June 22, 2007

The Unintended Consequences the Senate's Energy Bill

 
  
This post was part of a discussion on the far reaching consequences of government involvement in markets.

Your point about Microsoft is important. Good economists visualize the economy like a movie. Poor economists see the economy as a snap-shot. By this I mean that the good economist places time into his analysis. He anticipates that any policy will have ripple effects that will impact other parts of the economy over time. He anticipates that people will respond to take advantage of a policy or to avoid being hurt by a policy.  

The Senate passed an energy bill today and I read a summary of the bill on NPR. http://www.npr.org/templates/story/story.php?storyId=11276443 Unfortunately, it seems that Congress favors the snap-shot view of the economy. Rather than allowing markets to pick which energy alternatives will be most effective in the future, they want to lock in ethanol as a choice (which as explained below the way will probably be an economic disaster and make global warming worse). Also, there is a price gauging provision, which if it really has any effect will like all price controls result in shortages of gasoline, since it will undermine price as the method of determining production and allocation. http://www.energybulletin.net/30685.html 

Graphical illustration of how a price ceiling creates a shortage.

Unlike Brazil, the US relies on corn to make ethanol. Sugar cane in Brazil is an efficient method for making ethanol. With sugar cane, one unit of energy input creates about 8 units of output. With corn the ration is approximately 1 to 1.3 units. However, with large amounts of corn being diverted by government mandate to the production of ethanol, look for increased food prices as the price of corn increases. From beef to corn flakes, the price should increase as corn prices increase. Also, as more farmers shift to corn in response to high corn prices, the supply of other agricultural products will decline and the price of other food items will also increase.

Remember the riots in Mexico over increases in corn tortilla prices? Even higher corn prices will make the situation for Mexico's poor even worse. Last summer's election in Mexico saw the leftist-communist candidate lose by less than one percent. Could increased instability in Mexico be caused by a US government mandated use of ethanol? Could such instability lead to a communist government on our southern boarder? If so, what will the immigration problem look like then?  

My point is, when you look at economic policy, you have to look at how a policy will play out over time. You have to think about how it will affect other parts of the economy. When government takes away from markets the decisions of what will be produced, how much will be produced, or at what price it will be sold, the result is almost always a disaster.  

As an example of this concept see Milton Friedman's famous article "Franklin D. Roosevelt, Silver, and China," explaining how a 1933 silver subsidy program in the US to help a handful of western senators contributed to the communist takeover of China. http://econpapers.repec.org/article/ucpjpolec/v_3A100_3Ay_3A1992_3Ai_3A1_3Ap_3A62-83.htm