Biofuel Subsidies and International Trade

Bandyopadhyay, Subhayu and Bhaumik, Sumon and Wall, Howard (2010): Biofuel Subsidies and International Trade.

Abstract

This paper explores optimal biofuel subsidization in the context of a general equilibrium trade model. The focus is on biofuels such as corn-based ethanol, which diverts corn from use as food to use as an intermediate input in energy production. 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, a biofuel subsidy spurs global demand for food and confers a terms-of-trade benefit to the food-exporting nation. In the absence of beggar-thy-neighbor trade policy tools due to WTO rules, the twin objectives of pollution reduction and term-of-trade improvement justify a combination of crude tax and biofuel subsidy for the food exporter. If the food importer also uses a biofuel subsidy (or tax), we have a Johnson (1953) type Nash equilibrium augmented by pollution considerations. If biofuel subsidies reduce global crude use, then in a Nash equilibrium, the food-exporting nation must use a subsidy, while a food-importing nation will impose a subsidy if and only if the pollution-reduction effect dominates the terms-of-trade effect.

• Item Type: MPRA Paper
• Language: English
• Keywords: Optimal Biofuel Subsidy; Pigouvian Tax; Terms-of-Trade; Pollution Externality
• Subjects: O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development; H - Public Economics > H2 - Taxation, Subsidies, and Revenue; F - International Economics > F1 - Trade

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