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Biofuel Subsidies: An Open-Economy Analysis

Subhayu Bandyopadhyay (), Sumon Bhaumik () and Howard Wall ()

No 4584, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: 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.

Keywords: pollution externality; Pigouvian tax; optimal biofuel subsidy; terms-of-trade (search for similar items in EconPapers)
JEL-codes: F1 H2 O1 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-agr, nep-ene and nep-env
Date: 2009-11
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Published in: Economics and Politics, 2013, 25 (2), 181-199

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Working Paper: Biofuel subsidies: an open-economy analysis (2009) Downloads
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