Targeted and untargeted subsidy schemes: Evidence from postdivestiture efforts to promote universal telephone service

Normative economic analysis traditionally has pointed toward the merits of policies wherein prices reflect the economic cost of providing a good or service. Subsidization policies are, nevertheless, common in a variety of industries. Where such subsidies occur, economists have long advocated targeting those subsidy hows to maximize their effectiveness and minimizing the allocative inefficiency caused by financing of the subsidy. Despite the apparent consensus in economic thought on this subject, empirical evidence of the relative effectiveness of targeted versus untargeted subsidies to date has been lacking. In this article, we address this lacuna by examining a set of large-scale targeted and untargeted subsidy flows that have developed side by side, each with the same nominal policy goal-promoting universal telephone service. Specifically, we test empirically the relative contributions of the alternative subsidy mechanisms in promoting the policy goal of maximizing subscription to the public switched telephone network. Our analysis indicates that targeted subsidy programs are considerably more effective than untargeted subsidies in promoting the goal of universal telephone service. Moreover, our results indicate that the financing mechanism used to generate subsidy flows may seriously erode the effectiveness of either targeted or untargeted subsidy policies.