Download In order to adequately simulate the ethanol promotion policy, we

Economic impact of ethanol promotion under uncertainty in Mexico: a general equilibrium
analysis
Alejandra Elizondo, CIDE, +5255 57279800, [email protected]
Roy Boyd, Ohio University, 740-593-2040, [email protected]
Overview
We analyze the economic impact of a decision to produce ethanol in Mexico, comparing the effect of a subsidy to
initiate ethanol production with that of alternative public policies. Biofuels support has been a public policy goal
since 2008, and the promotion of ethanol remains an active part of the government agenda. Little is known, however,
about the impacts of ethanol promotion since it is not presently produced in Mexico and there is substantial
uncertainty as to its cost as well as how capital and technology would adapt to its introduction.
Before committing significant resources to ethanol development, Mexican policy makers need to address three
fundamental questions. First, what would be the economic benefits and costs of such a policy? Second, how do these
benefits and costs compare to alternative policies? And third, how sensitive are all of these results to assumptions
about technology? In short, they must understand to what extent ethanol promotion can foster growth in the
agriculture and manufacturing sectors, as well as in the economy as a whole, and the impact of this policy should be
compared to that of alternative policies.
This paper then evaluates the impact of an ethanol subsidy on GDP, sectoral production, consumption and social
welfare, building and adapting a computable general equilibrium model (CGE) for Mexico. Additionally, in order to
deal with the inherent uncertainty of an economy-wide approach, we conduct a rigorous sensitivity analysis of our
model’s key parameters by conducting an exhaustive Monte Carlo analysis.
Methods
Our work follows the tradition of computable general equilibrium modeling and is largely based on earlier work by
Ballard et al. (1985), and Shoven and Whalley (1984). The model is based on Rutherford’s work on nonlinear
complementarity problems and utilizes the solution algorithm MPSGE (Rutherford, 1987, 1999; Böhringer,
Rutherford and Wiegard, 2011) developed by Rutherford and integrated into the Generalized Algebraic Modeling
System (GAMS). The model employed is based on Boyd and Ibarrarán’s model (Boyd and Ibarrarán, 2002,
Ibarrarán and Boyd, 2008).
In order to adequately simulate the ethanol promotion policy, we modify the social accounting matrix (SAM) to
generate an activity on the supply side of the economy that becomes active when the subsidization policy is
implemented. Our approach is to model ethanol production as a “latent technology”. This method closely mimics the
situation in Mexico, where a technology is poised to produce but is not yet active in the base scenario due to the lack
of sufficient profits.
The model is national and includes consumers, producers, government and a foreign sector. In all the model contains
13 producing sectors and 4 consumer groups (or agents), clustered according to their income. It is calibrated to a
2010 social accounting matrix with data from national statistics and other national and international sources
(Ministry of Finance, The Mexican Central Bank, World Bank, among others). Estimates on sugar cane ethanol costs
are calculated from Brazilian sources based on their experience, and adapted to reflect the Mexican context.
We compare the effects of a subsidy to foster ethanol production with the impact of alternative policies that focus on
any of the objectives openly declared for this policy. The rest of the policies under evaluation are: renewables
promotion for electricity generation, subsidies to car manufacturing leading to higher gasoline efficiency in cars, and
subsidies for biofertilizers. In all of our simulations, key elasticities and technology parameters will be perturbed
randomly and our model re-run using Monte Carlo methods to obtain a robust realistic range of results with respect
to production and consumer welfare.
Results
According to our estimates, we can be reasonably confident (in spite of uncertainty) that subsidizing ethanol does not
have a major impact on the aggregate economy, nor does it measurably enhance economic growth. It does, however,
generate a limited increase in welfare for all agents, since they now receive a higher level of subsidies. Government
welfare declines, however, since funds are now directed towards ethanol promotion. The government does not have
new sources of income to compensate this loss, given that this activity (as noted) does not generate additional
growth. Our results show that subsidies to ethanol would increase agriculture production but at the expense of
aggregate welfare. By contrast, alternative “clean energy” policies appear to advance economic growth to a greater
extent, and increase welfare on all agents, at least as much as the biofuel promotion does.
Conclusions
Three important issues stand out. First, viewed in terms of the aggregate economy, the benefits of a policy designed
to promote the use of ethanol are rather small. Aggregate welfare would change very little under a wide range of
model assumptions, while savings, GDP, and energy production would only be modestly impacted.
Second, from a sectoral level, although there are winners and losers from ethanol promotion it is not clear what is
ultimately achieved. Agricultural sectors benefit modestly but this is largely counterbalanced by decreases in other
sectors (such as energy), and the welfare benefits to Mexico’s poorest households are small. Ethanol promotion has
been touted as a means to diversify energy production, increase the income of the poorest agents and lower Mexico’s
GHG emissions. However, the policy does not contribute to any of these goals in a significant way.
Third, and most importantly, our analysis shows the drawbacks that often accompany policies with multiple
objectives, and calls attention to the importance of stating a policy’s main objective. If the main objective of this
policy is the promotion of cost effective agricultural production, then subsidies to bio-fertilizers would provide a
better means of doing this. If on the other hand, the objective is to lower Mexico’s energy requirements then ethanol
promotion is again a poor choice since lower gasoline content occurs simultaneously with higher overall fuel
consumption. And even though our model shows that petroleum production diminishes, other goods heavily
involved in ethanol manufacture increase their production, and this in turn, may result in even higher GHG
emissions. In sum, the public promotion of ethanol cannot readily be justified in terms of social welfare, GDP or
energy security. Particular sectors such as agriculture and manufacturing do benefit from this policy, but the
subsidies required negatively affect both government revenue and the productivity of other sectors.
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