The hidden costs of biofuels production

The euphoria may be moderating over the theory that bio-fuels could both reduce greenhouse gases and dependence on Middle East oil as more facts become known about the energy and cost of their production. But little attention is being paid to the huge impact that bio-fuels production is likely to have on income distribution within countries and between nations.

On the one hand, farmers worldwide may deserve better deal. On the other, the poorer a family the bigger the percentage of its income goes on food. The past year has seen rises of 20 percent to 100 percent in most farm products. Though some of this was due to local weather or disease problems, bio-fuels demand has been a major factor and will remain so.

Targets in the EU and elsewhere for agricultural products that can be turned into biofuels will probably not be met, but enough investment commitments – and promises to farmers – have already been made to ensure that demand for corn, soybeans, sugar cane, palm oil, wheat etc will keep prices high for years and will have a knock-on effect on rice, cotton, barley, poultry and livestock prices. Agricultural exporters such as Brazil, Thailand and Malaysia, as well as western industrial countries, now promote bio-fuel production.

The common assumption is that a global rise in farm prices will benefit farmers who, at least in the developing world, have not enjoyed rises in their income levels to match national income gains. But the balance sheet is more complex. On the plus side, US and EU use of crops for bio-fuels will absorb excess crop production which would otherwise have been dumped on world markets, depressing prices for unsubsidized producers.

However, even that is a dubious benefit. It will be achieved, for example, by keeping Brazilian cane-based ethanol out of US markets, and ensuring that EU taxpayers continue massive subsidies in the name of the environment rather than reform the agricultural policy. Temperate-zone crops cannot compete as bio-fuel sources with tropical ones.

At the national level, obvious beneficiaries of higher prices are unsubsidized major food exporters such as Brazil, Argentina, Canada, Australia, Malaysia, Indonesia and Thailand and Vietnam. But four of those are relatively thinly populated and farmers represent a small part of their population. Even in poor and middle income Southeast Asia, only Thailand and Vietnam, with predominantly small-farmer agriculture, seem likely to see widespread benefit. In Malaysia and Indonesia, most palm oil production – globally the lowest cost source of bio-diesel – is mostly in corporate rather than smallholder hands. So even excluding the environmental cost of forest clearances to plant oil palms, the income gains will be unevenly spread.

In the developing world at large, marketable surpluses mainly come from bigger, more efficient farms, while smaller ones have little saleable surplus whilst the biggest losers from high food prices are low-income workers, urban or rural. India demonstrates the dilemma most acutely. Its spending on food and fertilizer is approaching 1 percent of GDP, providing both support prices for farmers and a food distribution system to provide low-cost staples to the poor. But most of the support benefit goes to a few regions with big surpluses while the administrative cost of the distribution system is very high.

In theory India should be capable of being a net farm exporter. But output has been lagging behind demand as incomes rise. India is now importing wheat and edible oils on a large scale, increasing its trade deficit. Worse, high food prices will either increase the cost of subsidies, which the government has been trying to reduce, or further disadvantage the lowest income groups which have not benefited from fast GDP growth.

In China too, food prices have been rising faster than other prices partly thanks to China’s own impact on global demand and constraints to local supply caused by urbanization and water shortages. China as a whole will be a large net loser from global price trends. Some farmers will see significant income gains but higher prices will do little or nothing for those on poor lands or remote locations, and low income urban workers will feel the pinch unless food prices become a signal for large wage increases which will eventually flow through to a higher inflation level.

For people in rich service-sector countries the impact of 50 percent increases in the farm-gate price of basic foods on their overall cost of living is tiny. In countries such as China food is at least 30 percent of consumption expenditure and most of that reflects farm prices not intermediation costs.

But even these countries may not be immune to the bio-fuel price cycle forever. Eventually the wages of workers in China and India etc will have to rise and with them prices of trainers, toys, tee shirts and all the other industrial products outsourced to factories in Asia. Indeed, that may have already begun. There are several reasons why the prices of US imports from China have suddenly started to rise after years of decline. Bio-fuels is surely one.