Tuesday, October 04, 2005

Uneconomic additive 

I consider it the duty of the Scholars to correct MOBsters who perform bad economic analysis. It is rare that I must exercise this duty, but recently Republican Minnesota (not currently a MOBster but may request membership at some time) showed a need to revisit his principles class. He first poses the problem:
By the 2006 elections, our party will have had control of the House, Senate, and White House for four solid years with some success. During the same time we�ve seen Bush�s approvals tank, record oil prices and the big I-word looming on the horizon. Not exactly the ideal environment for reelection.
OK, and I guess the I-word is inflation, though I'm not sure. It's not clear that higher oil prices will lead to greater inflation -- they needn't, if the Fed continues to pursue its aggressive monetary policy -- but let's assume it will. It will not matter much in off-year elections, as there is little evidence that inflation affects Congressional voting. So while inflation isn't an ideal environment, it shouldn't matter much.

Oil prices? Yes, I suppose voters could punish incumbents for that, and maybe Republicans more than Democrats. I'll stipulate to the point: What do you think we should do about it?
Sadly, most Republicans treat the potential energy crisis as the elephant in the room (pun intended).
What "potential energy crisis"? Two hurricanes? Maybe you'd like to spend that money on a storm-killing device. Let me say this slo-o-o-owly. Rising prices for a product in short supply after a natural disaster isn't an energy crisis. It's solving an energy crisis by letting prices allocate goods and services.
The one Republican tackling energy head on is Gov. Pawlenty. He has been a strong advocate for ethanol-based fuels since being elected Governor. In fact, earlier this week, Pawlenty hosted the Governor�s Ethanol Coalition meeting here in Minnesota.
From the link you learn that Minnesota is one of only three states with a minimum ethanol requirement -- the others are Hawaii and Montana -- and the only one where it is currently in force. Why do you suppose that is? Because it's highly unlikely that ethanol is economically efficient. There has been much debate over technical efficiency (this article explains it well), but that isn't what I'm talking about.

Of course, 17% of ethanol produced in the country is made here in Minnesota, and the benefit to corngrowers is large. RPPI estimates that in 2002 714 million bushels of corn were fermented into ethanol; this was subsidized by the federal government to the tune of $956 million ($.54 subsidy per gallon of ethanol, 2.5 gallons of ethanol per bushel). 17% of that is $162.5 million. No wonder Pawlenty wants to have the ethanol share in reformulated gas in Minnesota raised to 20%.
Our nation, and our state, only stands to benefit from widespread ethanol use.
No, because the subsidy is encouraging resources that would have gone to produce something else into the production of corn for ethanol. We are paying $956 million because without that money the resources devoted to corn-for-ethanol would be producing something else. They produce something else because the profits there are higher than in corn production for other uses. (Indeed, the RPPI estimate shows that at the margin, additional corn production loses money -- the subsidy more than pays for this.) Because you are producing ethanol, you are forgoing whatever crops are not grown on that land, and the value those crops create for consumers and producers.
Besides strengthening our rural economies, it would reduce our dependency on foreign oil, which would do as much for national security as tightening our borders.
We are not "strengthening our rural economies"; we are transferring money to them from taxpayers to buy a crop the market indicates it does not want. And if ethanol did in fact hold prices down, we would retard the exploration of other energy sources and continue to use foreign oil. There's no certainty that the barrels ethanol replace all come from the Arabian Peninsula. If you really wanted to not buy Saudi gas, embargo them.
Don�t forget that we�d need to find jobs to replace the one�s we�ve shipped to China and India.
This is nonsequitur. How many jobs would more ethanol production create? A few more refineries? Really? Where would they be built? In cities where jobs are needed?

There is a price for unreformulated gas -- more correctly, a relative price between corn and gasoline -- for which ethanol makes sense. We don't know what that price is, in large part because ethanol is subsidized. But that part of principles of economics that RM does not get is that the market makes these decisions itself, "as if guided by an invisible hand". Sadly, the party of Reagan seems to forget this.