Gains by one group are at expense of another

Gains by one group are at expense of another By Dennis A. Johnson The editorial pages of the Plain Talk have recently been enlivened by conflicting essays on ethanol.

David Lias, in a July 22 editorial, expressed skepticism about the benefits of ethanol that have been so frequently touted on these pages. Paul Roberts, in a subsequent guest editorial, sang the praises of ethanol while snarling a little at big oil, and mildly scolded Lias for his unorthodox views.

Both Lias and Roberts call the ethanol issue a �no brainer,� yet their opinions are diametrically opposed.

While both essays are well done, neither of them, it seems to me, directly focus on quite the right question. I believe the appropriate question is whether ethanol production should be encouraged by public subsidies.

The politics is much different from the economic of ethanol subsidies. Such subsidies have big political payoffs � note the unanimity of SD senators and congresswoman on this issue, and the near unanimity of senators and representatives from ethanol producing states.

The economics is not so benign. Subsidies are usually pernicious, reducing the real income of those countries that have them. Exceptions occur when a subsidy properly offsets mistakes in product valuation. I briefly outline why a subsidy is usually harmful and then address exceptions.

Much of the impact of a subsidy is zero-sum. Gains by one group are at the expense of another. For example, if subsidizing ethanol raises the price of corn, it also raises our grocery bill, as corn is part of what we eat. Further, since a subsidy to ethanol causes more land to be devoted to corn, there is less land left to produce (say) soybeans, and the price of soybeans increases too. But the pleasure of the soybean producer is offset by the pain of the soybean consumer. And so it is with other price adjustments.

But not all the effects of subsidies are zero-sum. For example, the extra acres used to grow corn instead of soybeans imposes a cost on the economy not offset by a benefit to anyone. The extra corn is less valuable than the beans that are displaced. This �deadweight loss� exists independently of the �energy balance� of ethanol, and is a good measure of the decline in real income occasioned by the subsidy.

It is important to recognize that while the gains from the subsidy are real, the losses from the subsidy are also real, and in aggregate the losses are (in the standard case) demonstrably larger than aggregate gains. Those who gain from the subsidy gain less than losers lose.

Yet there can be exceptions. Is ethanol one of these?

Proponents of ethanol commonly argue that 1) ethanol damages the environment less than does gasoline, 2) ethanol reduces dependence on foreign oil, and 3) oil from abroad is underpriced, as the price does not include the cost of military expenditures necessary to secure such oil. A 2002 National Science Foundation report indicates, based on a review of a number of studies, that carbon emissions from petroleum gasoline harm the environment to the extent of about 12 cents per gallon. Production and consumption of a gallon of ethanol emit about 43 percent of the carbon emitted by production and consumption of a gallon of gasoline. This reduced carbon makes it reasonable for the federal tax on ethanol to be about seven cents less than the tax on gasoline. Other claimed environmental benefits of ethanol are vanishingly small or too controversial to be quantified.

The cost of dependence on foreign oil has also been estimated, and a figure reported by the NSF is again 12 cents per gallon. Hence it can be reasonably argued that the ethanol subsidy should be increased to 19 cents.

Virtually no economist argues that military expenditures necessary to secure foreign oil should be reflected in the price of imported oil. The U.S. national income is maximized if foreign oil is priced at its marginal cost. If military expenditures do not vary with the quantity of oil imported, such expenditures do not affect marginal cost, and they must not be permitted to influence import price.

Ethanol is heavily subsidized. All ethanol has an exemption of 51 cents per gallon from the federal gasoline tax, and individual producing states add, on average, a subsidy of about 40 cents, for a total subsidy of about 91 cents per gallon.

Ethanol supporters may be able to justify a small subsidy, something in the neighborhood of 20 cents per gallon, but anything over that is hard to swallow. The current ethanol subsidies make the country poorer, as in the aggregate losers lose more than gainers gain. Any net benefits to the agricultural industry are exceeded by the cost to the rest of the country.

Dennis A. Johnson, Ph.D., Vermillion, is professor emeritus of economics.

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