Cross-subsidization Due to Inframarginal Support in Agriculture: A General Theory and Empirical Evidence

A general theory of cross-subsidization due to inframarginal support is developed. Two sources of output distortion are identified: exit deterrence and extramarginal 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 inframarginal 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 inframarginal support to be substantial, with implications for trade negotiations, dispute settlement, and policy formulation. Copyright 2008, Oxford University Press.