All husk and no kernel
Outdated ethanol policies failed to live up to their promise. Will new EPA leadership allow them to continue?
Preface
John McCain passed away this week. His passing is an enormous loss for statesmanship throughout our political constructs but specifically for the U.S. Senate. I was fortunate to have interacted with Senator McCain and his staff on several occasions during my time in the Senate. This post provides insight on a policy topic that made its way to the Senate floor via a 2011 amendment offered by my boss at the time and critically supported by McCain.
In certain circumstances, amendments can be rendered powerless when an opposing Senator offers a “second degree” amendment, which effectively replaces the underlying text with another version contrary to the original amendment’s intent. In 2011, Senator McCain graciously offered a “friendly” second degree amendment to ours in order to fend off would-be hostile legislative action. This played no small role in the ultimate passage of our amendment.
I still remember leaving the Senate floor that day. I took the train that shuttles Senators and staff back and forth from the Capitol with Senator McCain who sat across from me. We chatted casually. Then, in the spirit of the vote that just took place, he said nice work but that we needed to go after sugar subsidies next. For him, the work of the people was truly never finished.
Intro
The resignation of Scott Pruitt as EPA administrator has ethanol groups scrambling to make inroads with the new acting administrator, Andrew Wheeler. Prior to the announcement, Pruitt led a series of White House negotiations between ethanol policy’s congressional advocates and opponents that were left in limbo after his departure.
The Politics of Ethanol
This is an unusual political issue, because the very nature of a federally-subsidized ethanol industry runs counter to the principles of a market-driven economy, yet its supporters are led by members of the Republican Party, which of course is traditionally known for market-oriented platforms. This GOP support comes from a particular cross-section of the country that grows the bulk of our country’s corn crop – the primary ingredient of ethanol.
In contrast, Democrats outside of the corn belt are largely indifferent to federal involvement in ethanol, leaving conservative republicans in states not dominated by corn crops to lead opposition against ethanol subsidies, i.e. against their republican peers.
What this paradox reveals is that republican backing of federal ethanol support is parochial in nature rather than based on principle or classical liberal economic theory. Knowing that this policy issue pits republicans against republicans is key to understanding why the administration cares to dabble in the subject in the first place.
Let me state from the outset that finding compromise is incredibly important in many instances. But the facts are in on ethanol. If you’re not familiar with them, let me offer a brief primer.
Background
The federal government incentivized and has sustained the U.S. ethanol industry since the 1970s in two major ways – (1) subsidizing through the tax code and various federal programs (grants and loan guarantees) and (2) mandating that a certain volume of ethanol be blended into the fuel supply on an annual basis.
The federal ethanol mandate was created in 2005 under an honorable yet false premise: that the U.S. was running out of oil and that ethanol – made from American corn – would provide a home grown fuel source to allow the country to avoid a national security threat. Seems reasonable enough, assuming the underlying thesis about a depleting oil supply was true. Well, the world would soon come to realize, as the shale revolution took hold, that our nation’s commercial (accessible and economic to produce) hydrocarbons were far larger than once thought. In fact, the onset of unconventional oil and gas development turned America into arguably the world’s most important producer and a major exporter of oil and gas.
It would be one thing to continue federal ethanol programs despite our eventual disproving of its initial reasoning if the fuel made sense from a market perspective, but it fails this test in four primary ways. First, ethanol contains roughly one-third of the energy content as regular grade gasoline, meaning that you have to burn more ethanol to travel the same distance that a smaller volume of gasoline would take you. Second, it artificially promotes the growing of more corn and displaces land from other use, distorting agricultural markets. Third, it’s been reported to actually cause damage in small motors and some boat engines. Finally, it’s no better for the environment than gasoline.
Fortunately, Congress demonstrated an appetite to significantly curtail federal ethanol support. In 2011, the democratic-led Senate passed an amendment that eliminated the largest federal ethanol subsidy – the Volumetric Ethanol Excise Tax Credit (VEETC) that provided $0.56/gal to companies that blend ethanol into the fuel supply. The credit amounted to approximately $6 billion of taxpayer dollars every year. The House took the same action, which together amounted to the only significant policy correction since the 1970s. This came when the democrats ran the Senate and republicans dominated the House. Now that the party that supposedly supports marked-based policies holds the majority in both chambers of Congress, this change should come with relative ease.
Yet, the government has not changed course in its support of the ethanol industry.
The Moral Conundrum
Decades of government subsidies and mandates have created a $60+ billion industry that leans heavily on federal policies, so I concede that there is some honor to sustained monetary support. Why would a government willingly pull the rug out from under it’s own people? I don’t believe it’s right for the same government that created and sustained an industry to also sabotage it.
Pure economic theory suggests that federal monetary support should be eliminated immediately, but this policy – like so many others – doesn’t exist in a vacuum. Rather, it exists in a complex economy that is defined by numerous interdependent mircoeconomies woven together by decades of interconnectedness. Most importantly, it impacts the lives of those now working in the industry. Changes to the policies will have knock-on effects that will impact the livelihoods of honest, hardworking Americans. There’s a moral imperative for some level of continuity from one administration to the next.
It’s understandable that defenders of ethanol policy do so forcefully. Taking subsidies away would be the equivalent to shattering the economic engine across many communities, and they’re right to argue against any attempts to flippantly do so based on an abstract economic or management theory.
So I absolutely respect their opinions but respectfully disagree with them.
The Sunk Cost Fallacy
The economic fallout of eliminating federal support is real, but it doesn’t give the federal government license to continue federal support indefinitely.
It’s been a few years since I graduated with an MBA, but I still remember a few management pitfalls taught during school. One of them is the sunk-cost fallacy. This is a well established pattern of behaviour where decision-makers, despite realizing negative outcomes from a given action or investment, continue down the same path and may even double down with additional resources. To the decision-maker, this course of action rests on the faint hope of recouping prior investments but is more palatable than cutting his loss to prevent further pain.
A June edition of The Economist ran a story covering a paper on this topic written by Christopher Olivola published in Psychological Science. The paper adds to the theory by suggesting that people are not only likely to throw money after bad projects, they’re also likely to double down on the bad project of others, much like multiple congresses and administrations have balked at the chance to change. The ethanol debate embodies this pitfall to a dreadful degree.
The Art of the Deal
The Administration is fundamentally wrong to frame a potential compromise in a way that simply re-balances mandates, waivers, and subsidies, such that it sufficiently appeases real conservatives while managing to avoid offending parochial corn states republicans.
True visionary leadership would fight against the instinct to hold course and, instead, find a solution that, though radical, puts the country on the best path for the long-term. Not a compromise of the sorts that simply modifies a situation as Pruitt’s efforts aimed to do but one that profoundly re-defines the underlying vision.
Because the unique politics of ethanol make clear that the divided interest on this topic is between parochial interests and principled interests, a simple compromise fundamentally won’t work.
Don’t take it from me though. Senator Cornyn (R-TX) was recently quoted in reference to the federal blending mandate (“renewable fuel standard”), saying,
“[It’s] like trying to come up with peace in the Middle East…It’s not easy. There’s a reason this has been hanging around for a long time.”
He’s right; there is no compromise solution like the White House is trying to broker. What’s clear is that the Administration is trying to make a political calculation by threading a needle between the two camps.
Again, a subtle distinction here is important: Trying to appease both sides in an argument can be a worthy, conciliatory endeavour. But sometimes it just amounts to a lack of conviction, foresight, and leadership. The latter is what our current situation has become.
Closing thoughts and proposal
So we’ve come to a place where we realize that ethanol is not needed for its original purpose to avoid a national security threat. Plus, there are significant unintended consequences of incentivizing the mass production of ethanol that limit economic productivity. Yet, the government not only digs its heels in, but continues to consider higher mandates. If ethanol was truly demand by markets, it should be able to sustain itself without mandates and subsidies, especially now that the industry has reached a certain level of maturity after nearly 50 years in existence.
The compromise conundrum should not be whether to have a weak or a robust policy; rather it should be how long must the phase out period be to minimize negative impacts on workers in the ethanol industry and what measures should be taken to support the industry’s current and future generation workers?
The compromise that the White House should be brokering would acknowledge the shortcomings of our current ethanol policy, eliminate it, and seek to alleviate the harsh, short-term economic consequences of doing so.
Artificially creating an entire industry rather than allowing it to be created organically according to market-based demand, requires that the government also wind it down in a responsible manner so as not to put good working people out of a job. We should provide short- and medium-term monetary and financing support as well as job training and job placement help. Over time, the deployment of capital for the transition will be cheaper and more efficient, stabilizing, and growth-enabling than simply keeping everything the same.
Ends to the mandates should be signalled now and grandfathered out over 10-15 years. If this is codified into legislative law, the multiple presidential administrations that will inhabit the White House during the intervening years will have a harder time over-turning it.
The government got American workers tangled up in ethanol nearly five decades ago, and now people’s livelihoods are centered on it. That doesn’t mean we should continue it into perpetuity. We need the Administration to lead by making the tough decision in a firm but logical and compassionate way and to then follow through by finding a solution that prevents economic pain for the people involved.