#13: Why Germany is Setting Up Electric Car Subsidies (Commentary)
Guten tag!
Today, we’ve got a pretty special article in store. We’ve been posting a lot of tech-related stuff lately, so I thought I would go ahead and try to mix it up a little bit, and today consider a topic which has a lot to do with economics. It’s actually going to be a commentary on this article by Guardian newspaper, presenting the subsidies the German government had implemented on electric vehicles. It’ll be a little bit of a critique of the policy, and will seek to analyze it in an unbiased way. Enjoy!
This article is about the German government’s implementation of subsidies to increase the consumption of electric vehicles. Electric cars have positive externalities of consumption, which are social benefits experienced by a third-party to an economic transaction, due to their zero-emission allowing for decreased pollution. The government seeks to increase consumption by implementing a subsidy, which is a payment made to firms by the government, to decrease production costs.
The positive externality of consumption of electric cars means their consumption has a marginal social benefit (MSB) greater than the marginal private benefit (MPB).
The market for electric vehicles (Diagram 1) is socially inefficient, because it operates at the point (Qe, Pe), rather than at the quantity where the marginal social cost (MSC) intersects MSB, represented by the point (Q1, P1). This is because the market fails to consider the positive externality of consumption, represented by the vertical difference between MSB and MPB. For electric cars, this arises because although consumers receive utility from using the car, the rest of society experiences a greater benefit due to the reduced pollution brought on by its consumption. This creates a potential welfare gain in the market, shown by the triangle. The difference between Qe and Q1 implies that electric vehicles are under-consumed.
Thus, the German government aims to increase consumption by implementing a subsidy, which lowers price and increases quantity demanded.
The €4,000 subsidy on electric vehicles in Germany reduces production costs, which incentivizes producers to supply a greater quantity at all prices. Therefore, the supply curve shifts vertically downwards from S to S2, creating a surplus at the equilibrium price Pe, which signals to producers that the price must be decreased in order to allocate goods. As a result, the price is lowered from Pe to P1, consequently increasing the quantity demanded from Qe to Q1. Thus, the market operates at the quantity where MSC = MSB, and is therefore socially efficient.
Germany’s actions are an example of the implementation of subsidies to correct positive externalities of consumption. Since electric vehicles are relatively elastic goods, due to a large number of substitutes in the form of non-electric cars, a small price decrease of €4,000 can lead to a significantly greater increase in quantity demanded, proportionally speaking. Thus, Germany’s ambitious “goal of putting one million electric cars on the road […] up from around 50,000 now” is attainable.
Due to increased consumption, producers of electric vehicles benefit from the subsidy. The increased quantity demanded is accompanied by a substantial increase in revenue, allowing for greater investment in factors of production, and the establishment of economies of scale, eventually leading to industry growth.
However, if the subsidy is sustained over time, it could also lead to inefficient firms, which rely on government intervention to remain in business. Therefore, “auto companies that already make billions in profits” are artificially protected, despite being able to make the necessary investments to grow organically. This would be detrimental for small producers of non-electric vehicles, which cannot compete with the subsidized firms, and thus experience a significant decline in revenue.
In the short-term, consumers also benefit from the subsidy. Decreased prices mean that purchasing an electric vehicle is cheaper, allowing for the utility to be maximized at a lower cost. Those who don’t benefit from the decreased price directly, however, still experience advantages, as the positive externalities through reduced pollution lead to better health and quality of life. However, consumers also experience some downsides following the implementation of the subsidy.
The article states that half of the subsidy is paid for by “the public purse,” implying that the government increases taxation to make up the cost. This is disadvantageous for the public, especially low-income segments of the population, who don’t benefit directly from lowered car prices but still experience greater taxation. Eventually, this could, however, be compensated by healthcare tax cuts, given the better health standards resulting from decreased pollution.
Moreover, the government, which “has budgeted €600m for […] subsidies,” has a significant opportunity cost, because the spending could be instead allocated towards other projects. Eventually, however, this is compensated by long-term benefits, as the positive externalities of consumption allow for lower healthcare spending and greater economic efficiency due to a better quality of life.
Overall, a subsidy on electric vehicles has the potential to be effective, increasing consumption, leading to decreased pollution and a better quality of life. However, risks such as the artificial protection of firms, increased tax on the low-income population, or opportunity cost in government spending should be considered carefully before implementation.
Thank you for reading! Hope you enjoyed the article. I’m actually planning to release another one of these articles soon enough, about the destructive effect of coal-burning in Pakistan. China has been doing this for a number of years, so I really think it is worth talking about. But anyway, until that happens….see ya!
Note: Certain parts of this work were adapted from my IB economics coursework on a similar topic. All rights to this work are reserved to Najem Abaakil and the International Baccalaureate Organization.
