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A tangled web of government polices pushes up fuel, food prices

By John Garen

Sir Walter Scott’s well-known childhood admonition cautions: “Oh what a tangled web we weave, when first we practice to deceive.”

But another tangled web – governments worldwide intervening and regulating – deepens problems with food and energy prices. This requires untangling, not more government tinkering added to the already unhealthy mix.

As usual, the story starts in a good way. Worldwide economic growth pushed up real incomes and pulled many out of poverty. Laudable concerns for the environment then came into play.

But then the web began through pleasant-sounding, but ultimately heavy-handed, government policies.

The remarkable worldwide economic growth experienced during the past decade or two got much of its impetus from free-market policies. These included relaxing trade barriers and impediments to foreign investment, and dismantling some inefficient domestic policies in many countries. These positive steps led to increased productivity and incomes for a number of people.

However, the worldwide capacity to produce energy did not keep pace. A simple market equation came into play: demand grew faster than supply. This drove the price of energy upward. Indeed, some increase in the price of energy probably was inevitable. However, subsequent policy actions made the problem worse.

The tangle began with a well-intentioned environmental motive. Global warming concerns caused the United States and other nations to require the use of biofuels in an attempt to reduce carbon emissions. In the short term, this led to further increases in the price of gasoline because capacity to produce fuel in the modified manner necessary lagged behind. Again, the principles of supply and demand came into play, but this time the limited supply pushed up the price.

However, the longer-term ripple spilled into agricultural markets. Farmers converted a great deal of land to crops for biofuels and away from crops for food.

Not surprisingly, the laws of supply and demand quickly took hold and the prices of food items rose. The combination of rising fuel and food prices induced many governments to “do something.”

One result is that many countries – China, Mexico, Malaysia and Venezuela – have made the situation worse by capping food prices.

These artificially low prices give incentives for suppliers to produce less but consumers to keep buying – the exact opposite of what’s needed when goods become scarce.

Other government reactions work just as poorly.

For example, when the price for rice rose rapidly, it provided an incentive for farmers in rice-producing regions to produce more for export to areas that don’t grow the staple. Yet rice-producing countries such as India, Indonesia, Vietnam, China, Cambodia and Egypt have restricted rice exports. Again, suppliers are induced to limit production precisely at the time when the world needs the crops most.

The U.S. and European Union countries don’t have much to brag about, either. For years, each engaged in policies that limited supply and raised food prices.

A similar issue occurs with gasoline. Though the biofuels mandate plays a role in the run-up in gasoline prices, a major factor remains the rising price of crude. This generates tremendous profits for owners of crude oil sources, but bad policies present obstacles to increasing the supply.

Some examples:
• To tap new reserves in Mexico, the country needs the expertise and investment of non-Mexican firms. Yet, the government of Mexico won’t allow this.

• Russia faces a similar need to develop its reserves, but the Russian government continues to squeeze Western companies, slowing new investment.

• The United States continues its moratorium on drilling for known reserves in the Gulf of Mexico. While legitimate environmental concerns exist, surely – with oil prices rising well above $100 a barrel – someone can find environmentally sound ways to get that resource.

The price system and markets provide a great incentive system. High prices simultaneously signal more consumer desire and provide incentives to produce more. But while we bemoan high prices, many of our policies impede individuals and firms from acting on the incentives offered by these skyrocketing costs.

And here’s a final and exasperating irony: All the efforts to reduce carbon emissions through biofuels, which pushed gas and food prices up, don’t seem to work! Rather they have resulted in more land-clearing and greater net emissions.

Through ineffective subsidies for biofuels, price controls and hurdles to production, governments have created a tangled web of policies that aggravate – rather than ease – problems in food and energy markets.

We don’t need any new grand government schemes for energy and food costs. We just need to get rid of the lousy ones in place.

— John Garen is the chair of the Department of Economics and Gatton Endowed Professor of Economics at the University of Kentucky. He can be reached at jgaren@uky.edu.

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