Iowa State Studies Effects Of Ethanol Subsidies

Iowa State Researchers have been studying the effects of ethanol subsidies on the the welfare of producers and consumers as well as as on the fuel market. They looked at the effects of the 51 cent ethanol blenders credit, the 54 cent ethanol import tariff and the ethanol mandate. After adding all the pluses and minuses they concluded the overall results of the ethanol policy have been positive.

Ethanol production in 2007 provided a benefit to corn, ethanol producers, gasoline/fuel consumers, and taxpayers. It reduced welfare for grain consumers and gasoline refiners. The overall net welfare gain is approximately $2.65 billion.

This came as somewhat of a surprise since subsidies generally create market distortions but in this case they concluded that it reduced market distortions that already existed as a result of farm subsidies.

Government support policies coupled with high energy prices stimulated a rapid increase in ethanol production and associated welfare transfers in multiple markets. We find that the net welfare change of the U.S. ethanol subsidy is positive. This result is counterintuitive because the first fundamental theorem of welfare economics would suggest the market-distorting ethanol subsidy could not be welfare enhancing. The markets for agricultural commodities, however, were not competitive prior to large-scale ethanol production because there was already significant intervention in the form of farm subsidies. Our results show that subsidizing U.S. ethanol production actually does improve aggregate welfare, a result that is robust with respect to a reasonable range of alternative parameter values. By reducing the distortion from farm payments in agricultural commodity markets, the ethanol subsidy—even though market distorting itself—reduces net distortion.

Source : Ethanol: A Welfare-Increasing Market Distortion?