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Biofuel Subsidies: An Open-Economy Analysis

Author

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  • Bandyopadhyay, Subhayu

    () (Federal Reserve Bank of St. Louis)

  • Bhaumik, Sumon K.

    () (University of Sheffield)

  • Wall, Howard J.

    () (Federal Reserve Bank of St. Louis)

Abstract

We present a general equilibrium analysis of biofuel subsidies in an open-economy context. In the small-country case, when a Pigouvian tax on conventional fuels such as crude is in place, the optimal biofuel subsidy is zero. When the tax on crude is not available as a policy option, however, a second-best biofuel subsidy (or tax) is optimal. In the large-country case, the optimal tax on crude departs from its standard Pigouvian level and a biofuel subsidy is optimal. A biofuel subsidy spurs global demand for food and confers a terms-of-trade benefit to the food-exporting nation. This might encourage the food-exporting nation to use a subsidy even if it raises global crude use. The food importer has no such incentive for subsidization. Terms-of-trade effects wash out between trading nations; hence, any policy intervention by the two trading nations that raises crude use must be jointly suboptimal.

Suggested Citation

  • Bandyopadhyay, Subhayu & Bhaumik, Sumon K. & Wall, Howard J., 2009. "Biofuel Subsidies: An Open-Economy Analysis," IZA Discussion Papers 4584, Institute for the Study of Labor (IZA).
  • Handle: RePEc:iza:izadps:dp4584
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    Cited by:

    1. Quentin Grafton, R. & Kompas, Tom & Van Long, Ngo, 2012. "Substitution between biofuels and fossil fuels: Is there a green paradox?," Journal of Environmental Economics and Management, Elsevier, vol. 64(3), pages 328-341.
    2. R. Quentin Grafton & Tom Kompas & Ngo Van Long, 2010. "Biofuels Subsidies and the Green Paradox," CESifo Working Paper Series 2960, CESifo Group Munich.
    3. R. Quentin Grafton & Tom Kompas & Ngo Van Long, 2010. "Do Biofuel Subsidies Reduce Greenhouse Gas Emissions?," International and Development Economics Working Papers idec10-01, International and Development Economics.

    More about this item

    Keywords

    pollution externality; Pigouvian tax; optimal biofuel subsidy; terms-of-trade;

    JEL classification:

    • F1 - International Economics - - Trade
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development

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