Pandering to (Some) Economists: Trade in Ethanol

by Tom Bozzo

Another major energy proposal in the McCain economic plan is ending subsidies for corn ethanol and eliminating the tariff that effectively bars to importation of sugar cane ethanol. Greg Mankiw scored these on behalf of the economics profession as points for McCain over Obama in the NYT over the weekend. I agree that corn ethanol subsidies are best eliminated as soon as possible — though I note that Obama, while not going so far as McCain on subsidies, is pretty straight-talking about the limitations of corn ethanol especially considering that he represents the corn belt and not the desert.

On the McCain plans for promoting trade in cane ethanol — the Shorter Version of which is that he’s proposing to substitute dependence on foreign ethanol for dependence on foreign oil (*) — there are significant issues that go to the suitability of “free” markets for provision of biofuels. Whether or not expanding trade in ethanol is a good thing depends on other institutional arrangements that are not automatic consequences of reducing tariffs and other moves to freer trade. Since critical policy decisions are outside the reach of U.S. policymakers, economists should be concerned about making policy with the institutions we have, and not the institutions we’d like to assume we have.

There’s been a broad dawning that not all biofuels, and not all methods for producing all biofuels, equally satisfy all of the policy goals that they might purport to help satisfy. Those include substituting domestic resources for imported resources, reducing fossil fuel use, and reducing the carbon intensity of liquid fuel use. Land use issues are critical both for the global warming-related goals for biofuel use and for avoiding blowback from high food prices. (Recent research out of UW-Madison shows that redirecting marginal agricultural lands to cane ethanol in fact can be beneficial, but conversions from forests and other uses are not.) The problem is that lowering tariffs on cane ethanol doesn’t guarantee, and indeed in the absence of other interventions would probably work strongly against, desirable land use patterns.

Brazil produces a lot of ethanol by the standards of the ethanol industry, but not a lot relative to U.S. petroleum-based fuel imports. The former was 327,000 barrels/day in ’07, whereas the latter is 13-14 million b/d (unadjusted for the energy densities of the fuels). Growing enough cane to replace U.S. oil imports with ethanol would require on the order of half the arable land area of Brazil; major cane ethanol substitution would necessarily occur at scales where adverse land-use consequences can’t be assumed away. Note that the current food-price spike, largely blamed on biofuel mandates, happened with only a couple percent of arable land devoted to biofuel crops.

Economists certainly can imagine market-based remedies for the problem, such as Pigovian taxes on certain land-use changes, to name one that Mankiw ought to support in principle. But removing U.S. tariffs won’t make land-use regulation in countries suitable to cane growing appear by magic.

It wouldn’t hurt to add in liquid-fuel demand destruction on hitherto unprecedented scales for the U.S. Along those lines, apart from his willingness to commit 15% of one year’s “clean coal” research funds to the cause of battery technology, McCain isn’t explicitly committed to more than the pending tightening of fuel economy regulations. McCain’s long-standing hostility to rail and apparent indifference towards non-automobile transportation modes doesn’t make the job of reducing petroleum-based fuel consumption (and doing it in less painful ways to consumers than letting the price mechanism work its magic) any easier.

(*) Economists wouldn’t tend to be bothered by this, but it’s at odds with McCain’s energy independence rhetoric.