The Effects of Ethanol Subsidies on Food Prices - Thesis Example

?Ryan Foster Alice Kinman ECON 5900 07.25 Ethanol aides energy: The effects of ethanol subsidies on food prices Food security is a very criticalissue that no government can afford to ignore. This is because rising food prices affect not only the ability of people to put food on the table but also leads to political instability in some cases. In many societies, economic distress translates into social unrest and political distress as well. In relation to this, an abnormal increase in the price of food has the potential of increasing the number of failing states. Bruce (2007) observes that such reasons are driving governments, the United Nations (UN) and other organizations to critically analyze the various factors that are driving food prices up. The main aim of their actions is to identify those causative factors that can be avoided, mitigated or controlled and possible courses of action in relation to each. One factor that is being scrutinized as a possible cause of rising food prices is ethanol subsidies. For a long time, critics and supporters of ethanol have differed over the effects of longstanding ethanol subsidies on the prices of food. The main aim of this paper is to determine the effects of ethanol subsidies on food prices. Its specific objectives are to establish the relationship between ethanol production and food production, to determine if there is a correlation between the existence of ethanol subsidies and food prices and to determine potential consequences of the removal of subsidies on ethanol on the prices of food. A review of arguments on both sides of the question leads me to conclude that there is a positive correlation between ethanol subsidies and food prices, both at local and global markets. Policies for ethanol subsidies Countries like the United States, United Kingdom, France and Germany have supported the use of biofuels through mandated use, tax breaks and subsidies. Under these policies, fuel taxes are not levied on fuel that is used for agriculture. This means farmers are in a position to obtain duty-free diesel or petrol. The effect of this is reduced costs of production, which in turn encourages large-scale agricultural production. Ethanol refiners and fuel blenders are paid subsidies in order to maintain the price of ethanol and other biofuels at low levels. Most of the countries or states that have instituted ethanol subsidies aim at maximizing the economic potentials presented by the emerging bio-fuel industry through the tax incentives and substantial subsidies they offer to ethanol producers. In order to maximize their economies, these countries always aim at minimizing their dependence on imported oil by growing their own fuel. This situation has greatly been encouraged by the increasing oil prices. Contributions of ethanol subsidies to increased food prices Generally, the use of bio-fuels like ethanol helps to maintain the price of motor vehicle fuels at low levels while at the same time minimizing dependence on petroleum imports. This has motivated governments to offer such subsidies to encourage the utilization of this cheap and sustainable alternative. However, ethanol subsidies have resulted in extensive ethanol production using agricultural products, especially corn. According to Chakrabortty, the use of biofuels has forced the price of food across the world to go up by close to 75%1. The highly demanding energy market has led to a general increase in demand for biofuels. Although the expanded market may not cause food shortage, the scenario leads to the setting of higher market prices2. These prices are troublesome to consumers, and the result of this is reduced consumption of corn. The two main markets for agricultural food products are the ethanol production/energy market and the food market. Just like people in any other type of business, farmers who engage in corn production also seek to maximize profits through the sale of their corn harvest. This means they have to channel their produce to markets where they are highly valued. If the price of corn or other agricultural food product is higher in the food market, most farmers will channel their produce to that market. The converse of this is when these agricultural food products are highly valued in the energy market as compared to the food market. In such a situation, farmers will divert their harvest to the well paying energy market. This happens even though these produce were initially produced for the food market. In other words, the energy market has created better markets for corn and other grain products. In such a case, farmers are always motivated to sell much of their produce to the energy market. The result of this is plentiful supply of corn in the energy market and a corresponding shortage in the food market3. There are claims that high food prices in the US are a result of the US policy that encourages the production of ethanol through the tilling of arable land and the implementation of agricultural subsidies4. The argument behind these claims is that the channeling of agricultural produce to the energy market will definitely cause a great imbalance between supply and demand in the food market. According to the laws of demand and supply, a rise in the demand for corn will cause corn prices to rise5. This is statement is true as it concerns the prices of other agricultural produce in the food market. This is to say, the presence of a strong competitor for the food market has led to decreased supply of agricultural food products to this market. The result of this is an increase in food price as the market tries to meet the demands of its ever-increasing number consumers. It should be noted that the effects of ethanol subsidies on food prices is not limited to the local food markets. This is because some of the agricultural products are destined for the export market. If the local energy market is more attractive than the external food market, farmers will evade the export market. There are times when bio-fuel production accounts for a significant proportion of the use of various crops. During the 2007-2009 period for example, it accounted for 4% of the use of sugarbeat, 9% for the use of vegetable oil and 20% for the use of sugar cane6. The US is a significant exporter of food stocks but in 2008, the country converted about 18% of its total grain produced into ethanol7. In the year 2007, the percentage of corn used for this purpose was 25%8. This was approximately 2.5 billion bushels. This amount has been rising in the subsequent years to over 3 billion bushels in 2008, 4 billion bushels in 2009 and 5 billion bushels in 20109. The effect of such a situation is a shortage of food supply in the initial target (export) market and consequently, high global food prices. This means that ethanol subsidies have a great significance in the volatility of global food prices. Corn is the main grain used in the production of ethanol. The emergence of a more attractive market for this agricultural produce has made it more profitable as compared to other agricultural products. This high profitability associated with the growing of corn has made many farmers to switch their lines of production. About 3200 farmers have changed the use of their land from the production of other agricultural produce into pure corn production10. Such farmers have set their minds that the trend will continue until the profitability of other agricultural prices has also increased. The result of such shifts is a general decrease in the production and supply of other agricultural commodities and consequently, high prices. This means that ethanol subsidies is the driving force behind the increase in the prices of other agricultural food products11. Studies undertaken in the US reveal that in the year 2006, 92,900,000 acres of land that was formerly utilized for the production of other agricultural crops was diverted into corn production4. Although corn is the main grain used in the production of ethanol, much of the ethanol production does not only threaten human life. This is because direct human consumption does not constitute a 100% utilization of agricultural produce in the food market. It is common knowledge that corn is used as a main feed for cows, pigs and chicken. This means that an increase in corn prices increases the cost of production among cattle, pigs and chicken keepers. These farmers have to spend more in order to achieve similar levels of production than before. The overall effect of this is a corresponding increase in the prices of chicken meat, pork, beef, eggs, milk and cheese. The price of soya beans increased by 2.8% while that of eggs increased by 2 cents per dozen, equivalent to 1.1% rise. By 2010, beef and pork prices had increased by over 9% and 7% respectively12. Eventually, such farmers raise the prices of their produce as dictated by the increasing costs of production. For a long period, bad weather trends and population growth have been blamed for the increase in the food prices. However, these factors have existed for many years yet the drastic increase in food prices is a more recent thing. In fact, food prices were static until the year 2006, but in 2007 and 2008, there was a sudden increase in these prices. Since January 2002 through September 2006, the prices of corn averaged $2.18 per bushel. Coming to the period of September 2006 to May 2007, these prices averaged $3.56, a 61% increase13. It is true that increase in food prices as a result of population growth always occurs at slow and manageable rates. In the US, for example, food prices normally increase by approximately 2.5% each year14. However, this rate stood at 4% in 2007, the highest increase in 17 years. During the same period, world food prices increased by a stunning 40% leading to hoarding of food products, and food riots in some countries15. From the above explanation, it is reasonable to conclude that the contribution of bad weather trends and population growth to the volatility of food prices is minimal as compared to the effects of ethanol subsidies16. In July 2008, the World Bank published a policy research working paper concerning this recent extraordinary increase in global food prices. According to this paper, the research conducted by the World Bank revealed that the rise in the prices of food was led by grain prices. In fact, the initial increase in grain price was sharp despite the high grain harvests globally. As earlier noted, corn is the main food crop used in ethanol production. In the food market, its main substitutes are other grains. Therefore, the revelation that grains prices were the first to rise is a clear indication that the use of corn to produce ethanol is the lead cause of increase in global food prices. In relation to this, the utilization of sugar to make ethanol is lower as compared to that of corn, except in Brazil. This explains the abnormal rate of increase in grain price, and that of other products whose production involves extensive use of corn. An example of this is beef. Ethanol supporters Although there is evidence that the existence of ethanol subsidies has a direct relation with increased food prices, supporters of ethanol production have also presented justifiable arguments to oppose this. First of all, a deliberate and benefit-oriented production of ethanol from corn requires the production of enough corn for this purpose. Such a level of production has been well achieved in places like US where land under corn production has increased considerably. This makes such a utilization of agricultural food products a self-sustaining project. Despite the general increase in the prices of food in 2007 and 2008, there are substantial reasons for rejecting the argument that ethanol-subsidies are the cause of increased food prices. For example, the prices of corn reached its highest-ever in June 2008 but by October 2008, these prices had already fallen by 50%. On the other hand, the level of ethanol production from corn has not changed. This means that the impact of the utilization of corn for ethanol production on global food prices was not as great as it was assumed to be17. If this was not the case, then this trend should have been continued until the end of the year. It is true that increased demand for corn for ethanol production leads to an increase in the prices of corn. However this effect is small hence it should not be blamed for the great increase in global food prices. Analysts claim that the demand for ethanol only increases the price of corn by a figure of between 75 cents to $1.00 per bushel18. Others give a figure of just under 80 cents per bushel. From these estimates, corn priced at 4USD per bushel can be priced at 3USD if there was no demand for ethanol19. Despite the evident impacts of ethanol subsidies on corn prices, these subsidies are not the main driving force behind the increase in the overall costs of food. Findings from research indicate that US ethanol policies had modest impacts on the prices of soybeans, rice and wheat. The greatest impact among these was on soybeans, the figure being 2.8%. The impact of US ethanol subsidies through higher feed costs of beef, eggs, chicken and pork was even smaller. The highest impact was on the consumer prices of eggs. The price of a commodity rises if quantity demanded exceeds quantity supplied at the original price20. Based on this explanation, ethanol-subsidies should not be blamed for the increased prices of food in all regions. The president of US Commodities Inc. in the state of Iowa Don Roose said that in 2008 that Iowa had enough stocks of corn. This means there was no shortage of corn that could justify the linking of ethanol production to increased food prices. Instead, Mr Roose claimed that the US dollar went so low while the price of crude oil increased and this inflated the price of many commodities. Given the above views and explanations, there is a need to analyze the impact of many other relevant factors on food prices. One such factor is the prices of oil. Oil is used in all sectors of production including agriculture and this means that an increase in its price has a direct impact on the general cost of production. This includes the costs incurred by farmers when using farming machinery, transportation and packaging costs. Finally, a combination of all these costs constitutes the consumer price. It is also notable that since 2003, the demand for biofuels increased because of an increase in the prices of oil. The conversion of vegetable oil into biodiesel is easier and cheaper as compared to production of diesel from crude oil. This has motivated the production and reliance on biodiesel as compared to diesel. Diesel is normally produced from crude oil. This means an increase in the prices of vegetable oil is partially linked to an increase in the prices of crude oil. The impact of biodiesel production using vegetable oil is expected to increase in the near future. The reason for this is that if the profitability of vegetable oil crops increases, farmers might shift from growing food crops into the production of vegetable oil crops. Some supporters of ethanol production using food products are blaming depression and poor economic policies for the increased food prices21. One such person is Luiz Inacio Lula da Silva, the president of Brazil. Speaking at a Food and Agriculture Organization (FAO) conference in Brasilia, Mr. Silva said that the allegations that food prices were rising because of biofuels was baseless. He also stated that food prices were on the increase because people in the developing nations like India, Brazil and China were eating more as a result of their improved economic conditions22. Currently, Brazil is the leading exporter of biofuels like ethanol in the world. Its bio-fuel program involves the production of ethanol from sugarcane. As earlier noted, the rise in global food prices began with grains such as corn and wheat. This trend was witnessed in Brazil just as in any other country. This means there were other driving factors behind the increase in the prices of grains. If this was not the case, the increase in food prices in Brazil would have begun with sugar prices. Increased utilization of sugarcane in the energy market has no or minimal impact on the prices of grains since they are not substitutes products. The actions of US corn growers have been linked to the increase in food prices for example diverting their produce to ethanol production. However, these corn growers through their association called National Corn Growers Association (NCGA) have defended themselves by publishing their views. The NCGA claims that the US corn growers have always and will continue to produce adequate corn to ensure that demand and supply meet. This has and will always ensure that there is no shortage of corn. The NCGA also claims that farmers use the signals from the market place to make their planting decisions. If corn has a high demand and its projected-revenue-per-acre is higher than that of other crops, then farmers will plant more corn. For example, in 2007, farmers increased the acreage of corn to 92,900,000 acres, a 19% increase from the 2006 corn output. Corn output per acre in the US has doubled over the last 40 years and the situation is expected repeat itself in the next 20 years23. This means that with a double production of corn from each acre, it is possible to put corn into new uses without depriving the human and animal populations or causing deforestation. In essence, the use of corn for ethanol production is one such application of the product. The actual costs of production account for a small percentage of the US food prices, about 19%24. The other percentage is attributed to the costs of shipping, advertisement, transportation, packaging among others. This means that if the price of a bushel of corn was to increase, then it is expected to have unnoticeable impacts. In addition, it is only the starch portion of a corn kernel that is converted to ethanol. The rest is normally passed to the production of ingredients like starch or co-products. Conclusion Ethanol subsidies, for example the removal of taxes for fuel used in agriculture, have led to a general increase in the quantities of corn produced annually in different parts of the world. This is evidenced by the increase in the number of acres under corn production in the US in 2007. Therefore, we can conclude that ethanol production leads to an increase in food production. Ethanol subsidies encourage the diversion of agricultural food products to ethanol production leading to decreased supply in the food market. Food prices were generally low before the introduction of subsidies on ethanol but after the institution of these subsidies, food prices have increased. Basing on all the facts obtained, it is reasonable to say that there is a positive correlation between ethanol subsidies and food prices, both at local and global markets. The use of crops to make bio-fuels increases the price inelasticity of demand leading to volatility in the prices of agricultural products. This means that policies that support ethanol subsidies force the global food prices to increase. Those who argue in support of ethanol base their claims that the production of biofuels like ethanol can rescue a country out energy dependency without interfering with food prices. This argument is supported by the view that double production of corn from the same acre, for example in the US, makes it possible to put corn into other uses without causing food crisis. Generally, there is more evidence that ethanol subsidies have led to an increase in global food prices. Most of the arguments that support ethanol subsidies come countries that benefit them. Others like Brazil do not use corn for their ethanol production yet it has been found out that the utilization of corn for ethanol production is the main force behind increased food prices. This means the removal of these subsidies has the potential of lowering global food prices. It is therefore the duty of every government to do away with all policies that support the use of corn and other agricultural food products in ethanol production. There is also a need to shift to total reliance on non-food crops for ethanol production. The use of ethanol is not bad. However, if something is not done about its effect on food prices, then ethanol subsidies could turn out to be one of the worst crimes against humanity. Bibliography Bounds Andrew. 10 September, 2007. “OECD Warns Against Biofuels Subsidies”. Financial Times. Bruce, Gardner. 2007 .“Fuel Ethanol Subsidies and Farm Price Support”, Journal of Agricultural and Food Industrial Organization. 5 no. 2. Article 4. Bruce, Babcock. Kanlaya Barr, and Carriquiry Miguel. 2010. “Costs and Benefits to Taxpayers, Consumers, and Producers from U.S. Ethanol Policies”. Staff Report 10-SR-106. Center for Agricultural and Rural Development, Iowa State University. Chakrabortty, Aditya. 4 July, 2008. "Secret report: biofuel caused food crisis". London: The Guardian. http://www.guardian.co.uk/environment/2008/jul/03/biofuels.renewableenergy Colitt, Raymond. 16 April, 2008. “Brazil Lula defends biofuels from growing criticism.” Reuters UK. http://news.bbc.co.uk/2/hi/science/nature/7351766.stm. Accesses July 15, 2011. FAPRI. 2009. “Impacts of Selected US Ethanol Policy Options”. FAPRI-MU Report #04-09. Food and Agricultural Policy Research Institute, University of Missouri. Gernot, Heller. 17 April, 2008. “Bad policy, not biofuel, drive food prices: Merkel.” Reuters. http://www.reuters.com/article/2008/04/17/us-germany-biofuels-idUSL1721113520080417?feedType=RSS&feedName=environmentNews. Accesses July 15, 2011. Heather, Timmons. 14th May, 2008. “Indians Find U.S. at Fault in Food Cost”. The New York Times. http://www.nytimes.com/2008/05/14/business/worldbusiness/14food.html?_r=3&adxnnl=1&oref=slogin&partner=rssnyt&emc=rss&adxnnlx=1210858219-6h6cWsH086zu54tvcDuKXw. Accesses July 15, 2011. Lee, Dwight. 1998. "Demand and Supply," The Freeman: Ideas on Liberty. http://www.fee.org/publications/the-freeman/article.asp?aid=3666. Accesses July 15, 2011. Nelson, Sam. 23 October, 2008. “Ethanol no longer seen as big driver of food price”. Reuters http://uk.reuters.com/article/2008/10/23/food-corn-ethanol-idUKN2338007820081023 Accesses July 15, 2011. Annotated Bibliography Borger, Julian 05 April, 2008. “UN chief calls for review of biofuels policy”. London: The Guardian. This article brings out the views of the UN Secretary General Ban Ki-Moon regarding biofuel policies. Ban called upon nations to consider a reformulation of their policies that encourage the use of agricultural food produce for ethanol production. Ban also pointed out that the current food prices was a result of the change in production patterns due to favorable corn prices in the energy market. Bruce, Gardner. 2007 .“Fuel Ethanol Subsidies and Farm Price Support”, Journal of Agricultural and Food Industrial Organization. 5 no. 2. Article 4. This article points out that policies supporting ethanol production from corn is responsible for the current high food prices. The article also points out how high corn prices finally translates into a general increase in the prices of other food products. It also argues in defense of the effect other factors like population growth and climate change in relation to this issue. The article argues that the abnormal prices is a more recent thing as compared to population growth and climate change. Bruce, Babcock. Kanlaya Barr, and Carriquiry Miguel. 2010. “Costs and Benefits to Taxpayers, Consumers, and Producers from U.S.Ethanol Policies”. Staff Report 10-SR-106. Center for Agricultural and Rural Development, Iowa State University. This article points out that the existing policies relating to ethanol substitutes has led to a shift in the production trends among farmers, specifically to extensive corn production. This has led to a decrease in the supply of other agricultural food products and consequently their high prices. It also discusses the benefit of this policy to farmers, especially those who produce corn. Chakrabortty, Aditya. 4 July, 2008. “Secret report: biofuel caused food crisis". London: The Guardian. This article is a confidential World Bank report which reveals that biofuel production has forced the prices of food in the global markets to increase by up to 75%. It contradicts claims made by the US government that bio-fuel production contributes less than 3% to the issue of food price increase. It also points out food riots as one of the effects of the increase in food prices. Colitt, Raymond. 16 April, 2008. “Brazil Lula defends biofuels from growing criticism.” Reuters UK. This article presents the defensive views of Mr. Lula, the president of Brazil as regarding the role of ethanol subsidies in increased food prices. Mr. Lula claims that the situation was a result of increased ace to food by people in developing countries. He states that improved economic conditions in developing countries like China and India have caused people to change their eating habits. This has increased the general demand for food. FAPRI. 2009. “Impacts of Selected US Ethanol Policy Options”. FAPRI-MU Report #04-09. Food and Agricultural Policy Research Institute, University of Missouri. This article gives a description of the effect of the US policy on biofuel. The article points out that this policy encourages diversion of US agricultural output to biodiesel and ethanol production. The result of this is a decrease in the amount of US agricultural food produce available for export. It largely blames expanding biofuel production for the increase food prices. Heather, Timmons. 14th May, 2008. “Indians Find U.S. at Fault in Food Cost.” The New York Times. This article supports the perspective that ethanol subsidies are the cause of increased food prices. The article shifts this blame from India and other developing nations to developing nations like the US that have instituted unfriendly energy policies. It also points out that America waste a lot of food compared to other nations. Lee, Dwight. 1998. "Demand and Supply," The Freeman: Ideas on Liberty This book explains how the forces of demand and supply work in order to determine the prices of food. Lee explains that when the supply of a commodity in the market is lower than its demand, its price shoots up. The two forces always work as opposing directions and their meeting point represents the market price. In this way, the force of demand is controlled by increased prices. Nelson, Sam. 23 October, 2008. “Ethanol no longer seen as big driver of food price”. Reuters This article gives an analysis of the argument that the use of agricultural food products was the main cause of increase in food prices. The article points out that there was a sharp decline in the prices of corn as from June 2008 yet the production of ethanol had not reduced. It also points out that the rate at which ethanol production causes an increase in food prices is minimal. The article uses the price of corn bushel as an example of this. Gernot, Heller. 17 April, 2008. “Bad policy, not biofuel, drive food prices: Merkel.” Reuters. This article blames bad inadequate agricultural policies for the current abnormal increase in food prices. The article points out that the agricultural prices in the developing world are not efficient enough in meeting national demands hence their continued reliance on imports. It points out food sustainability in ethanol producing countries as compared to those which do not. The article gives an example of sufficient corn supplies in early 2008, the period when corn prices shot up to its highest. Read More