U.S. ethanol policy major contributor to global food price volatility

U.S. ethanol policy may be the single most significant contributor to world food price instability, states a Stanford study on the global costs of American ethanol. The rapid rise of biofuels has tied energy and agricultural markets together, making it difficult to assess one without understanding the other.

The price of corn recently hit an all time high, a departure from a long-term trend that has seen the cost of corn decline with each passing decade. Price spikes have happened before, and some experts viewed the latest jump as part of this familiar cycle. Stanford food policy economists Rosamond L. Naylor and Walter P. Falcon alternatively argue in a new paper released in The American Interest that we have entered a new era where agricultural commodity prices are increasingly driven by U.S. biofuel policies. This food and fuel linkage has, and will continue to have, major implications for global food prices and the world’s poor.

Over the last decade, the U.S. ethanol industry experienced a major increase in production and consumption as a result of beneficiary of tax breaks, tariffs and government mandates. In 2005, MTBE was phased out as a gasoline additive because of environmental and health risks, and ethanol became the preferred MTBE substitute. Production was further supported with a mandate to reach a minimum target of 15 billion gallons by 2015. 

A jump in the price of crude oil gave a further boost to ethanol as a potential replacement for petroleum. As a result, 40% of the U.S. corn crop is now devoted to ethanol production. These policies have been promoted under the banner of protecting the American farm industry, securing energy independence, and decreasing greenhouse gas emissions, and they have succeeded on a number of these fronts.

However, as a major global producer and exporter of corn, the rapid rise of ethanol production in the U.S. during such a short period of time has produced a fundamental change in the structure of demand for corn. Increased demand has led to higher and more volatile food prices, not only for corn but other agricultural commodities. If the United States, along with the rest of the G-20, is serious about stabilizing global food prices, U.S. domestic biofuels policy in its entirety will need to be re-examined.

High prices are a boon to the U.S. farm sector, but can be devastating for poor consumers with minimal income to spend on food. Food riots have broken out in several countries suggesting the new volatility in the price of staple crops has had a severe impact on developing economies. Where once the policies of the U.S. helped keep agricultural prices on an even keel, current support for the production of corn-based ethanol has reversed this stabilizing role. 

Given the bullish financial outlook for the U.S. agricultural sector, this is an ideal time to begin dismantling both ethanol and corn (and other major commodity) subsidies. Corn-based ethanol tax and tariff provisions together cost the federal government around $6 billion annually. Cutting these subsidies would help reduce the Federal budget deficit without harming the rural economy.

The trickier political and economic questions relate to reassessing mandates, and are likely off the table with the 2012 elections approaching. This is unfortunate, for these policies will continue to cause unrest in food markets far beyond American shores.