People who defend subsidies for particular sectors often highlight the goods or services that have been produced, or the new jobs created. What they do not normally acknowledge is that the benefits to society of that money, if it had been spent otherwise, or left in the pockets of taxpayers, might have been even greater.
Economists refer to the value of an expenditure in its highest alternative use as its "opportunity cost." The concept of opportunity cost is reasonably intuitive. At the household level, if a person spends $100 on a night on the town, that $100 is no longer available to buy necessities, like food. Similarly, if a government spends $100,000 on a bridge that few people will use, that money is not available to be spent on education, or health care, or any other government priority. Because of taxes and other feedback mechanism in an economy, the analogy between the government and a household is not perfect. But in the presence of a budget constraint, all spending decisions, at the margin, imply trade-offs.
Ideally, a government would strive to structure its expenditures so as to achieve a return to society that is roughly similar for each dollar spent. Subsidies can easily upset that balance.
Consider a hydro-electric project that also provides water to irrigate adjacent farmland. A cubic metre of water from its reservoir has a high value when it passes through turbines and generates electricity, but also to a farmer growing thirsty crops. Nevertheless, the incremental value of an additional cubic metre of water may well be much higher when used to generate electricity than to irrigate the farmer's crops. Policies - such as subsidies that allow the farmer to pump out the water from the reservoir at a very low cost, or that artificially increase the profitability of farming - will result in some of the water being diverted to its lower-value use. In that case, the economy as a whole generates a smaller surplus.
