The High Cost of Food
When there is a product subsidy, then the increase in demand is artificial, and this shifts production from one use to another. That shift distorts prices, profits, and quantities.
April 1, 2008
Fred Foldvary, Ph.D.
Economist

Land for growing food has always competed with land used to grow plants with other uses. Farmers who grow cotton could instead grow grains or fruits. Also, forest land has the alternative use as food crop land. These trade-offs are called opportunity costs. The economic cost of farmland is the value of the forests and wild grasslands that would otherwise be there. Likewise, the opportunity cost of a forest is the value of the land if used for housing, crops, and grazing.

Recently a new opportunity cost has arisen, as crops such as corn and sugar can be grown for fuel rather than for food. This would not be harmful if not for government subsides for ethanol made of corn. The U.S. federal government subsidizes ethanol production at 51 cents per gallon. Farmers who used to grow corn for animal feed or human consumption now sell crops to biofuel distilleries. One-fifth of American grain is used for ethanol. Food prices almost doubled from 2005 to 2008, while the price of corn has tripled from $2 to over $6 per bushel.

The increasing global demand for meat, eggs, and grains, has contributed to the price increase, as the Asian and Eastern European economies become wealthier. Foreign demand has greatly increased U.S. exports of grain, and even more so with the lower exchange value of the U.S. dollar, which makes U.S. goods cheaper for Europeans. The rising price of oil also contributes to higher food prices. Still, it has been estimated that using corn for fuel rather than food contributes a third of the rise in prices worldwide, and about half of the increase in demand has been the use of grains for fuel.

If there is a greater market demand for food, the market response is an increase in supply. But when there is a subsidy, then the increase in demand is artificial, and this shifts production from one use to another. That shift distorts prices, profits, and quantities. Subsidies are just as damaging to an economy as taxes. And there have been subsidies and restrictions for food crops as well as fuel crops, creating a colossal global distortion in food prices. Some countries are now even banning the exports of foods to prevent hunger.

Taxes on goods, labor, and business profits create an excess burden, a misallocation and waste of resources, also called a “deadweight loss.” The annual loss has been estimated at around $1.5 trillion, over ten percent of GDP. That means we would be over ten percent richer if not for the waste caused by taxes. This is not a necessary waste, since we could tax land value with no deadweight loss, as land does not hide, shrink, or flee when taxed.

A subsidy too creates a deadweight loss because the economic cost of the tax revenue used for the subsidy is greater than the increase in benefits to the consumers of those goods. If a subsidy is not in cash but in protection from competition, the deadweight loss comes from the higher prices paid by consumers, which in effect is a tax on their consumption.

Ethanol made from sugar is cheaper than ethanol made from corn, so to protect corn farmers from foreign competition, the U.S. government has quotas on sugar imports. That also raises the price of sugar, driving candy makers out of the country. For example, Lifesavers candy moved its factory to Canada, where it could buy sugar at the lower world market price. Americans are not allowed to import Cuban sugar, but Canada imports sugar from Cuba and turns it into candy, and then exports the candy to the U.S. So Americans end up eating Cuban sugar anyway, except that Canadians have the candy-making jobs instead of Americans.

Some farmers in the less developed countries have benefitted from the higher prices for corn, wheat, soybeans, and rice, but the urban poor have been hurt badly. U.S. subsidies for ethanol creates hunger in Latin America, Africa, and Asia. Children are especially harmed from inadequate nutrition.

Corn subsidies make for good politics and terrible policy. Politicians need the campaign funds provided by farm interests, and they cater to the corn vote, while most folks are too busy to notice. But now, indulging in corn subsidies is killing impoverished children. Rising food prices affect most people, so we should tell the politicians and state officials that we oppose subsidizing crops for fuel. The fuelish subsidy should be stopped right now.

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Fred Foldvary, Ph.D.
Economist

FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for Progress.org 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.