Friday, July 13, 2007

The True Cost of Ethanol

Shortly after Hurricane Katrina hit, when people were charging huge amounts of money for bottled water, John Stossel wrote an article that defended so-called “price gouging.” (John Stossel: Price Gouging)

He used a standard claim that one of the virtues of a free market is that it guarantees that resources go to those who value it the most. If one person is only willing to pay $20 for something, and another is willing to pay $21, then this implies that the second person values the water (or what she can do with the water) more than the first. We should praise the system that makes sure that resources go to their most highly valued use.

Or so the argument goes.

However, this claimed benefit of free markets is quite simply false. Free markets do not distribute those who most need the product. It distributes goods to those who can most afford the product. Often, those who need the product are not those who can afford it.

This is, quite simply, one area where free markets utterly fail to fulfill desires.

In my earlier post I illustrated this point by suggesting a scenario where a person with a dehydrated child goes up to somebody selling water for $20 per bottle. But, what if she does not have $20? She doesn’t get the water. However, somebody else going up to the same water seller, who wants to use a bottle of water to shampoo her poodle, will get the water.

Clearly, the water did not go to those who most needed it. It went to those who could most afford it, even if what they want it for is something that has trivial value.

If the poor woman with the sick child had the same size bundle of cash as the rich woman, she would have certainly outbid the rich person for the water. What kept her from bidding more was not that she did not value the health of her child as much as the other valued a shampoo for her poodle. What kept her from bidding more was the fact that she did not have the ability to express her values in market terms because of a lack of money.

The situation regarding the use of some (though not all) forms of ethanol is exactly the same. Most ethanol is made from food – or from resources that could have otherwise been used for growing food. What we have is a situation where billions of poor people want to buy food for themselves and their children. However, wealthier people are willing to bid more for those resources to feed their demand for fuel – much of which goes for recreational or other non-essential uses.

It is the same situation of rich people bidding essential resources away from poor people who have a higher-valued use for those resources, but who lack the ability to express their preferences in market terms.

Compounding the Problem through Regulation

This analogy is not perfect, of course.

We confront one of those limits when we recognize that, in the case of ethanol, we are talking about a subsidy that will increase the demand for the materials that go into the production of food, and food itself, in the face of a population that is not able to afford the higher prices.

It is as if, in the case of a water shortage, the government introduced a low that required people to replace the practice of heating food over a fire with boiling it. Not only will poor, in this case, need to deal with the wealthy bidding away the last bottles of water to shampoo their poodles, they will also have to struggle against the demand for water created by this new requirement for boiling food. This will make their situation that much more desperate.

The analogy is found between requirements to consume water in boiling food in the analogous case, and consuming food as automobile fuel in the ethanol case.

Imaginary Benefits; Real World Harms

I find it particularly tragic when an individual goes to bed, wrapping himself in a warm glow of pride, thinking that he has done great deeds and made the world a better place, when, in reality, he has made the situation worse. I compare it to a person hooked up to a machine that feeds experiences directly into his brain. In this case, the machine makes him think he is a surgeon saving children’s lives. He is proud of his work, and there is nothing that he would rather be doing. Only for every fictitious life he saves, a real child is tortured and killed. If he were merely to give up the practice of saving children, the real-world children who face torture and death because of him will be spared.

The advocates of ethanol are much like this hypothetical doctor, thinking that they have done good deeds while real-world children are made to starve because of their actions.

There is an important difference between the ethanol case and the experience machine. Ethanol advocates face a world where, if they look, they can see the arguments against their position.

Then I imagine the person in the experience machine being woken from her fantasy. She is told that, while she is hooked up to her machine, every fantasy child she saves results in the torture and death of a real-world child. Yet, she still protests that she be placed back into the machine. “There, I was somebody important. I was a doctor. I was saving children. I demand that you return me to the machine.”

Answer: “No, you were not saving children. You were torturing children – or bringing about their torture, even if you were not doing so intentionally.”

We see this type of denial and continued harm in the Bush Administration. They did not want to believe that invading Iraq would lead to problems. They wanted to believe that attacking Iraq was a good idea, so he simply ignored any evidence or arguments that were brought up against it. It is something they had a great deal of practice in. One of the traits that their religion promoted was the ability to ignore evidence and to stick with an idea on the basis of faith alone. “Invading Iraq is a good idea. This evidence, or these arguments, suggest that it is not a good idea. Therefore, this evidence, or these arguments, must be flawed.”

Again, in the case of ethanol subsidies and requirements, the argument has the same form. “The use of ethanol is a good idea. This evidence, or these arguments, suggest that it is not a good idea. Therefore, this evidence, or these arguments, must be flawed.”

Demand and Supply

There is one more complication that deserves our attention. As a matter of fact, we are not talking about a world in which there is a limited resource. We have the ability to grow more food-stuffs, either for consumption as food or consumption as fuel. We are assuming that the additional demand will increase price. That extra price, in turn, provides an incentive to increase supply. At least some of that extra supply of food-stuffs can be made available to those who are starving.

However, this whole mechanism requires the incentive of higher prices, which is exactly what keeps food out of the mouths of those who have a higher-valued use for this product but no way to make their preferences known on the free market. We are still creating a situation where rich people are bidding food away from poor people so that rich people can have fuel for their vehicles. The slope may be less steep than I described it in the sections before this, but it still exists.


Given the particularly high value of food to those who are starving, there is no justification for subsidizing the use of food stuffs for anything other than this high-valued use until all of the starving people are being fed. If there are any subsidies to be had, they need to go first and foremost to the use of foodstuffs for their most valued use – feeding the hungry (particularly hungry children).

Any food stuffs above and beyond that are surplus can be made available for other uses, such as ethanol. Any food stuffs below this limit of adequately feeding the population means bidding food away from the starving in favor of the least-valued uses that we may find for ethanol.

Of course, the issue of providing food to the poor is more complicated than I made it here. Too often, the food is available, but political or social barriers get in the way - such as tribal warlords and national leaders holding whole populations hostage demanding payment before they would let the food through. These issues do not affect the principles outlined in this posting. It does, however, argue for the moral merit of eliminating these barriers.

We can imagine the case of the two women bidding for a bottle of water and ask ourselves what we think of the woman who bids $21, keeping the water out of the hands of the mother with a sick child who only has $20. What type of person would do that?

It’s the same type of person who would bid up the price of food stuffs so that it could be used in recreation, taking it away from the mothers who need it to feed their starving children. We are that type of person, if we advocate and support such a policy.


BlackSun said...

I'm with you as far as removing subsidies from ethanol. I'm with you as far as outlawing externalities. Very good points.

I have to part company, however, when you insist that the severity of a person's need should determine their ability to buy something. This to me is drifting dangerously close to flat-out socialism.

Putting the discussion of externalities aside, we cannot know what got a person into a situation where they cannot afford to buy necessities. But we can say that if everyone knows they will have to buy them, they can and should plan accordingly.

In a world without destructive subsidies, there will still be haves and have-nots. As soon as you start giving things to the have-nots, they will expect the handouts to continue and you will create a permanent dependency.

If we are to engage in handouts, it should be at the barest minimum subsistence level, so that people will be discouraged from relying on them.

I agree with a strong framework to encourage voluntary charity. If people are as ethical and compassionate as they claim to be, it should not require coercion to get them to take care of the poor.

Anonymous said...

Blacksun, I think Alonzo was arguing that the situation he's describing artifically increase the price of food beyond what a poor person can reasonably afford. It didn't seem to me like he was advocating handouts so much as pointing out that this is an inappropriate use of resources. Perhaps he'll come by and clarify this point.

The craziest thing about the current policy, in my opinion, is not the use of perfectly good food to make fuel, which is crazy. But that we can make enough ethanol from various waste sources that using food isn't even necessary to fill the demand! So, it's more like the rich woman in the story insists her poodle must bathed in purified filtered water instead of a readily available store of water that's not suitible for drinking, but is fine for washing a dog.

Sheldon said...

Blacksun said
"This to me is drifting dangerously close to flat-out socialism."

GASP! No, not that, flat-out socialism! How horrible! (Do you watch the O'Reilly factor?) But what is "flat-out socialism"?

"....we cannot know what got a person into a situation where they cannot afford to buy necessities. But we can say that if everyone knows they will have to buy them, they can and should plan accordingly."

And why and how do you presume to know that they can plan to buy these neccessities? Perhaps this is the case in some universe imagined by libertarians, but not in the universe in which we live.

Lets be explicit in who this case might apply to. For example a former peasant woman and child in some third world country. Due to market forces, her family has been dispossessed from their small land holdings. There has been innadequate social investment in waste management systems, and systems that provide potable water to the public. Industrial ranching and agriculture, which primarily produces food stuffs for export has left ground water contaminated. These same enterprises only offer this woman the most pathetic wage, innadequate to buy bottled water. If her and her fellow citizens organize to demand better wages and public utilities, then those capitalist enterprises can always pack up shop in search of a more desperate and compliant population.

Now tell me Blacksun, continue with this very real world scenario and explain how you know that "they can and should plan accordingly."

BlackSun said...

There has been innadequate social investment in waste management systems, and systems that provide potable water to the public. Industrial ranching and agriculture, which primarily produces food stuffs for export has left ground water contaminated.

All textbook examples of market failures based on unpaid externalities.

Do you watch the O'Reilly factor?

i.e. everyone who doesn't buy into my raving coercive anti-capitalist worldview is a raving fascist.

(No, by the way.)

Sheldon said...

"i.e. everyone who doesn't buy into my raving coercive anti-capitalist worldview is a raving fascist. (No, by the way.)"

Ah shucks Blacksun, maybe we got off to a bad start. And maybe its my fault with that question that could have seemed like a cheapshot. Its just that your comment reminded me so much of a slippery slope to "socialism" argument made by O'Reilly, and the premise that anything deemed "socialist" is to be assumed bad in the first place.

I have visited your blog (before today), I know you are not a fascist, nor did I imply that you are. So don't imply that I did.

In fact, I thought I made it quite clear that I read you as operating under a libertarian like paradigm. If I am wrong on that, then correct me on that. I make distinctions, give me the credit for doing so.

And while I confess to being close to some type of socialist, it is a pragmatic type that sees a legitimate role for capitalist enterprises and socialist sectors (i.e. a mixed economy). Therefore the "raving anti-capitalist" does not quite apply.

Now that we have cleared the air a little bit, maybe you could respond to the meat of my objection.

You claim that we cannot know how some hypothetical have-not came to the circumstances that they are in.

I claim that we can analyze political-economic processes to know how many of these "have-nots" comes to these circumstances. The scenario I describe, that of third-world small-scale agriculturalists who become dispossessed from their means of production, and thus turned into wage laborers is a real world process that has been occurring for some time now.

You make the claim there will always be "have-nots", no matter what type of political-economic circumstances prevail. This seems more of a rationalization for not dealing with problems of poverty.

You claim: "But we can say that if everyone knows they will have to buy them, they can and should plan accordingly."

This reveals an often criticized premise of classical liberal economic theory. That is the assumption that people have adequate knowledge of the market. I claim in the real world they don't.

Next, you claim:
"All textbook examples of market failures based on unpaid externalities."

As for waste management and potable water systems, has there ever been a case of these critical infrastructures being put into place without a significant role being played by the state public sector? I don't think so. Market failure would always be the case here.

Could it be that if capitalism was not able to externalize costs, then the system itself might cease to exist? That is not a rhetorical question, and one that I do not presume to know the answer to.

Libertarian theory also seems to ignore issues of social and political power. That is they presume that people enter into the market on a equal footing with everyone else.

BlackSun said...

Hi Sheldon. Sorry about that. Yes, I did interpret that Bill O'Reilly thing as a cheap shot.

I'm kind of a libertarian, but not really. I think everyone should pay for the consequences of all their actions. I think to do otherwise is ultimately no different from stealing.

But I also think that life cannot be made fair. Sometimes people's exercise of their legitimate rights, even when they pay all the costs, are still going to affect others.

I think adjudicating these types of disputes is extremely important and complicated, and cannot be lumped under one system or another.

Now to your objections about insufficient infrastructure investment. I have no problem with whether these things are done privately or publicly. They key is accountability and transparency--so that users of services pay for them.

If an international conglomerate comes into a country with insufficient infrastructure, then industrially farms it or extracts resources, leaving it polluted, that company is guilty of heinous crimes and everyone who benefited should be prosecuted.

In a world I'd like to see, all such companies should be forced to contribute to the infrastructure and leave the land, groundwater, and everything else better than they found it. If they take resources, they should put money into a depletion fund (the resources can be said to be the endowment of the population).

That would be simply the cost of doing business. A side benefit would be better relationships with the host country, healthier workers, etc. Most of what's wrong with capitalism has to do with focusing on short-term results and ignoring the longer-term picture. This must be stopped.

But what I object to is taking an example of capitalism in the throes of its worst abuses and using that to argue for replacing it with equally corrupt nationalized industry.

It's not government vs. private that I'm concerned about (unlike most libertarians). It's transparency and sustainability.

We should support whatever structure can provide the best results.

I do object to socialism on principle. Entitlements kill motivation and destroy creativity.

There's a lot wrong with the world, I don't have all the answers. But I think I'm getting closer to asking the right questions.

Hume's Ghost said...

"Entitlements kill motivation and destroy creativity."

There is not a necessary conclusion in this statement. Many of the world's most motivated, creative, and brilliant individuals were part of a leisure class that inherited wealth and/or lived off the labor of others.

Bertrand Russell addresses the issue of balance between need, want, motivation, conformity, and creativity in his 1917 work, Political Ideals. I abridged it, here.