Not all dilemmas are really dilemmas. Open up the lid and upon closer inspection, the dilemma unravels without much investment in effort. One such apparent dilemma concerns the production of food and biofuel. There is really no dilemma between food and fuel however. Free price is the scissor to cut the fake Gordian knot.

In explaining the current food crisis, the production of biofuel has been named as one of the culprits which forced food prices to go up. Some sources typically harvested for food are now being turned into fuel as a solution to high crude oil prices and to some extent, as a solution to an environmental concern as well.

With all that, the food sector suddenly finds it is competing with the fuel production industry for supply; cross-elasticity of demand ensures that. Cross-elasticity is basically a fancy way in economics of saying changes in prices of one item affect the quantity demanded for another item. This happens when a product could substitute another dearer item. Coming back on track, as crude oil prices continue to rise, so too demand for alternative fuel. In this case, it is biofuel.

Price is essentially a signal of scarcity. Price reflects all available information about the associated good. In a market free of state intervention, all market participants will face prices that reflect the true situation of the market.

With free prices, market participants including producers will base their decisions on the true market situation. Within the context of food and fuel production, when there is relative scarcity of one item to another, production of the scarcer item will see an increase.

In the end, there will be a dynamic equilibrium between food and biofuel production closely matched to the reality on the ground.

With deeply statist policies in place however, information about the reality on the ground does not get relayed to market participants. Through subsidies, prices floor and ceiling and other mechanisms set in place for purposes ranging from welfare to environmental and development of new technology, prices are unfree. From there on, prices stop acting as a signal of scarcity. As market participants, consumers and producers alike choreograph their decisions based on these flawed prices, their actions will not approximate the true situation of the market.

The larger the effects of statist policies, the harder it is to estimate the true situation of the market, setting the stage for a painful fall. An extreme scenario would lead to a violent collapse of the state as the market would eventually overwhelm the state.

To a statist and even more to a populist, the question of food and fuel production is a dilemma. Price increases of food and crude oil require a hike of production of food and biofuel. Yet, there is a trade-off of production between the food and biofuel.

A statist in the end sits at his desk, trying to think which is more important to the society or in most cases, to the stability of the state. He has to devise a model, whatever the model may espouse, to decide on the matter.

An adherent of free market principles would deal with the question with an ease that would insult any statist. The free market solution is simple: let the market decide for itself.

Before that can happen, the prices have to be set free, especially from policies which suffer deadweight losses. This includes most if not all of welfare-based policies. As for policies on externalities and development of technology which could push the supply curve outward, it should be judged on a case-by-case basis. Let prices with true reflection of the market reach all market participants without unnecessary friction.

Once the market is free, the dilemma will dissolve into oblivion.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

p/s — a version of this article was first published at The Malaysian Insider.

6 Responses to “[1663] Of food? Fuel? Dilemma?”

  1. on 21 May 2008 at 13:36 hyperx

    Agreed… both fuel and food are important though. With current fuel consumption, it’s driving the earth into a critical level. Let’s hope the scientist able to fix the problem right now.

  2. on 22 May 2008 at 20:40 Azrir

    Dear Hafiz,

    You are not telling anything new here. Reading your article is like reading chapters of few articles cut n paste and you throwing in few economic theory for good measures word for word from Economy 101.

    Better if you could write something on the characteristic of Malaysian Economy vs the basic supply and demand economic model. Malaysian economy with its fuel subsidy is not truly a free market.

    Perhaps if i could interest you in the new book by George Soros, New Paradigm for Financial Markets, just launched at LSE. It talks about what we learn about Economy 101 is totally wrong. Soros believes that the financial bubles (what we are experiencing now with the rise in price) is just that; always started with a genuine economic transformation like the invention of internet, the rise of China as a power house etc and would eventually burst.

    Just trying to give you some constructive comments. No hard feelings.

    Regards

    Azrir

  3. on 22 May 2008 at 21:39 Hafiz Noor Shams

    Dear Azrir,

    No offense taken but it really depends on which crowd one is targeting. I’m trying to make free market popular to the general population, not more elitist than it seems to be. Thus, I need to make it easy to grasp, especially those without any background in economics.

    You’ll be surprised at how many people are not familiar with economics even at the most basic level.

  4. on 23 May 2008 at 10:27 oster

    I have some contentions about a market lacking intervention will achieve a dynamic equilibrium.

    Not that I don’t think it can happen, but I think this equilibrium will be highly localised, due to variations in demand geographically.

    American energy demand will probably look more attractive to African farmers than African food demand, and should the market reign, I do believe that the losers will ultimately be those with less purchasing power.

    Yes this is very standard socialist talk, but that does not detract from its substance, IMHO.

    cheers

  5. on 29 May 2008 at 21:43 Azrir

    Dear Hafiz,

    Nice article about this in the Edge.

    http://www.theedgedaily.com/cms/content.jsp?id=com.tms.cms.article.Art icle_231ba072-cb73c03a-18bbf550-c2f9dacc

  6. on 29 May 2008 at 21:48 Hafiz Noor Shams

    Dear Azrir,

    Yeah, read it earlier.

    I’ve written about subsidy anyway, if you are interested in it. I don’t think I’ll write about subsidy any more in the near future because there is only so many can be written about subsidy. It all comes from standard models after all.

    oster

    What does the “equilibrium will be highly localised” got to do with not achieving equilibrium?

    And with your concern with localized equilibrium, you went on to talk about African farmers catering to American demand. Your concerns seem contradictory to me.

    In any case, if African farmers cater American demand, why would African farmers be the losers?

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