The Corn is as High as the Subsidy's Aye
Corn adds value to agriculture, but who benefits from the higher price of corn?
December 1, 2006
Fred Foldvary, Ph.D.

The price of corn shot up during the last months of 2006. Corn sold for $2 per bushel at the beginning of 2006, and by the end of the year, the price had zoomed to $3.75.

It's not that folks are eating more corn on the cob. The rising demand has come from the increased production of ethanol, the ethyl alcohol fuel made from corn. The higher corn price affects all uses of corn, so the cost of food will also be rising. Chicken, pork, and beef will become more expensive, as well as corn for eating by human beings. Stock up on canned corn while it is still relatively cheap. Corn is also made into a syrup that is used to sweeten food and drinks, so those prices will also be rising.

So what about the ethanol? Will fuel made from corn reduce dependency on oil and reduce air pollution? Or is it a subsidy due to the political clout of corn farmers?

The American Coalition for Ethanol says that "Ethanol's production drives economic development, adds value to agriculture, and moves our nation toward energy independence. Its use cleans America's air and offers consumers a cost-effective choice at the pump. This year the U.S. ethanol industry will grow to provide more than 5 billion gallons of clean burning, renewable fuel to our country's supply."

Any good economist will tell you that ethanol does not and cannot drive economic development. If ethanol did not exist, the resources now devoted to its production would instead be producing other things, and those other products would drive development just as much. And corn would be much cheaper.

Yes, corn adds value to agriculture, but who benefits from the higher price of corn? The main beneficiaries are the owners of farmland. The classical British economist David Ricardo explained that the price of corn is not high because land values are high; rather, farm land is high because corn is high. With a limited amount of land suitable to growing corn, the high price of corn enables farmland owners to greatly increase the rent of their land. The higher profits of owner-occupied farmland are an implicit rent that the owners receive, although it takes the form of profit. Farmers who are tenants renting land do not benefit, as the increase in the price of corn is soaked up by higher rent. The wages of farm workers also don't rise in the long run, as those workers compete with other workers, and higher wages will attract labor into that industry, pushing the wage back down. The landowners end up the gainers.

Does ethanol move the USA or other countries towards energy independence? First of all, why is energy independence a prime goal? In a global economy, ever more production and consumption is based on trade with other counties. Energy independence is inefficient and unnecessary from a purely economic perspective. However, perhaps from a strategic military point of view, less energy dependence is desirable because much of the world's oil production comes from potentially hostile areas such as the Middle East, Venezuela, and Russia. But even that argument is weak, because the US imports energy from Canada and Mexico and other friendly countries, and so if Venezuela refuses to sell oil to the US, more can be imported from other countries, as there is a world market for oil, and at the market price, one can get as much as one is willing to pay for.

If ethanol is cost effective at the pump, it is only because its production is highly subsidized by the federal government. If ethanol is economically cost effective, then it does not require a subsidy. Brazil produces fuel from sugar, and it is cost effective there because labor is much cheaper in Brazil than in the US, and the climate in Brazil is favorable to growing sugar cane. Labor is more expensive in the USA, and the mass production of corn uses high-cost machinery and a great deal of fuel.

To measure the cost of producing ethanol, all the costs of growing the corn inputs need to be accounted for. This includes the machinery used to grow the corn and the environmental costs. Current vehicles can use a blend of up to ten percent ethyl alcohol, and one needs a "flexible fuel vehicle" to use a mix of 85 percent ethanol and 15 percent unleaded gasoline (E85). Widespread use requires gas stations that sell E85, and so far they are not numerous except in the Midwest.

If we include all the costs, is ethanol cost effective? Many economists conclude that ethanol made from corn is an economic waste, that the production of ethanol requires more energy than it provides. The article "Corn Dog" by Robert Bryce in the July 19, 2005, Slate magazine points out that corn is the most subsidized crop in the US measured in total dollars. Critics of ethanol say that the calculations done by the ethanol advocates do not account for the full social costs. Bryce refers to a study by professors David Pimentel at Cornell University and Tad Patzek at the University of California, Berkeley, that concludes that producing ethanol from corn requires 29 percent more fossil energy than the ethanol fuel itself provides. It is also costly to blend ethanol with gasoline, and ethanol has to be transported in vehicles rather than by pipelines. Also, a gallon of ethanol provides less energy than a gallon of gasoline, so more must be used up.

Taxpayers for Common Sense also reports findings that ethanol subsidies benefit the landowners and producers rather than the public. The Cato Institute said ten years ago that ethanol keeps the big farmers and ethanol chiefs "drunk on tax dollars."

There are far better alternatives to the reduction of air pollution and less dependence on oil. Diesel provides a truly cost-effective alternative to regular gasoline. Hybrid electric cars can juice up their batteries at night when electricity demand is low, using up current excess capacity. These alternatives do not require subisidies. The most effective policy is to eliminate all subsidies and also all taxes and restrictions on energy and driving, including the abolition of gasoline taxes and carpool lanes, while making car owners and drivers pay the full social costs they generate. Charge car owners for the pollution, congestion, and collision costs they impose on others. The let the market evolve as folks voluntarily turn to less expensive alternatives, whether they be public transit, carpooling, or driving when the streets and highways are not crowded. Only in a truly free market, where everybody pays the full social costs of one's consumption, can we discover the most cost effective production and use of energy.

Until a truly free market in energy and agriculture is established, the subsidies to ethanol and other alternatives create an economic waste that hurts the environment and the economy, while the farmland owners enjoy the subsidy, as most folks are unable to connect the dots from the ethanol they buy at the pump to the land values pumped up by the subsidies, which do not even benefit the current owners of farm corporations but mainly by those owning the shares when the subsidies began. The benefits are already in the past, and the costs are in the present and future. When will Americans wake up?

Find Out More.
Inside information on economics, society, nature, and technology.
Fred Foldvary, Ph.D.

FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.

Foldvary is the author of The Soul of LibertyPublic Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.

Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.