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Working Paper 2009-053A

"Biofuel Subsidies: An Open-Economy Analysis"
by Subhayu Bandyopadhyay, Sumon Bhaumik, and Howard J. Wall

We present a general equilibrium analysis of biofuel subsidies in an open-economy context. 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, the optimal tax on crude departs from its standard Pigouvian level and a biofuel subsidy is optimal. A biofuel subsidy spurs global demand for food and confers a terms-of-trade benefit to the food-exporting nation. This might encourage the food-exporting nation to use a subsidy even if it raises global crude use. The food importer has no such incentive for subsidization. Terms-of-trade effects wash out between trading nations; hence, any policy intervention by the two trading nations that raises crude use must be jointly suboptimal.

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Category > Applied Microeconomics
Category > International
Author > Subhayu Bandyopadhyay
Author > Howard J. Wall
Research Papers and Publications: JEL Code > F1
Research Papers and Publications: JEL Code > H2
Research Papers and Publications: JEL Code > O1