Tuesday, January 13, 2009

Distortions due to Subsidies and Protectionism in Domestic Corn Production

When discussing government intervention in the economy, many times we see industries where government's role is primarily one of suppression of an industry. That is, regulation, taxation, and trade restrictions serve to depress an entire industry. This is true in my industry, the chemical industry. It is also true in the pharmaceutical industry. While there may be differences in impact from firm to firm, generally all firms suffer from government intervention, and generally all firms can be viewed in some ways as victims of government intervention.

But what happens in an industry when government subsidizes a particular set of players at the expense of another? Are all firms victims? No, The picture it turns out is very different.

Dr. Monica Hughes of Free Agriculture - Restore Markets and I have been having a discussion on the economics of the agricultural industry. I wanted to understand where the biggest economic impacts were and their mechanism of impact. She has been extremely helpful in providing background information on the subject. Subsidies are a huge factor in agriculture, and I've decided to use the largest subsidized segment of agriculture, corn, as an example.

Two things happen when government subsidizes an industry. First, on the economic side, the subsidies create distortions in normal markets. These distortions generally benefit some players in the industry, and hurt others. Also, these distortions can usually be shown to be inefficient. That is, the distortions incur costs that would not normally be incurred if the system were free of intervention. Second, on the political side, some firms that benefit from subsidization use political influence to attempt to preserve those subsidies. Essentially, some firms use their political "pull" to attempt to preserve (or maybe even increase the benefit) to themselves, at the expense of others. The subsidy creates a class of "Orren Boyle" businessmen [referring to the corrupt steel mill owner who uses his political connections to stay in business in Ayn Rand's Atlas Shrugged]. Not all businessmen are innocent victims. Some are complicit in preservation of the distortions, and economic inefficiencies, through the use of political "pull."

Agriculture is an industry that takes on this sort of character. Let's illustrate with corn. I've put together a small diagram showing corn production and consumption in the U.S. today. Now analyzing this industry as a whole is a complex undertaking and I don't purport to be an economist. But I have shown the corn production "envelope," extended out to one step beyond simple production. That is, I've shown some of uses that contribute to the consumption of corn, and their impact on the corn subsidy as well.

2008 corn production in the U.S. totaled 13.2 billion bushels, and utilized 87M acres of farmland. It was consumed primarily in four downstream uses: grain for export, feed for meat production, raw material for fuel ethanol production, and as an input to the food and sweetener industry. Stunningly, food for human consumption is a very small part of this mix.

This envelope is subsidized to the tune of about $20 billion dollars annually. It's important to consider all of the various ways in which subsidies act on this envelope. This includes direct Federal payment to corn producers, capital funding and subsidies for ethanol production, subsidies for feedlot waste disposal, and the sugar import tariff/quota system (which is currently cost neutral but will become an additional subsidy soon), and also the additional price consumers must bear for ethanol and corn sweeteners.

These subsidies create huge distortions. Both the fuel ethanol industry and the corn sweetener industry are industries that exist almost entirely due to the subsidy. The U.S. sugar quota / duty system inflates domestic sweetener prices by two times. High fructose corn syrup and other corn-based sweeteners, along with domestic sugar, cost twice to manufacture than international sugar does, but the quotas and duties on imported sugar assure you'll pay the extra cost. Fuel ethanol costs twice what gasoline does, but ethanol content laws in some states assure you'll pay the extra cost. The subsidy of corn and feedlot waste disposal make concentrated farming operations more competitive than they would normally be, and thus much more prevalent.

All of this has the effect of inflating corn and corn product production at the expense of the substitutes it replaces. Ultimately this comes at a net cost to the consumer and the taxpayer. Firms within the industries that exist as a result of subsidization now have a direct incentive to use political pull to maintain their positions. Who are these firms? They are those firms who lobby for and directly receive government benefit. Monica has shown that large corporate farms (not the small independent farmer) are the most prevalent recipients of direct corn subsidies. Also included in this mix are ethanol producers, and corn-based sweetener producers, neither of which would exist in any significant number without the subsidy. Probably the most notorious recipient of corn-based subsidies, and one who possesses a formidable Federal lobby is corn-products firm Archer Daniels Midland. From a 1995 profile of ADM by The Cato Institute:

ADM is certainly the nation's most arrogant welfare recipient. And it is one of the few welfare recipients that spend millions of dollars each year advertising on Sunday morning television shows populated and watched by politicians. Chairman Dwayne Andreas's and ADM's success in farming Washington represents the rational result of contemporary government policies that turn elections into "an advanced auction of stolen goods," as H. L. Mencken quipped. Thanks to its multi-million-dollar hustling in Washington, a company that lives and dies on the generosity of the American taxpayer has managed to get itself revered as a great public servant. Although ADM is not the only corporation with its hand out in Washington, it is easily one of the most successful beggars on the block.(1)

This is the nature of those who would use political pull to get government to force you to subsidize them, and to force you to pay higher prices for the products they produce. It is reprehensible.

What would the industry envelope look like without subsidies? I took a first pass estimate, assuming ethanol and HFSC are eliminated as a result of the changes, and animal feed is replaced mostly by grass feeding practices (for beef only using Monica's analysis), but all other consumption is steady. The answer is that we would produce significantly less corn, use less land overall, replace sweeteners with cheaper [by half!] imported sugar, and cut the cost of fuel by approximately $0.22/gallon of gasoline.

Now the practicality and effectiveness of a laissez faire system is part of what makes it moral. But the laissez faire system fundamentally preserves individual rights; it prevents the confiscation of funds from some to benefit others; and it rewards the free productive farmer, not the skilled politico's. Notice how many laws go toward the distortion of the corn industry? A truly free market means the repeal of them all.

The answer is laissez faire!

1 comment:

Kelly said...

Great post, Kendall. I've been reading Monica's blog now for a few weeks, and it's great to hear someone else talking about these things!

Kelly Edge