Why the accommodation supplement does little to help low-income tenants

In an article in The Conversation earlier this year, Edward Yiu and William Cheung (both University of Auckland) discuss New Zealand's accommodation supplement for low-income renters:

New Zealand’s unaffordable housing market has left many low and middle-income families reliant on the accommodation supplement to cover rent and mortgage payments.

But our new research has found the scheme, which costs the government almost NZ$2 billion a year, might not be an effective tool in addressing the country’s housing affordability crisis.

Introduced in 1993, the accommodation supplement is a weekly, means-tested payment designed to subsidise part of a household’s rent or mortgage. The supplement is calculated using the actual rent or mortgage payments a client is paying.

But our study looking at data from Auckland between 2019 and 2023 found accommodation supplement rental subsidies were not delivering meaningful improvements in affordability for renters.

That the accommodation supplement doesn't deliver improvements in affordability for renters is consistent with a simple model of the market for rental housing, as shown in the diagram below. This is the stylised version of this market that I use in my ECONS102 class, and is based on the rental market for land. In this market, the supply curve is very inelastic (very steep), and starts at a positive quantity (meaning that if rent falls to zero, there is still a positive quantity of land that is made available to rent). That's because of two reasons. First, this market includes owner-occupiers. They would rent land to themselves, even if the rent falls to zero (that explains the positive quantity when the rent is zero). Second, the quantity of land supplied doesn't respond very much to the rent - landlords can't suddenly make more land available - as Mark Twain once noted: "The thing about land is, they aren't making it anymore". Twain isn't quite correct, as land can be reclaimed from the ocean. However, landlords are unlikely to be very responsive to changes in rent, making the supply curve very inelastic.

Now, consider this market operating at equilibrium (with no accommodation supplement). The market operates at the point where supply meets demand, at a rent of R0, with Q0 housing (technically, land) rented. The accommodation supplement acts as a subsidy, paid to the tenants. We show this on the diagram with a new curve, D+subsidy, which lies above the demand curve D. It acts like an increase in the demand for rental accommodation. The price that landlords receive for housing increases to RL. That is the rent that tenants pay to the landlords. However, once the accommodation supplement is subtracted, the effective rent paid by the tenants decreases to RT (the difference between RL and RT is the amount of the accommodation supplement).

But notice the difference in the rents with the accommodation supplement to the equilibrium rent. The rent that landlords receive increases by a lot (from R0 to RL). The effective rent paid by tenants is barely affected (decreasing from R0 to RT). Landlords benefit the most from the accommodation supplement, with tenants barely benefiting at all. That is because the side of the market (supply or demand) that is more inelastic will always capture most of the gains from a subsidy. In this case, the supply is very inelastic (and certainly more inelastic than demand), so landlords stand to gain most from the subsidy.

It gets worse though. The increase in rents that landlords receive also affects rents paid by tenants who don't receive the accommodation supplement at all. These higher-income tenants pay higher rents as well, because they have to compete with the subsidised tenants for housing. However, the government doesn't provide them with any subsidy, making them clearly worse off as a result.

So, it should be no surprise that the accommodation supplement does not deliver meaningful improvements in affordability for renters. It barely has any effect on the effective rent paid by tenants who receive the accommodation supplement, and raises the rents paid by tenants who don't receive the accommodation supplement.

Are there better options? Yiu and Cheung suggest that:

...mortgage support seems to level the playing field more effectively than rental assistance.

Possibly. If a mortgage subsidy allows some low-income tenants to become owner-occupiers instead, then they will benefit greatly (from capital gains, as well as many other benefits associated with home ownership). If the mortgage subsidy is given to landlords as well, it might help to lower rents. Overall, it could well be more effective than the current accommodation supplement paid to tenants. It is certainly something worth further exploration.

The welfare consequences of 3c-per-litre petrol in Iran

The price of a litre of petrol in New Zealand is creeping up towards $3 on average (and is already over $3 in some parts of the country). However, as this Financial Times article (paywalled) notes, petrol in Iran is 3 cents (US) per litre, and that is causing problems for the government:

As western governments struggle to keep a lid on fuel prices, the leadership of Iran faces a very different problem: its petrol is just too cheap.

Heavy state subsidies ensure that Iranian prices start at just $0.03 a litre, a fraction of the $1.10 paid at US pumps or the $1.88 that motorists in the UK are charged to fill their cars...

Oil-rich Iran vies with Libya and Venezuela, which has proven oil reserves greater than Saudi Arabia, as the countries with the cheapest petrol in the world.

But now a widening gap between supply — which is limited by domestic refining capacity — and rising demand has forced the Iranian authorities to tap its strategic reserves and import petrol for the first time in a decade...

As the government makes a significant loss by importing fuel at market rates and then selling it to consumers at a much lower price, there is mounting pressure to end the years of ultra-cheap petrol to which Iranians have become accustomed.

Mohammad-Reza Mir-Tajeddini, a member of parliament, told local media this week that fuel subsidies were now three times more than the country’s total development budget, but “nobody dares to speak” about raising the petrol price.

When you have a subsidy in place that keeps a price fixed, and there is increasing demand, the subsidy becomes increasingly burdensome on the government, and society more generally. To see why, let's consider the general case of a subsidy, as shown in the diagram below. The diagram is more complicated than a usual subsidy, as we need to also consider that Iran should be an exporting country (although sanctions largely prevent the exports), and that fuel use is subsidised. As an exporting country (with comparative advantage in producing fuel), the domestic equilibrium price (P0) is below the world price (PW). Without trade, the market would operate at equilibrium, with a price of P0 and Q0 fuel would be traded. The subsidy is shown by the curve S-subsidy (because it is effectively paid to the sellers). The subsidy decreases the price for consumers to PC (3 US cents per litre), and increases the effective price (including the subsidy) for sellers to PW (note that, to make our diagram a bit easier, we'll assume that the subsidy makes Iran exactly self-sufficient in fuel, before the increase in demand). The quantity of fuel traded increases to Q1.

Now consider the impact of the subsidy on economic welfare. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity (and with trade not allowed), consumer surplus is the area AEP0. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, producer surplus is the area P0ECO. Total welfare is the sum of the two areas (consumer surplus and producer surplus), and is equal to the area AECO.

With the subsidy (and still no trade allowed), the consumer surplus is the area ABPC, while the producer surplus is the area PWFCO. The government loses the area of subsidy, which is the rectangle PWFBPC (this rectangle is the per-unit amount of the subsidy, multiplied by the quantity of subsidised fuel). Total welfare is the sum of consumer surplus and producer surplus, minus the subsidy (the subsidy is subtracted because it has an opportunity cost of lower government spending in other areas), and is equal to the area AECO-EFB [*]. In other words, total welfare is lower by EFB as a result of the subsidy. This is the deadweight loss of the subsidy.

Now, consider what happens when demand increases (and the government wants to keep the consumer price at 3 cents per litre). This is shown in the diagram below, where demand increases from D0 to D1. The price for consumers remains PC, and the effective price for producers remains PW. [**] However, to keep the consumer price at PC, the subsidy must increase (shown by the new curve S-subsidy2). The quantity of fuel traded increases to Q2.

Now consider the areas of economic welfare. The consumer surplus is now the area GJPC, but the producer surplus remains the area PWFCO. The area of the subsidy is now PWHJPC. Total welfare is now AECO-EFHJB. [***] In other words, while consumers are better off as a result of the increase in demand (because consumer surplus is larger), all of that extra welfare arises from additional subsidy spending by the government, and the deadweight loss increases substantially.

It's no wonder that the Iranian government is worried. When demand is high, the subsidy becomes increasingly burdensome for government (greater spending on the subsidy) and society more generally (due to the increased deadweight loss). 

.*****

[*] The overlapping areas of consumer surplus, producer surplus, and subsidy make this tricky to see. However, there is a shortcut. The area of total welfare is the area that is in-between marginal social benefit (MSB) and marginal social cost (MSC) out to the quantity that is traded (in this case, Q1). When MSB is greater than MSC, this represents positive welfare (the area AECO). But when MSB is less than MSC, this represents negative welfare (the area EFB).

[**] If demand was the be satisfied only by domestic producers, the effective price for producers would need to increase. However, the government can import fuel from the rest of the world for the price PW, so this limits the effective price for producers to PW.

[***] On the surface, this slightly violates the rule above that the area of total welfare is the area that is in-between MSB and MSC out to the quantity that is traded. However, the cost to society of buying fuel from the world market is equal to PW, and so the MSC (with trade) is increasing only up to PW, and then becomes horizontal.

The deadweight loss of free beer

My excellent (and sports-mad) colleague Shaen Corbet shared with me a story about the Nebraska-Northwestern college football game played in Ireland last year. As reported in the Irish Mirror:

But what couldn't be predicted was the events in the Aviva Stadium on Saturday night as technical glitches saw thousands upon thousands take advantage of free food, drink and alcohol.

There was always going to be a party atmosphere for the first Aer Lingus College Football Classic since 2019, a momentous occasion to remind us just how lucky we are to have these events back.

But the Aviva Stadium was rocking like a Harry Styles gig from just a few weeks prior as queues went a dozen deep as match attendees fleeced the concession stand and bar in a one time only offer of everything being free.

A Twitter (ok, X, but it was Twitter then) user posted this video of the queues for beer, where you can see that the entire foyer area in front of the bar is jam-packed with spectators looking for free beer. Usually, if the price is reduced to zero, we would expect to see a shortage. That's because the sellers would want to sell less (because it is less profitable) at the same time that the buyers are wanting to buy more.

However, in this case, the government chose to subsidise the beer (Shaen tells me it was to reduce the chance of unruly fans getting out of control). We can see the effect of this subsidy, reducing the price to zero, using a supply and demand model as shown below. If the beer market was operating in equilibrium, the price would have been P0, and the quantity of beer traded Q0. Instead, the government paid a subsidy to the beer sellers. We demonstrate this on the diagram with a new curve, S-subsidy, which is below the supply curve S by the amount of the subsidy (which was exactly enough to lower the price from P0 to zero). The effective price for the beer sellers increases to PP, which is the zero price they receive from the spectators, plus the per-unit amount of the subsidy. The quantity of beer demanded increases to Q1, and so does the quantity of beer supplied. There is no shortage of beer.

It is worth considering the impacts on economic welfare of this subsidy though. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity, consumer surplus is the triangle AEP0. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, producer surplus is the triangle P0EB. Total welfare is the sum of the two areas (consumer surplus and producer surplus), and is equal to the triangle AEB.

Once the subsidy is introduced, the consumer surplus increases to AQ1O, while the producer surplus increases to the area BCQ1O. The government loses the area of subsidy, which is the rectangle PPCQ1O (this rectangle is the per-unit amount of the subsidy, multiplied by the quantity of subsidised beer). Total welfare is the sum of consumer surplus and producer surplus, minus the subsidy (the subsidy is subtracted because it has an opportunity cost of lower government spending in other areas), and is equal to the area AEB-ECQ1 [*]. In other words, total welfare is lower by ECQ1 as a result of the subsidy. This is the deadweight loss of the subsidy.

To add insult to injury, even though the price of beer may have been zero, the cost of beer was not free. That's because you have to factor in the cost of the time spent waiting to be served (which will be much higher when the queues are longer), as well as the loss of enjoyment of missing part of the game while waiting for beer. Plus, there are external costs of over-drinking imposed on other fans. Shaen, who was at the game, tells me that there were spectators who vomited all over other spectators after over-indulging in 'free' beer. So, free beer wasn't necessarily a good deal for everyone, least of all for Irish taxpayers and for those who needed a dry-cleaner (and possibly a counselling session) after the game.

[HT: Shaen Corbet]

*****

[*] The overlapping areas of consumer surplus, producer surplus, and subsidy make this tricky to see. However, there is a shortcut. The area of total welfare is the area that is in-between marginal social benefit (MSB) and marginal social cost (MSC) out to the quantity that is traded (in this case, Q1). When MSB is greater than MSC, this represents positive welfare (the area AEB). But when MSB is less than MSC, this represents negative welfare (the area BCQ1).

Network externalities and electric vehicle subsidies

The government's Clean Car Discount scheme has been in the news this week. As Stuff reported:

The Government is changing the Clean Car programme to increase fees slapped on higher emitting vehicles, changing the rebates for zero emissions imports and lowering the threshold for eligible vehicles.

The changes come as the scheme was “successfully exceeding industry and government projections”, Transport Minister Michael Wood said, after it was reviewed a year into its full implementation.

It is timely to remind ourselves of the positive and negative aspects of a subsidy. A subsidy leads to a deadweight loss (as I outlined in the footnotes to this post from 2021 when the electric vehicle (EV) subsidy scheme was introduced). That is, there is a loss of economic welfare associated with a subsidy. However, as I noted in that same footnote:

...this assumes that there are no positive externalities associated with electric vehicles, which there probably are - a person buying an EV is a person not buying a carbon-powered vehicle, and so each EV sold reduces carbon emissions (and reducing a negative externality is the equivalent of a positive externality).

It is possible that a subsidy on a good that has a positive externality (or that reduces a negative externality) could increase total welfare. However, that is not the only reason that we might favour a subsidy for EVs.

Think for a moment about the infrastructure that exists to support petrol vehicles. In most towns and cities, there are many petrol stations where cars can refuel. It is very easy and inexpensive for a petrol vehicle owner to find somewhere to refuel. Now think about the corresponding situation for electric vehicle owners. Although there are electric vehicle charging stations around (in mall carparks, for example), the infrastructure is nowhere near as available as it is for petrol vehicles. An EV owner faces a more difficult and costly (in time and effort) exercise to charge their vehicle away from home.

Clearly, the fact that there are few places to charge EVs means that there is not as much incentive for firms to provide EV charging as there is to provide petrol refueling. Most of the reason for a lack of EV charging infrastructure is simply a lack of demand. However, there is a bit of a chicken-and-egg problem here. If there are few places to charge EVs, then few consumers will buy EVs. And if few consumers buy EVs, then there is little incentive [*] for firms to provide EV charging stations. In other words, there are positive network externalities across these two goods (EVs, and EV charging stations). The more EVs there are, the more profitable it is for a firm to provide EV charging stations. The more EV charging stations there are, the more value there is for each EV driver, since they can more easily find somewhere to charge their vehicle.

Subsidising electric vehicles may help us to get out of this chicken-and-egg situation. Having more EV owners (because EVs are less expensive as a result of the subsidy) creates incentives for firms to build out the charging infrastructure necessary to support EVs. The subsidy acts as a kickstart for the process of building more EV charging stations, which then makes it easier to own an EV, which incentivises more charging stations, and so on. The process snowballs. So, quite aside from any argument associated with environmental externalities, there is an argument to be made for a subsidy.

However, what is not at all clear is whether this is the right subsidy to achieve the goal of kickstarting an EV-charging snowball. The same outcome could be achieved by subsidising the EV charging stations, rather than the EVs. Subsidising EV charging stations might even be less costly for the government, as it would mean dealing with fewer subsidy recipients (reducing the transaction costs of the subsidy). That is the approach adopted in the US, where Tesla is making its charging network available to owners of EVs from other manufacturers, in order to receive a subsidy from the US government.

The key difference between the two subsidy options is political. Subsidising consumers to buy EVs provides a handout to voters (or at least, to voters who buy EVs). Subsidising firms to build EV charging stations provides a handout to firms. Handouts to voters play out much differently in the media than handouts to firms. It should be little surprise then, that a government might prefer to subsidise EVs rather than EV charging stations, even if subsidising the charging stations would be less costly for the same outcome.

*****

[*] Note that there isn't no incentive for firms to provide EV charging stations. Firms with environmental goals, or firms that want to look like they are supporting green causes, may provide EV charging stations even if there is little demand for them.

Read more:

• Who will really gain from the electric vehicle subsidy?

The Madagascan vanilla crisis

Le Monde reported last month:

Nothing has gone as planned: The scheme devised by Madagascar to guard against a sudden collapse of the vanilla market by imposing a minimum price of $250 per kilogram (€228) for the past three years has resulted in gridlock. While hundreds of tonnes of unsold pods are piling up in growers' fields and exporters' warehouses in Sava, in the north-east of the island, Andry Rajoelina admitted his failure, on Thursday, April 13, by opening the way to a "liberalization" of exports. Stakeholders called for the decision, which is supposed to calm the furor that has been rising in the region for several months...

The equation Rajoelina has to solve today is not entirely a surprise. Doubts were expressed by buyers as well as some exporters back in 2020 when the new regulations were announced. They entailed a minimum export price; the obligatory repatriation of all foreign currency earnings; and the creation of a national vanilla council, whose prerogatives included granting export approvals.

For buyers, the price tag is "not in line with market realities."

Price controls are almost always a bad idea. Let's put aside the export controls for now (I may come back to these in a future post - see here), and focus on the domestic market for vanilla as if there was no exporting. This is shown in the diagram below. Without the minimum price, the market was operating at equilibrium, with a price of P0, and Q0 vanilla was traded. To complete our analysis, let's also consider the areas of economic welfare. The consumer surplus (the difference between the consumers' willingness to pay and the price, or the consumer's economic rent) is the area AEP0. The producer surplus (the difference between the price and firms' marginal costs, or firms' profits or economic rent) is the area P0ED. Total welfare (the sum of consumer surplus and producer surplus) is the area AED.

Now, consider the situation where there is a binding minimum price of vanilla, PMIN, which is set above the equilibrium price. The quantity of vanilla demanded decreases to Qd, while the quantity of vanilla supplied increases to Qs. There is a surplus of vanilla equal to the difference between Qs and Qd. Only Qd vanilla is traded in the market. The consumer surplus decreases to the area ABPMIN, while the producer surplus increases to the area PMINBCD. Total welfare decreases to the area ABCD, and the lost welfare (the deadweight loss) is equal to the area BEC.

So, the minimum price of vanilla leads to a large surplus of vanilla. Not all the vanilla that is produced is able to be sold. Vanilla consumers are made worse off, and Madagascan society overall is worse off (because total welfare is lower). On the positive side, the higher price might make vanilla producers better off (as per the diagram above), but it could actually make the producers worse off if the minimum price is set too high. As the article notes:

"This year, we have sold almost nothing. Families are hungry. Some have been forced to sell their houses or fields to pay off their debts to the banks," said Mounirah Philibert, president of the Vohémar organic growers organization.

The surplus vanilla essentially just sits around unsold. The vanilla producers have to store the surplus vanilla, or waste it. The Madagascan government didn't necessarily have to set up their price control in that way. They could have followed a similar path to many Western countries did when they had agricultural price supports (or still do, in some cases). When New Zealand had agricultural price supports, the government essentially guaranteed the price by agreeing to buy any surplus that farmers produced at the regulated price. There was still a surplus, but it was held by the government (which then had to store it, leading to the famous butter mountain in Europe, or waste it). Agricultural price supports implemented in this way are essentially a form of subsidy.

That situation is shown in the diagram below. The producers produce Qs vanilla at the regulated price of PMIN, and the domestic consumers buy Qd vanilla, and the government buys the excess supply (the difference between Qs and Qd). The consumer surplus remains the area ABPMIN, but the producer surplus increases to the area PMINFD (because the producers can now sell all of the vanilla that they produce). The government buys the vanilla at the regulated price of PMIN, and eventually they have to sell that vanilla, but in order to sell it all they have to accept the low price of P1 (at this price, the quantity of vanilla demanded is equal to the quantity of vanilla the producers supplied at the regulated price of PMIN). In other words, the government makes a loss on its sales of vanilla. The area of government loss is equal to the area PMINFGP1 (which is the difference in price, PMIN-P1, multiplied the by quantity of vanilla the government sells, Qs). Total welfare is now the area of consumer surplus and producer surplus combined, minus the area of government loss. It takes a bit of thinking through, because of the overlapping areas, but the area of total welfare is now AED-EFG. Total welfare is smaller than without the price support and government purchases, by the area EFG. That is the deadweight loss of this government intervention.

Price controls are almost always a bad idea. They distort markets, and there are often simpler ways that governments can redistribute welfare than using price controls. As the Le Monde article notes, it seems the consumers, producers, and Madagascan society overall are all being made worse off by the price control policy. When that happens, it is clearly time to re-think the policy.

[HT: Marginal Revolution]

[Update: See the follow-up post here]

Peanuts no long cost peanuts after China subsidises soybean production

The Financial Times reported earlier this week (paywalled):

Peanuts have become China best-performing agricultural commodity as dry weather and Beijing’s policies have eaten into supplies, raising traders’ fears that demand from the world’s largest importer of the legume will push up international prices.

China suffered a severe drought in key growing areas last year, while the government’s agricultural subsidy programme, which favours soyabeans, has led to a sharp drop in the country’s peanut acreage...

Beijing has yet to announce official production figures for 2022, but Chinese media have begun sounding the alarm in recent months, warning that government subsidies encouraging farmers to raise corn and soyabeans, a rival oilseed, had pushed farmers to abandon peanut planting in pursuit of greater returns from other crops.

Consider the market for soybeans, shown in the diagram below. Without the subsidy, the market is in equilibrium, with a price of PA, and QA tonnes of soybeans are traded. The subsidy, paid to the farmers (the sellers in this market), is represented by a new curve S-subsidy, which sits below the supply curve. It acts like an increase in supply, and as a result the price that soybean buyers pay for soybeans falls to PC. The farmers receive that price, and then also receive the subsidy from the government, so in effect they receive the higher effective price PP. The difference in price between PP and PC is the amount of the subsidy. The lower price for consumers, and the higher effective price for farmers, leads the quantity of soybeans grown and traded to increase from QA to QB. As noted in the article, farmers grow more soybeans.

Now consider what happens in the market for peanuts, as shown in the diagram below. Farmers have shifted agricultural production to soybeans, because of the subsidies (as shown above). This, along with the dry weather, reduces the supply of peanuts from S0 to S1. This increases the equilibrium price of peanuts from P0 to P1, and decreases the quantity of peanuts traded from Q0 to Q1.

So, you can see that Beijing's agricultural subsidies flow through to the prices on non-subsidised products as well. Both soybeans and peanuts (as well as products derived from soybeans and peanuts) are going to cost more as a result.

Increased childcare subsidies will almost certainly raise the price of childcare

The National Party has announced a new childcare policy, called Family Boost, which would be implemented if they are elected later this year. As Stuff reported earlier this week:

If the public service stops hiring so many consultants, National Party leader Christopher Luxon says it could afford greater childcare subsidies.

During his State of the Nation speech on Sunday, Luxon promised he would order the public service to cut $400 million from its consultancy bill. That money, he said, would fund a new childcare policy, giving a 25% rebate to most families’ childcare bills.

The childcare rebates were expected to cost about $250m per year and would be available per household – not per child...

National’s new childcare policy, which it calls Family Boost, would give a rebate of 25% on childcare costs up to an annual limit of $3900 for families earning under $140,000. This would mean up to $75 per week to offset childcare costs.

So far, so good. But then:

 Luxon dismissed concern that giving tax rebates for early childhood fees would lead to an increase in prices, given the majority of children attend for-profit childcare centres. He said the “really competitive” ECE market would mean prices wouldn’t go up.

”I think early childhood education providers will know that they try and pump up fees, they will lose families,” deputy leader Nicola Willis said.

Both Luxon's statement that a competitive market won't raise prices, and Willis' statement that increasing childcare fees following the subsidy will lead childcare centres to lose families, are very likely wrong. To see why, let's consider a model of the market for childcare services, as shown in the diagram below. For simplicity, let's start with no subsidy in the market. [*] Without a subsidy, the market is in equilibrium, with a price of P0, and Q0 hours of childcare are provided. The subsidy, paid to the families (the buyers in this market), is represented by a new curve D+subsidy, which sits above the demand curve. It acts like an increase in demand, and as a result the price that childcare providers receive for childcare services increases to PP. The families pay that price, then receive the rebate back from the government, so in effect they pay the lower price PC. The difference in price between PP and PC is the per-hour amount of the subsidy. [**] So, our model immediately suggests that Luxon's comment about the competitive market not raising prices is incorrect. It is true that the price doesn't go up by the whole amount of the subsidy - the difference between the original price P0 and the new higher price PP is less than the per-hour subsidy (PP - PC).

Next, the number of hours of childcare services provided increases from Q0 to Q1 (because families want to have children in childcare for more hours because of the lower effective price they have to pay, and childcare providers want to provide more hours of childcare because of the higher price they receive). So, even though childcare services have increased in price, the quantity of childcare services demand has increased. So, our model also suggests that Willis' comment about childcare services losing families is also incorrect.

Of course, the model is not the real world. However, what would it take for a subsidy not to increase prices? If the supply curve was horizontal (meaning that supply is perfectly elastic), then prices would not increase. Perfectly elastic supply suggests that there is a large reserve army of childcare providers at the current market price, just waiting for families to call them for childcare services (in fact, it means that there is unlimited supply available at the market price). Any parent who has tried to find a childcare centre for their child at short notice will know that is not the case (see here, for example). And that is just the tip of the iceberg for problems in this sector, as this Stuff article by Michelle Duff documents.

Subsidies increase prices. That happens when the market is competitive, and when the market is not competitive. I'm sorry Mr Luxon - you can't appeal to the competitiveness of a market to argue that subsidies won't increase prices.

*****

[*] This assumption essentially doesn't change any of the main conclusions. It just makes the market a bit easier to draw.

[**] The actual amount of the subsidy varies between families, but again that doesn't change any of the main conclusions.

Confused (or cynical) policy on fuel taxes and public transport prices

I've been meaning to write about the government's announcement last week of changes in petrol excise tax and public transport fees. From the government's press release:

The Government will cut 25 cents a litre off fuel for three months as part of a cost of living package aimed at giving Kiwi families immediate relief through the current global energy crisis triggered by the war in Ukraine, Prime Minister Jacinda Ardern announced today. 

Fuel excise duties and road user chargers will be reduced by 25 cents each and the price of public transport will be halved as part of a package of measures to reduce transport cost pressures on middle and low income households.

“We cannot control the war in Ukraine nor the continued volatility of fuel prices but we can take steps to reduce the impact on New Zealand families,” Jacinda Ardern said.

That's fair enough. Around the same time as this announcement, the Prime Minister finally acknowledged that New Zealand is facing a cost of living crisis (which in itself is unnecessary hyperbole, since literally everything seems to be a crisis these days - the word crisis is starting to lose all meaning). Inflation is at the highest level in a generation. Pay rises are not keeping up, meaning that real wages are falling. But all of that was the case before Russia invaded Ukraine. And fuel prices are only part of the cost of living story. So why wait until now to address cost of living? Despite the war, cost of living didn't suddenly become an issue last week. Or did it? The cynical view, expressed for example by Jack Tame, is that:

...petrol taxes would never have been cut if Labour had been well ahead in last week's poll. They saw the poll numbers. They freaked out. They dropped almost $400m to try and win back some popularity.

A slightly less cynical take is that, for the reduction in public transport fees at least, the government may have planned to include the change in the Budget (to be announced in May), but felt the need to bring them forward (although, the reason why they would announce it early so gets us back to the recent negative political polls).

Anyway, there are two serious problems with this policy package of reducing excise taxes on fuel, and increasing public transport subsidies. First, it isn't well targeted. My wife and I really appreciated being able to fill our car with petrol for $30 less on our way back from Whanganui last week. But surely the purpose of the petrol excise reduction was not to assist in defraying the cost of inter-city travel for families in the top quintile of earnings? If the government really wants to help low-income families dealing with a higher cost of living, they should increase Working for Families, increase benefit rates, or pay a one-off payment through the benefit or tax system. Then the money goes to those who really need it. And if they don't need it for fuel, they can use it for something else. To be fair, the Prime Minister reminded us that they are doing some of that as well:

“In addition on April 1 a suite of permanent increases to household incomes will see 60 percent of families earning more from Working for Families, as well as increases to superannuation and benefits. On May 1, one million New Zealanders will also start receiving the Winter Energy Payment which will provide $30 a week extra to many.”

However, those are not new changes, having been announced much earlier (see here and here). The government could have made the benefit and WFF increases even larger if they wanted to mitigate further increases in the cost of living. Alternatively, given that the excise tax reduction is temporary, perhaps the government could have given a temporary increase in benefits and WFF (although, it would be much more difficult for those changes to be undone later, with potentially negative political consequences).

The second problem has been well laid out elsewhere (see these posts by Eric Crampton or Matt Nolan). If climate change really is this generation's nuclear-free moment, why on earth would the government undo some of the good work that the Emissions Trading Scheme is doing, by making carbon-emitting vehicles cheaper to run? Yes, the lower public transport fees may induce some commuters to switch to public transport, but lower fuel prices totally work counter to that, decreasing the incentives for commuters to switch to public transport.

All up, it's hard to see those policy changes as anything but a cynical vote grab. They aren't targeted at reducing costs or increasing incomes for those who truly need it. They're undoing an otherwise positive effect of high fuel prices on carbon emissions. And they're unlikely to have a positive effect (and may even be counter-productive) in terms of public transport patronage. Possibly, the government is hoping that the voting public has the same low level of economic literacy that they do. Things may not be that bad, yet. On the plus side, the government now seems to recognise that an excise is a tax.

Who will really gain from the electric vehicle subsidy?

The government is pressing ahead with introducing subsidies on electric vehicles. However, that comes with unintended consequences, as Newsroom reported last month:

The prices of used electric vehicles have leapt in response to the Government announcing its subsidy of up to $3,450 a car, the country's biggest secondhand car importers say.

Japan-based vehicle buyer Marcus Jones has emailed car importers with a somewhat sardonic update on pricing.

"I thought perhaps you could pass on thanks from the wives and orphans of Japanese EV and Phev owners," he wrote, "who have seen the auction values of their cars rise in the past few days by more or less the precise amount that the New Zealand taxpayer has generously agreed to contribute."

That a subsidy causes prices to rise should come as no surprise to anyone with a good understanding of basic economics. This point is illustrated in the diagram below, which assumes that the subsidy is paid to the buyers of EVs. [*] Without the subsidy, the market is in equilibrium, with a price of P0, and Q0 electric vehicles are traded. Introducing the subsidy, paid to the buyer, is represented by a new curve D+subsidy, which sits above the demand curve. It acts like an increase in demand, and as a result the price that producers receive for an electric vehicle increases to PP. The buyers pay that price, then receive the subsidy back from the government, so in effect they pay the lower price PC. The difference in price between PP and PC is the per-vehicle amount of the subsidy (which is up to $3450 per car, as announced by the government). The number of electric vehicles traded increases to Q1 (because buyers want to buy more electric vehicles because of the lower effective price they have to pay, and sellers want to sell more electric vehicles because of the higher price they receive). One thing to notice is that the price doesn't go up by the whole amount of the subsidy - the difference between the original price P0 and the new higher price PP is less than the per-vehicle subsidy (PP - PC).

Who gains from the subsidy? It turns out that both buyers and sellers do. Without the subsidy, the consumer surplus (the difference between the amount that buyers are willing to pay, and what they actually pay) is the area FBP0. With the subsidy, the consumer surplus increases to the area FEPC. Consumers are better off with the subsidy. Without the subsidy, the producer surplus (the difference between the price that sellers receive, and their costs) is the area P0BH. With the subsidy, the producer surplus increases to the area PPGH. Sellers are better off with the subsidy.

However, not all groups gain from the subsidy. The government has to pay it, and that comes with an opportunity cost. Perhaps the government has less money to spend on schools, or roads, or raising the pay of striking nurses. Or perhaps they borrow, in which case future generations have to pay it back through higher taxes or decreased services. The area that represents the amount of subsidy paid by the government is PPGEPC (it is the rectangle that is the per-vehicle amount of the subsidy (PP - PC) multiplied by the number of subsidised vehicles Q1). [**]

Now, we can consider who gets the most benefit of the subsidy. In simple terms, on the diagram you can see that the price rise for sellers (from P0 to PP) is greater than the price fall for buyers (from P0 to PC). Sellers benefit more from the subsidy. In fact, the sellers' share of the subsidy is the area of the subsidy above the original price - the area PPGFP0. The buyers' share of the subsidy is the area of the subsidy below the original price - the area P0FEPC. The sellers' share is much larger than the buyers' share.

That need not necessarily be the case. Notice that the supply curve is quite steep, much steeper than the demand curve. The supply curve is relatively more inelastic than the demand curve. That means that sellers are less responsive to a change in price than buyers are. It turns out that whichever side of the market is more inelastic gets the larger share of welfare gains (or losses) when there are changes in market conditions. In the diagram above, the sellers are more price inelastic, and so they receive the greater share of the benefits of the subsidy. The reverse could be true. If buyers were more price inelastic, they would receive the greater share of the benefits of the subsidy. This is shown in the diagram below (which retains all of the same labels as the previous diagram, but shows the case where supply is more elastic than demand).

Coming back to the Newsroom article, if the price of electric vehicles is going up a lot, then that suggests that the supply is more inelastic than the demand. In fact, if the price actually went up by the entire amount of the subsidy, that would suggest that supply is perfectly inelastic, that is, completely unresponsive to price changes. Not everyone is suggesting that the price is going up by the full amount of the subsidy (from the same Newsroom article):

[Robert Young, director of New Zealand's biggest used car importer Nichibo Japan] estimated about half the $3450 subsidy would end up off-shore, benefiting the auction vendors in Japan and the UK as well as new car manufacturers. More would go to GST – meaning Kiwi EV buyers would pocket only about one-third of the subsidy.

It's hard to see what supply of electric vehicles to New Zealand would be very inelastic compared with demand. There are other markets that Japanese second-hand car sellers could be selling to, including Australia, Thailand, Malaysia, the Indian subcontinent, and southern Africa (all areas that drive on the left). Receiving a higher price for selling into the New Zealand market should induce Japanese sellers to shift to selling their EVs to New Zealand instead of into those other markets. It is also hard to see why demand for EVs in New Zealand would be very elastic compared with supply, but many substitutes (including petrol- or diesel-powered vehicles, which are due to be taxed and become more expensive concurrently with the introduction of the EV subsidy) and the high cost of EVs would play a part. It wouldn't surprise me to learn that the subsidy is roughly evenly shared between buyers and sellers.

Anyway, the key point of this post is that this is somewhat futile (again from the same Newsroom article):

But Transport Minister Michael Wood said the Government was keeping a close eye out for any attempts to take advantage of the subsidy.

“The new and imported used vehicle market is very competitive and I’m sure anyone attempting to distort market pricing will be called out," he said.

It's not the sellers that are distorting the market pricing, it's the subsidy.

[HT: Eric Crampton at Offsetting Behaviour]

*****

[*]  The subsidy could be paid to the sellers instead of the buyers. However, it turns out that the price and welfare effects would be exactly the same, regardless of who it is paid to. The only difference would be in terms of the transaction costs (the costs of administration of the subsidy). There is an argument that it would cost less to pay the subsidy to EV sellers, because there are fewer of them, and so fewer payments would need to be made. However, a canny government would realise that not every buyer would claim back the EV rebate, and so paying the subsidy to buyers in the form of a rebate may turn out to be cheaper overall. And even if it doesn't, it looks better politically for the government to pay the subsidy to 'ordinary car buyers' than to 'millionaire car salespeople'.

[**] For completeness, adding the consumer surplus and producer surplus together, and subtracting the subsidy, gives us a measure of total welfare (or total surplus). Without the subsidy, total welfare is the area FBH. With the subsidy, total welfare decreases to the area (FBH - BGE). The area BGE is the deadweight loss of the subsidy. However, this assumes that there are no positive externalities associated with electric vehicles, which there probably are - a person buying an EV is a person not buying a carbon-powered vehicle, and so each EV sold reduces carbon emissions (and reducing a negative externality is the equivalent of a positive externality).

When does a hobby farmer become a used car importer? Hopefully never...

Earlier this week, the government announced final details of its proposed 'feebate' scheme to incentivise a shift to electric vehicles. As the New Zealand Herald reported earlier this week:

Drivers who buy new cars from July 1 will be able to get taxpayer-funded rebates of almost $8700 for a new electric or plug-in hybrid car, and about $3,500 for used cars.

But those who buy petrol vehicles will cop the cost under the Government's plan announced today – from January 2022, buyers of new petrol cars will have to pay a fee of up to $5875 while those buying newly imported used cars face fees of up to $2875.

That fee would be based on emissions – for example, it would add $2,900 to the cost of a new Toyota Hilux, $1230 to a Kia Sportage, and $830 for a Nissan Navara.

Incentivising a shift to electric vehicles in this way makes little sense in the presence of a binding emissions trading scheme cap. Those issues have been well explained elsewhere (see Thomas Lumley's post at StatsChat, or Eric Crampton's post at Offsetting Behaviour, for example). Instead, let's consider a potential problem that the government has so far thankfully avoided.

Farmers and contractors are up in arms about the feebate scheme, because their work vehicles will suddenly be much more expensive. As RNZ reported yesterday:

Farmers and tradies say the government's clean car package is an unfair tax on them as no alternatives are available for their work vehicles...

Federated Farmers president Andrew Hoggard suggested allowing an exemption for selected sectors - such as farming and construction - until meaningful alternatives were available in New Zealand.

[Canterbury high country farmer Simon Guild] said that was a system the rural sector could get behind.

"That makes total sense while there is no alternative, and I challenge anyone who thinks that there are alternative vehicles we can use to come to our place and I'll take them around in a high-emitting Hilux or whatever vehicle we have available and then they can tell me if that job can be undertaken by one of the current alternatives on the market."

Dunedin builder Sacha Gray said electric vehicles were similarly not up to scratch at the moment for tradies...

Gray also supported Hoggard's proposal.

I can immediately see two problems with a system that would exempt 'work vehicles' for farmers and tradespeople from the tax on imported petrol and diesel vehicles. The first is a variation on the great Jaffa Cake controversy in the UK (see also my post on a similar topic here). Who counts as a farmer or tradesperson, able to buy an imported petrol or diesel vehicle without paying the import tax? Farmers and tradespeople, you may say. Of course, but where do you draw the line? Do people with lifestyle blocks that are large enough to count as businesses for tax purposes farmers for the purpose of avoiding this tax? How big a block of land would you need to own? Do sharemilkers count? They don't own land. What about farmhands? Then that raises similar questions about tradespeople. Do handymen count? What about landlords who repair their own properties? The feebate scheme may be stupid or unnecessary for ETS-related reasons, but at least it is sensible in avoiding the necessity for a bunch of additional regulations about who is exempt.

The second issue is, once some defined group is exempted from the import tax, what stops them from buying an imported petrol or diesel vehicle, then selling it on the local second-hand market? There's no proposal to tax petrol or diesel vehicles, other than those that are newly imported. So, second-hand cars sold locally do not attract the tax. You would need another set of rules to govern how long a tax-exempt purchaser would have to hold onto their vehicle before reselling it. But it gets worse. What would then stop a farmer (or hobby farmer with a lifestyle block) from buying a bunch of Hiluxes, parking them up in a paddock, waiting out the no-resale period, then selling them, avoiding the tax, and pocketing a nice profit? Again, the feebate scheme may be stupid or unnecessary for ETS-related reasons, but at least it doesn't need to have a bunch of secondary rules to deal with people profiting from their exemptions.

The feebate scheme may be stupid or unnecessary, but at least it is not as stupid as it could get. The last thing we need is a feebate scheme that you could drive an SUV through. Literally.

Incentivising coronavirus vaccination

A couple of weeks ago, my ECONS102 class covered externalities. An externality is the uncompensated impact of the actions of one person on a bystander. Externalities can be negative (and make the bystander worse off), or positive (and make the bystander better off). One of the examples I use for a positive externality is vaccines. A person who gets vaccinated makes themselves better off (by reducing their chance of getting sick), but also makes others better off (because there is at least one fewer person who they can get sick from) - that's a positive externality.

The problem with positive externalities is that the market, left on its own, will not ensure that enough is produced or consumed. That's because the market participants don't have an incentive to take into account the benefits that their actions confer on others. That market will produce too little, compared to the quantity that maximises societal welfare. In the case of vaccines, too few people would get vaccinated.

There needs to be some mechanism to encourage more people to purchase goods with positive externalities. One way is to subsidise them (for example, see this post about subsidising education). The subsidy effectively increases the benefits of selling the good or service (if it is paid to the sellers), or reduces the cost of the good or service (if it is paid to the buyers). Either way, it increases the amount that is produced and consumed, and can ensure the quantity is increased to the socially optimal quantity.

Alternatively, the government could find some other way to incentivise more production and consumption. Right now, we're in a situation where governments want to roll out coronavirus vaccines in the face of a substantial amount of vaccine hesitancy. Some governments have started to incentivise vaccines through more than just subsidising them and making them available for free. For example, the New York Times reported last month that:

West Virginia will give $100 savings bonds to 16- to 35-year-olds who get a Covid-19 vaccine, Gov. Jim Justice said on Monday.

There are roughly 380,000 West Virginians in that age group, many of whom have already gotten at least one shot, but Mr. Justice said he hoped the money would motivate the rest to get inoculated, as “they’re not taking the vaccines as fast as we’d like them to take them.”

Some people worry that giving monetary incentives reduces intrinsic motivation. Indeed, this famous research by Uri Gneezy and Aldo Rustichini (ungated version here) showed that fining parents for picking up their children late from a childcare centre encouraged more late pickups. When the moral incentive to pick up on time is replaced by a financial incentive, it turned out to be less effective. The corollary for vaccines is that paying people to get vaccinated could encourage fewer of them to do so.

However, to counter that argument UCLA has run some experiments showing that monetary incentives are effective, as reported by the New York Times a couple of weeks ago:

In recent randomized survey experiments by the U.C.L.A. Covid-19 Health and Politics Project, two seemingly strong incentives have emerged.

Roughly a third of the unvaccinated population said a cash payment would make them more likely to get a shot...

Similarly large increases in willingness to take vaccines emerged for those who were asked about getting a vaccine if doing so meant they wouldn’t need to wear a mask or social-distance in public, compared with a group that was told it would still have to do those things.

So, perhaps we don't need to worry so much about whether the monetary incentive would be effective. And, perhaps we wouldn't have to pay it to everyone. CBS News reported yesterday:

Health officials in Ohio have reported a surge in the amount of people getting their first COVID-19 vaccination shots, a week after Ohio Governor Mike DeWine announced the $5 million "Vax-a-Million" lottery.

Just days after DeWine said the state would award five vaccinated residents $1 million each in order to raise vaccination percentages, the Ohio Department of Health reported more than 113,000 people received their first dose of the vaccine.

Based on preliminary data, the department said the recent period showed a 53% week-to-week increase (May 13 to 18) compared to the time period before the announcement, where 74,000 people received their first dose (May 6 to 11). 

"We are seeing increasing numbers in all age groups, except those 80 and older, who are highly vaccinated already," said Ohio Dept. of Health director Stephanie McCloud. "Although the rate among that group is decreasing, it is doing so at a less rapid pace, demonstrating some positive impact even in that group."

Ohio residents 18 and older who have received at least one dose of the vaccine can enter to win one of the five $1 million prizes. Ohioans between the age of 12 and 17 who have received at least one dose of the COVID-19 vaccine can enter to win one of five four-year, full-ride scholarships to any state college or university in the state. So far, approximately one million entries have been collected, according to Ohio Lottery and Ohio Department of Health.

Gamifying vaccination by attaching it to a lottery is kind of inspired. If people who are the least risk averse are those who are least likely to get vaccinated, and also those who are most likely to play the lottery, then this could be incredibly effective in increasing vaccination rates. People constantly overestimate the chance of events happening that have small probabilities (this is one of the key features of what is called prospect theory), like winning the lottery. So, government wouldn't necessarily have to ensure that the lottery amount was high enough to ensure that it captures all of the social benefits of vaccination, making this solution more cost effective than paying everyone who got vaccinated. For example, paying 100,000 people $100 each to get vaccinated costs $10 million. But, government could possibly offer five prizes of $1 million each and get the same outcome of 100,000 people getting vaccinated for half the total cost.

Overall, New Zealand's approach to vaccination is slow and steady. We're ahead of target (see the New Zealand Herald's Vaccine Tracker), but there is a fair amount of concern about whether we will achieve the overall target (e.g. see comments here or here). There seems to be plenty of demand for vaccines right now, but if things start to slow up later, perhaps we need our own vaccine lottery?

[HT: Marginal Revolution for the NY Times article on incentives; The Dangerous Economist for the article on Ohio's lottery]

Bye-bye Rio Tinto, don't let the door hit you on the way out

Finally New Zealand appears to be about to discard the parasitic Rio Tinto from our shores, as the New Zealand Herald reported last month:

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.

 

Read more:

• This isn't what the 'year of delivery' was supposed to be delivering

The effect of cutting subsidies for after-hours doctors

The New Zealand Herald reported last week:

Parents who received free after-hours medical care for their children are now having to pay up to $61 at two Auckland clinics following funding cuts from district health boards...

The changes meant White Cross Glenfield's casual fee for under 13s after hours skyrocketed from free to $61.

At Three Kings Medical Centre, prices for care after 5pm had gone up to $50 for children aged between 6 to 12 - and $35 for under-6-year-olds.

This is what happens when you remove a subsidy - the price that consumers pay goes up. To see why, consider the market in the diagram below. The subsidy is paid to the supplier (the after-hours medical clinic), so we show it using the S-subsidy curve. The consumers (patients) pay the price where that curve meets the demand curve (PC), which from the article above could be as low as zero. The clinic receives that price (PC) from the patient, but then is topped up by the government subsidy, and receives an effective price of PP. The number of patients going to the clinic is Q1. If the subsidy is removed, the market shifts to equilibrium, where demand meets supply. The price for patients increases to P0, and the price received by clinics decreases to P0. The number of patients going to the clinic decreases to Q0.

The article notes that the subsidy hasn't been removed from all clinics. So, patients may simply go to some other clinic instead of the nearest one, if the nearest one is no longer subsidised. This was effectively what the DHB was trying to achieve:

Waitemata and Auckland City DHB announced a rejig to after-hours clinic funding in July in a bid to "reduce inequalities".

Presumably, that means that the DHB removed the subsidies from clinics in areas that are relatively more affluent (so that a higher proportion of the total subsidy goes to areas that are less affluent)? A more cynical view is that the DHB will benefit from some cost savings (which they may need!). The cost savings arise because fewer patients in total will go to after-hours clinics that are subsidised (if your illness isn't urgent or critical, maybe you choose not to go to the doctor, because the subsidised clinic is far away, and the unsubsidised clinic is now more expensive). The DHB also benefits from administration cost savings, because the DHB now has to deal with fewer clinics. The costs of the removed subsidy are borne by patients (their medical care is now more expensive, because it is unsubsidised, or because they have to travel further to get to a subsidised clinic) and the now-unsubsidised clinics (who receive a lower effective price from patients, and see fewer of them).

Another way of looking at who is made worse off by removing this subsidy is to consider economic welfare. Consumer (patient) 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, the consumer surplus is the triangle AEPC when there is a subsidy, but decreases to ABP0 when the subsidy is removed. Consumers (patients) are worse off without the subsidy.

Producer (clinic) surplus is the difference between the price that the producers receive and the producers' costs (shown by the supply curve). In the diagram above, the producer surplus is the triangle PPFG when there is a subsidy, but decreases to P0BG when the subsidy is removed. Producers (clinics) are worse off without the subsidy.

The taxpayer (the DHB) is the only party made better off without the subsidy. [*]

Finally, the loss of economic welfare is not the only cost of the removal of the subsidy. If patients are dissuaded from attending a clinic at all because of the higher cost, there could be real health losses that arise from the change in policy. It would be interesting to know how big an effect this has.

*****

[*] I have ignored what happens to total economic welfare in this diagram and this analysis. Typically, if we draw a subsidy on a market and the subsidy moves the market away from the quantity where marginal social benefit is equal to marginal social cost (as in the diagram I have shown), total economic welfare decreases (the subsidy makes society worse off, on aggregate). However, health care has positive externalities that are also not represented in the diagram, and in the presence of positive externalities a subsidy can actually increase (rather than decrease) total economic welfare. I've opted to keep the diagram simple by ignoring positive externalities and the effect on total welfare.

The minimum wage, EITCs, and criminal recidivism

Much of the empirical literature on the minimum wage focuses on the employment effects. There is no strong consensus, though my reading of the latest research (see here) is that it broadly supports the dis-employment effects of the minimum wage. However, the minimum wage has a number of other effects. Last month I wrote a post on the effects (or lack thereof) on the cost of living.

On a similar theme of under-recognised effects of the minimum wage, a recent paper by Amanda Agan (Rutgers) and Michael Makowsky (Clemson) looks at the effect of minimum wages on criminal recidivism. This research is interesting, because the theoretical effect of a higher minimum wage is ambiguous, as Agan and Makowsky explain:

A change in the minimum wage could impact the labor market prospects of released prisoners, and thus recidivism, through a change in their likelihood of finding employment and/or through a change in the wage they can expect to earn if they succeed. The first of these, the employment effect, is at the heart of most economic studies of minimum wages... A reduction in labor demand and increase in the likelihood of unemployment stands to reduce the opportunity cost of returning to jail, increasing the probability of recidivism... This simple model also predicts a second wage effect that pushes in the opposite direction.

So, it isn't clear whether a higher minimum wage would decrease criminal recidivism (through higher wages making engaging in crime less attractive to working), or increase criminal recidivism (through jobs being harder to find, especially for ex-convicts).

Again and Makowsky also look at the effects of earned income tax credits (EITCs), which are paid to parents who are in work (in New Zealand, we have an EITC that is called the "in-work tax credit"). This is in effect a wage subsidy, so should increase low-skilled employment and wages. The effect of the EITC on criminal recidivism should theoretically be less ambiguous than for the minimum wage, but given that most female convicts are sole parents while most male convicts are not, the EITC effects should be concentrated among women.

The authors have data from 5.8 million prison releases in the U.S. (from 4 million prisoners) over the period 2000-2014. They find that, as expected:

...an 8% increase in the minimum wage (the average increase over our time period) corresponds to a 2.8% decrease in the probability an individual returns to prison within one year over the average, with no discernible difference in effect for men or women. That is, the increased incentive to substitute legal employment for criminal market activity, on net, appears to be greater than any employment effects of reduced labor demand resultant of minimum wage market distortions. While our results are agnostic regarding the debates over the magnitudes of the employment effects of minimum wages, they do serve as evidence that wage effects, on balance, dominate employment effects in the decisions made by would-be recidivists... we find that the availability of state top-ups to the federal EITC corresponds to a 1.6 percentage point (7.1%) lower rate of recidivism amongst women, while having no significant effect on men.

Interestingly, their results imply that the effects (of both higher minimum wages and higher EITCs) are larger for those with less education. So, in evaluating the costs and benefits of higher minimum wages and wage subsidies, we shouldn't focus only on the disemployment effects. Even if higher minimum wages reduce employment, they may also reduce crime.

[HT: Marginal Revolution]