Taxpayer bailouts are common, yet rarely make economic sense. Here’s how to strike a better balance

Most market economists oppose the idea of large corporate bailouts, where taxpayer funds are used to provide failing companies with financial assistance.

Despite this, Australia, and many other economies, seem to be embarking on a golden age of corporate support. My analysis of data from Global Trade Alert shows that in the past two years alone governments made more than 2,830 direct market interventions, including bailouts.

More than 64% of these were to specific firms, as opposed to sectors. And while countries such as Brazil and China account for the majority of interventions, Australia, the United States and the European Union also feature prominently.

This year, there have already been several high-profile government bailouts in Australia’s minerals sector, including a A$2.4 billion joint state-federal support package for Whyalla steelworks, and a $135 million bailout for Nyrstar’s lead and zinc smelters.

Taxpayers are also on the hook for the federal government’s $50 million investment as part of lithium miner Liontown Resources recent capital raise – even though shareholder Gina Rinehart (Australia’s richest person) decided not to take part.

Earlier this month, representatives from several Australian smelter owners met in Sydney to discuss possible government support, including Glencore for its struggling Mt Isa smelter.

Speaking ahead of the meeting, Glencore chief executive Gary Nagle said:

If the government would like to take an equity piece of these operations as part of [assistance measures], and that is contributing towards making these operations financially viable and commercially viable in the short, medium and long term, we are open to that.

But herein lies the problem. Why should a government invest in a firm – especially over the long term – if private sector investors don’t think it is worth it?

The case against ‘corporate welfare’

In a nutshell, the main argument against bailouts and other types of “corporate welfare” is one of efficiency.

The worry is bailouts can create what’s called a “moral hazard”. This is the idea that companies will take more risks if they have reason to believe someone (such as the government) will cover the costs of things going wrong.

If that happens, government support can encourage a misallocation of resources and lead to higher costs across many other sectors that must compete for capital and people with the subsidised sector.

As economist Milton Friedman pointed out, private enterprise isn’t just about profits – it’s about profits and losses. If anything, losses are a more important part of the system as they are more effective in forcing firms to change their ways.

So, why do we do it?

Why do governments fork over taxpayer dollars to save individual companies? One common justification for stepping in to save a firm is that it plays a large role in regional or local employment.

There is some evidence that areas experiencing large plant closures have worse economic and health outcomes over time. However, these studies are largely based on old economic models.

Governments can no longer assume factory workers will find other factory jobs, for example. Many sectors – hotels, retail, grocery stores – are also subject to disruption and employ large numbers of people.

Does that mean the government should get involved every time a retail chain falters? Probably not – money is often better spent on assistance for retraining and re-employment in growing sectors.

National security

One area where most economists accept the need for industry support is national security.

Many recent bailouts have been for companies in Australia’s mineral sector. Proponents say they are vital to ensuring Australia can meet its own needs to build and utilise modern technology, including for the transition to net-zero.

These markets have been operating under the cloud of foreign subsidies for years now. Chinese subsidies have long distorted markets in ways that make operating at a profit in these sectors close to impossible.

While maintaining domestic production capacity in certain strategic sectors may be a real priority, we still need to recognise that it comes at a cost.

Hidden costs

Those costs do not just relate to the use of taxpayer money, although admittedly this is a big factor. They also bear on the discussion currently underway in Canberra about Australia’s economic performance and productivity.

One of the biggest challenges facing the Australian economy is the lack of capital investment by firms, which is driving a slowdown in innovation and productivity.

If government funds are used to prop up firms that have been shown to be ineffective, unprofitable or lack a drive for innovation, what happens to those firms that are – or are on the road to being – innovative and profitable?

How to strike the right balance

When considering bailing out a firm, governments need to assess the situation carefully. That means asking some key questions, such as:

1. Why is this company struggling in the first place? Is it due to mismanagement, or external factors? What are the long-term expectations for this industry?

2. Will an investment lead to sustainable growth and jobs? Or is it simply providing a lifeline for the company to collapse sometime in the future?

3. Is there a legitimate national security issue at stake for Australia? And are there potential spillovers to the rest of the economy that could drive growth as a result?

Generally, bailouts are inefficient, but if we need to do them, let’s make sure we do them for the right reasons.