Governments in many countries are acutely aware of the environmental problems that vehicle emissions can have.
Many car manufacturers are exploring the production of electric vehicles, but production costs are relatively high in comparison to traditional petrol or diesel vehicles and this means that prices to consumers are also relatively high. This dampens the demand for electric vehicles and arguably leads to a market outcome which is not socially efficient.
In China, car manufacturers have received subsidies to encourage the production of electric vehicles. There are reports that a quarter of a million electric vehicles were produced in China in 2017, and included in this number were both public transport vehicles and individual cars. The number produced in 2017 represented an increase of over 50 per cent on the previous year. Part of the reason is the subsidies the Chinese government has provided to manufacturers of electric vehicles.
In addition to subsidies to producers, the Chinese government and local governments have given subsidies to consumers amounting to around €8,500 for the purchase of electric vehicles.
The cost of providing subsidies was estimated at around €6.5 billion in 2017 alone. Some of the growth in sales of electric vehicles can be put down to the subsidies provided.
However, in 2018, the Chinese government announced that it would be reducing subsidies to car manufacturers and consumers from 2019. The structure of the subsidies available would also change, with more subsidies for vehicles which had greater ranges and reduced subsidies, or removal altogether, on vehicles with smaller ranges. One of the reasons given for the change in policy is that car manufacturers in China are relatively profitable, and the government believes they are in a stronger position to innovate so that the market offering of vehicles is more diverse and appealing to the consumer. Having electric vehicles with a longer range is one factor which would increase that appeal, hence the increase in subsidies for vehicles which meet the increased range specifications.
Critical Thinking Questions
1 Part of the reason for the Chinese government providing subsidies on the production and consumption of electric vehicles is to improve the impact on the environment of traditional internal combustion engine vehicles.
Considering the fact that electric vehicles still need energy to operate, what factors will determine whether the effect on the environment will be positive of such a policy?
2 Using supply and demand diagrams, show the effect on the production and consumption of electric vehicles as a result of a subsidy. What does the market outcome depend upon? Is there a deadweight loss associated with a subsidy?
3 The article notes that the cost of subsidies was estimated to be around €6.5 billion in 2017. Comment on what an economist would consider to be the ‘true cost’ of subsidies such as these referring to the idea of total surplus and equity and efficiency.
4 Would there be any difference in market outcomes if the Chinese government provided subsidies to consumers only rather than to producers? Explain.
5 How do you think subsidies can be used to encourage innovation? Use the example of electric vehicles as the basis for your answer.