The effects of lump-sum subsidies on the structure of production and productivity in regulated industries

The theoretical model developed in this paper indicates that a lump-sum subsidy granted to a monopolist facing a binding rate of return constraint will result in a higher level of capital employed and output produced. Furthermore, production costs at any level of output will be higher compared to the pre-subsidy situation. The empirical results emanating from the application of the model to the bus transport sector indicate that lump-sum subsidies have been factor-biased and have led to higher costs as predicted by the model. The average rate of productivity growth has been reduced by 0.60 percentage points per year as a direct result of the lump-sum subsidy.