Ethanol and Midwest Rural Communities

Those who are interested in the prospects of Midwest rural areas will want to peruse the presentations from Dave Oppedahl’s recent conference on “Ag Biotech and Midwest Rural Development.” Right now, the papers and presentations are posted (see conference link). Dave will soon be summarizing the conference for an upcoming issue of Chicago Fed Letter.

One topic of the conference was the rising prominence of ethanol production in rural communities, and the associated economic benefits. Ethanol raises hopes in many rural communities because of agriculture’s shrinking role in supporting rural jobs and income. But while ethanol production appears to be a boon to many rural communities, some question the efficacy of the subsidies for the overall nation.

As both Dave Oppedahl and I covered in our September 8 presentations, production agriculture has been shrinking profoundly as the basis for income and jobs in many rural areas, and government support payments make up sizable shares of what remains. But while direct income and jobs are shrinking in production agriculture, some rural income and work is being created downstream in transportation of the voluminous crops, along with financing and service support of production agriculture. In addition, related manufacturing has become more important in many Midwest rural counties in the form of “food processing,” such as oil seed crushing, meat processing, packaged foods, and prepared packaged foods. It is somewhat insightful to consider how we count the processing of food in our economic statistics and in what particular industry we place food processing. If food is prepared (grown) on the farm, it is agriculture. If it is prepared in a factory as a frozen meal, it is “manufacturing.” If it is prepared in a grocery store at the deli department, it is retail. And in a restaurant, it is in the services industry. And if it is prepared at home, it is not counted in our measure of national output, GDP, at all!

The concentration of food processing (manufacturing) in rural counties in the U.S. has doubled since the 1970s and accounts for about one-fifth of rural manufacturing earnings according to the U.S. Bureau of Economic Analysis. Economies of transportation is one reason that much of the processing activity remains in rural areas. By processing raw farm product near the farm, the products shed weight and volume before delivery to market.

In this regard, the ethanol industry is closely akin to food processing. This alternative fuel to gasoline is most widely processed from corn, and done so nearby to corn production. In production of ethanol, Iowa is the leading state, followed closely by Illinois (these two states also lead the nation in corn production).

The domestic market for ethanol was encouraged by the Clean Air Act Amendments of 1990. Concerns about urban ozone pollution, relating largely to breathing difficulties, led non-attainment areas to require additives to gasoline that diminished emissions of compounds that are thought to be precursors to (ground level) ozone formation. Today, such encouragement primarily takes the form of a federal $0.50 per gallon tax exemption at the wholesale level for ethanol as compared to gasoline. Some states such as Minnesota and Iowa add additional incentives.

As a result, ethanol demand has more than doubled since 2000 and annual production will likely exceed four billion gallons for the year 2005. At the September 8 conference, John Miranowski of Iowa State University reported that 30 new plants ethanol plants have been added over the past 3 years, with many more in progress or on the drawing board.

Many rural communities have welcomed and encouraged ethanol plants for the associated jobs and income at the plant. And again, the economics of transportation savings has meant that local corn farming operations typically receive higher prices than they would otherwise. In addition, some of the by-products from the ethanol processing can be used as livestock feed. This livestock production too contributes to the local community’s economy. And as usual, some enterprising economists have estimated the indirect and “multiplier” impacts of an ethanol production atop the direct local economic impacts.

From a national perspective, the advantages and sustainability of the ethanol industry are not very clear. We don’t know how well ethanol would compete in an unfettered marketplace, without subsidies. At the oil prices of two years ago, and without the very large subsidies, ethanol production today would have been much lower. However, at today’s petroleum prices, ethanol is looking more attractive. Further, some would argue that, as the infrastructure to transport and distribute ethanol are developed and attain greater scale, ethanol might find a place in the market without its very large subsidies.

Subsidies are sometimes justified for the alleged environmental benefits to ethanol in reducing urban ozone. But to the contrary, others argue that today’s engines burn so much more cleanly that there are no ozone benefits to burning ethanol rather than gasoline in urban markets. In addition, ethanol evaporates more readily in comparison to gasoline, thereby possibly aggravating urban ozone. In rebuttal, many point out that ethanol is advantaged because it does not release as much carbon into the atmosphere, and thereby helps out “global warming.”

Energy security is also an elusive idea. Buffer stocks of vital materials are an alternative to subsidizing domestic fuel industries, and possibly less costly. So too, in other countries such as Brazil, ethanol can be produced more cheaply than in the U.S., from cane sugar. Even if ethanol displaces a small portion of our imported petroleum, would we not find that we can securely and cheaply import ethanol from South America? At least one conference participant suggested that domestic ethanol interests may soon be fighting for further trade protections against ethanol imports.

In all likelihood, we will never know the answer as to how ethanol would fare on a level playing field, or whether subsidies already in place are justified on the basis of non-market considerations such as environmental features and energy security. That is because ethanol’s future in the U.S. seems quite robust since the recent federal energy bill has mandated consumption of 7.5 billion gallons in the U.S. by 2012. As one visitor to our bank commented, “apparently, U.S. industrial policy is not quite dead.”

Surprisingly, despite the many analytic tools that economists have to inform public policy, no one at the conference could report that there had been any comprehensive and respectable benefit-cost study conducted to evaluate subsidies and mandates for ethanol production and use. There has been a prominent debate as to whether the ethanol production process consumes more energy than it produces. But the study results are highly sensitive to the assumptions of each researcher as to what is the corn yield per acre of land, for example. But even aside from these vagaries, the “energy balance” approach is not really very helpful in deciding the issue–the way a market test would be helpful. In the generation of electricity, for example, there is an enormous loss of energy as scientifically defined. The heat content of coal used, for example, is far more than the electricity produced. Yet, it goes without saying that electricity is quite valuable, and end users are willing to pay for it. As for spillover benefits relating to the environment, economists are learning to use shadow prices obtained from surveys, for example, to put dollar values on environmental emissions so that lower pollution can be evaluated using a value yardstick.

Whether or not national ethanol policy would be seen favorably by a thorough cost-benefit analysis, many rural communities would welcome an ethanol plant, and some will get that chance.

The Midwest Economy “Blog”

Anything resembling an opinion or viewpoint contained in the blog are my own, and do not necessarily represent the views of anyone else at the Federal Reserve Bank of Chicago or in the Federal Reserve System.

Coming topics:

Impact of biotech on agriculture

Midwest economic conditions and recent hurricanes

Chicago area economy

Funding and access to higher education

Midwest Economy

Hello midwesterners and those interested in the Midwest’s economic growth and development. My name is Bill Testa, and this is an introduction to my Midwest Economy Blog.

In this blog, I will offer some current information on the Midwest economy, as well as analysis of important public policy issues and even an occasional prediction or two. In this effort, I will be looking for those of you who share my keen interest in the Midwest economy to contribute not only your attention and readership, but also your thoughts and information. Those of you who do respond, as well as those who only listen, will help us all to enrich our understanding and knowledge of this region. And as time passes, we will also have an extensive compilation of information and experts to draw on as the Midwest encounters new issues and economic challenges.

Unlike some economists who sponsor blogs, I am neither a Nobel prize winner nor a renowned media personality. However, I have been following and analyzing the Midwest economy for over 25 years, most recently as the director of Regional Programs in the Chicago Fed’s Economic Research Department. The most burning questions that keep me up at night include: Why do some regions grow faster than others? What are the prospects for the Midwest and other regions? What can we do to influence our economic destiny? What roles, if any, do state-local governments and public-private partnerships play, or should they play, in the growth and development process?

At the Chicago Fed, my interest in the Midwest economy is shared by a talented and varied group of economists. Some of them—such as Rick Mattoon, Thomas Klier, Yukako Ono, and Mike Munley—are part of my Regional Team, while some are in other areas of our Research Department, including our Chief Business Economist, Bill Strauss, and our agricultural/rural specialist, Dave Oppedahl.

And if you are a true Midwest economy buff—as I am—you will find your way here—to our newly launched Midwest Economy web page. This new page features content galore, including our own vast archive of published analysis organized by subject area. You can also access regional data to create your own analysis; or link to other related web sites. Also, the site features our many past conferences, along with the presentations of renowned experts on the Midwest economy, state-local finance, economic growth, and a host of special topics concerning economic growth and development.

“Ag Bio” Conference at the Chicago Fed

Last week, Dave Oppedahl, our agriculture and rural specialist, held a conference at the Bank addressing agricultural biotechnology and rural development prospects in the Midwest. The best-known of these technologies are so-called bio-fuels, such as ethanol (which is largely refined from corn in the U.S., but it is largely refined from sugar cane in other countries like Brazil), and GMOs or genetically modified organisms, such as pest-resistant and herbicide resistent grains. Dave’s chief interest in these technologies and their prospects are how they will affect the well being of Midwest agriculture and rural communities.

New biotech products linked to agriculture are but one of several avenues by which rural counties hope to revive their fortunes and sustain their populations. Historically, family incomes in rural counties were supported by agriculture, mining, and forestry—especially agriculture. The U.S. Bureau of Economic Analysis compiles figures on the shares of personal income that derive from various industry sectors, and they estimate that as recently as 1969, 935 “rural” or nonmetropolitan counties counted on agriculture for 20% or more of personal income. By 1999, the number had fallen to only 235.

The problem has not been so much a failure of sagging production, or vulnerability to foreign producers, as it has been rising productivity itself. Improved strains of agriculture and better/more mechanized farming methods have increased yields astronomically. Since 1947, U.S. real farm product is up over 3.5 times. But despite rising real product, prices for farm products have fallen steeply, because the demand for raw agricultural products has not kept pace with rising production and productivity. In 1950, corn in the U.S. cost five times its price today as measured by inflation-adjusted dollars. Falling prices (along with labor-saving productivity) have come to mean meager farm earnings and jobs in most nonmetropolitan counties. In 1870, over 50% of the U.S. work force could be found in agriculture, but this had dwindled to 13% by 1947, and to 2% today.

In our Seventh Federal Reserve District states of Iowa, Illinois, Michigan, Wisconsin, and Indiana, farm earnings comprised 13% of personal income in 1969, but had fallen to only 2.8% by 2002. Of course, such productivity gains, along with urbanization of population, have also created the world’s highest standard of living for the average American.

But in generating income and jobs, many rural communities have not found a sufficient replacement for agriculture. (Though some, of course, have become suburbanized by nearby metropolitan area expansion, while others have redeveloped toward service industries and manufacturing). Consequently, the decline of agriculture-related income in nonmetropolitan areas has often been accompanied by lagging population growth or even outright declines. In the U.S., nonmetropolitan population grew at around one-half the pace of metropolitan counties from 1969. With falling population, many rural towns have been challenged to sustain essential services such as health care, schools, and retail. And in relation to metropolitan standards of living, rural personal incomes have fallen. Per capita income in nonmetropolitan counties in the Seventh District, for example, declined from 85% of the nation’s average in 1969 to 80% in 2002.

What’s a rural area to do? In our part of the Midwest, two distinct avenues to re-development are most prominent—manufacturing/distribution and retirement/recreation.

What other development paths are you seeing around the Midwest? Please share your thoughts and observations with us.

Bright prospects as a haven for retirees and recreational visitors can be most commonly observed in our northern states of Michigan and Wisconsin. Places such as Walworth and Door Counties in Wisconsin, and the northwest coastline of Michigan are perhaps the best-known in this regard. The map below illustrates those nonmetropolitan counties that have experienced hikes in population since 1969 (shown in blue, declines shown in green), and the “north woods” pattern in Wisconsin and Michigan is quite evident. (A map of second homes from the 2000 Census would show much the same effect). In many such places, the choice to develop tourist or retirement centers is not without its downsides. Recreational and retirement homes, and attendant commercial activities, often change the very character of rural towns, sometimes to the consternation of its original residents. Many towns on the periphery of large and sprawling metropolitan areas also face many of the same difficult choices: How much to grow, and in what directions?

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