Minnesotans For Sustainability©
Sustainable: A society that balances the environment, other life forms, and human interactions over an indefinite time period.
Information Distortion and Competitive Remedies
in Government Transfer Programs:
The Case of Ethanol
Table 1: Corn Prices, Target Prices, and Deficiency Payments
C. Information Obfuscation in the Absence of Competing Interest Groups: 1978-1986.
D. Competing Constituencies and the Generation of Information about the Ethanol Subsidy: 1987-1998.
V. Concluding Remarks.
In this paper, we reconsider the analogy between competitive markets and the political process that is central to much of the literature on the efficiency of government transfers. The key problem is that property rights in politics are much less well defined than they are in competitive markets. As the paper outlines, obtaining accurate information about the benefits and costs of transfers is likely to be much more difficult than envisioned in the literature. Investigators, as well as general voters, often must rely on the government and competing parties for provision of information about underlying program parameters and functional relationships. We argue that politicians and the affected interest groups have incentives to limit and distort the information that is released to voters and that political competition is unlikely to be an effective counter. In developing the argument, a theoretical framework is provided and applied in a case study of the ethanol transfer. The documented efforts to disguise the actual costs and benefits of the program are important for gaining a broader understanding of the functioning and costs of government transfers in the economy.
The view that government programs often are merely masked efforts to transfer wealth via the political process is a prominent part of the rent-seeking literature.1 More recently, however, these rent-seeking arguments, which imply that government transfer programs reduce wealth, have been criticized as ignoring the incentives of politicians in representative democracies to promote wealth-maximizing outcomes.
Representative is Donald Wittman, who claims that democratic politics are inherently efficient.2 Using an analogy with competitive markets, Wittman argues that entry by entrepreneurial politicians and competition between them and incumbents generates sufficient information about the benefits and costs of government transfer programs to allow voters to reward efficient behavior.3 Wittmanís argument is an extension of Gary Beckerís claim that the political process will favor the most efficient policy instruments for affecting a transfer.4 Beckerís point is a natural application of the standard Pareto conditions: If a given wealth transfer to a special interest group can be obtained under different policies, then the policy instrument that imposed the least costs on the general electorate would be chosen. Although Becker doesnít claim that redistribution enhances aggregate wealth, his argument is the cornerstone for Wittmanís more general assertion that political institutions in a representative democracy work as well as markets.5 The notion is that market-like pressures provided by competing politicians discipline government policies and institutions, and those that survive over time are presumed to be reasonably efficient, given the transaction costs of changing them: "to the extent that rent seeking exists, rents will be shifted efficiently and the seeking of these rents will involve minimal social cost."6
In this paper, we question the close analogy between competitive markets and the political process in a representative democracy.7 The focus of the analysis is on the extent and basis of voter information about transfers and the role of political competition in providing that information. It is our contention that obtaining accurate information about transfers is likely to be much more difficult than envisioned by Wittman and others. Investigators, as well as general voters, often must rely on the government for provision of information about underlying program parameters and functional relationships. We argue that politicians have incentives to limit and distort the information that is released to voters and that competition for elective office alone is unlikely to be an effective counter. Our approach builds on Gordon Tullocksís insight that politicians engage in information obfuscation because direct transfers "...would be just too raw.
The voters would not buy it."8
The analysis we offer distinguishes between competition among politicians for political office and competition between powerful competing interests groups as a means of policing the flow of information.9 We argue that although competition among politicians may not generate sufficient information to allow voters to assess the welfare effects of transfers, competition among interest groups might. That is, if a transfer to one constituency seriously disadvantages another cohesive group, then it will be in the latterís interest to organize to counter the policy. It is this process, competition among concentrated interests and the spill over incentives of aligned politicians, that is most apt to release information to general voters. Even then, however, voters will be faced with assessing the relative claims of competing parties, and if the issues are complex, voters may not have sufficient unbiased information to make informed judgements.
In politics, there are incentives to provide focused benefits to influential constituents and to spread the costs among all taxpayers. As we argue, obfuscation or the opportunistic distortion of information about program benefits and costs by sponsoring politicians makes such transfers more likely. Although government programs are usually aimed at specific constituents, typically there are important external effects whereby costs and some benefits are spread to other voters.
Politicians have incentive to take advantage of these externalities by overstating benefits and understating costs. The emphasis on the external benefits of programs increases demand from general voters for what otherwise might seem to be blatant special-interest legislation. As such, information obfuscation can enhance the re-election prospects for politicians.
Information obfuscation by politicians raises the costs of program evaluation by general voters. The incentives to distort information and the opportunities provided by the political process to do so, explains the commonly-viewed phenomena whereby politicians wrap narrow, special-interest legislation with broad external benefits.10 Consistent with this view are the preambles of major enabling legislation that describe how programs and policies improve safety, provide national defense, or protect the environment.11 We argue that linking narrow transfers to broad externalities is more than mere window dressing. It is an integral part of the political process whereby politicians provide transfers to key constituents, while distorting information on the broad benefits and costs involved.
The institutional structure of the political system allows politicians to engage in information obfuscation with few negative electoral consequences. This condition challenges the analogy between competitive markets and the political process in a representative democracy.
Whereas in competitive markets, firm share holders capture the benefits and costs of adhering to or cheating on product quality, in politics property rights to program benefits and costs are much less well defined. Given the property rights structure in the political arena, the resort to information obfuscation by politicians as a means of advancing special-interest programs appears to be wide spread, and competition among politicians alone likely will have little impact in reducing the use of information distortion. Where competition exists amongst two or more powerful interests groups, information distortions are more apt to be revealed. But that form of competition is far from ubiquitous, and even where it occurs, voters may not be able to successfully disentangle the claims made by the competing interests. The resulting uncertainty may facilitate the provision of special interest benefits.
We develop our arguments in the following two sections and then illustrate them with reference to the ethanol program, a long-standing subsidy that benefits corn farmers, but is advertised as having significant benefits to the environment, rural development, and national security.12 The documented efforts to disguise the actual costs and benefits of the program are important for gaining a broader understanding of the functioning and costs of government transfers in the economy. In the final section, we consider the usefulness of labeling transfer programs as "efficient" or "inefficient" once information costs, which are the basis for transaction costs, are included.
The notion that there is competition among politicians and political institutions and that their actions can be analyzed by applying the same tools used to explain the behavior of individuals and firms is widely accepted, certainly by the two authors of this paper. We question, however, how far the underlying paradigm of competition and resulting optimization can be applied to the political arena.
According to the market analogy, competitive entry and exit among office holders and seekers is a necessary condition for directing political outcomes towards aggregate wealth maximization. It generates the desire among politicians to invest enormous funds in campaigning, in learning constituent demands, and in mobilizing resources to satisfy those demands. Politicians who fail to be responsive to influential constituents will not be re-elected.
Further following the market analogy, competition among politicians also can mitigate the problems commonly associated with rationally-ignorant voters.13 Since most models of government failure are premised on voter ignorance, this is an important point. Although voters may not be fully informed, competition in the political arena is argued to release information about program benefits and costs. Entrepreneurial politicians are rewarded for assessing program effectiveness and for finding new funding sources or ways of reducing taxpayer burdens.
Fraudulent claims and behavior by some politicians will be revealed by other politicians because they will be rewarded by voters for doing so. The process of information generation and revelation provides voters with sufficient insights that they will not be swayed by mere rhetoric.
The problem with the analogy between a representative democracy and a competitive market is that the property rights structures are so different. For example, while there are similarities in the relationships between stockholders and firm managers and between a constituency and its elected officials, there are important differences in the recourse general voters have with elected officials compared with that available to consumers in dealing with firms. Consider the incentives and penalties a firm manager faces when contemplating whether to lie to customers about product quality. If the deception goes undiscovered, at least for a substantial period of time, the stockholders will likely support management. The competitive process of new firm and product entry, however, generates needed information for evaluating firm quality claims. Discovery of quality deception can be extremely costly for the manager because stockholders will turn on management if asset prices plummet.
Firm reputational costs seem to be substantial compared to civil penalties.14 Accordingly, there are market forces for assuring contractual performance between a firm and its customers.15 Moreover, the U.S. legal system allows consumers to sue for damages, including punitive damages, and agencies like the Federal Trade Commission monitor fraud and false advertising. At the very least, consumers can cease buying the product. Accordingly, consumers have recourse and thus, discovery of deception posses a threat to both managers and stockholders in private markets.
Now consider the incentives faced by an elected official to deceive general voters about special-interest program costs and benefits. In contrast to consumers, the general populace who often pay the bulk of program costs have little direct recourse against deception. If they do not reside in the politicianís district, they can not vote directly against him, nor is it clear that they would be in any position to inflict much harm against the constituents in the politicianís district. In a federal system such action would require a considerable degree of collective behavior on the part of general voters. Unlike consumers who can discontinue purchasing a commodity, the comparable option for general voters is a high-cost one, leaving the country.16 Thus, under a federal system in a representative democracy a politician may be largely immune from any penalty so long as the deception benefited the local constituency.
The standard market analogy also glosses over the structure of district-based representation and the weak property rights that exist over tax revenues and program costs and benefits in the political arena. Competitive market outcomes result in wealth maximization when property rights are well defined and enforced. When they are not, competition among agents results in rent dissipation. The classic example is the open-access fishery where entry by fishers is free.17 Once there, they compete to harvest prior to other fishers, resulting in the dissipation of the rental value of the fishery. The weak property rights conditions that result in the wastes associated with open-access fisheries seem more like those that exist in politics than the fully defined rights that underlie standard competitive models.
Consider tax revenues. Tax revenues are not a pure open-access resource with complete rent dissipation since there is only a limited number of politicians in a representative democracy to compete for them. Even so, no individual politician has a clear property right to tax revenues.
Politicians and their programs compete for budgets in order to satisfy constituent demands. As in the fishery, the rule of capture defines property rights to the budget at any point in time, and funds migrate, like fish, to the most effective competitor. Politicians who are particularly skillful in securing taxpayer largess for their districts become locally-notorious and typically, are rewarded with repeated re-election by grateful constituents.18 Majority voting rules for funds allocation require logrolling and other exchanges among politicians. These trades result in program benefits being concentrated on certain constituencies while the costs are dispersed to general taxpayers and voters. Hence, the underlying property rights structure in politics neither equates constituent program benefits with relevant tax costs, nor constituent benefits with overall social costs that would account for externalities. As in markets, the failure to equate private benefits and costs with social benefits and costs leads to non-optimal resource allocation.
In politics, the lack of a well-defined residual claimant fosters information distortion. It is, of course, in the interest of the sponsoring politician to make sure that key constituents recognize how much they are served by his actions. In contrast, however, those bearing the program costs will typically be less informed, and it is in the interest of sponsoring politicians to keep it that way. Elected officials have substantial control over the flow of information that could expose deception. We argue that if narrow-interest programs can be portrayed as providing positive externalities across jurisdictions, it may not be in the interest of other politicians to reveal the information distortion by one of their colleagues.
The incentive to jointly engage in obfuscation is reinforced by each politicianís desire to be a repeat bargainer in log-rolling trades to advance special-interest legislation. Thus, politicians have the incentive and opportunity to engage in obfuscation in order to distort the information available to general taxpayers about the size and incidence of special-interest program benefits and costs. Only if a well-defined constituency is negatively impacted is there likely to be a counter to the claims of generalized benefits from specialized transfers. But this is a special case and one that politicians would seek to avoid. Further, the information generated by competing interests may not turn out to be particularly useful for voters in evaluating the conflicting arguments.
This section explains the incentives for politicians to take advantage of information asymmetries and distort information, and why competition for political office is unlikely to deter such behavior.19 Because of the nature of many government-provided goods and services, there generally are externalities and information problems. These information problems create uncertainty for voters in the assessment of program benefits and costs. As votersí agents, politicians are expected to provide public goods and information about their benefits and costs.
But, politicians seeking re-election also have incentives to provide transfers to key constituents and to shift the costs to others. By distorting information about the true social value or cost of those transfers, such as by linking them to public goods, politicians can provide more private benefits to the targeted constituency. Through exaggerating the social benefits or minimizing the social costs of transfers, politicians can increase demand for a particular program or reduce opposition to it. Rather than resolving the information uncertainties facing general voters, politicians take advantage of the situation and further distort and manipulate information flows in order to provide more transfers to favored constituents.
A. The Single Political Jurisdiction.
We start with the bench mark case of a single political jurisdiction wherein all the benefits and costs of a program accrue to the voters within that jurisdiction. Assume two groups of voters. The first group is composed of the direct beneficiaries of the program. These may, for example, be agricultural producers benefiting from subsidies, or manufactures benefiting from import restrictions. The program benefits accruing to this group, net of their share of taxes, is a function of the programís policy instrument, P, which can be thought of as the level of subsidy, price support, tariff, or regulatory stringency imposed on foreign competitors. Net benefits are assumed to be a positive function of P, but may have a maximum value as in the case of a quota.
The second group is composed of voters who experience spill-over effects from the program. While spill-over effects may be positive or negative, we simplify and assume they are positive. Net program benefits to the spill-over group are assumed to be a concaved single peaked function of P.
Now consider an incumbent politician who attempts to maximize expected votes in the next election.20 The incumbent faces an opposing candidate and will be judged, in part, on the positions taken on various bills. While voters decide to vote for or against the politician on the basis of an array of issues, the focus here is on a single issue, the level of P. The probability that members of the direct beneficiary group vote for the incumbent is denoted as É, and it is a positive function of how close actual program benefits match that groupís maximum potential net benefit. Accordingly, É is a positive function of P. The probability that the group experiencing the positive spill-overs votes for the incumbent is denoted as g. This probability is also a function of P, and has a maximum value. Let N be the total number of votes in the jurisdiction, and n be the number of those voters in the direct beneficiary group.
The vote maximizing objective function for the incumbent is,
(1) V = nÉ (P) + ( N - n) g( P).
The elected official selects P to maximize V,
(2) ∂V/∂P = nÉ' + (N - n)g' = 0
Consider how the politician can exploit the situation through the control and manipulation of information. We assume that the direct beneficiary group carries out their transactions in the market place, and knows with certainty what their net gains are. On the other hand, voters in the spill-over group may find it difficult to measure the benefits of the external effects, especially when they involve claims of national defense, or health and environmental benefits requiring risk assessment.22 Accordingly, we assume that the group benefiting from the spill-over effect is uncertain about the true level of benefits associated with varying levels of P.
If the incumbent can control the information that group has about that relationship, there is a potential for increasing V. For example, with É' positive and g' negative, an increase in the perceived level of benefits accruing to the spill-over group could reduce opposition and allow for an increase in V. Indeed, if the incumbent could costlessly shift perceptions, it is conceivable that a solution where both É' and g' were equal to zero could obtain. But, there is likely to be a cost if the incumbent is discovered lying to his own constituents.
Let the probability that the politician is discovered lying, D(a), be a positive function of the degree of deception, where a is the extent to which perceptions about the benefits to the spillover group have been shifted away from their "true" levels. Discovery lowers the probability that the spill-over group votes for the politician. The new objective function is
(3) Vmax(p,ś) = nÉ ( P) + (N - n) g (P,ś,D(ś)).
The first order conditions are
(4) ∂V/∂P = n (∂É/∂P) + (N - n( ∂g/∂P) = 0
(5) ∂V/∂ ś = n (∂g/∂ ś) + (N - n( ∂g/∂D ∂D/∂ś) = 0
Although it would seem that the political challenger would also have an incentive to expose the incumbent, there are complications. By exposing the incumbent, the challenger gains support from the group experiencing the spill-over effect, but suffers the displeasure of the other group because future levels of P will be lower. Whether this is sufficient to deter the challenger depends on the reactions of the two groups of voters, but it should be clear that competition among politicians can differ substantially from competition for control of a firm. Compared to a political jurisdiction, stockholders in a firm are likely to have very narrow and similar objectives.23 While management may attempt to fool the stockholders, there is really only one group the challenger need address, not two as in the political model offered here. Thus, the incentives for the challenger to expose an incumbentís obfuscation seems greater in contests over the control of a firm compared to contests in the political arena.
We emphasize that it is the diversity of interests that provides the underlying incentives for the type of obfuscation addressed in this paper. If instead of two distinct groups, we assume there is only a single group, composed of both the direct beneficiaries and the group experiencing the spill-over effect, the challenger would now have a clear incentive to expose the incumbent.
This appears to be the condition that those who rely on the role of competition in the political market place have in mind, but it fails to capture much that goes on in representative democracy.
B. Multiple Political Jurisdictions.
Consider a system that more closely resembles representative democracy. Let there be
two districts, one that contains all the members of the direct beneficiary group while the other district contains the group experiencing the spill-over effect. The incumbents in each of these district will attempt to maximize votes by selecting the level of P that maximizes the net benefits of the group in their district. Again, only under extremely remote conditions would there be a transfer level where both É' and g' are equal to zero.
From the standpoint of the incumbent in the direct beneficiary groupís district, the level of P preferred by the incumbent in the other district will be either too high or too low. The two incumbents, however, must reach agreement on the appropriate level of P. But, by engaging in information obfuscation, the incumbent in the direct beneficiary groupís district can attempt to influence perceptions in the district experiencing the spill-over effects. The goal would be to shift perceptions so that the preferred level of P in the district experiencing the spill-over approaches or equals that of the direct beneficiary groupís district.
While the incentive for the incumbent in the direct beneficiary groupís district to engage in obfuscation is clear, the reaction of the incumbent in the other district is not as apparent, but with obfuscation, g increases. That is, the politician representing the spill-over district might want the obfuscation to take place, or simply be ambivalent about it, because it raises the perception of benefits from this particular government activity.
Much will depend on the incentives of the challenger in the district experiencing the spill-over effect to expose the distortion. A political challenger in that district might choose to expose the information distortion as a means of attracting voter support, but if the challenger is to benefit from the exposť, the incumbent must be made culpable. That may not be easy. First, it is the incumbent in the direct beneficiary groupís district who will take the lead in distorting the information flow, while the incumbent in the district experiencing the spill-over effect can simply act passively.
Second, as soon as it is recognized that a challenger is about to expose the distortion, the incumbent could preempt the challenge with his own attack on obfuscation, thus reducing the rewards to the challenger. Importantly, the incumbents in both districts can have an incentive to block information flows that would reveal the obfuscation. Together they will attempt to control the flow of information and win re-election.
The simple model presented here can readily be expanded to include familiar aspects of distributive politics, such as logrolling or vote trading.24 Logrolling is an integral part of the workings of a representative democracy, but it requires that elected officials impose costs on their own general constituents in exchange for specialized or targeted benefits to specific constituents. That is, in negotiations politicians trade off support for narrowly-based programs that impose costs on other, typically broader, constituents. Since obfuscation reduces the perceived cost by convincing the voters in the paying districts that they are actually benefiting from the transfer, it facilitates logrolling. Moreover, if the benefits of a program remain concentrated, while the number of electoral districts expands, costs will become dispersed.
While both obfuscation and discovery require effort, the rewards to the latter will decline as program costs become dispersed. Thus, elected representatives may have only a very limited incentive to expose the obfuscation of fellow representatives because the rewards of doing so are likely to be small and they too benefit from engaging in that same practice.
Politicians, then, are motivated to act collectively and adopt policies that reduce access to information. Indeed, if a politician stridently exposes obfuscation by politicians in other districts sufficiently to attract wide-spread voter attention and negative reaction, the logrolling trades among many politicians that depend on it may be disrupted. While the politician may gain broad voter approval across many districts, as a whistle blower he may not be invited to engage in logrolling trades of his own. Hence, he may not be able to deliver to specialized constituents within his own district, jeopardizing his re-election. Accordingly, the returns to obfuscation for politicians suggests that they will attempt to control the flow of information that may weaken or bolster their claims. In particular, the use of information from neutral, scientific agencies can be very important in adding credibility to political rhetoric. Hence, if agency reports, which are often vague, can be interpreted and presented as consistent with the political rhetoric, politicians will do so. Clear reports that are inconsistent with the rhetoric will be suppressed through a variety of means.25
The arguments presented thus far should not be taken to imply that elected officials have no incentive to expose information obfuscation by their colleagues. There are situations where the incentives could be very large, but as we have indicated these are likely to be cases where certain well-organized interest groups are adversely affected by a distributive program and know that they have been harmed. Indeed, we should expect that when competition amongst relatively powerful interest groups occurs, there should be a substantial amount of conflicting information generated and studies inaugurated aimed at offsetting or discrediting the information advanced by the opposing group. This process may provide useful information to general voters, if they can evaluate the competing claims. But absent those circumstances, there will be little in the way of systematic cross examination of political claims about transfer program benefits. The ethanol story illustrates both of these scenarios.
The Arab oil embargo of 1973 and the related oil price shocks made the United Statesígrowing dependence on foreign oil supplies a political issue, and politicians searched for ways to promote domestic, renewable energy sources.26 Subsidies for ethanol were an integral part of these early efforts to promote energy independence. The Energy Tax Act of 1978 authorized the first federal excise tax exemptions for biomass derived fuels, chiefly gasohol, a mixture of 90 percent gasoline and 10 percent ethanol. The Energy Security Act of 1980 set a goal for alcohol fuels production equal to10 percent of motor fuel consumption by 1990 and provided over a billion dollars in loan guarantees for ethanol plants.27
But even as the energy crisis waned in the early 1980s, the subsidization and the promotion of ethanol continued. The ethanol subsidy has amounted to more than $7.1 billion between 1979 and 1995, and is projected to equal an additional $3.3 billion between 1996 and 2000.28 The largest component of the subsidy are exemptions from federal excise taxes that have ranged from $.50 to $.60 per gallon of ethanol or $.05 to $.06 per gallon of gasoline blended with 10 percent ethanol.29
In this section we describe how the ethanol subsidy was linked by sponsoring politicians to a variety of externalities that were positively viewed by general votersĖenergy independence, environmental benefits, and rural economic development. Importantly, the ethanol subsidy was also tied to an alleged reduction in government support payments to farmers. Since 95 percent of ethanol is made from corn, ethanol production became a convenient alternative source of demand for corn stocks to reverse the fall in domestic corn prices that began after 1980.
Because ethanolís actual contributions to energy independence, clean air, and rural economic development were tenuous, politicians had to control the flow of information to the public so that supportive information was released and negative information was suppressed. As a result of these efforts, voters received a distorted assessment of ethanolís broad contributions to the economy that went largely unchallenged until the late 1980s, in large measure because no competing interest group was seriously harmed. While the major oil companies may have viewed the subsidization of ethanol as a potential threat, there was no plan to promote ethanol to the extent practiced in Brazil and the energy crisis was viewed broadly as a serious problem. A criticism of the ethanol subsidy by oil companies would have appeared as self-serving as those firms were also developing their own alternative fuels, such as methanol, with government encouragement.30 Methanol, made from natural gas, was less costly to produce than ethanol, and it captured a larger share of the alternative fuels market.
In the late 1980s, however, competition among interest groups began to develop, with more information about the nature of the ethanol subsidy being generated for voters. Stricter air quality standards and requirements for the use of reformulated gasoline (RFG) under the Clean Air Act Amendments, proposed in 1987 and adopted in 1990, opened new markets for oxygenate additives.31 Corn-state politicians sought to mandate a share of this new market for ethanol at the expense of MTBE (methyl tertiary butyl ether), a natural gas derivative.
Legislation and administrative rulings on behalf of ethanol were introduced. These efforts led to the mobilization of the natural gas and chemical industries to protect MTBE. Congressional hearings and other public testimony contained the claims and counter claims of the proponents of ethanol and MTBE, and through this process the external benefits of ethanol were challenged systematically for the first time. As a consequence, ethanol supporters were unable to secure preferential treatment in the new developing market for oxygenated fuels. Even so, given the scientific nature of the claims and counter claims made by ethanol and MTBE proponents and the absence of neutral bodies to assess the arguments, it is not obvious that this conflict among interest groups has released useful information to voters for weighing the social benefits and costs of the ethanol subsidy.
A. Externalities and the Ethanol Subsidy.
Although the cost of producing ethanol in 1980 was nearly twice that of gasoline, forecasts of high future gasoline prices (as high as $4.00 per gallon) by 1990-91, issued by the U.S. National Alcohol Fuels Commission, made ethanol seem like a reasonable alternative.32
The nineteen congressional members of the fuels commission were predominately from agricultural states, most likely to benefit from greater ethanol production.33 They repeatedly stressed externalities as justification for a ethanol subsidy.34 Foremost on their list were a). energy independence, b). environmental benefits linked to the Clean Air Act of 1970 and its mandate for cleaner burning fuels, and c). rural economic development and reduced farm program costs, achieved through lower domestic corn stocks and higher corn prices as corn was diverted to ethanol production. These concerns were heightened by President Carterís embargo of grain sales to the Soviet Union in 1980.
Although those external benefits were described in 1980, eighteen years later, in 1998, political proponents of the ethanol subsidy have continued to tout the same benefits. The claims made by Representative Richard Gephardt of Missouri in May 1998 are typical: "ethanol is good for our environment, our nationís energy security, and for American farmers."35
The feasibility of ethanol as an alternative fuel in 1980 was strengthened by expected technological advances that would further close the gap between (rising) crude oil prices and (falling) ethanol prices. Further, the potential for correcting externalities in energy security, air quality, and agriculture meant that government intervention in the market was appropriate. If the externalities were substantial, a subsidy for ethanol could have broad economic benefits beyond transfers to corn growers, and hence, the subsidy could merit support among general voters.
Farm state politicians continually re-emphasized these external effects throughout the 1980s, and for the most part were successful in obtaining favorable legislation, because no other constituency had incentive to critically evaluate their claims.
Comments stressing the benefits of ethanol beyond the pecuniary gains to corn farmers were especially important to corn growers because they helped camouflage larger direct transfer payments to that group. As such, externality assertions are part of information obfuscation in the political arena. But politicians have gone beyond mere rhetoric. They have also taken actions designed to control or distort potentially damaging counter information and to circumvent administrative processes that might reveal such information.
B. The Ethanol Subsidy to Corn Growers: Masking the Transfer.
To illustrate the nature of the ethanol subsidy to corn producers, we consider how feed grain programs operated prior to the Federal Agricultural Improvement and Reform (FAIR) Act of 1996.36 These programs used a number of policy instruments, including target prices and deficiency payments, an acreage reserve program, and nonrecourse loans.37 When market prices were below the target or support price, farmers who met the eligibility criteria (usually participation in whatever supply control program existed) received payments equal to the difference between the target price and the higher of the average market price or the nonrecourse loan rate. The total payment received by each farmer was a function of the difference in those prices, multiplied by the number of eligible acres times the normal yield for each participating farm, and most corn producers participated.
Throughout the 1950s and 1960s the target price typically exceeded the market price. In the early 1970s, increases in foreign demand drove corn prices above target levels. As shown in Table 1, however, this situation was relatively short-lived. By 1982 target prices were once again exceeding market prices and large deficiency payments were a mainstay of the farm program.38
Figure 1 helps to illustrate the ethanol subsidy. The curve D0 represents the aggregate presubsidy demand function for corn in the United States. The domestic supply curve for corn without government intervention is denoted as S0. With implementation of the governmentís price support program, accompanied by an acreage reduction requirement, the supply function shifts to the left. The target price is denoted as PT and intersection with the restricted supply function, S1, determines output under the program, Q1. Note that the restricted supply function is a function of PT, with the market price, PM0, determined ex-post. As drawn, Q1 is the same output that would prevail in the absence of government intervention.39
The per unit deficiency payment is the difference between the target price and the market clearing price, PM0. Assuming that all producers are eligible, the federal governmentís total outlays for deficiency payments is area PM0baPT. Even though output is the same as in the nonintervention case, this program results in an increase in the cost of production, generating a deadweight loss equal to area eba. It is assumed, of course, that the gain to producers under the program, area KeaPT, is larger than would have prevailed in the absence of intervention, area KbPM0. In the long run, these gains are typically capitalized into the value of farm land.40
Figure 1. The Market for Corn
Now consider the introduction of a subsidy on ethanol and how it affects the demand for and supply of corn. Although the actual shape of the new demand curve will depend on how the subsidy is implemented and conditions in the industry, the primary effect is an increase in the demand for corn to D1. The market price increases to PM1, but given our assumptions, the output of corn is the same. Unless the demand for ethanol is sufficiently high so that the market price exceeds the target price, there is likely to be little effect on output.41 Between 1950 and 1985, for example, the average market price for corn was greater than the target price in only 13 of those 36 years.
But, if the ethanol subsidy had at most a minor impact on the output of corn that would seem to suggest that corn producers did not directly gain from the ethanol subsidy.
There was, however, a clear political benefit to corn producers from the ethanol subsidy. It masked the costs of the federal farm program by reducing deficiency payments. With the ethanol subsidy, deficiency payments could be reduced from PM0baPT to PM1caPT.
Continuing the subsidy for ethanol was important if agricultural program costs were to be kept in check.
The political importance of concealing deficiency payments is indicated by the data in Table 1. Deficiency payments ballooned in the 1980s, rising from $88 million in 1978 to $25.8 billion in 1986, and became one of the largest components of agricultural commodity program costs.42 At the same time, the federal budget deficit was increasing and a source of considerable political and financial concern.43 In 1985, the Congressional Budget Office (CBO) estimated that elimination of deficiency payments would save taxpayers $28,900 million over five years.44
While such an outcome is possible, the GAO report was not conclusive, and the trade off between ethanol subsidies and agricultural program costs remained unanswered. Moreover, even if that trade-off proved positive it would not have amounted to a full cost-benefit analysis.
A full cost-benefit analysis would involve accounting for numerous potential trade-offs.
For example, there may be rents that accrue to firms engaged in the production of ethanol, and purchases by foreigners accounted for. If the latter are not considered part of the welfare calculations, the higher market prices they pay for corn represents a gain to the United States.
But there are other factors that work in the opposite direction. The production of ethanol yields feed byproducts and these compete with soybean meal and other feeds. Increased ethanol production will lower the price of these other feeds. The potential for these types of interactions suggests that a full fledged cost-benefit analysis would require an enormous amount of information and faith in the modeling of these complex interactions.48 As we show, in an environment of political information obfuscation, the challenge of completing such a study would be even more difficult. Because any results would have important implications for corn growers, the studies were unlikely to be done without political intervention to control the information released.
C. Information Obfuscation in the Absence of Competing Interest Groups: 1978-1986.
In the early 1980s, congressional hearings and other sources of information were enthusiastic about the potential contribution of alternative fuels, such as ethanol, methanol, and liquefied natural gas to energy independence, cleaner air and rural development.49 Because no cohesive constituency was disadvantaged by the transfer, the claims made on behalf of ethanol were not seriously disputed by outside parties. The most damaging challenge came from an internal 1986 USDA cost-benefit analysis of the subsidy.
The 1986 USDA study was headed by career civil service employee and Director of the USDAís Office of Energy, Earle Gavett. It was undertaken specifically to address the question of whether a positive trade-off existed between price support program costs and the ethanol subsidy.50 The 1986 study also was a prerequisite to further programs regarding the feasibility of a strategic ethanol reserve as required by Section 1774 of the Food Security Act of 1985. When the report was issued, however, its findings came as a shock to ethanol proponents.
While falling short of a full cost-benefit analysis, the 1986 USDA study utilized a general equilibrium approach to estimate the non-environmental benefits and costs of the subsidy to ethanol. The report concluded that the industry could not survive through 1995 without "massive Government subsidies, given the outlook for petroleum prices."51 Further it suggested that "[i]f the principle argument for subsidizing ethanol is to boost farm income, we conclude from this analysis that it would be more economical to burn straight gasoline in our automobiles and pay corn growers a direct subsidy equal to the amount they would receive as a result of ethanol production."52
The response from ethanol subsidy advocates was quick. Industry representatives asked the Secretary of Agriculture to repudiate the reportís findings and to fire Gavett.53 Secretary of Agriculture Lyng agreed to have another study preformed, ostensibly to examine the costs of state-of-the-art plants, to determine whether new technology would reduce ethanolís costs, and to determine whether commodity program cost savings, largely corn deficiency payment savings, might exceed federal ethanol subsidies. The Gavett report had already concluded that any program savings would not offset the costs of the ethanol subsidy. Accordingly, the charge to the new study was to determine whether or not that outcome might be reversed.
Senator Robert Dole of Kansas added an amendment (Section 13) to the Farm Disaster Assistance Act of 1987 (P.L. 100-45) that required that the Secretary of Agriculture establish a seven-member panel to conduct a study of the cost-effectiveness of ethanol production, the likelihood of new cost-saving technology, and the impact on agriculture and government farm programs. Dole sought specifically to dilute the input of USDA researchers with ethanol industry representatives:
The "bias" of concern to Dole clearly was the relatively neutral position presented in Earle Gavettís study. Ultimately, the panel members included the Executive Vice President of the Ohio Farm Bureau Federation, the Energy Chairman for Women Involved in Farm Economics, the V.P. for Government Relations for the National Corn Growers Association, the Administrator for the Nebraska Gasohol Committee, the Staff V.P. for the American Soybean Association, the Director of the Office of Mobile Sources, EPA, and in what may have been an attempt to show that everybody was now aboard, Earle Gavett of the USDA.55 The Department of Agriculture, feeling the political heat from the Gavett report, decided to conduct another study of its own, but this time it would be conducted by the Economic Research Service, rather than the Office of Energy.56
Before any of the new reports were released, however, ethanol proponents were already discrediting the Gavett report. For example, in June 1987 Representative Richard Stallings of Idaho speaking in support of H.R. 2052 to mandate ethanol blending requirements in gasoline, stated: "Incidentally, the USDA has acknowledged that a previous study done of the viability of ethanol as an alternative fuel was seriously flawed and will conduct a new study as required by recently passed legislation."57 The USDA had made no such assessment of the Gavett report, but this is but one case where claims were made by politicians that did not fit with the facts.
The panel report was issued in November 1987, but it did not provide the cost effectiveness analysis as mandated. Rather, the reportís conclusions were optimistic generalizations, including the statements that innovation likely would lower ethanol production costs, that there were environmental benefits, and that ethanol production would raise corn prices and farm incomes. The study did not determine whether or not any fall in farm program costs and other benefits would offset the cost of the ethanol subsidy, the point of contention raised by the 1986 Gavett report.58
The conclusions of the 1986 USDA study were clearly a blow to ethanol supporters and their congressional backers. The emphasis of further studies was not to be on the benefits and costs of the ethanol subsidy, but rather on reductions in deficiency payments and increases in farm incomes. The ethanol subsidy provided a convenient cover for rising corn deficiency payments in the late 1980s, and corn-state politicians were not about to lose or weaken that cover from publication of critical new information by a reputable government team of researchers.
The flurry of reports that followed and subsequent repeated emphasis of the environmental and rural development benefits of ethanol by politicians successfully blunted the effects of the 1986 report.59 Finally, a 1988 USDA report argued that with ethanol production reaching 2.7 billion gallons by 1995, corn prices would increase substantially, reducing deficiency payments to such an extent that there would be a net savings to the government.60
Ethanol supporters viewed the Gavett report as a threat, and acted quickly to reduce the potential damage it could cause. There is no evidence that the report caused lasting damage. It was successfully glossed over, in part, because there was no competing powerful interest group to take advantage of it. This episode reveals the extent politicians, backed by a powerful interest group, will go to mold the information the public holds about the benefits and costs of a transfer program.
D. Competing Constituencies and the Generation of Information about the Ethanol Subsidy: 1987-1998.
Despite tax exemptions and loan guarantees, ethanol did not become the major fuel proponents claimed it would be in 1980. Moreover, ethanol did not become the predominate oxygenate additive. Less costly MTBE, made from natural gas, became more common with about two-thirds of the oxygenate market. By 1992, despite predictions of new technological breakthroughs, the ratio of the cost of producing a gallon of ethanol to a gallon of gasoline had changed little since 1980 so that absent the subsidy, ethanol was not competitive with gasoline.61
In 1997 ethanol accounted for less than one percent of transportation fuels consumed in the U.S., clearly a minuscule amount in terms of providing security against foreign oil interruptions.62 Amendments to the Clean Air Act, introduced in 1987 and adopted in 1990, required the use of gasoline blended with oxygenates, reformulated gasoline or RFG, to reduce Volatile Organic Compounds (VOCs) and air toxic emissions in regions where air quality was low.
These amendments provided an opportunity for proponents to extend demand for ethanol. They did so through legislative and administrative mandates for ethanol use at the expense of MTBE.63 With MTBE and natural gas producers largely concentrated in states outside the corn belt, for the first time there were incentives for a cohesive interest group to challenge ethanol.64 This competition among interest groups would generate more data to general voters about the costs and benefits of ethanol.
Any environmental benefits of oxygenated fuels came through reduced CO2 emissions.
But ethanol or MTBE could be added to gasoline to reduce those emissions.65 To insure that ethanol secured a larger share of the oxygenate market, legislation was introduced mandating that "renewable" (ethanol) sources be included in reformulated gasoline: H.R. 2031, Clean Air Act Amendments of 1987, required that one half of all U.S. gasoline have at least 10 percent ethanol and the other half have 5 percent methanol and 1.5 percent ethanol and H.R. 2052, the Ethanol Motor Fuel Act of 1987, required that 10 percent of all gasoline sold in 1988 be gasohol, 15 percent in 1989, 25 percent in 1990, 35 percent in 1991, and 50 percent by 1992.66
This legislation was introduced by Representative Durbin of Illinois and 71 co-sponsors, 43 of whom came from major corn growing states.67 Hearing testimony from Representatives Alexander (Arkansas), Madigan (Illinois), Durbin (Illinois), Stallings (Idaho), Glickman (Kansas), and Eric Vaughn, President of the Renewable Fuels Association stressed the environmental benefits of ethanol and the desirability of reducing U.S. dependence on foreign oil.68 Opposing testimony was provided by officials from Conoco, Chevron, ARCO, Marathon, UNOCAL, Amoco, National LP-Gas Association, Service Station Dealers of America, National Petroleum Refiners Association, and other groups.69 Dixon Smith, General Manager of Operations for Chevron, representing the American Petroleum Institute, argued that the ethanol mandates would involve high investment costs with little gain in energy security or clean air advantages.70
Until these debates, there had been no serious challenge to the environmental claims made on behalf of ethanol. The bills were not enacted. Legislation was passed to promote both ethanol and methanol-based fuels through government purchase of vehicles using alternative fuels, creation of an Interagency Commission on Alternative Motor Fuels, and raising the DOT corporate average fuel economy rating of automobiles using alternative fuels.71
The Clean Air Act Amendments of 1990 provided another opportunity for ethanol producers. To reduce emissions of VOCs by 15 percent, gasoline sold in 39 carbon monoxide (CO) non-attainment areas was required to contain 2.7 percent oxygen. Additionally, only reformulated gasoline (RFG) could be sold in the nine worst ozone non-attainment areas.72
In promoting ethanol use proponents had to get around new problems regarding the environmental impact of ethanol that were surfacing.73 New information indicated that ethanol, when mixed with gasoline, did not reduce emissions of VOCs to the same extent as did MTBE.
Further, the use of ethanol could also increase emissions of nitrogen oxide and other pollutants such as carcinogenic aldehydes. Finally, any alcohol additive increased the volatility of the gasoline blend, making it difficult to meet the newly established VOC standards unless the base gasoline were made less volatile or the rules changed. Despite all the claims made that ethanol was good for the environment, VOC standards would have to be relaxed to encourage its use.
Given their earlier legislative defeats, ethanol proponents used more obscure administrative rulings rather than the more open legislative process. This action made it more difficult for methanol/MTBE supporters to counter and it raised the costs to voters of monitoring the costs and benefits of the ethanol subsidy. In 1994, the EPA issued a renewable oxygenate rule or ROR that required at least 30 percent of the oxygenates used in RFG come from renewable sources.74 The rule was clearly aimed at expanding ethanol or its derivative ETBEís market share of oxygenate additives. Carol Browner, the EPA Administrator emphasized the gains to farmers from the ethanol program as well as its ability to reduce oil imports and to provide environmental benefits, particularly reduced emissions of green house gasses.75 The Clinton Administration was applauded by corn-state senators for initiating the 30 percent mandate.
The ROR led to another round of congressional hearings on ethanol. The farm program and the environment were again emphasized by leading advocate, Senator Daschle of South Dakota: "If successfully implemented, the RFG program has the potential to reduce air pollution, reduce our dependence on foreign imports and petroleum and create domestic jobs."76 Senator Kerrey of Nebraska added that "ethanol production currently raises the price of corn by about 15 cents a bushel, and is expected to raise the price even more by the year 2000. Not only....would this give vital financial help to our Nationís farmers, but it will also help to reduce the Federal farm outlays. Each one cent increase in the price of corn saves the taxpayers $55 million in lower corn program costs. Thus, the current benefits of ethanol production saves about $825 million in annual USDA expenditures."77
Senator Harkin of Iowa dismissed questions about ethanol and ETBEís environmental effects as "misinformation and misrepresentations," and claimed that: "Without the renewable oxygenate rule, it is clear that the reformulated gasoline market would be monopolized by MTBE."78 Similar statements were submitted by Senators Grassley of Iowa, Exon of Nebraska, Lugar of Indiana, and Wellstone of Minnesota.79 John McClelland of the USDA Office of Energy testified that the 30 percent mandate would save $3 billion in farm program outlays between 1995 and 2000, largely through lower deficiency payments.80
In other hearings, methanol proponents, such as Senator Johnston of
Louisiana, challenged the EPAís action.
During the policy debates over ROR, environmental groups became actively involved in the ethanol subsidy for the first time, and they opposed the oxygenate mandates. Representatives of the Sierra Club, the Environmental Defense Fund, and Resources for the Future, argued that neither the alleged benefits nor the environmental and health costs were sufficiently established to justify the EPAís action.84 A. Blakeman Early, Washington Director for Environmental Quality Programs of the Sierra Club argued that greater ethanol production could increase the release of global warming gasses, such as nitrous oxide.85
The EPAís 30 percent renewable oxygenate rule (ROR) was challenged in the United States Court of Appeals for the District of Columbia by the American Petroleum Institute and National Petroleum Refiners Association in February 1995. The administrative ruling was reversed by the court as exceeding the EPAís authority.86
During this time, the debate over the relative merits of ethanol, ETBE, methanol, and MTBE led to scientific studies by the EPA, National Academy of Sciences, the White House National Science and Technology Council, and the Committee on the Environment and Natural Resources of the National Science and Technology Council. None of these or other studies found conclusive air quality benefits from the use of any oxygenate additive.87
The General Accounting Office reported in 1997 that removal of ethanol subsidies (and hence, the end of costly ethanol production) would have little environmental impact or little effect on petroleum imports.88 Hence, these and other studies, based on the best available data, provided no basis for the strong claims and fervent advocacy of ethanol and ETBEís air quality benefits made by cornstate politicians.
Although the EPAís renewable oxygenate rule was rejected in 1995, efforts by proponents to advance ethanol through regulation have continued.89 Further, in May, 1998 Congress overwhelmingly agreed to extend the ethanol tax incentive through 2007 as part of the six-year federal highway re-authorization bill.90
The competition between supporters of MTBE and ethanol has recently shifted to the debate over the health and water quality effects of MTBE in California. In March 1996, the California Air Resources Board implemented Phase II RFG and required that all gasoline be oxygenated during the four or five winter months. MTBE has been by far the most common oxygenate used in Phase II reformulated gasoline in California. Reformulated gasoline with ethanol could not meet the stateís restrictions on oxygen content and volatility (VOC limits).
In December 1997, the EPA issued a drinking water advisory regarding MTBE for its possible contamination of ground water.91 In November 1998, the EPA announced creation of a Blue-Ribbon Panel to review use of MTBE and other oxygenates.92 Taking advantage of these ground water concerns, ethanol supporters such as the Renewable Fuels Association lobbied for legislation in Sacramento that would lift Californiaís volatility limits and allow for ethanolís use in Phase II RFG.93 More broadly, Senator Durbin of Illinois called on President Clinton to change Phase II rules for RFG nationwide to open the market for ethanol:
Concerns about MTBE, however, also raised questions about the need for any oxygenates to meet the requirements of the Clean Air Act. H.R. 630 was introduced in the 105th Congress in 1998 to allow for the implementation of Phase II RFG without the use of oxygenates.95 John Dunlap, Chairman of the California Air Resources Board, argued that no oxygenate was required to meet air quality standards. He was supported by some environmental groups.96 But both MTBE supporter, Marvin Schlanger of ARCO, and ethanol supporter, Eric Vaughn of the Renewable Fuels Association, objected to rules that would allow elimination of oxygenate use.97
Because of growing environmental concerns pertaining to ground water, however, in March of 1999 Governor Gray Davis ordered the phaseout of MTBE from California gasoline supply.98 It remains uncertain whether there will be sufficient supplies of ethanol to replace MTBE or whether ethanol will become the oxygenate of choice. California RFG regulations allow refiners to produce complying fuel without any oxygenates, but it is a costly process.
With all of the claims and counter claims about the environmental benefits or costs of ethanol and MTBE generated by the competing interest groups, it would be very difficult for voters to sort through the material. Indeed, this debate raises questions as to how much useful information is presented to voters even when there are competing interests. The information is provided by parties with biased points of view, and in this case, the issues are complex. Because of the scientific nature of the material and the mixed incentives of MTBE and ethanol producers to protect oxygenate use, much of the information released has been difficult for voters to assess, as there is little in the way of impartial bodies to weigh the conflicting claims and promote their findings.
As we have shown, federal agencies, such as the EPA and the Department of Agriculture are subject to extreme political pressure when much is at stake. For the most part, EPA and the USDA have become proponents of ethanol. When potentially damaging and apparently neutral information was released in 1986, corn-state politicians were able to suppress the results and have them countered with updated studies. Recent scientific studies by the National Academy of Sciences and other bodies have suggested that the clean air contributions of ethanol are likely small at best. Yet, those studies have remained obscure, largely out of the debate, and have not prevented corn-state politicians from repeating the claims in congressional hearings that ethanol is good for the environment and good for energy security. The emphasis on these externalities by ethanolís political advocates has provided an appealing cloak for regulations and subsidies among the public. Given the value of the ethanol subsidy to corn growers, over the years advocates have actively and successfully resisted challenges to the externality argument.
The history of the ethanol subsidy reveals that politicians took advantage of energy concerns in the 1970s to put the transfer in place and since then have engaged in deliberate attempts to distort information flows and to obfuscate the underlying objective of the ethanol program in order to sustain it. Ethanol is an example of special-interest transfers that are promoted by claims of positive spill-over effects. The ethanol subsidy was first used to camouflage farm program costs and facilitate the channeling of funds to corn producers. Today, under the FAIR Act, the objective is relatively more conspicuous and direct, to increase the demand for corn. Corn-state politicians remain intense proponents, and they continue to stress broad benefits of ethanol beyond what the evidence would warrant.
No penalty will be placed upon members of the corn-state congressional delegations by their voters for obfuscating the benefits and costs of ethanol, and no challenger in those states will gain through exposure of new evidence counter to the claims of ethanol supporters.
Other than politicians from oil-producing states there is not much incentive for members of Congress from other states, where the impacts of the program are small and dispersed, to expend resources to uncover more accurate information about the underlying benefits and costs of the ethanol program. Even among MTBE producers, oxygenate programs are beneficial, only preferential treatment of ethanol is opposed. Transfers are sought by all elected officials and to attack, or even demand closer scrutiny of some other memberís program, would only invite retaliation.
Indeed, these transfers are the glue that helps hold political coalitions together.
The systematic distortion of information available to voters by sponsoring politicians raises the transactions costs facing general voters in assessing the true benefits of transfer programs. These actions add to the information costs that general voters face. Although competition amongst relatively powerful interest groups will provide an expanded information set to voters, that set will be characterized by conflicting claims aimed at offsetting or discrediting the information advanced by the opposing group. This process may provide useful information if voters can evaluate the competing claims, but the sources are not neutral.
Our analysis indicates that there may be no unbiased sources of information that would allow voters to evaluate the claims and counter claims of the competing parties. Hence, even when there is competition among interest groups there is information obfuscation in the political arena, and that activity can be interpreted as costly rent-seeking.
Once it is recognized that the competitive market analogy to politics is misplaced by its proponents, the notion that there is an automatic, corrective mechanism seems far too sanguine.
Nor, should a programís endurance be taken as justification for labeling the transfer as "efficient." Indeed, doing so not only confuses the standard meaning of the term, but diverts attention away from useful research on the origins, promotion, and magnitude of transfer programs in a democracy.
There is a tendency to presume that programs that survive over time must be reasonably efficient, given the transaction costs of changing them. Otherwise, it would be in the interest of politicians and constituent groups to adopt institutional changes and capture the resulting rents saved.99 But, an economy with rent seeking will have resource allocation patterns that do not fit with an idealized "optimal" standard. Criticizing the alleged wastes of existing government policies and institutions by comparing them to hypothetical, transactions costs-free alternatives, however, is viewed as engaging in a "nirvana" fallacy. According to this line of reasoning, the transactions costs of institutional change must be considered before labeling a particular program as wasteful or inefficient.100 But, once transactions costs are introduced, the standard concept of Pareto efficiency loses meaning. The notion can be reduced to a tautology because by definition, all observed arrangements will be "efficient" if all of the transactions costs of adjustment are properly accounted for.101 Proponents of the efficient redistribution hypothesis could avoid this tautology trap if they were to describe how their efficiency assertions could be tested and falsified, but little progress has been made in that area.
Clearly, transaction costs in politics are positive and we should not expect outcomes in either the market place or the political arena to lie along the same frontier as they would in the absence of these costs.102 Indeed, most practitioners of the efficient redistribution hypothesis compare a current policy with an alternative program they believe to be politically feasible rather than one that ignores transaction costs. But while such an exercise can be informative to both policy makers and voters, once transaction costs are considered it becomes imperative that we examine the extent and basis of the information endowments possessed by those doing the analysis, elected officials, and of course, the voters.
The question is how much confidence can any of these parties place in the information set presented to them in the political arena.
While competition exists within the political arena, the key question posed by this paper is whether the underlying institutions in which this competition occurs fosters the production and release of sufficient information to allow voters and others to make informed decisions about the efficacy of a particular program. Only after answering that question can we assess whether or not the program promotes general welfare in a representative democracy.
1 Major contributions to that view are James M. Buchanan, and Gordon Tullock,
The Calculus of Consent, Ann Arbor: University of Michigan Press, 1962;
George J. Stigler, "The Theory of Economic Regulation," Bell
Journal of Economics 2, 1971, pp. 3-21; Anne O. Krueger, 1974, "The
Political Economy of the Rent Seeking Society," American Economic Review,
64, 1974, pp. 291-303; and Tullock, Gordon, "The Welfare Cost of Tariffs,
Monopolies, and Theft," Western Economic Journal, 5, 1967, pp.
25 The Freedom of Information Act or FOIA (5 U.S.C. Sec 552, 1966) would
seemingly provide voters with the opportunity to defend themselves against
obfuscation. Analysis of the administration of the FOIA, however, suggests the
law provides little real access to information on policy making and details
essential to benefit/cost analysis. For example, see Joan M. Katz, "The
Games Bureaucrats Play: Hide and Seek Under the Freedom of Information
Act," Texas Law Review, 48, 1970, pp.1261-1284; Kristi A. Miles,
"The Freedom of Information Act: Shielding Agency Deliberations from FOIA
Disclosure," George Washington Law Review, 57 (5), 1989, pp.
136-1341; Deanne M. Sobczak, "A Survey of Recent Developments Under the
Freedom of Information Act," Administrative Law Journal, 3, 1989,
pp.181-213. Sean E. Andrussier, "The Freedom of Information Act in 1990:
More Freedom for the Government; Less Information for the Public," Duke
Law Journal, 1991, pp. 753-801; and James T. OíReilly, "Applying
Federal Open Government Laws to Congress: An Explorative Analysis and
Proposal," Harvard Journal on Legislation, 31,1994, pp. 415-468.
78 United States Senate, Subcommittee on Nutrition and Investigations of the
Committee on Agriculture, Nutrition, and Forestry, Hearings on Renewable
Oxygenate Rules in the Reformulated Gasoline Program, 103 Congress, 2nd
Sess, Washington D.C.: Government Printing Office, May 27, 1994, pp. 1-2.
Hereafter referred to as U.S. Senate, Agriculture Hearings, 1994.
91 EPA-822-F097-009, December 1997, Drinking Water Advisory: Consumer Acceptability Advice and Health Effects Analysis on Methyl Tertiary-Butyl Ether (MTBE).
92 Clean Air Advisory Committee, Panel on Oxygenate Use in Gasoline.
93 See Renewable Fuels Association, Press Release, September 29, 1999, "Ethanol Industry Vows to Continue Fight to Open California Gasoline Market to Ethanol."
94 Renewable Fuels Association, RFA Ethanol Report, #87, January 7, 1999.
95 "Implementation of the Reformulated Gasoline Program in California," Hearings before the Committee on Commerce, 105th Congress, 2nd Sess. U.S. House, April 22, 1998 on H.R. 630. Referred to as U.S. House Hearings, 1998.
96 See < http://www.oxybusters.com/casehist.htm >.
97 U.S. House Hearings, 1998, pp. 28-589, ibid.
98 California Energy Commission, Fuel Resource Office, "Timetable for the Phaseout of MTBE from Californiaís Gasoline Supply," Docket No. 99-GEO-1, June 1999.
99 For discussion of the efficiency of long-standing government transfer programs, in the context of the U.S. sugar subsidy, see George Stigler, "Law or Economics?" Journal of Law and Economics, 35 (October), 1992, pp. 455-68. The argument that institutional change will occur whenever there are net gains from taking such action is described by Harold Demsetz, "Towards a Theory of Property Rights," American Economic Review, 57, 1967, pp. 347-59.
100 For discussion, see Harold Demsetz, "Information and Efficiency: Another Viewpoint," Journal of Law and Economics, 12 (April), 1969, pp. 1-22.
101 The problems raised by expanding the Pareto efficiency concept to include transactions costs have not gone unrecognized. See, for example, Steven N.S. Cheung, Will China Go "Capitalist"?, London: Institute of Economic Affairs, 1982; Louis De Alessi, "Property Rights, Transactions Costs and X-Efficiency," American Economic Review, 73 (March), 1983, pp. 64-81; and Eirik G. Furubotn and Rudolf Richter, Institutions and Economic Theory: The Contribution of the New Institutional Economics, Ann Arbor: University of Michigan Press, 1997, pp. 458-62, 475-77.
102 For discussion of some of the key issues regarding transactions costs and redistribution in politics, see Oliver E. Williamson, 1996, The Mechanisms of Governance, New York: Oxford University Press, pp. 195-213. Williamson attempts to resolve some of the conflicting issues regarding the efficiency of government policies by introducing a remediableness criterion for evaluating programs. See Oliver E. Williamson, "Public and Private Bureaucracies: A Transactions Cost Economics Perspective," working paper, Haas School of Business, University of California, Berkeley, May 1998, pp. 11-6.
* Originally delivered at the World Bank "Annual Bank Conference on Development Economics", Washington, DC. 2000.
"Information Distortion and Competitive Remedies in Government Transfer Programs: The Case of Ethanol", Ronald N. Johnson, Department of Agricultural Economics & Economics, Montana State University, Bozeman, MT 59717. And, Gary D. Libecap, Department of Economics, University of Arizona, Tucson, AZ 85721. And, National Bureau of Economic Research, Cambridge, Massachusetts 02138. March, 2000. See original at < http://www.worldbank.org/research/abcde/washington_12/pdf_files/libecap.pdf >. See list of Conference papers at < http://wb.forumone.com/research/abcde/papers/index.f1ml >.
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