Cross-Subsidization Due to Infra-marginal Support in Agriculture : A General Theory and Empirical Evidence

A general theory of cross-subsidization due to infra-marginal support is developed. Two sources of output distortion are identified: exit deterrence and extra-marginal output. Some firms would not be in business without the subsidy. Cost savings due to declining average costs are always greater than the losses incurred where price equals marginal cost. Moreover, it is theoretically possible for infra-marginal subsidies to expand output more than equivalent fully coupled subsidies. Empirical analysis of U.S. dairy subsidies isolates these components of cross-subsidization and finds distortions from infra-marginal support to be substantial, with implications for trade negotiations, dispute settlement, and policy formulation