June 22 2011

Grocery Cart Economics: Why the Price of Corn Pops Keep Rising

Anna Rittgers

I (like most women) do all the grocery shopping for my family, so I have first-hand knowledge of the rise in food prices. Women be warned, things will probably get worse: Earlier this month, the USDA projected the 2011 corn harvest will be even smaller than previously expected, causing corn futures to soar. The basic principles of supply and demand are in part to blame: If demand for a good remains the same (or increases), and supply is reduced, prices will rise. In addition to being a staple for humans, corn is a chief component of livestock feed. So we can expect these higher corn prices to push grocery prices higher , and not just for corn-based food like fresh corn and corn meal. Dairy products, meats, and foods containing high fructose corn syrup will be more expensive to produce, and producers will pass along some of these increased costs to consumers via higher prices or smaller product sizes.

What caused the reduction in corn supply? First and foremost, crop prices are affected by the weather. Good weather and bumper crops bring lower prices; droughts and floods bring higher prices. Wet weather and flooding in the Midwest affected this year's planting season, and thus farmers planted fewer acres of corn.

But the corn supply was tight and prices rising before the bad weather struck, thanks to the federal government's corn ethanol polices. Around 40 percent of the nation's corn harvest goes to ethanol production. That means that the supply of corn available for food was already relatively small even before bad weather affected planting.

In essence, Uncle Sam would rather you burn corn than eat it.

The oil crisis in the 1970's sparked Congress' interest in ethanol as an alternative fuel, but U.S. consumers never found it to be a viable replacement for gasoline. Ethanol is an inferior energy source . From the time it is planted, harvested, distilled, and transported, it takes more energy to make a gallon of ethanol than the gallon of ethanol itself produces. There are also concerns that ethanol brings its own unique environmental problems and, when burned, may produce more pollution than fossil fuels. There are reportsthat ethanol reduces gas mileage in cars. And absent any subsidies, a gallon of ethanol is still more expensive than a gallon of gasoline.

Since ethanol wasn't going to make it in a free market, Congress decided to interfere and directly encourage domestic ethanol production. Starting in 1978, it instituted a number of measures to encourage farmers to grow corn for ethanol, including tax credits per gallon refined, tariffs on each gallon of imported ethanol (now at 2.5 percent of the value plus 55 cents per gallon), corn crop subsidies, government-guaranteed loans to cover up to 90 percent of plant construction costs for ethanol producers, and tax credits for small-scale ethanol producers (currently 10 cents per gallon). Blenders also get an excise tax credit of 45 cents for every gallon of ethanol they blend with gasoline.

As the supply of corn ethanol increased, Congress stepped in yet again to address the lack of consumer demand. As part of the Energy Policy Act of 2005, the Renewable Fuels Standard (RFS) mandates that refiners blend 7.5 billion gallons of corn ethanol into gasoline by 2012. In 2007, Congress increased it to 15 billion gallons of corn ethanol by 2015. Thanks to Congress, consumers now have no choice but to buy gasoline blended with some percentage of ethanol (up to 10 percent) for their automobiles.

The effects of government intervention ripple through the economy. The artificial increase in demand for ethanol coupled with production and supply incentives persuades farmers (as good businessmen) to devote more of their land to growing corn for ethanol, and in turn growing less corn for food and animal feed. In fact, food prices began increasing after the RFS took effect in 2006.

Add in a severe weather season affecting planting, and you have world food prices skyrocketing. And when people have to spend more on food, they have less to spend on other goods and services, which is bad news for businesses everywhere. The only winners in this scheme are corn growers, agricultural conglomerates like Archer Daniels Midland (ADM), and the politicians perpetuating this scheme. Farmers are guaranteed a premium price for corn. Distillers and blenders get tariffs, tax credits, and mandated usage. The politicians a href="http://conrad.senate.gov/">get reelected.

By distorting the free market and favoring one industry (ethanol production) over others (food production), the federal government is actively making it more expensive for us to feed our families. When the economy was strong, average Americans could afford to overlook the interdependence of agribusiness and politicians. That time has passed. We should end ethanol's dependence on the domestic taxpayer.

The Senate voted last week, in a largely symbolic measure, to allow the ethanol blender credit and import tariff to expire at the end of this year. Congress should take serious action and end ethanol subsidies.

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