Is there a reason to give benefits to specific sectors? – 04/11/2023 – Bernardo Guimarães

The National Council for Industrial Development was reactivated last week, aiming to generate jobs with tax benefit plans for industry sectors.

With idle assembly lines, automakers have been talking to the government about reducing taxes for the production of popular cars.

After all, when does it make sense to give benefits to specific sectors? To understand this, it is instructive to consider an intervention that certainly does not make sense.

Let’s assume that a government decides to encourage the creation of dairy cows in the region of Avenida Paulista. So that this does not have a fiscal cost, establishments and residences in the region are prohibited from buying milk from other parts of the country. Let’s assume that it is impossible to escape legislation.

The idea is silly, nobody proposes it, and of course it would be difficult to enforce the law, but it is instructive to think about the consequences of this measure.

Producing milk in the Paulista Avenue region is very expensive because of the value of the land. But if we cannot buy from other regions, we have to choose between not consuming milk or paying R$25 per liter produced by local cows.

Because of the high price, we would buy less milk. There would still be some demand. Therefore, we would start to see cows and pens in the region.

Agricultural production around Paulista Avenue would increase a lot. Several jobs would be generated! And we don’t even need subsidies.

So it seems that the measure would have good results. We understand, however, that it makes no sense —and not just because of the practical problems of implementing it.

Something is missing from this reasoning. What?

It failed to consider that people’s work, capital and land employed in dairy farming were being used in other activities.

This policy does not generate skilled workers, capital or land; it just modifies the allocation of resources in the economy. This conclusion applies to any sectoral stimulus policy.

Of course, there are always unemployed people in the economy — and some of these could end up working in São Paulo’s livestock industry because of the strange support policy. But it is up to macroeconomic policy to take care of these issues, not sectoral stimulus policies.

So, the question we must ask ourselves when faced with a proposal to support a sector or product is: do we want to encourage these activities to the detriment of others?

In a market economy, the price system governs the allocation of resources. In this way, cheaper production processes and better products replace the old ones.

In the 19th century, for example, my wife’s great-great-grandfather tended cows and sold milk in central London, near the British Museum. When it became possible to transport refrigerated milk, London milk could no longer compete with the product coming from the countryside and the cows moved to other pastures.

Sometimes, however, it may make sense to encourage or discourage specific activities.

This occurs mainly when some cost or benefit of a product or activity does not affect the price. Pollution is a classic example — which is why we want more taxes on activities and products that pollute.

We must discuss sectoral policies in these terms. Incentives to specific activities must be justified by benefits not captured by the price system. My dream? It could be, but if job creation is any justification, we could end up paying for cows to graze next to Masp.

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