Market Power

Musings by an academic economist on the power of markets and the power over markets.

Monday, January 24, 2005

Ethanol Mandates

Tim Pawlenty, the governor of Minnesota, has proposed to push legislation in the state that would require all gasoline sold in the state to contain 20% ethanol. See here and here and see here for a Google Search with several pertinent results.

Why does this have to be mandated "from above"? From the first link:

“We want to move Minnesota dramatically and boldly toward the development and use of more ethanol and alternative fuels,” Pawlenty said.

Ethanol is made from corn and mixed with gasoline. Experts have said it burns cleaner than normal gasoline.

OK, clean air is nice. But air quality is not that big of a problem in Minnesota. If we want alternative fuels, I think a good place to start is to have a high price of gasoline so that demand for alternative fuel sources will increase and create incentives for people to find and develop alternative sources. What else is at play here?

He said that increasing the use of renewable fuels was one way to lessen the country's dependence on foreign oil.

“Frankly, our national energy policy is going to benefit to the extent we can encourage other states to follow our lead,” he said.

Are we really dependent on foreign oil or do we consume it because other countries have a comparative advantage in producing oil?

Minnesota is the only state that mandates the use of ethanol in gasoline. If it is such a great alternative resource and is so clean burning, why aren't other states, say Colorado and California, following Minnesota's lead? Why would increasing the mandated proportion from 10% to 20% cause others to follow our lead?

OK. What else matters?

Pawlenty said his plan would be a “huge boost'” to Minnesota farmers. ` “I don't have any numbers, but I think we can say in rough terms that it's going to be very significant,” Pawlenty said.

and later....

About 17 percent of the corn crop is now being used for ethanol, said Minnesota Agriculture Commissioner Gene Hugoson.

“When you look at the opportunities that exist for agriculture in Minnesota, for that matter throughout the United States, to be involved with a renewable energy becomes a win-win situation,'' Hugoson said.

Now we are getting somewhere.... a special interest - specifically the farm interest - want to increase the demand for one of their products. I have no doubt that it will be a "huge boost" to farmers. The mandates will increase the demand for corn which will increase the price of corn. But what about the collateral effects to consumers?

I imagine that the reason that there is already not 20% ethanol in gas right now is because the costs of doing so outweigh the benefits. If Shell put ethanol in its gas and began to draw consumers away from Texaco, Texaco would have incentive to put ethanol in its gasoline.

There is an externality argument to be made. Burning marginally cleaner gasoline mostly helps other people, not the person buying the gas. The gas buyer doesn't account for all the benefits from using the cleaner gas, only his/her private benefits. But just because there is an externality does not make it appropriate to mandate the use of the ethanol.

This mandate, if it passes, will also push up the value of land used to produce corn which will give incentives to farmers to take other crops out of production, pushing up the prices of these goods. If demand for these crops is inelastic, expenditures will increase as well. Corn is also used in animal feed, so the mandate should also increase the prices of pork, beef, etc to consumers (PETA may come out in favor of this mandate! Farmers and PETA - talk about strange bedfellows!).

This proposal has bipartisan support. If it didn't, the unsupportive party would not get much support from the farmers.