Domestic Subsidies and

Export Subsidies

Source: Houck Chapter 10

What is the difference between an

Export Subsidy and a Domestic Subsidy?
• An Export Subsidy is conditional upon the product or service, receiving
the subsidy being exported
• The WTO prohibits export subsidies for industrial products
• Export subsidies for agriculture are permitted subject to disciplines

• A domestic subsidy is any subsidy received by domestic producers that

is not classified as an export subsidy
• In agriculture, the WTO Agreement on Agriculture, limits the use of
domestic subsidies and provides certain reduction commitments
• To the extent that domestic subsidies affects trade, importing
countries can, under certain circumstances, apply countervailing
duties to off-set the effects of these subsidies

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 Large Country Case
Deficiency Payment
Excess
Supply
Supply I Supply II

Pproducers
a b c PW
PW d e g f
PW’

Excess
Demand I Demand
Demand II

Q0P Q1p Q0T Q T Q0P Q0c

Q0c World Importer
Q1c Exporter 1
p
Q1 Q1c
Gain in producer surplus a+b
Home Gain in consumer surplus a+d+e
country
welfare
Government expenditure –(a+b+c+d+e+f+g)
Net loss -g–f-c
3

Large Country Case

Input Price Subsidy
SI ES0
Supply II
S I´ ES ´

PW

PW ´ PW’

Excess
Demand I Demand
Demand II

Q0P Q0c
Q0c Q0P Canada Q0T Q1T World EU
Q1c Q1p wheat Wheat Q1p Q1c wheat

2
 Large Country Case
Production Control
ES ´
S I´ SI ES0 Supply II

PW a b c
d
PW’

Excess
Demand I Demand
Demand II

Q0P Q0T Q0P Q0c

Q0c Exporter World Importer
Q1c Q1p Q1T Q1p Q1c

Gain in producer surplus a+b+c-d

Loss in consumer surplus –a-b
Net loss c-d
(not counting any government expenditure to bid resources out of production)

General Comments on Domestic

Subsidies
• If the subsidizing country is a small country relative to the rest of the
world it’s domestic policies will not distort world prices or resource
allocation

• Domestic programs can have conflicting effects, US CRP acts as a

brake on US production, reduces its exports and this supports world
prices; some US programs do not affect decisions at the margin and as
such should be not affect trade; some programs (target prices and loan
deficiency payments) act like deficiency payments and can distort trade

• Distortionary effect on world markets is difficult to determine and

requires careful empirical work to untangle the effects and determine the
trade-offs
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3
 What is a countervailing duty (CVD)?
• Definition ≡ An import duty imposed on a commodity to off-set a
reduction in its price as a result of a subsidy in the country of origin

• A countervailing duty investigation requires:

– To determine if a subsidy exists
– To determine if the import competing industry is injured
– That there is a causal relation between the subsidy and injury

• These are actions taken under the domestic trade law of the importing
country

•The WTO (Agreement on Subsidies and Countervailing Measures) has

rules about how these domestic laws can be applied and a dispute
settlement mechanism reviews domestic CVD cases to determine if the
disciplines have been applied according to WTO principles

CVD on domestic subsidy

SI ES0
Supply II
S I´ Counter with
ES ´
CVD
Domestic
subsidy
PW P2d e f
c d
P1W a b
P1W
P2W
P2d

Excess
Demand I Demand
Demand II

Q0P Q0c
Q0c Q0P Exporter Q0T Q1T World Importer
Q1c Q1p Q2T Q1p Q2p Q2c Q1c

• injury = loss in producer surplus abdc

• countervailing import duty over compensates for the
distortion ⇒ recovery of producer surplus abfe
• The CVD further distorts world markets 8

4
 What is a countervailing duty (CVD)?
• Countervailing duty investigations deal with questions such as:

• What are the effects of subsidies on production, trade flows and

industry welfare (import competing industry)

• Three kinds of trade-distorting subsidies can be identified:

• Domestic subsidies which enhance a country’s export performance

• Direct export subsidies

• Domestic subsidies which reduce or prevent the substitution of

imported goods for domestically produced goods

Reasons for Export Subsidies

• Policies are normally geared to meeting domestic policy
objectives
– Dispose of surpluses created by domestic programs
– Increase producer prices
– Motivation is protectionist
• Export subsidies can be specific, ad valorem, or a
combination or export subsides can be applied as an open
ended or variable payment
• Government gives exporter a payment on goods
cleared for foreign destinations. This allows the firm to
purchase the product internally at a higher price and sell
it externally at a lower price

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5
 Effect of Export Subsidy
Large Country Case

Excess
Price Supply I Supply Supply II

Subsidy
P subsidy a b c

PW h g f e d

i j P1W
PW1

Excess
Demand I Demand
Demand II

c Q0 Q subsidy Q1P Q0P Q0c Q1c

Q1c Q0 Q0P Q1P Exporter World Importer

Gain in Producer Surplus = abcefgh

Loss of Consumer Surplus = abfgh
Government Expenditure = bcji
Net Loss = bgf + cde + gdji
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Welfare Loss: Small versus Large Country

Small Country Large Country
Supply I Price Supply I
Price

P subsidy a b c P subsidy a b c

PW h g f e d PW h g f e d

i j PW1 i j

Demand I Demand I

c
Q1c Q0
c
Q0P Q1P Exporter Q1c Q0 Q0P Q1P Exporter

Gain in Producer Surplus = abcefgh Gain in Producer Surplus = abcefgh

Loss of Consumer Surplus = abfgh Loss of Consumer Surplus = abfgh
Government Expenditure = bcdfg Government Expenditure = bcji
Net Loss = bgf + cde Net Loss = bgf + cde + gdji

• So the net losses are greater for the large country

because of depressing effect on world price 12

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 Effect of Export Subsidy

Excess
Supply I Supply Supply II

Pe subsidy
Original
PW X-subsidy
P1W
CVD

ED0
Demand I ED1 Demand II

Q0P Q0T Q subisdyT Q0P Q0c

Q0c Exporter World Importer

• CVD balances off injury in the importers market

• But world price declines side-swiping other traders
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