A few decades ago, Uzbekistan was a centrally planned economy within the USSR, in that the government set the prices of goods, determined where goods would be sold, and decided where and how goods would be produced. The government considered energy necessary for a pleasant life, and to make sure even the poor had the means to heat their residence and cook food, they provided "free" natural gas. Producing gas was not free, of course, it required expensive equipment and lots of labor. The government paid the cost of extracting the gas though, and then allowed its citizens to use however much they wanted at no cost to them.
This is essentially a subsidy for natural gas—a subsidy that didn't just lower the price, but lowered it to zero.
Gas was free and plentiful but matches were not, and you need matches to light a stove. Many households solved this dilemma simply by leaving their gas cookers running all day long, every day. Most of the time they were not cooking, and the stove is an inefficient source of heat, so this subsidy incentived Uzbekistan to waste most of the natural gas they produced.(S1)
This true story is a great illustration of the destribution subsidies cause. People will buy something if they value it more than its price. Market prices help us manage our resources prudently because the price of a good will always be greater than its cost of production, ensuring people only buy the good if they value it more than it costs to produce. Subsidies distort the information in market prices, and cause us to buy goods we value less than it costs us to produce.
In reality, subsidies trick us into buying things we don't want. Uzbekistan citizens paid for the gas indirectly, as the money used to extract and distribute the gas could have been used to buy other things, like matches. If given the choice of paying to extract gas they would never use they never would have taken the choice, but they were not given this choice. The government gave the gas away for free, making the person act as if it were free, and then indirectly charged them for it.
Subsidies destroy wealth because they trick us into buying things we don't really want, and the money spent on those undesirable goods would be better spent elsewhere. If someone tricks you into paying $20,000 for a boat when you would rather spend the money on a car, that is a destruction of wealth. In Uzbekistan the wealth destruction was obvious: natural gas which has value for cooking and heating was instead wasted, like throwing dollar bills into a bottomless pit.
Farm subsidies
A similar story could be told for farm subsidies. If governments pay farmers for producing certain foods we will pay a lower price at the grocery store, but the subsidy doesn't change the actual cost of raising the food. The lower prices trick us into buying more of certain foods we do not want. We see the lower price, respond by buying more, and are then charged indirectly for the price difference in taxes.
Like natural gas in Uzbekistan, farm subsidies destroy wealth, in that we are tricked into paying more for food we would rather spend elsewhere. Farm subsidies are more complex than this though, and the best source for how farm programs are operated and its effect on society, consult the excellent video below produced by ReasonTV.
Video 1—Agricultural Subsidies, by ReasonTV(R1)
(must use Internet Explorer)
References(must use Internet Explorer)
(R1) ReasonTV. January 27, 2009. "Agricultural Subsidies." Reason Foundation. Accessed October 17, 2012 at http://reason.com/reasontv/2009/01/27/agricultural-subsidies
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(S1) Seabright, Paul. 2004. In the Company of Strangers. Princeton University Press: Princeton, NJ.
