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David S. Bullock University of Illinois Dept. of Consumer and Agricultural EconomicsPowerPoint Presentation

David S. Bullock University of Illinois Dept. of Consumer and Agricultural Economics

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### Dangers of Using PoliticalPreferenceFunctions in Political Economy Analysis:Examples from U.S. Ethanol Policy

David S. Bullock

University of Illinois Dept. of Consumer and Agricultural Economics

Paper prepared for presentation at the

16th ICABR Conference,

‘The Political Economy of the Bioeconomy: Biotechnology and Biofuel’

June 26, 2012

Ravello, Italy

Rausser and Freebairn(1974)

I. PPF

Political preference functionapproach.

- Empirically measure political power of interest groups.

Many studies followed:

- Paarlberg and Abbott (1986)
- Lianos and Rizopoulos 1988)
- Oehmke and Yao (1990)

And continue to be published:

- Rausser and Goodhue (2002)
- Redmond (2003)
- Simon et al. (2003)
- Burton, Love, and Rausser (2004)
- Atici (2005)
- Atici and Kennedy (2005)
- Lence et al. (2005)
- Lee and Kennedy (2007)
- Francois, Nelson, and Pelkmans-Balaoing (2008)
- Rausser and Roland (2008)
- Ahn and Sumner (2009)

Typical Results

“Group A was 2.72 times as powerful as group B.”

Two decades ago, von Cramon-Taubadel (1992) and then Bullock (1994) published serious critiques of the PPF method.

But, obviously, they had little impact on the literature (1994) published serious critiques of the PPF method.

This is largely my own fault. I have been known to write arcane papers.

So here I present a step-by-step example of dangers of using the PPF approach.

To do so, I develop a model of U.S. ethanol policy, and apply the PPF approach to it.

The model is every bit as rich and descriptive of U.S. ethanol policy as are several that have recently been published in ag econ journals.

I didn models.’t design this model with PPF methodology in mind. It’s just a model, like many other models in the policy literature.

Multi-market, multi-policy-instrument model models.

I illustrate my arguments with a multi-market, multi-policy-instrument, partial equilibrium model of the U.S. ethanol policy.II. The Model

Crude Oil models.

Refinery-specific

capital and labor

Ethanol-specific

capital and labor

Corn-specific

land, capital,

labor

Livestock-specific

land, capital,

labor

Biofuel

Petrofuel

“Fuel”

Meat

Labor (taxed for government revenues)

Policy Instruments Modeled: models.

Ten independent policy instruments

tb, per-unit tax/subsidy on biofuel

tg, per-unit tax/subsidy on petrofuel (gasoline)

tc, per-unit tax/subsidy on corn

to, per-unit tax/subsidy on crude oil

tr, per-unit tax/subsidy on refiners and distributors

ta, per-unit tax/subsidy on ethanol-specific resources

tl, per-unit tax/subsidy on non-corn meat input resources (livestock)

tf, per-unit tax/subsidy on fuel (retail)

tm, per-unit tax/subsidy on meat

qbman, (producers of “fuel” must use some minimum amount of biofuel)

One models.dependent policy instrument: tw (tax on labor). Biofuels policy must be paid for.

Interest groups models.

At most disaggregated:

- Corn suppliers
- Crude oil suppliers
- Oil Refiners/Distributors
- Suppliers of ethanol-specific resources (think ADM)
- Livestock suppliers
- Labor suppliers (“employees”)
- Labor demanders (“employers”)
- Consumers of fuel and meat

Biofuel models.

Petrofuel

Meat

qcb

qcm

qr

Corn to biofuel

Refining and distribution

Corn to meat

qa

ql

qo

Non-corn biofuel resources

Livestock

Crude oil

Leontief production technologies (goods produced by zero-profit firms):Simple model of fuel production: petrofuel and biofuel are perfect substitutes in the production of “fuel.”

Fuel

qg

Petrofuel

qb

Biofuel

Feasible Welfare Manifolds perfect substitutes in the production of

Concept central to understanding PPF methodology: welfare manifolds.

I discuss feasible welfare manifolds in detail in another paper.

Framework perfect substitutes in the production of

n+1 interest groups:

Group 0: government

Groups 1, …, n: other interest groups

x perfect substitutes in the production of 2

(Production mandate)

X, set of feasible policies

x´

x1

Per-unit biofuels subsidy (tax if < 0)

A particular policy

Government’s strategies involve policy instrumentsA vector of market parameters , perfect substitutes in the production of (supply and demand elasticities, perhaps)

Group perfect substitutes in the production of i’s welfare depends on government policy:

ui = hi(x,),i = 0,1, … , n.

Payoff vector function h maps set of feasible policies into perfect substitutes in the production of “welfare space.”

u = h(x, ) =

(h0(x, ), h1(x,),…, , hn(x,))

Every place the government can send the interest groups perfect substitutes in the production of

x´

u2

h(x´)

H{1,2}(X)

u1

x2

h(x)

X

x1

“feasible welfare manifold”

{1,2} here is the set of utility-bearing groups

Welfare manifolds are a generalization of Josling perfect substitutes in the production of ’s (1974) and Gardner’s (1983) surplus transformation curves.

“ perfect substitutes in the production of feasible welfare manifold”

“feasible welfare submanifold”

u2

x2

H{1,2}(T)

h(x´)

T

X

x´

H{1,2}(X)

x1

u1

{1,2} here is the set of utility-bearing groups

III. PPF Results using the model perfect substitutes in the production of A. One policy instrument, two interest groups

“ perfect substitutes in the production of Everybody else’s” welfare

Status quo policy result:

(∆U1, ∆U2) = (0, 0)

Increase ethanol tax or decrease ethanol subsidy

Corn farmer/ethanol producer welfare

If in PPF model we assume ethanol tax/subsidy is the only instrument:

Decrease ethanol tax or increase ethanol subsidy

Political power weights: perfect substitutes in the production of

Corn/ethanol industry: 0.514

Everyone else: 0.486

PPF weights would be:

Farmers/ethanol producers: 0.514

Everyone else: 0.486

“Everybody else’s” welfare

Corn farmer/ethanol producer welfare

Slope = -1.059

Interpretation: “The corn/ethanol industry is just a little bit more powerful than the rest of society.”

Say we had observed an ethanol tax of $1.00/gal. What would our PPF method say that the political power weights were?

“Everybody else’s” welfare

B

Corn farmer/ethanol producer welfare

Slope = -0.93

Political Power Weights

Corn/ethanol industry: 0.482

Everybody else: 0.518

Because their weight droped by 0.03, corn/ethanol industry loses about $23 billion.

Say we had observed an ethanol subsidy of $1.50/gal. What would our PPF method say that the political power weights were?

“Everybody else’s” welfare

Slope = -1.22

Corn farmer/ethanol producer welfare

Political Power Weights

Corn/ethanol industry: 0.551

Everybody else: 0.449

Compared to status quo, corn/ethanol industry gains about $42 billion.

C

D

So what seems like a fairly small change in political power weights leads to a huge change in transfers!

“ weights leads to a huge change in transfers!Everybody else’s” welfare

Corn farmer/ethanol producer welfare

Reason: the welfare submanifold is nearly linear.

What if instead of looking at the ethanol tax/subsidy, we decided to look at the gasoline tax?

What decided to look at the gasoline tax?’s going on? Higher gas tax allows a lower labor tax, less distortion.

To a point, raising the gasoline tax improves the welfare of both groups!

Status quo

But decided to look at the gasoline tax?“negative” political power weight means that government can’t be solving the max problem.

Positive slope!

Increasing the mandate benefits the corn/ethanol industry, but hurts everyone else.

“ but hurts everyone else.True” political power

Your measurement of political power

A little weird: surplus transformation curve is not concave. If you measure the slope to get a political power measurement, you may be using the wrong measure, because the actual solution might be a corner solution.

“ but hurts everyone else.Everybody else’s” welfare

Using instruments separately

petrofuel tax/subsidy

Corn farmer/ethanol producer welfare

biofuel use mandate

biofuel tax/subsidy

Better question: how are these instruments best combined?

Is that even a very good question?

Is one of these instruments “better” than the others?

Also, it should be clear that the political power measure obtained from PPF methodology very much depends on which instruments are modeled.

B. Two instruments, two interest groups obtained from PPF methodology very much depends on which instruments are modeled.

- Instruments used simultaneously: obtained from PPF methodology very much depends on which instruments are modeled.
- biofuel tax/subsidy
- Petro-fuel tax/subsidy

“Everybody else’s” welfare

Corn farmer/ethanol producer welfare

Result: 2-dimensional welfare manifold

Most PPF studies just assume away this problem by having the number of interest groups be 1 more than the number of policy instruments in their models.

“Everybody else’s” welfare

But then the “observed” policy outcome will almost never be Pareto efficient, and therefore you can’t get PPF weights.

Corn farmer/ethanol producer welfare

C number of interest groups be 1 more than the number of policy instruments in their models.. Three instruments, two interest groups

“ number of interest groups be 1 more than the number of policy instruments in their models.Everybody else’s” welfare

- Instruments used simultaneously:
- biofuel tax/subsidy
- petrofuel tax/subsidy
- biofuel use mandate

Corn farmer/ethanol producer welfare

If we allow the third instrument to be used, and our model has two interest groups, this just expands the welfare manifold, and we still can’t get PPF weights from the observed policy.

D. Two instruments, three interest groups number of interest groups be 1 more than the number of policy instruments in their models.

And if we disaggregate the interest groups a little more, it changes the whole picture: a 2-dimension manifold in 3-space: Now we can get PPF weights again…

Welfare submanifold when only the petrofuel tax/subsidy and the biofuel tax/subsidy are used

E changes the whole picture: a 2-dimension manifold in 3-space: Now we can get PPF weights again…. Three instruments, three interest groups

“ changes the whole picture: a 2-dimension manifold in 3-space: Now we can get PPF weights again…Everybody else’s” welfare

Corn farmer/ biofuel producer welfare

unon-intervention

Petrofuel producers’ welfare

Allowing the use of another policy instrument changes the whole picture again. Now we have 3 instruments and 3 interest groups. Again, an “observed” policy will take us to an interior point in the welfare manifold. Result: Can’t get PPF weights.

Conclusions changes the whole picture: a 2-dimension manifold in 3-space: Now we can get PPF weights again…

- The best way to measure the “political power” of interest groups is by examining the sizes of the transfers brought about by policy, not by measuring the slopes of a contrived surplus transformation manifold at a contrived “observed” point.

Conclusions changes the whole picture: a 2-dimension manifold in 3-space: Now we can get PPF weights again…

- Like this: “Group A received $x, which was taken from group B, which lost $y.”
- Not this: “Group A’s political power weight is 0.xx and group B’s is (1 – 0.xx).”

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