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September 23, 2005

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

Posted by Testa at September 23, 2005 5:39 PM

Comments

We found an interesting article about the problems with Ethanol on ConsumerReports.org:

http://blogs.consumerreports.org/cars/2008/03/ethanol-e85.html

"But there are some problems with increasing ethanol blends. Ethanol contains less energy than gasoline, so increasing the amount of ethanol in gasoline will likely result in lower fuel economy. Increasing standard fuel blends from zero to 10 percent ethanol, as is happening today, has little or no impact on fuel economy. In tests, the differences occur within the margin of error, about 0.5 percent. Further increasing ethanol levels to 20 percent reduces fuel economy between 1 and 3 percent, according to testing by the DOE and General Motors. Evaluations are underway to determine if E20 will burn effectively in today's engines without impacting reliability and longevity, and also assessing potential impact on fuel economy."

TheSUBWAY.com would like to invite readers to post their own views and ideas in TheSUBWAY.com's Investor Forum:

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Posted by: TheSUBWAY.com at April 4, 2008 1:13 PM

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