Biofuels, and the Problem of Thinking of the US as a Closed Economy

7/23/2012 05:30:00 PM
Usually it is fairly reasonable in economics to think of the US as a closed economy--after all gross imports are only about 4.5% of GDP. That means that the vast majority of all stimulus dollars, for example, will boost US rather than foreign demand. But not all government interventions work that way. Here's one.

Timothy A. Wise points out that as a result of new regulations requiring that biofuels be used to replace a portion of US energy fossile fuel energy sources, the US will be importing 4 billion gallons of ethanol from Brazil, even while Brazil imports 2 billion gallons of ethanol from the United States. The reason is that the Brazilian ethanol is made from sugar cane, which means it has a much smaller carbon footprint than the US made corn ethanol, so it is much easier for firms to satisfy the new regulations with Brazilian sugar cane ethanol than with US corn ethanol. This has made the sugar cane ethanol more expensive than the corn ethanol, so that it is profitable for Brazil to see its sugar cane ethanol to the US and buy US made corn ethanol for their domestic use. But, of course, environmentally it does not matter whether the ethanol is burnt in the US or Brazil, so there is an exchange of 2 billion gallons of ethanol--incurring additional fuel costs for the transportation--which has no environmental benefits whatsoever. For reference, the combined ethanol production of the US and Brazil is about 20 billion gallons, so 10% of the total is being pointlessly shipped between the two countries because of the regulations.

Clearly the regulations need to be changed to get the incentives right. But I think that Wise and others go off the rails when they criticize biofuels policies because of the impact on food prices. It is certainly true that the price of corn is rising in part due to the ethanol requirements. This may not be economically efficient, but I have a hard time getting worried about it. Here's why:
Figure 1. Spending on all Food and Beverages, including restaurants
Even though we eat way more than we ever have, and even though we eat a lot more of the most expensive foods, the proportion of our incomes that we spend on food has fallen drastically over time (even including what we pay for restaurant services). We produce more than enough food to feed everyone in the US well above what they need, so much so that the modest price increase caused by biofuels will have an inconsequential effect on households budgets.