Subsidies and High Crop Prices

Not everyone is a fan of the commodity boom. Some blame federal policy for higher feed and food bills.

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The boom in agricultural commodity prices has been good for many farmers and companies providing farm products. But other groups—including food producers and consumers—are feeling the negative effects of the boom in the form of higher prices. What especially irks some of them is their belief that these prices are not simply the inevitable product of the marketplace but rather the unintended consequence of several U.S. government policies.

Even some farmers are unhappy. As grain prices rise, so does the price of livestock feed. As a result, beef, pork, poultry, and dairy farmers are incurring record-high feed costs. According to Cal Dooley, president of the Grocery Manufacturers Association, about 40 percent of the cost of producing pork, for example, comes from feeding the livestock.

That hits consumers, too: A May 2007 study by Iowa State University economists found that "the direct effect of higher feed costs is that U.S. food prices would increase by a minimum of 1.1 percent over baseline level."

What's causing grocery bills to rise? Some blame policies that have made it especially profitable for farmers to divert their crops into corn for the production of ethanol. "The ethanol industry is hogging more and more of the corn supply, and that is squeezing ranchers and dairy farmers," says Daniel Griswold, director of the Center for Trade Policy Studies at the Cato Institute, a Washington, D.C., think tank.

The federal government gives preferential treatment to domestic, corn-based ethanol in the form of a 54-cent-per-gallon tax on imported ethanol, which largely affects Brazilian producers of ethanol from sugar cane. That tax comes on top of a 51-cent exemption from the federal excise tax on gasoline that goes to fuel mixed with ethanol.

These subsidies raise the demand for domestic ethanol. That drives up the price of not only the corn used to produce the ethanol but also of wheat and soybeans, which farmers plant less of because they switch to corn. That, in turn, translates into a scarcer supply—and higher prices.

Dooley says the net impact is bad for the food producers he represents. "For most American farmers, they're producing commodities—they're seeing their best years ever. But for farmers that have to feed grains and corn to livestock, they're seeing very tough times.... The [ethanol] policy is having a significant adverse impact on a significant sector of our agriculture, while I admit it is helping some farmers."

These higher costs are also seen in consumers' grocery bills, and that has made ethanol subsidies an issue in Washington. Democratic Sen. Chuck Schumer of New York this month proposed legislation that would end the 54-cent-per-gallon tariff as a way to stop a spike in milk prices. "There are a lot more milk consumers than ethanol producers in New York. He's hearing an earful from his constituents," Griswold says of Schumer.

Not everyone agrees that ethanol subsidies are to blame for the commodity boom. "I don't think [the tariff] drives corn prices at all," says Harry Baumes, an official in the Department of Agriculture chief economist's office. "If anything, I would argue that if you have a demand for ethanol, and you're looking at the various sources, if you could produce more from domestic sources, it's actually a little cheaper."

Economic analysts are quick to note that government subsidies are certainly not the only—and probably not even the biggest—driver of rising agriculture commodity prices. Other factors include growing international demand. But Dooley says that price pressure from subsidies is still unnecessary.

"The bottom line is that it shouldn't be dictated by tax subsidies. It ought to be dictated by market forces," Dooley says. "Then you would have every bushel of corn treated the same. You would allow the market to determine how corn would be utilized. Right now, it's not a level playing field."

But don't hold your breath for changes in Washington's ethanol policies. "People have drunk too much of this ethanol, and they're taking a distorted view of the benefits, and are totally oblivious to the adverse impacts of those policies," Dooley says.