More Meddling in Markets or "The Problem of Too Many Balls in the Air" Revisited

     We have in the US energy policy regarding ethanol an illustration of the classic problem in economics which I like to call "too many balls in the air".  When it comes to economic thinking and analysis, individuals or groups with "skin in the game" tend to focus tightly on the single variable they want to improve (like the corn price in the case of ethanol) and fail to understand that markets are complex interactions of sometimes hundreds of linked transactions and markets all of which can and usually are affected by extra-market interventions to move the target variable.  There are economic models that can and do attempt to account for all of these impacts simulataneously and track the movement to a new equilibrium in all affected markets but they can be large and clumsy and not very good at tracking the short term movements to new long term equilibria.

     A good illustration of this is the ethanol policy.  By subsidizing ethanol and mandating its use, the government has stimulated nothing short of a gold rush to build plants and to plant corn.  We have all witnessed how the related markets have been affected.  Land values, corn production inputs such as fertilizer, seed, and combine prices just to name a few shot up dramatically.  Pulling land out of other crop production to focus on corn caused soybean production to fall and its price as well as related product prices to advance substantially.  Where corn was used as a feed input in meat production, dramatic cost of production increases forced albeit limited substitution of corn and what is arguably the single greatest equity drain catastrophe in the history of the hog business.  One prominent agricultural lender believes that the industry is now within 90 days of a near complete liquidity freeze up (out of operating capital and no additional willingness to loan) and we all know the saying, "When you are out of cash, you are out of business".   

     The collapse of the global markets brought everything back down to earth.  The collapse of gasoline prices drove ethanol profitability and the ability to move the growing supply into the ground.  Well capitalized plants with strong management bit the dust leaving participating corn farmers in their shadow holding worthless commitments to buy corn at once inflated prices which now had vanished.  Puzzling as it may seem, the government reaction to this is to move in behind the collapse and fix the problem with more market distorting policy actions.  Since the government now has a management position in much of the automobile industry, it will start by forcing a ramp up in the percentage of vehicles produced that can utilize E85.  Next, it just announced a program to push cash into faltering ethanol production plants to make sure they are as immune as possible from another round of market-based signals to shut down.  Force an increase in demand, cushion and prevent management failure to operate at a profit.  How can this lead to anything but another mess and de-stabilization of the delicately balanced agricultural complex?

     The policy makers and narrow agricultural interests who like to think they are performing a nice juggling act by tossing this one ball in the air have just been blindsided by the EPA which has recognized that there are a few more balls that need to be juggled.  One of them is the global reaction to diverting a hefty part of the world corn supply into energy production and out of the food sector.  When the EPA looks at the global greenhouse gas accounting of the US energy policy it rightly acknowledges that throughout the world, corn production is likely to increase substantially due to the price/demand incentive caused by the reduced availability of US corn.  They refer to this as the "indirect land use charge".  What this means is that around the world, forests, pastures, wetlands and other beneficial land use practices are likely to be cut down, filled in and ripped up to plant corn.  Already, as is well documented, Asian countries are ranging into Africa, Brazil and Indonesia to establish long-term leases on vast tracts of land which could be coverted to corn production.  The EPA wants to "charge" ethanol distilling with this penalty price to restore a market signal preventing some of the over production of ethanol which is once again being teed up.  Guess who is opposed to putting any market based signals into the equation which might dampen a renewed gold rush in ethanol production?  You got it, the one ball jugglers.