(By Fisher Investments) Politicians seem pretty universally confused—about many things, but
particularly incentives. Merriam-Webster defines "incentive" thusly:
"Something that incites or has a tendency to incite to determination or
action." But incentives can be perverse things, too—for though the
definition might imply incentives typically spur folks to do something
they should (for whatever reason), they can equally inspire folks to do
things not intended or less than ideal (at least from
politicians' perspectives). It seems, though, politicians may be
getting (yet another) first-hand lesson in the finer points of
incentives this summer—with corn prices.
Back in 2007, the federal government passed
the Energy Independence and Security Act, which mandated fuel refiners
blend corn alcohol into petroleum-based fuels. (It also required oil
companies blend certain amounts of cellulosic ethanol
into fuel or face steep fines. But cellulosic ethanol doesn't exist in
terribly meaningful quantities—so most companies are paying billions
annually in fines for their failure [read: incontrovertible inability]
to comply. But that's for another column….)
Near-instantaneously, corn producers began increasing production—which,
according to basic macroeconomic theory, would typically result in
lower overall prices, all else equal. But all else wasn't equal: Some
40% of the annual corn crop was scooped up by energy producers in order
to comply with the new federal mandates.
Fast-forward to 2012 and factor in a drought, and the situation starts
looking trickier, to say the least. As supply has shrunk this summer due
to the drought alone, the fact energy producers must still comply with
(fixed) ethanol mandates means there's even less corn than
usual to meet demand. In other words, just because there's less corn
this year doesn't mean energy producers must include less ethanol in
petroleum-based fuels—ostensibly resulting in energy taking a bigger chunk of corn harvests than usual.
Adding to the difficulty, rising corn prices are incentivizing (that
word again) beef and pork producers to slaughter stock sooner because
of incrementally higher feed costs this year. Which is potentially
setting us up for not only a corn shortage next year (as farmers dip
into excess stores this year to meet demand), but also potentially a
beef and pork shortage—which would likely incrementally increase those
Now, to be sure, capital markets are flexible animals, as we've said before.
And prices are themselves incentives. As they increase, they'll likely
encourage a couple complementary actions: Consumers likely decrease
their consumption of increasingly expensive goods some and find
substitutes to the extent they can, and additional suppliers likely
begin producing corn, beef, pork, etc. as they're attracted by the
possibility of bigger profits from higher prices.
But that doesn't diminish the silliness of the ethanol mandate in the
first place—without which it's entirely possible all the shuffling just
described would be relatively less necessary (though there'd no doubt
still be some shifting due to the drought's effects alone).
The reality is, no matter the attractiveness of the end goal—in this
case, ostensibly increasing America's "energy independence" by
encouraging alternative energy development—if it's not economically viable
without government propping up, it's far more likely to create perverse
incentives and/or unintended consequences that do more harm than good.
Maybe not immediately—we're five years out from the Energy Independence
and Security Act's passage—but certainly at some point.
A far better alternative, in our view, would be allowing the free
market to determine whether, when, who, in what quantities, etc. to
produce alternative energy. How does it do that? Through its own
incentives—namely, through prices and profit potential. And through
millions of choices made by billions of consumers over time, all of whom
are pursuing their own (usually) rational self-interest. As new
technologies surface, folks will undoubtedly capitalize on them. And
when the time's right, economies will shift to those technologies,
capturing whatever benefits are to be had—increased efficiency,
decreased costs, etc. But until such time, attempting to force change
through "incentives" likely yields poor results. A lesson of which it
unfortunately seems our politicians need continual reminding.
source: Market Minder
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