Thursday, November 01, 2007

Subsidies, Special Interests and Biofuels: Wolf speaks

Martin Wolf of the FT writes an excellent article on the farce that is the Biofuel industry. The economics of biofuels is complex and it is my no means clear that Biofuels offer a golden bullet on climate change - far from it as Martin Wolf points out.

The article is free if you register at the FT and includes a good commentary and diagrams. I merely report the problems with the "5 rationalisations".

This article should be a wake up call to pro-biofuel proponents to get their house in order.

Martin Wolf got his analysis from the Global Subsidies Initiative (so Wolf is not so different to your average econ-blogger really).

Biofuels: a tale of special interests and subsidies

Energy security and climate change are two of the most significant challenges confronting humanity. What we see, in response, is the familiar capture of policymaking by well-organised special interests. A superb example is the flood of subsidies for biofuels. These are farm programmes masquerading as answers to energy insecurity and climate change. Not surprisingly, they have the depressing characteristics of such programmes: high protection, open-ended support to producers, and indifference to economic rationality.

Already the support in members of the Organisation for Economic Co-operation and Development costs about $13bn to $15bn a year. But this sum generates much less than 3 per cent of the overall supply of liquid transport fuel. To bring the biofuel share to 30 per cent, as some propose, would cost at least $150bn a year and probably more, as marginal costs rose.

Here are the 5 rationalisations for the high subsidies and special interest group activities:

Is it possible to justify this cornucopia of complex and expensive subsidies, mandates and protectionist measures? No. But that does not stop people from trying. Indeed, they point to a host of different (and often changing) justifications, as is too familiar from the history of farm policies. Here are just five of them.

Rationalisation one: biofuel subsidies reduce farm support payments. But, in fact, US evidence strongly suggests that these subsidies are being piled on top of existing farm subsidies, not replacing them.

Rationalisation two: mandating biofuels will lower petrol prices. But it is obviously mad to try to lower the price of a commodity by subsidising the production of more expensive alternatives.

Rationalisation three: subsidising biofuel is an efficient way to reduce reliance on risky fossil fuels. But biofuels are, under current technologies, complements to, rather than substitutes for, fossil fuels and are also vulnerable to their own risks of weather and disease.

Rationalisation four: subsidising biofuel is an efficient way to reduce greenhouse gas emissions. According to the report, the cost of eliminating a tonne of carbon dioxide equivalent through biofuels varies from a low of about $150 to as much as $10,000. Even the lower of these figures exceeds almost all estimates of the marginal benefit of reducing a tonne of emissions. It certainly much exceeds the cost of many alternative ways of doing so.

Rationalisation five: subsidies are only needed to establish the infrastructure. But if biofuels are to be competitive, it will be unnecessary to subsidise the infrastructure. Investors can do that for themselves.

What then should or can be done?

So what should be done? Here are some simple negative suggestions: eliminate increasingly popular (because apparently costless) mandates to use specific quantities of biofuels, since these shift all the risk of fluctuations in demand and supply of foodstuffs on to their use as food; discipline the stacking of subsidies on one another; and eliminate all open-ended supports for production before these become impossible to reverse.

Here, also, are some positive ideas: define the objectives and instruments of policy precisely, in terms of the overall goals of energy security and reductions in emissions of greenhouse gases; create a single global price of carbon that governs all activities; make producers compete for any support that is offered; let the markets decide on sale of flexible-fuel vehicles (and indeed the energy efficiency of vehicles); and, above all, move to free trade in biofuels.

We should at least try to learn from painful experience with a century of farm policies. I know that is naive. But is it impossible to respond to the big challenges of energy policy and climate change by applying a little intelligence, for a change?

An excellent conclusion and bang on the nail.


No comments: