Using biofuels to supplement transportation fuels at modest blends—under current technology—has its pros and cons. Biofuels can supplement traditional fuels while contributing to rural development. However, until new technologies are developed, using food to produce biofuels might further strain already tight supplies of arable land and water all over the world, thereby pushing food prices up even further.
Realizing the potential benefits of biofuels requires better policies. Brazilian ethanol derived from sugarcane, for example, is less costly to produce than corn-based ethanol in the United States, and also yields greater environmental benefits. However, generous tax credits for blenders, tariffs on imported biofuels, and agricultural support for grain farmers in the United States and the EU make it difficult for low-cost foreign biofuel producers to compete in these markets.
If tariffs and subsidies in the United States and EU were eliminated, biofuels would likely be produced largely by lower-cost producers such as Brazil and other Latin American countries. Similarly, under such a scenario, biodiesel would be produced mostly by Malaysia, Indonesia, India, and some African countries.
In sum, while we wait for more efficient fuel technologies to emerge, the first-best policy would be to allow free trade in biofuels. This would benefit the environment as well as make biofuel economically more viable.
Source: IMFSurvey Magazine, 2007-10-17.