Let’s stop subsidising the production and use of bio-fuels

A recent World Bank report on the causes of the rise in food prices during the past three years confirms the view, widely held outside the Washington DC White House and the French farmers’ lobby, that increased bio-fuel production has made a major contribution to rising food prices.  According to Rising Food Prices: Policy Options and World Bank Response, global wheat prices rose by 181 percent over the 3-year period leading up to February 2008 and overall global food prices by 83 percent. Food crop prices are expected to remain high in 2008 and 2009 and then begin to decline.  They are likely to remain well above the 2004 levels through 2015 for most food crops.  Around 15 percent of the increase in food crop production prices is due directly to higher energy and fertilizer costs.

The list of the usual suspects for the cause of this food price boom is not controversial, but the quantitative magnitudes of the individual contributions is.  The main drivers are (1) global economic growth and especially rapid growth of real per capita income in the emerging markets (mainly the BRICs), countries whose consumption expenditure share on food (and energy) is still high because of the low levels of real per capita income: (2) crop failures; (3) diversion of crop production away from food into bio-fuels; (4) food subsidies in emerging markets and developing countries and food export controls/taxes/tariffs leading to hoarding in food importing countries; (5) destabilising speculative behaviour in the commodities futures markets.

Crop failures have been a local rather than a global phenomenon, and appear to have been cancelled out by above-normal crop yields in other parts of the world.  Food export controls may have cause sharp peaks in certain cereals, especially rice, but their impact is likely to be transient, especially with most of the recently imposed controls now reversed.  Evidence for any lasting impact of futures market speculation on the spot price for physical commodities actually delivered is conspicuous for its absence.  That will not stop the usual parliamentary ‘let’s blame the speculators’ enquiries.  Enquiries into abusive and destabilising speculative behaviour in the oil futures markets are already under way in the US and have been announced for the UK.  They may well be extended to include food crops.  As is so often the case, our legislators hope that the electorate will confuse motion with action and action with effective measures to deal with the problems.  Fundamentals alone are quite capable of explaining the relentless trend in real food crop prices.

I have not been able to locate the paper A Note on Rising Food Prices by Donald Mitchell, which was around in mimeo format as early as April 2008.  This paper is supposed to contain more detailed calculations and estimates of the effect of bio-fuels on global food crop prices.  Different accounts claim that Mitchell estimated that either 65 percent or 75 percent of the increase in real food prices over the past three years is due to bio-fuel demand.  Economics/econometrics isn’t rocket science, but the difference between even 65 percent and the 3 percent claimed by the Bush White House is large enough to make me want to have a close look at the research supporting both numbers.  Personally, I am surprised that the contribution of food demand growth in the rapidly growing BRICs apparently accounts for less than 20 and possibly less than 10 percent of the rise in global food crop prices, but until I get hold of the Mitchell paper, I cannot judge the robustness of his calculations or venture a guess at the confidence intervals that surround his point estimates.

Increased bio-fuel production has contributed to the rise in food prices, according to the report. Concerns over oil prices, energy security and climate change have prompted governments to increase bio-fuel production and use leading to greater demand for raw materials including: wheat, soy, maize, palm oil and sugar cane. Food crop price hikes are also linked to higher input costs, including energy and fertilizer prices.  The report also lists a weak dollar as a cause of high oil prices.  While a weak dollar may make for high dollar prices for food crops, there is no obvious link between the weakness of the dollar and a high real price of food crops, or a high relative price of food crops compared to other goods and services.  Exports bans on food crops, higher export tariffs and import subsidies also raised the world real price of food crops.

High food crop prices and high energy costs are painful for everyone except for the net exporters of food crops and energy; this applies to individual farming households and to countries.  It is disastrous, indeed life-threatening, for the poor in the poorest countries.  During the early phase of the latest globalisation wave, when industrial production in China the other BRICS and many other emerging markets and developing countries first took off, the reduction of extreme poverty in China and India also was sufficient to improve the World Bank’s figures for the number of people surviving on $1 or $2 a day.  With food and energy prices rising, partly in response to the rapid growth in emerging market demand but partly because of wrong-headed policies, that reduction in global extreme poverty may well be reversed.  Some of the new or renewed poor may even live in China and India.  Many will live elsewhere, including Bangladesh, Pakistan, Egypt and sub-Saharan Africa.

What can be done?

In the advanced industrial countries:

  • End all subsidies to the production of bio-fuels and all official targets for their use.  Currently, the E.U. has an official goal of 5.75 percent of motor fuel use from bio-fuels by 2010. The U.S. has mandated the use of 28.4 billion litres of bio-fuels for transportation by 2012. Some emerging markets will have to change their tunes also.  Brazil (the leading producer of sugar-cane-based ethanol) requires that all diesel oil contain 2 percent bio-diesel by 2008 and 5 percent by 2013, and Thailand has required 10 percent ethanol in all gasoline starting in 2007. India mandates a 5 percent ethanol blend in nine states, and China is requiring a 10 percent ethanol blend in five provinces.  All this will have to go.  It is part of a process called ‘learning’.  More governments and official institutions should try it.
  • Public funds should instead be allocated to research and development into alternative, renewable and environmentally friendly sources of energy.  There is no argument to tax the use of bio-fuels or to ban them.  There just is no argument for subsidising their production or use.  This was the case even before food prices began to rise steeply as a result of the diversion of potential food crops to the production of bio-fuels.
  • Encourage research in genetically modified crops, both through the public funding of R&D and by overcoming phobias (common in Europe) against the growing of GM food crops.
  • End all policies to subsidise or protect agriculture as well as all policies to restrict agricultural production through set-asides (paying farmers not to grow stuff) and other idiocies.
  • Stop using phony phytosanitary standards as arguments to restrict free trade in agricultural products.  Free trade in agricultural products and unimpeded market access on the same terms as local producers should be the rule.
  • Only send food abroad on below-market terms to address short-term humanitarian disasters.
  • Use cash aid for the poorest in the rich countries, or, even better, raise the real value of the lower end of the social safety net.  The poor spend a larger proportion of their income on food and energy than the rich.  When the relative price of food and energy rises, a larger amount of ‘real’ income is required for the poor to maintain their standard of living (if ‘real’ income is defined by deflating money income in terms of the cost of living of the average consumer).

For emerging markets and developing countries where most of the poor are located.

  • Stop subsidising the production of bio-fuels.  According to the World Bank report, Converting rainforests, peatlands, savannas, or grasslands to produce food-based bio-fuels in Brazil, Southeast Asia, and the United States creates a ‘bio-fuel carbon debt’ by releasing 17 to 420 times more (CO2) than the annual greenhouse gas (GHG) reductions these bio-fuels provide by displacing fossil fuels. ”  This does not necessarily mean that these rainforests, peatlands, savannas and grasslands should not be converted to the growing of crops.  What it does mean is that the crops should probably not be used to make bio fuels.  Without subsidies or other incentives, they probably would not be used to produce bio fuels.
  • Lower taxes on foodgrains make obvious sense.
  • End food export controls and food export taxes.  This is a useful part of the solution, but only if countries agreeing to export food when domestic prices are high and rising can be assured of access to open global food markets when their needs are acute.
  • Running down foodgrain stocks to increase food supply by only makes sense if these stocks are too high from a best-practice precautionary perspective.  In food importing countries, fear of food export restrictions in food exporting restrictions leads to individually rational but collectively costly hoarding of foodgrains.  Price controls may help consumers but discourage local producers and encourage the diversion of food to other destinations where prices are higher.  Selective food subsidies, aimed at the staple foods of the poor (not a caviar, salmon and filet mignon etc.) may make sense.
  • The economist’s first-best solution – cash transfers to the poor – requires the government to know who the poor are.  That information is often not available.  Universal cash benefits are ruled out for budgetary reasons.  Food-for-work programs that tie access to free food to the performance of (hopefully) socially useful labour may be an efficient way of targeting only those who really need the food.  They also satisfy the inner Puritan in us.  The problem is that it leaves those who are both poor and unfit or disabled to fend for themselves.  Food rations and food stamps tend to be expensive if they are universal.  They require the government to be able to identify the poor if they are to be selectively targeted.   Food ration/stamp; school feeding programmes may be a cost-effective way of ensuring that the majority of youngsters get at least a minimum level of food intake during school days in their formative years.

Conclusion

The logic of the case against subsidising (through cash subsidies or through protection) the production and use of bio-fuels is the same regardless of whether bio-fuels account for 3 percent or 75 percent of the increase in global food crop prices over the past three years.  The degree of urgency with which we tackle the removal of the production subsidies, protectionist measures and other inducements to encourage the production and use of bio-fuels does depend on the numerical magnitude of the distortions created by this ill-conceived policy.

In the absence of firm evidence to the contrary, I am inclined to attach more weight to the figures produced by Donald Mitchell than to those generated by the White House.  The reason is simple.  The experience of the past 7 plus years has demonstrated beyond a reasonable doubt that the Bush White House is a shameless production line of blatant lies and misrepresentations.  In the Clinton White House, the mendaciousness related mainly to the personal (mis)behaviour of the inhabitants of 1600 Pennsylvania Avenue.  In the Bush White House, lies deceptions and distortions are the weapon of choice for the promotion and defense of favoured policies. Iraq’s non-existent weapons of mass destruction and the alleged but never proven close links between Al Queda and Saddam Husain’s administration are the most obvious examples of Bush White House mendaciousness.  Its record as regards attempts to suppress research findings generated within the Administration that might undermine the White House’s environmental policies betrays the same underlying attitude that telling the truth is a tactical option at best.

So let’s pursue an end to the promotion of bio-fuels, except as part of an impartial research and development programme into renewable and environmentally friendly sources of energy.  And let’s start at home.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website

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