Understanding the role subsidies play in environmental outcomes is crucial; I would argue that it is the most important environmental policy issue of all. So here’s a very quick primer.

  1. There are two broad classes of subsidies: active and passive. Active subsidies are when governments pay producers or consumers in exchange for doing an activity, e.g., paying farmers to produce corn. Passive subsidies occur when the cost of pollution or other types of environmental degradation is not included in the price of a good or service, e.g., fossil fuels currently receive a passive subsidy since no price is assigned to greenhouse gas emissions.
  2. Subsidies are a negative tax — that is, taxes and subsidies are essentially two sides of the same coin. Taxes discourage activities while subsidies promote them.
  3. There are essentially two situations in which it makes sense to subsidize an activity. The first is when the social returns are higher than the private returns — that is, when the market alone would not produce an optimal amount of the good or service. The classic case is education; society greatly benefits from a more educated population. Society may also deem it desirable to subsidize a basic minimum standard of living for equity reasons.
  4. The worst type of subsidy is what is called a “perverse” subsidy; this is when the government actively subsidizes polluting or environmentally degrading activities (i.e., those that are already passively subsidized).

So where does thus lead us?

First, it is important to understand some of the secondary effects of subsidies. Lowering the price of one form of activity by subsidizing it makes it much harder for alternative forms of production to enter the market. If the price of oil and coal reflected its true price many renewable fuels would be much more competitive. This is why environmentalists should be wary of promoting subsidies even for activities that appear “green”; by default, they make it harder for other alternatives to enter once the government starts choosing “winners.” Do a thought experiment: do you really think we know what the best energy technologies in 20 years are going to be right now?

Perhaps more important, environmentalists should work hard to eliminate perverse subsidies in agriculture, mining, fishing, and timber. For an excellent summary of the issues check out this ground-breaking article (PDF). These subsidies wreak havoc on the environment all around the world, and they have powerful constituencies behind them, which requires a sustained campaign that begins with education. The elimination of perverse subsidies would be a huge step towards an environmentally sustainable future.

One last point.

I often talk about market distortions and incorrectly priced goods; this is what I’m talking about. And like I have said before, this language can be used to persuade even the most ardent right-wing free-marketers. After all, there is nothing a true conservative abhors more than subsidies. Armed with this knowledge, environmentalists have a powerful intellectual tool that they should wield much more often.