Production costs associated with biofuels are, in general, very high, with Brazilian bioethanol production being the exception. The gap between high costs of biofuel production and relatively low petroleum prices creates large deadweight costs that may overwhelm any external benefits. de Gorter and Just (2009a, 2010) have shown that policies favouring biofuel production, i. e. tax credits, generate what they term ‘rectangular deadweight costs’ that are much higher than those resulting from a standard analysis that estimates inefficiency costs in the form of deadweight cost tri­angles. Indeed, the deadweight cost triangles are also a component of inefficiency costs of biofuel policies. Gardner (2007), together with de Gorter and Just (2008b; 2009a), all estimated triangular deadweight costs in the United States and found them to be in the USD 300-600 million range. However, de Gorter and Just (2008b; 2009a) also found that rectangular deadweight costs resulted in an additional annual waste of over USD 2 billion. In estimating inefficiency costs in the form of dead­weight costs, we must also add the external costs of added gasoline consumption, oil dependence, increased CO2 emissions and a decline in terms of trade in oil imports. In particular, the annual deadweight costs owing to the combination of the biofuel mandate and tax credit alone are expected to be about USD 11 billion by 2022 (de Gorter and Just 2009b). As a result, biofuel policies may not generate social welfare improvement; rather, they may have adverse impacts on social welfare. They also have the potential to exacerbate negative externalities associated with gasoline con­sumption (de Gorter and Just 2008a, 2009b).

Pro-biofuel policies are generally used in various combinations, but de Gorter and Just (2010) have shown that these policies can be contradictory. At present, a quantity-based biofuel mandate (i. e. biofuel blend mandate) and a price-based consumption subsidy (i. e. biofuel tax credit) are most common (e. g. in the United States, Brazil and the EU). While a quantity-based biofuel mandate is theoreti­cally and empirically superior to a price-based consumption subsidy (Lapan and Moschini 2009; de Gorter and Just 2008b, 2009c), when mandates are used in conjunction with biofuel subsidies, they can have adverse policy interaction effects. Here, the benefits of a market-based policy like mandates can easily be nullified (de Gorter and Just 2009b, c). This is because, when a tax credit is intro­duced alongside the mandate, blenders will compete for the government sub­sidy and increase profits by lowering the retail price. Such behaviour results in an increase in the total amount of fuel consumed, which means that more petro­leum-based fuel will be consumed because of the binding mandates. Therefore, tax credits will unintentionally subsidize gasoline consumption instead. This con­tradicts the oft-stated objectives of reducing dependency on oil, improving the environment and enhancing rural prosperity. Furthermore, higher gasoline prices induced by a biofuel policy magnify the inefficiency of the preexisting wage tax by reducing real wages and thus discouraging work (Searchinger et al. 2008).

Given that pro-biofuel policies exist in a setting of multiple objectives and, at the same time, other policies targeting the same objectives also exist, policy-mak­ers should carefully evaluate the interaction between biofuel polices and other pol­icies to ensure that the stated objectives are achievable at an acceptable cost. The effects of each biofuel policy and their interaction with other policies are clearly very complex owing to the intricate interrelationships between energy and com­modity markets and the varied environmental consequences. The effects of biofuel policies become even more complicated if general equilibrium effects that seek to explain the behaviour of supply, demand and prices in a whole economy with many interacting markets are incorporated in the analysis. At present, given the high cost of biofuel production, together with the competitive pressure of com­paratively cheap oil, taxpayer costs resulting from biofuel and renewable energy policies in general are very high relative to their benefit, all of which can be highly negative owing to adverse policy interaction effects.

In sum, this chapter raises doubts about biofuels in relation to the specific objec­tives for which they have been supported. The production of biofuels that are being promoted to reduce dependence on fossil fuels actually depends on fossil fuels, and users will therefore find it difficult to escape from ongoing oil price volatility. Finally, the positive impact of biofuels on regional development, and employment in the agri­cultural sector in particular, is not immediately obvious. The frequent linking of bio­fuel policy to the goal of enhancing rural economies is questionable since the use of biofuels may result in shifts between sectors rather than the creation of new economic activity. To be precise, problems associated with biofuels have been intensified by the fact that economic issues are intricately related to biofuel policy objectives. Current biofuels in commercial production, except bioethanol produced from sugarcane in Brazil, are not yet competitive with fossil fuels. However, their competitiveness, espe­cially that of advanced biofuels using a lower cost proportion of feedstock not sensi­tive to food prices, will gradually improve as the price of oil increases.