Ethanol and fundamental economics

The fact is, there is very little argument in favor of corn-based ethanol; it is expensive, its is energy consumer and, most damaging, it is not economic. I am all in favor of alternatives to fossil fuel, in fact, I believe that finding such alternatives is one of the great challenges of our times. But an “alternative” that has to be propped up by protectionist measures put in place for political purposes is no alternative at all.

Regardless of how well a government thinks in can out-wit the markets, fortunately often simple economics comes back into play to show the fallacy of ill-thought-out policies. This is no clearer than in the ethanol market today.

There are many reasons for the high price of food right now, and I’m not claiming that there is one single magical cause. But a major contributor has to be that the price of corn is shooting up because of all of the protections around corn-based ethanol.

While these protections may not be going away (they are politically valuable), they are at least being called into question. And that is having a chilling effect on the corn-ethanol industry.

"If you sell one product and the only reason there's a market for it is because the government makes a law requiring consumption - if that law goes away, obviously you're in trouble," Gilpin said.

Greenwald argues that if there are still government regulations in your favor, that could be a competitive advantage. Indeed, the corn-ethanol industry has enjoyed competitive advantage verses other ethanols (Brazilian sugarcane for example) precisely because of these regulations. However, I don’t think Greenwald or anyone else would argue that if those policies are fundamentally uneconomic, they present a long-term haven. An attack on this false safe-haven is what we are seeing now in the markets.



Ethanol Turmoil Calls for Legislative Change a Threat to Some Companies - Business - redOrbit

The importance of separating globalization from politics

I don't really want to get into politics on this blog, but Nicholas Kristof makes some excellent points in his oped Better Roses Than Cocaine.

While I am an admirer of both Hillary Clinton and Barack Obama, I have been quite disappointed with their take on globalization (for the record I consider myself, among other things, both pro-trade and liberal).

At the core of the world's troubles is a question of economic security; you are more likely to be tempted by radical ideologies if you don't have it. In effect, when you have nothing to lose you become fertile ground for anti-social behavior.

Obviously, a lack of economic security isn't the only cause of radical ideologies, and there are many examples of those who are economically secure acting in anti-social ways. (I'm currently reading Confessions of an Economic Hit Man which provides enough examples)

All that said, global stability is obviously good for everyone, but it is especially good for the US as many of the world's problems often come washing upon its shores. Promoting economic security around the world is a far more effective way of, to paraphrase, fighting problems abroad so they don't have to be fought here.

The issue is neatly summed up here:

As she clips flowers in a vast greenhouse, Ms. Reynosa knows that her future depends on access to the American market. She agrees that Colombia has human-rights problems, but she argues passionately that the free-trade agreement is the way to register continued improvements. More trade will mean more jobs and more security and human rights, she argues.

Food inflation and biofuels

Food inflation is terrible but even more worrying are some of the steps being taken in an attempt to manage it.

Run-down on the whole problem in this article: Food Inflation, Riots Spark Worries for World Leaders

Here are some money quotes:

The global effect of export barriers, however, is to drive food prices even higher than they would be otherwise. Such policies "distort global prices," said Mr. Simsek, the Turkish finance minister, in an interview.

Yep, totally agree.

During informal conversations and interviews, ministers mainly agreed that the U.S. policies on biofuels were especially harmful. U.S. ethanol is made from corn, which, ministers said, could be exported to feed the hungry, and benefited from tariffs that block Brazilian ethanol, which is produced much more efficiently from sugar cane.

Ummm... Where have I heard that before?

Food inflation

The FT talks about a worrying trend to restrict global trade in food.

Countries are reducing import tariffs (a good thing) but to maintain some semblance of control over their food supplies, they are propping up export tariffs, which is bad. By reducing foreign competition (because countries aren't exporting as much), such export taxes on a global scale could have the impact of driving up local prices and limiting local supply.

If no supply is coming in from abroad, local producers of a restricted item (say corn or rice) will have an incentive to limit local production in order to drive prices up and make more profit.

I can hardly bemoan a poor farmer trying to make a healthy profit, but the end result is more hardship across a society. With a profit-maximizing farmer reducing supply, there is obviously less food to go around which increases prices and, ultimately, misery.

Ethanol and protectionism

I heard on the radio the other day about how the increase in the general price of food is being traced back specifically to the increase in corn prices. The logic is that corn is an important source of animal feed so as it becomes more expensive, there is a ripple effect that drives up the price of feed which in turn drives up the price of meat.

The cause of the rise of corn prices? Apparently it is ethanol. Because of the alternative fuel craze, ethanol producers are gobbling up supply of corn and driving the prices up. To venture backed ethanol companies, this rise in prices may not seem like such a big deal (and the farmer certainly love it!) But for the rest of us who like to eat, a rise in food prices is yet another dent in our already banged up wallet.

And with that, the two radio shock jocks went on to slam ethanol, the environmental movement, and the whole green craze for causing more trouble that it is worth.

Taking what they said on the connection between corn and food prices at face value (certainly seems plausible), it is still hard to blame ethanol producers for the run up in corn prices. This is not a green question, this is an economics question.

Agriculture is a heavily protected industry in the US (and much of the world.) As a move to boost farmers’ incomes in the Midwest, the US government has been supporting and protecting the US corn-based ethanol business.

There are however rivers of cheaper sugarcane-based ethanol coming out of Brazil. If the government were to relax protection, these rivers would flood into the US market. The result would be cheaper ethanol that would displace the more expensive corn-based ethanol. This in turn would reduce demand for corn and prices would drop. So if the market was allowed to operate unencumbered, we would have cheaper food and cheaper ethanol.

So if the shock-jocks on some random Bay Area radio station are listening, it is not ethanol or environmentalism that is driving up prices, it is agricultural protectionism.

Spinning a Global Plan - WSJ.com

Pretty good interview with IBM's Sam Palmisano talking about global ambitions.

Once again the issue comes up about foreign workers being a competition to US ones. I find this line of questioning to be uncreative.

1) This competition will push US workers into higher value jobs.

2) Opening markets abroad is essentially a form of global income redistribution. IBM (or any other company) actively doing business abroad creates jobs and wealth, which in turn creates new markets for goods and services.

Here are some money quotes:

WSJ: There's a lot of worry that globalization means fewer jobs and lower pay for U.S. workers. Is that a legitimate worry?

Mr. Palmisano: It's actually a big opportunity. Why not take advantage of it? The leading nation in the global economy is the United States of America. Great schools. Great capital formation. A system that works.

WSJ: Some would say that if you're helping Vietnam or South Africa build their education systems, it takes away job opportunities from Americans.

Mr. Palmisano: There is a real issue here where I think we need to do something more [in the U.S.]. IBM announced programs where we'll match money put in a learning account, and you can apply those tuitions to get future skills that you think are necessary for you.

WSJ: Can you give an example of a smaller country where your work has expanded rapidly?

Mr. Palmisano: Egypt's growing like crazy. We have a huge software laboratory in Egypt. It's doing development for IBM: software components and middleware. At the same time, it's doing commercial work, which they would view as an export business, you know, for clients around the world. The commercial business is growing double digits, right? Egypt is one of the largest populations in the Middle East and has a government that's trying to modernize its economy.

Deconstructing Krugman

It seems that few economists can raise the ire of other economists the way Paul Krugman can. In his latest column on trade, Krugman begins to discuss the increasing downward pressure being exerted on US wages by increased trade with developing nations.

As Krugman lays out the basic framework of his argument, he takes pains to state (twice) that he is not a protectionist. He does state in his final thought, however, that we should be wary of knee-jerk acceptance of trade and that we should listen to those who question trade.

This final thought has lead to two interpretations by Dani Rodrik and Greg Mankiw.

For his part, Mankiw seems intrigued by Krugman's thoughts(although would like to see the data backing them up) but wonders if we should take trade-questioners seriously if they are really just closeted protectionists.

Rodrik jumps on Mankiw's statement and asserts that people who question trade should not all by labeled as protectionists.

In fairness, I don't think that is what Mankiw was saying, that everyone who questions trade is necessarily a "protectionist" (which seems to be a bad word in economist circles.) What Mankiw (I think) was asking was if we know someone is a protectionist, should we listen to their views on trade? (presumably because their views will be highly skewed against trade).

My answer to Mankiw is yes, we should list to different (intelligent) views on trade, even if they are posited by a protectionist. Trade is crucially important to the economic growth of humanity and needs to be discussed, examined and deconstructed from many different angles. The purpose of this IMO is not to try to find a way to stop trade, but to continually try to find ways to make it better.

And to Rodrik I would agree that applying blanket terms to describe people's views is not helpful, but that is not what Mankiw was doing in this instance.