“Key ideas, missing in energy policies such as the new ethanol proposal, are that authentic market information as well as incentives matter in creating economic opportunity, wealth and prosperity throughout a nation. It’s part of the mystery of capital and capitalism.” This Free Market Minute is a carryover from the previous FMM, which discussed some of the issues surrounding a federal energy policy to increase the use and production of ethanol for fuel. Owing to the number of issues surrounding this topic, it’s closer to a two-minute Minute.
No discussion of a policy as far-reaching as government-promoted ethanol could avoid the issue of trade-offs. Any time government promotes a product, research agenda, or technology, trade-offs occur on several levels. In the short run, when government revenues are directed to ethanol production, they must be diverted from other competing public projects. Divorced from most of the normal market constraints of profit, loss, and risk assessment, it is especially hard to assess the worthiness of government projects; decisions are often made on the basis of political and other criteria, rather than consumers’ wants or the profitability of a good. Long run, we don’t know if this is an appropriate concentration of resources; other needs that are sacrificed cannot be know because they will never come to be.
Ethanol development policy is an example of another type of trade-off as well—the shift in the composition of output that occurs when more resource decisions are made by government, and fewer decisions are left in the hands of private resource owners. One has to wonder what would have happened to the energy market had industrial policy, rather than technology and entrepreneurial spirit, been calling the shots in the era when whale oil and the horse and buggy were the standard-setters in the energy and transportation markets. Instead, the whales were saved by capitalism, and society advanced en suite.
The more of the corn crop that is demanded for the production of ethanol fuel, the scarcer domestic corn will become for every other use . That means that ethanol producers will face—indeed already are facing—rising prices for their primary input. With corn relatively more scarce in every use, higher prices are needed to allocate output and coordinate plans. And prices have risen worldwide as the number of ethanol plants and ethanol production has increased.
Keeping in mind that one purpose of U.S. ethanol policy is to push the U.S. away from the uncertainty of petroleum supplies and U.S. vulnerability world political events, a fair question would be “Can ethanol do this?” The answer is at best uncertain. Agricultural production as a source of energy, particularly if we are counting on domestic sources, is a business subject to the vagaries and risks of nature, rather than those of the political world. Either one poses an economic challenge. One reason that corn prices are spiking now is the policy attempt to switch away from gasoline.
In the end, ethanol as fuel may make us no less vulnerable to energy bottlenecks than we now are, while potentially increasing our vulnerability in another critical area: foodstuffs. Higher prices for corn raise the prices of all of the products (foodstuffs and non-foodstuffs) that use corn as an input. But that’s not all—the prices of goods that can substitute for corn, whether in energy, food, or other production, will go up as well. The reason is simple. When the price of one input or product goes up, people try to use a substitute that is relatively less expensive. Choosing a substitute pushes those prices up as well. In the longer run, corn production may catch up to bring prices down, as it has periodically with gasoline after a short-run price spike, but this just makes my point in a different way. There are alternatives sacrificed and a perhaps precarious reliance on one output.
Another example of ethanol policy’s unintended consequences is occurring in the U.S. sugar market. The sugar market is relevant to the energy discussion because the technology exist to use sugar as a substitute for corn in producing biofuel. However, our existing sugar policies protect U.S. production from world competition through a complex series of quota arrangements. The result: the price of U.S.-produced sugar is at least twice that of imported sugar. Fortunately for consumers with a sweet tooth, there are substitutes for sugar. Unfortunately, one of the best substitutes is—you guessed it—corn syrup.
So U.S. sugar quotas are saving jobs and protecting incomes in the U.S. sugar-producing industry, at the expense of jobs in the sugar-using industries, and costing consumers more money for all kinds of products.
To be clear: as far as I know, there is no reason to object to using corn as a source of fuel. There are plenty of reasons to object to a policy that directs corn into use as fuel, however. Central planning, even writ small, never works as an economic proposition, but neither is it neutral in its effects.
Modern central planners who reject Soviet-style planning, assume that they know much more than they can possibly know. The real harm is in what planning leaves behind: it brute forces economic decisions, distorts economic information, redistributes costs and benefits to individuals according to political or social standards, and capriciously deprives some individuals of wealth while enriching others.
Without genuine market data, the relative value of economic decisions (to ‘go ethanol,’ or not) is obscured. That may help to get the policy passed—it doesn’t make the policy a success. At the same time, it is in no one’s particular self interest to ensure the best possible, most efficient outcome from conversion to ethanol, or one that serves consumers best.
The question with ethanol (any industrial planning policy) is: “Do we adjust our freedoms to fit the policy, or formulate the policy to comport with our freedoms?” Within the context of a free society, I suggest that the desirability of policy should be judged on whether it supports the minimum standard of free enterprise: private ownership and decision making with respect to one’s resources, security in one’s property rights, and individual liberty. Otherwise, we ourselves are laying bricks in the road that Hayek so feared we would build.