Biofuel Subsidies and International Trade

Authors


Corresponding author: Subhayu Bandyopadhyay, Research Division, Federal Reserve Bank of St. Louis, PO Box 442, St. Louis, MO 63166-0442, USA. E-mail: bandyopadhyay@stls.frb.org

Abstract

This paper explores optimal biofuel subsidies in a general equilibrium trade model. The focus is on the production of biofuels such as corn-based ethanol, which diverts corn from use as food. In the small-country case, when the tax on crude is not available as a policy option, a second-best biofuel subsidy may or may not be positive. In the large-country case, the twin objectives of pollution reduction and terms-of-trade improvement justify a combination of crude tax and biofuel subsidy for the food exporter. Finally, we show that when both nations engage in biofuel policies, the terms-of-trade effects encourage the Nash equilibrium subsidy to be positive (negative) for the food exporting (importing) nation.

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