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Biofuel Subsidies: An Open-Economy Analysis

  • Bandyopadhyay, Subhayu

    ()

    (Federal Reserve Bank of St. Louis)

  • Bhaumik, Sumon K.

    ()

    (University of Sheffield)

  • Wall, Howard J.

    ()

    (Federal Reserve Bank of St. Louis)

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.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4584.

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Length: 28 pages
Date of creation: Nov 2009
Date of revision:
Publication status: published in: Economics and Politics, 2013, 25 (2), 181-199
Handle: RePEc:iza:izadps:dp4584
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  1. von Braun, Joachim & Pachauri, R. K., 2006. "The promises and challenges of biofuels for the poor in developing countries: IFPRI 2005-2006 Annual Report Essay," Annual report essays 2006Essay, International Food Policy Research Institute (IFPRI).
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  4. Frankel, Jeffrey & Rose, Andrew K., 2003. "Is Trade Good or Bad for the Environment? Sorting Out the Causality," Working Paper Series rwp03-038, Harvard University, John F. Kennedy School of Government.
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  7. Ballard, Charles L. & Medema, Steven G., 1993. "The marginal efficiency effects of taxes and subsidies in the presence of externalities : A computational general equilibrium approach," Journal of Public Economics, Elsevier, vol. 52(2), pages 199-216, September.
  8. Lopez Ramon, 1994. "The Environment as a Factor of Production: The Effects of Economic Growth and Trade Liberalization," Journal of Environmental Economics and Management, Elsevier, vol. 27(2), pages 163-184, September.
  9. Fredriksson, Per G., 1997. "The Political Economy of Pollution Taxes in a Small Open Economy," Journal of Environmental Economics and Management, Elsevier, vol. 33(1), pages 44-58, May.
  10. Rauscher, Michael, 1997. "International Trade, Factor Movements, and the Environment," OUP Catalogue, Oxford University Press, number 9780198290506, March.
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