In this paper we analyze the indirect land use change (ILUC) effects of ethanol production expansion in Brazil through the use of an inter-regional, bottom-up, dynamic general equilibrium model calibrated with the 2005 Brazilian I-O table. A new methodology to deal with ILUC effects is developed, using a transition matrix of land uses calibrated with Agricultural Censuses data. Agriculture and land use are modeled separately in each of 15 Brazilian regions with different agricultural mix. This regional detail captures a good deal of the differences in soil, climate and history that cause particular land to be used for particular purposes.

Brazilian land area data distinguish three broad types of agricultural land use, Crop, Pasture, and Plantation Forestry. Between one year and the next the model allows land to move between those categories, or for unused land to convert to one of these three, driven initially by the transition matrix, changing land supply for agriculture between years. The transition matrix shows Markov probabilities that a particular hectare of land used in one year for some use would be in another use next period. These probabilities are modified endogenously in the model according to the average unit rentals of each land type in each region.

We ask whether biofuel expansion is consistent with new laws, limiting forest clearing in Brazil. A simulation with ethanol expansion scenario is performed for year 2020, in which land supply is allowed to increase only in states located on the agricultural frontier. Results suggest that each new hectare of sugar cane requires only 0.14 ha of new land, with another 0.47 ha converted from pasture use. Hence policies limiting deforestation are unlikely to prevent greater ethanol production. Finally, regional differences in sugarcane productivity are found to be important elements in ILUC effects of sugar cane expansion.

During the 2009 Conference of the Parties meeting in Copenhagen, the Brazilian government announced voluntary targets to reduce GHG emissions, with the targets being reconfirmed in Cancun (2010) and in Durban (2011). An estimate is presented of the economic impact of alternative policies to achieve such targets, including actions to cut emissions from deforestation and agricultural production. A dynamic-recursive general equilibrium model of the world economy is used. The main results show that deforestation emissions in Brazil can be reduced at very low costs, but the cost of cutting emissions from agriculture and energy use may lead to a 2.3% drop in gross domestic product by 2020 if sector-specific carbon taxes are applied. Such costs may be reduced to 1.5% under a carbon trading scheme. The negative impact of carbon taxes on agricultural production indirectly reduces deforestation rates; therefore, directly cutting emissions from deforestation is the most cost-effective option since it does not adversely affect agricultural production, which continues to expand into low-yield, underutilized pastures and secondary forest areas.