I was invited this week to write an op-ed for Real Clear Markets concerning ethanol mandates. I dislike the mandates, but I had some problems with the logic people were using to attack them. At any rate, here it is:
Contradictory Food-Price Signals
By Brian Shelley
From Haiti to the Himalayas food riots have broken out over the soaring price of staple foods like rice, wheat and corn. A number of economists have been rallying around the idea that ethanol subsidies are to blame, and they paint a compelling story. The problem is that this story contradicts another one told about farm subsidies.
Simple economic analysis backs the claim that ethanol subsidies increase prices. The reasoning goes that demand for grain has risen because fuel now competes with food as the end use of farm output. Without the subsidies ethanol would not be able to compete as an energy source, but Uncle Sam has intervened with mandates that states increase the share of ethanol to be mixed with gasoline. With a significant portion of grain supply being diverted to energy production, a smaller amount of food is available for a growing world population. The price, in response to these market changes, has risen significantly.
News reports leave little doubt that high prices are hitting subsistence level consumers around the world, and anger has lead to riots. Images of gaunt refugees swarming delivery trucks flash in our minds when we hear aid agencies speak of the plight induced by high prices. The economic logic makes the argument a reasonable one and having an American policy causing hunger is surely a gripping story.
Free market advocates have jumped on the news with gusto to pillory the distortions of non-market mechanism of mandates. Many have become quickly convinced that ethanol subsidies alone are guilty. The evidence has been enough to convince Texas Senator Kay Bailey Hutchison to propose legislation to freeze biofuel mandates at current levels. In her recent op-ed she authoritatively states, “The fact that America's energy policies are creating global instability should concern the leaders of both political parties. Restraining the dangerous effects of artificially inflated demand for ethanol should be an issue that unites both conservatives and progressives.” Some writers have been more calamitous, such as Deroy Murdock on National Review Online who exclaims, “’Stop!’ The emergency brake should be pulled — NOW — before ethanol wreaks further havoc.” The topic and implications have clearly yielded a lot of strong emotions.
Hyperbole aside, it would be compelling logic if only it did not directly contradict the logic against farm subsidies. Over the last few years, free market advocates portrayed the same higher prices as being good for the poorest countries. David T. Griswold of the Cato institute in his 2006 paper “Grain Drain: The Hidden Cost of Rice Subsidies” states, in reference to farm subsidies, that “U.S. policy drives down prices for rice by 4 to 6 percent. Those lower prices, in turn, perpetuate poverty and hardship for millions of rice farmers in developing countries” If farm subsidies cause lower prices and perpetuate poverty, how can ethanol mandates raise prices and perpetuate poverty? Higher prices can not be a virtue of farm subsidies, yet a vice of ethanol subsidies.
The reality is that higher food prices cause consumers to lose and producers to win, and the net effect may be positive for these poorer countries dealing with the current market disruption. The market is giving a price signal to third world producers to revive dormant production. Previously they were pushed out of production when developed-world farm subsidies undercut world prices. If Mr. Griswold is correct, then high prices may be a boon for the most desperately poor because farming is one of the few forms of production that requires virtually no capital at its most basic level. The short-term pain for consumers may be a long-term gain as the inflated prices have finally produced a profitable environment for farming in countries so desperately in need of stable food supplies and expanded enterprise.
Ethanol as the sole explanation is hard to swallow in light of other global economic issues as well. With a laundry list of other commodities experiencing price spikes in recent years it seems a stretch to think that grains are not also subject to the same forces. From the weak dollar effects of Fed policy to the rising consumer class in India and China, explanations for the broad rise in commodities are being ignored in the narrow interest of unwinding ethanol subsidies.
The economic reasoning is there to explain that ethanol mandates increase prices, but exaggerating its effects for political expediency is dishonest. It has also not been established that high food prices are unequivocally against the interest of poorer nations. If the oft-stated objection to farm subsidies is the negative effects of lower food prices on the third world, drumming this claim that high food prices are bad into the folk economic understanding of Americans harms efforts to eliminate both market distortions. Ethanol mandates may have failed in many ways, but this attack doesn’t hold much water.