The subsidy that raised the price

A government offered buyers a grant of twenty per cent towards a product. Within eight months the list price had risen by about fifteen per cent, and buyers were paying slightly more out of pocket than before.

The mechanism is standard and depends on a single quantity: how quickly supply can expand. A subsidy raises the amount buyers are willing to pay. If producers can make more at roughly the same cost, output grows, the price stays near where it was, and the benefit reaches buyers. If output cannot grow quickly — because of a shortage of skilled installers, a licensing bottleneck or a scarce input — then the extra willingness to pay has nowhere to go except into the price, and the subsidy is captured by whoever controls the constraint.

Economists call this incidence: who ends up better off, as opposed to who receives the cheque. Incidence is decided by the shape of the market rather than by the design of the policy, which is why a subsidy, a tax credit and a voucher can all produce the same outcome.

The practical response is not to abandon subsidies but to sequence them. Programmes that funded training for installers a year before the grants, or that released licences in advance, saw price rises of a few per cent rather than fifteen. The money went to the same place and arrived after the constraint had been loosened rather than before.

The diagnostic question before any such programme is therefore narrow and answerable. What is the thing that would run out first if demand doubled next quarter? If nobody can name it, the programme is likely to discover the answer by paying for it.