17.3 Economic growth and subsidies

Wage subsidies, apart from being able to boost buying power of their recepients are also significantly contributing towards economic growth as such.

How does it work ?

If employees are asking for pay rises and they get them,  employers subsequently rise prices of their production and so after a time everybody is at the square one, only inflation climbed a few points furthers.

But looking at it from business perspective,  companies too did not gain any extra incentive to boost production and so contribute towards real GDP growth.
Wage rise was compensated by price increase and so margin gained by companies has not changed.

And this is crutially important.

With wage subsidies, situation is different.

Employees ( as main consumer force) are now able to buy more due to extra buying power coming from subsidy.
But companies did not record any extra increase in costs – here is the difference against standard pay rises ( either through union action or government mandated minimal wage increase)
This means that companies margins went up significantly.  Now they have 3 options:

-          They will increase the production immediately as consequence of increased demand
This is possible and is happening on a daily basis.  If company has spare capacity and demand is up,  the production is increased as well to  gain these extra profits. 
Employment goes up as well.

-          If production capacity does not allow immediate increase in production ,  companies can increase the prices.
Consumers can for a time accept increased prices because they have the money from subsidies:
That way companies  will gain some extra funds, which can be invested into capacity enlargement.
In comparison with price increase as response to wage increase companies did not gain any extra margin to be used for investment as with wage increases their costs went up as well and there is no extra margin available.

-          If companies are greedy, they increase the prices with no intention of investing into production increases – they simply intend to cream the market.
But they won´t be able to hold that position for long.  Other competitors ( current or potential)  are well aware that increase in their profits are coming solely from increased buying power of consumers thanks to subsidies.  As a response, they realize that big money is to be made there and they will enter the market and start producing their own products.

In comparison to situation without subsidies, when competition presses margings to minimum,  companies are reluctant to increase production as investment into new capacities would be too risky and its time of return is too long. There is very little money to be made by increasing the production.

Also potential new entrants into this market are not very eager to start their production as margins are very low. So even there is generally potential of significant producion increase ( genuine lack of certain goods or services and people want them) as a result of low demand stemming from low buying power this production increase is not going to happen.  So GDP growth is negatively impacted as well.


Here it is also highly visible how important is adequate buying power and how buing power determined just by primary productivity is not enought to fully realize production potential.


Wage subsidies can help bridge this gap between what can be easily produced and what is produced based on existing buying power.