the subsidy, which is the area PFKJPG. That area is negative welfare, because it comes with an opportunity cost - a dollar paid as a subsidy to Rio Tinto cannot be spent on health, education, public transport, or anything else that might increase society's wellbeing.
The overall effect on total welfare is that it decreases. The market operating at equilibrium has total welfare (consumer surplus plus producer surplus) equal to the area FGH, but with the subsidy, total welfare (now consumer surplus plus producer surplus, minus the subsidy) decreases to the area FGH-GKJ. There is a deadweight loss (lost total welfare) equal to the area GKJ. That is the welfare cost of this subsidy.
However, it only gets worse from there. Because the majority of aluminium is exported, the gains in consumer surplus don't actually accrue to New Zealanders. It's not clear whether we should be considering those as gains for New Zealand. Similarly, the gains in producer surplus (essentially profit) go to Rio Tinto, and almost certainly go offshore. So, it wouldn't be outlandish for us to consider the entire subsidy area as lost welfare to New Zealand. [*]
Now, of course removing the subsidy and the resulting closure of the Tiwai Point smelter will lead to some one thousand people losing their jobs. However, surely the government could spend some of the tens of millions of dollars saved from subsidising Rio Tinto on retraining those workers and/or redeploying them in other sectors. Overall, the net effect for New Zealand as a whole would be positive.
*****
[*] In this case, then most of the consumer surplus and producer surplus in this market at equilibrium also accrues to foreigners as well.
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