Ethanol Subsidies Have Many Bad Consequences

0:00All right, next up. He's senior fellow at the policy, political economy, in political economy at the Independent Institute. He edits their quarterly journal, The Independent Review. I'm sure you've seen this publication. He is the winner of the most prestigious prize that the Mises Institute awards. That's the Gary S. Slarbom Prize for lifetime achievement in the cause of liberty. He is the 2007 winner of that prize. He's written a number of books against Leviathan, Depression War and the Cold War. One that is especially near and dear to my heart is this one called Crisis and Leviathan. And if you don't think that is a good book, none None other than Murray Rothbard would assign that in his U.S. Economic History class.

0:55So there is no greater endorsement for a book than that. So we have it on sale and he is here. He can autograph it. He is also going to talk to you today about ethanol subsidies and many, many bad consequences. Robert Higgs. Well, it's a pleasure to be here in Indianapolis today and an experiment as well because I'm going to talk to you about the ethanol program and some of its causes and consequences.

1:44This is a talk I've never given before, so you may consider yourselves guinea pigs. Often people invite me to give talks because they're aware that I know something about a certain topic and they want me to talk about that. And of course that's something I've talked about before, sometimes many times. I have the feeling at times that I'm like this broken and Record that just keeps spinning the same groove over and over and over and so I'm hoping to have a good time with you guinea pigs talking about something I've never discussed publicly before. However, as a prelude to that, I will spend a little time talking about some of the principles that I think are helpful in understanding the ethanol program, why it exists at all, and why it continues in spite of all the horrors that it produces and these are elements of public choice or political economy that apply to many different government programs and it turns out that the ethanol program is a kind of poster child. These principles are especially

3:03is really evident when we look at that program, but they're generally visible in many other government programs as well. Some of the previous speakers have mentioned government ag policy has been around in this country for a long time. It actually began before the war between the states when the patent office was giving away seeds to farmers and then later on of of course the Department of Agriculture took over and expanded that kind of activity and added others and then the state experiment stations were created in the 1880s and I always remember a story about the extension agent going out and finding the old farmer out in I'm from the extension agent for the county. I'm here to tell you how you can farm better.

4:06And the farmer says, I don't need you. You're wasting your time. I already know how to farm better than I am. That was a kind of joke. I grew up on a farm, so the extension agent was really not that much of a welcome A welcome figure when he came around to farms, farmers always knew a lot more than the extension agent did, but at all events we've got many different forms of agricultural subsidies from giving away things such as seeds and nowadays giving away all sorts of things to subsidies technologies that take countless forms, price supports, conservation set-aside payments, guarantees of making up the difference between loans issued and crop values and you name it.

5:04So it just goes on and on and on. And even the ag economists have trouble, I think, keeping up with this. I want to second what Tom DiLorenzo said about Zeke Pesar. He really is excellent, and I want to add to it that one of my Ph.D. students from the days when I taught at the University of Washington, Randy Rucker, who teaches at Montana State University, has become a co-author with Zeke, and so they now have a book together which is the best book I know of, I believe this is far and away the best book you could read about agricultural economics and the role of government policy in it, PESAR and Rucker.

5:50And that happens to be one of the books produced by the Independent Institute with which I'm affiliated. But the first point I want to make to you is when the government goes out and injects itself into the market system It never does just one thing. It can't go in there with kind of a surgical strike, as they would say in the Defense Department. Even though the main intention may be one thing, such as raising the price of corn to a higher level than it would achieve if we didn't put the government into the market, Even if that succeeds, and especially, in fact, if it succeeds, other things are going to be affected.

6:44And, of course, this is no secret to the people who exert influence on the making of ag policy. And, in fact, historically, some of the guiltiest parties behind agricultural policy making are not farmers at all. But people associated with farming industries in some way, especially as suppliers of farm products, as banks that make loans to farmers, as purchasers of farm products, and so forth. Farming is part of the great division of labor and it's associated with a lot of other interests. and often times those interests have more clout in policy making than the farmers themselves.

7:33One of the good illustrations of that was that when the Agricultural Adjustment Act was passed in 1933 and the Agricultural Adjustment Administration was created to administer the act, the government had to appoint somebody and it appointed a man named George Peake. Peek was not a farmer. Peek had been the president of the Moline Plow Company. But of course, all of these equipment companies understood that if something could be done by the government to give higher incomes to farmers, they would in turn, as Doug was suggesting in his talk about the history of Kansas, they would use some of that higher income to buy equipment.

8:18And so the equipment manufacturers were part of the politicking that gave rise to this first great attempt to have widespread detailed government planning of agricultural output and prices from 1933 on. There have been countless changes over the years in the details of the ag programs, but And in many ways, there's been continuity all the way from 1933 to the present. So that's principle number one. You can't do just one thing when you intervene. You're going to affect a lot of other things. And because of that, people who have other interests besides farming are going to become players in policymaking.

9:13A second principle relates to what is sometimes called the bootleggers and baptists model. And I'm sure some of you have heard of this, but if you haven't, I'll give you a quick rundown. Bruce Yandel, an old friend of mine who teaches at Clemson, or is still associated with Clemson, I'm not sure he's still teaching actively, but Bruce came up with the idea that a lot of policymaking may appear on the surface to be the result of ideological zealotry or even religious zealotry. So that in the case of prohibitions against alcohol sales in many states, even after the End of National Prohibition and before National Prohibition for that matter, many states and local government jurisdictions prohibited sales of alcoholic beverages or they restricted sales such as not allowing sales on Sunday even if it were legally permissible on other days of the week.

10:26So Bruce said, we've got the Baptists, and they appear to be the ones that are backing these alcohol prohibitions. And sure enough, you know, the Baptists weren't ashamed of their faith. They would be very happy to stand up in public or even in a meeting of the state legislature,

11:21alcohol prohibitions, you might soon come in places like the South, where there were lots of Baptists and they therefore had some political clout, you would find the bootleggers. Because whenever government forbids commerce in some good or service that people really demand, people are going to look for a way to satisfy their demands. And if they have So when you make prohibitions on commerce and alcoholic beverages, you have bootleggers. And of course, during prohibition in the 1920s, we had tremendous involvement of organized crime. Because, you know, they stand ready to involve themselves in illegal activities. That's what they do.

12:10That's how, in large part, they make their money. So Bruce said what happens here is you have a de facto alliance. The bootleggers and the Baptists are in fact pushing for the same thing. The bootleggers want these alcohol prohibitions because that's what spills over into a demand for their supplies. If alcohol sales were completely legal, people would probably buy it, you know, it's cheap legal sellers rather than maybe paying a little more for bootleg product which is higher price and the risk associated with producing and distributing illegal product and and that adds to the to the cost and into the ultimate price of the product so so a lot of times you have bootleggers and Baptists working and this has become a metaphor and in the case of the ethanol program you had originally a lot of environmentalists and they were they were the Baptists here because they look like zealots that despise the automobile and they despise the internal combustion and they despise petroleum and its products, all of which were connected

13:19with what they viewed as the despoiling the planet. So they wanted to somehow get away from the automobile and the truck and all of these

14:01People that saw a chance to produce alternative fuels rushed into that opening and made their own voices known in the political process, made their own money felt by the politicians who had some power to decide these policies. So now we've got our own bootleggers and Baptists in the ethanol situation. All those people who produce ethanol or indirectly benefit from its production and all these zealots who at least in the beginning favored the ethanol program because it would be a slam against oil and oil burning vehicles.

14:54Well, as often happens, you have changes, and conditions may change in a way that makes it appear that a policy that was created is no longer politically viable, no longer has the same support, and that happened in the ethanol case, because the environmentalists began after a while to see that ethanol production and use was actually, as they saw it, harming in the environment. It wasn't the improvement that they thought it would be. They thought, oh, anything you do to reduce the use of oil products is good for the environment. But then they discovered that when you encourage ethanol production by subsidizing it, and therefore that spilled over into the demand for ethanol inputs, namely corn for the most in this part, the farmers grew more corn using more pesticide and more fertilizer and there's more runoff of these things into the waterways and so that was bad for the environment.

15:57So ultimately they turned against the ethanol program and recently they've politic actively in opposition to it and sought to end this subsidy but subsidies once put into play are are difficult to eliminate. Because of a number of things, one is there's simply political entrenchment. The people who benefit from a policy become closely connected with the people who sustain it in the Congress or the state legislature. They donate to politicians financially and they support them in other ways. And so politicians don't want to give up that support and benefit. The Transitional Gains Trap

17:12And as a result, that asset becomes more valuable. People are willing to pay more for an asset when it has an additional stream of income associated with its ownership. So if you subsidize, say, corn, land suitable for growing corn is bid up in the market. If you subsidize ethanol, These plants that are built to produce ethanol certainly have a higher value than they would have without the subsidy. In fact, in this case, they would probably have almost no value except junk value. You know, hauling away the metal and crushing it up. Because this entire ethanol industry is the product of the subsidies. It barely existed before these subsidies were put into operation.

18:01But, if you create an asset, if you create an additional revenue stream and cause the value of assets to be bid up, then people who come along and get into the business later, you know, they have to pay that higher asset value to enter the business. Even if there's no special gain to them, even if, you know, now, even with the subsidy coming to them, they don't make an unusual rate of return on producing ethanol. They had to pay to get that revenue stream, so we say that that revenue stream has been capitalized into the price of the asset. And because they've paid for it, they sure as hell don't want it taken away from them. They could say, well, we're not guilty of this.

18:48I paid full price for this asset and now if you remove the subsidy, you're going to remove You have a revenue stream flowing to this asset, and you're going to hurt me. And so when people anticipate economic hurt, they fight against it. So once you create a government benefit of any kind, you create a potential transitional gains trap. You get into something, you can't get out of it. That's the trap, okay? And so you have, for this and other reasons, you have a kind of ratchet effect, as I call it, in the expansion of government power. Government power is easier to increase than it is to diminish once it's been created.

19:34And this takes countless forms. But it's certainly taken that form in the ethanol case. And of course, at the end of the day, what we have here is a situation very much like and others, in which the benefits of this program are highly concentrated, pretty much just in the form of continued flow of revenue, mostly through tax credits, to people who produce ethanol or purchase it and use it for blending in fuels, which the law also requires them to do in certain amounts. So there's a mandate to use ethanol, and on top of that, the people who buy it and use it are subsidized to do so with a tax subsidy and other subsidies.

20:31There's a whole list of ethanol-related subsidies in operation, some federal, some state. And all of the states have some form of activity that has the effect of subsidizing the use of ethanol. But the upshot of this is we have a massive amount of loss. The ethanol subsidies are worth about $6 billion a year right now. And they're going to stay there or grow even. And this is the loss of taxpayers, loss of consumers. The ethanol blended gasoline gets worse mileage when you burn it in your car or your truck, and as a result you end up burning more fuel than you would otherwise to go the same distance.

21:17So it's kind of another way of offsetting any gain that the old environmentalist thought would flow from using ethanol instead of petroleum-based fuel. And the whole thing is just a disaster, but it seems impossible now to get rid of it. In fact, it just happened yesterday, I pulled up an article from The Guardian in the UK, and one of the sentences here says, the ethanol mania has verged on the bizarre. And that's certainly true. When you look at this, it's now at the point where the environmentalists hate it, the consumers hate it, people who drive cars and trucks hate it, you know, tout le monde hates this This thing, but you've got a handful of producers who own these ethanol plants. They're now somewhat more than 200 of them in the country, most of them here in the Midwest. And you've got a larger number of corn farmers. And these are the principal beneficiaries of these subsets.

22:20In fact, it's pretty hard to find anybody else who's gained, except perhaps a few input Suppliers for these people. But it's bizarre that this thing exists. Now, people are now trying to get rid of it. And in fact, there was a move when it was renewed at the end of last year in Congress that kept it from being renewed for five years, which is what looked as if would follow, but Senator Feinstein and Senator Kyle and about 15 other senators joined forces to work in opposition to the renewal of the ethanol subsidies.

23:09They were not successful, but what happened is that the subsidies, the main one, was renewed only for one year rather than five. So this battle is going to come up again in about 7 months and have to be re-fought again. And it may be that one of these days the political forces that oppose this subsidy will succeed in getting it tossed out. But meanwhile, those who are keeping it alive, you might be able to guess pretty much all The senators and representatives from the corn-growing states have lined up to back this program and in fact I found a study by a website called Open Secrets Blog which tracks There's a lot of money flowing to politicians from various organized groups and other donors and it turns out there's a lobby, you would expect that the senators are collecting very large amounts of donations from Arthur Daniels Midland, National Corn Growers Association, an outfit called POET, which is an ethanol producer, from something called Growth Energy, that's another one of them,

24:35and from Iowa Renewable Fuels Association, so you know, all the direct beneficiaries of this program are lined up giving tons of money to Chuck Grassley, who's the committee Chairman that deals with these things, so he gets the most. But then you have a bunch of other senators and representatives also raking in extraordinarily large amounts of money from these same interested, organized political groups. And on the other hand, you have these people I mentioned, the Feinstein-Kyle faction that have expressed its opposition recently, and if you look at where their money comes from, voila, of course, they don't get much money at all from these groups like the National Corn Growers and the ethanol producers associations and what have you, so it's just a classroom illustration of concentrated benefits, dispersed costs, a lot of ideological smoke being blown, across the whole undertaking as usual because nobody wants to come out and say look we're robbing you and we can do it so we're gonna they never say that they they always give you these reasons and and they're still standing up in public and talking about how this ethanol subsidy is great for the environment even though the environmentalist groups no longer agree but when Chuck Grassley gives a talk he talks about how great it is

26:13is for the Environment, and how it produces jobs, and every time you say the magic word jobs, you know, people fall down like they're having an epileptic seizure, and politicians know that, so they keep expressing the mantra jobs, jobs, jobs. It's like one of Bob Murphy's and the job zombie is at work here defending this program and also the talk about the programs creating market stability. And this is another one of the excuses that have been trotted out time and again to justify by Agricultural Subsidies, going back certainly to the 1920s and 30s, the idea that if markets are left to themselves, there's so much volatility that it's horrible. It's horrible not only for the producers, it's horrible for the consumers. They never know what the price is going to be for the product, so government can intervene and produce stability. Well, my advice to to you is whenever you hear anything in politics justified on the grounds that it's there to produce stability and I don't care whether we're talking about foreign policy or ag policy,

27:36you know you're being taken in. That's not what it's for. Follow the money. Thanks.