Knowledge Bank

In order to compensate for the gap in price competitiveness derived from fossil fuel production still being more price-competitive than production of biofuels, the ethanol industry is heavily subsidized inside and protected from the outside in both the U.S. and Brazil.

In this paper we assess the impact of the elimination of trade distortions, in particular, the 2.5 percent ad valorem tax, and a secondary tariff of 54 cents-per-gallon on imports from Brazil to the U.S., imposed to offset the 51 cents-per-gallon domestic subsidy to corn-ethanol production. For this purpose, we estimate a partial equilibrium trade model – an ethanol export supply curve for Brazil and an ethanol import demand curve for the U.S.-, based on annual data from 1975 to 2005. Two-stage least squares is used to estimate both curves, the world price of ethanol being treated as endogenous.

The results show Brazilian export supply to be very sensitive to changes in prices, thus it is very likely that elimination of trade distortions in the ethanol market will result in a more than proportionate increase in ethanol exports from Brazil due to the rise in the world price. Moreover, according to this model, if the U.S. increases its demand for imports from Brazil, there will be a positive impact of the U.S. in driving the world price up. Therefore, this paper supports the idea that the U.S. and Brazil reap gains from trade when trade distortions are eliminated.