Monthly Archives: January 2005

37 – Adoption of conservation technologies by rural landholders

This is a brief advertisement for a new paper on my web site. It’s called “Understanding and promoting adoption of conservation practices by rural landholders” and it’s by an (ahem) all-star multidisciplinary cast of social scientists from economics, sociology and psychology: David Pannell, Graham Marshall, Neil Barr, Allan Curtis, Frank Vanclay and Roger Wilkinson.

It was fun to work with such a diverse and eminent team of co-authors, and the result is pretty good I reckon. There was quite a bit of give and take in the process of the collaboration, and there needed to be. But the final result captures a genuine consensus built from our six perspectives.

I will highlight some particular parts of the review in future weeks, but for now here is the abstract and links to the full paper.

Abstract: Research on adoption of rural innovations is reviewed and interpreted through a cross-disciplinary lens to provide practical guidance for research, extension and policy relating to conservation technologies. Adoption of innovations by landholders is presented as a dynamic learning process. Adoption depends on a range of personal, social, cultural and economic factors, as well as on characteristics of the innovation itself. Adoption occurs when the landholder perceives that the innovation in question will enhance the achievement of their personal goals. A range of goals is identifiable among landholders, including economic, social and environmental goals. Innovations are more likely to be adopted when they have a high “relative advantage” (perceived superiority to the idea or technology that it supersedes), and when they are readily trialable (easy to test and learn about prior to adoption). Non-adoption or low adoption of a number of conservation technologies is readily explicable in terms of their failure to provide a relative advantage (particularly in economic terms), and/or a range of difficulties that farmers may have in trialling them. Implications for research, extension, and policy are discussed.

Pannell, D.J., Marshall, G.R., Barr, N., Curtis, A., Vanclay, F. and Wilkinson, R. (2006). Understanding and promoting adoption of conservation practices by rural landholders. Australian Journal of Experimental Agriculture 46(11): 1407-1424. Access paper at Journal web site here. Pre-publication version available here (161K).

David Pannell, The University of Western Australia

36 – Computer disasters: a cautionary tale

It was the day after my birthday. I was working on some emails in the Qantas Club in Perth. I’d been there for an hour or so and had made good inroads into the never-ending intray. I stood up to stretch my legs and clear my head, when all of a sudden the girl working next to me shouted something incoherent and I heard a loud crash. I looked down to see my laptop on the floor. It seemed like everyone in the Qantas Club was looking at me and I just wanted to cry. The people nearby who could see what had happened were very sympathetic.

Feeling sick to the stomach, I tried to assess the damage. The screen was still displaying but it was cracked open at the seam and wires were hanging out. I pushed the wires back in and clicked it all back together. Amazingly it seemed to be OK.

It sounded like the hard disk was still running but I thought I should be careful and save a big file I’d been working on that morning onto a floppy before I turned it off. I succeeded in doing that, and was starting to get complacent. What I should have done then was save as many recent files as possible onto the three floppies I was carrying. I didn’t do that – big mistake. Once I switched it off, it never booted up again. It tried and tried and tried, going for hours attempting to identify all the bad sectors on the disk, but eventually, a few days later, I came to the sad (and accurate) conclusion that I was never going to see those files again.

This was a good luck/bad luck story.

The good luck part was that I had backed up my working files only a few days before. Once I recovered the files I had emailed away to other people, I ended up losing only about a day of work, which is much less time than it took me to set up and fully install my new computer.

The bad luck part was the remarkable combination of factors that joined forces to lead to the loss of the hard drive.

  1. I chose to work on a glass-top table, rather than a desk in the business area as I usually did. The glass top was slippery.
  2. The rubber stoppers on the bottom of my laptop had long since fallen off, so the combination was really slippery.
  3. When I stood up, the computer’s power cable was wrapped around my leg. Because of the slippery table surface, I didn’t even feel any pull of the computer as I moved away from the table.
  4. I didn’t see it moving either, because I had turned my back to it as I stood up.
  5. The computer was downloading a large email attachment, so it was actually writing to disk at the time of the crash, giving the hard disk heads maximum opportunity to damage the disk surface.
  6. The floor in that area was surfaced with tiles so there was no cushioning of the blow whatsoever.

The computer was getting on a bit anyway, so, trying to look on the bright side, I decided to upgrade to a new one. I bought a lovely new Compaq with a big wide screen and heaps of everything. After far too much work, I finally got it set up with the right software and all my files in the right places.

When I got the new computer, I started backing up with furious frequency – at least daily – made easy by the presence of a CD burner built into the computer. It was a pace that couldn’t last, and it didn’t.

One day when I’d had the computer for about a month, I was working in my office at home, concentrating hard on writing a Pannell Discussion, or some other masterpiece. I was totally absorbed, when all of a sudden there was an almighty thunderclap apparently right above the house and I bounced about 10cm off my chair from the surprise. At the same time, I saw a tiny little flash of static electricity (a micro lightning bolt) inside the keyboard of the computer and the screen went blank. I stared at it in disbelief. This cannot be happening.

Jolted from my very focused state, I realised that I had been hearing thunder rumbling away quietly in the distance for some time. I hadn’t been concerned because it had seemed so far away. I should have unplugged the power to run on batteries and disconnected it from the phone line, but I didn’t. After that there were no more thunder claps near by, only continuing distant rumbles.

I tried to re-start the computer. It wouldn’t. This was just too much. I haven’t felt so unhappy for years. I suppose that indicates that I generally live a charmed life, which is true, but that didn’t stop me feeling pretty miserable for some days.

Ironically I was less well backed up this time than a month previously. About a week’s worth of stuff was on the line.

I took the computer back to the store where I’d bought it, and they tried to reset it, but that didn’t help either. Eventually I was ringing the Compaq call centre, which like almost every other call centre these days is in India. The Indian woman I spoke to had immediate access to databases of Australian street names and postcodes and could me tell where the nearest Compaq service centre was. It was just around the corner from the store. I took it there, and after about a month and a comedy of further errors with them ordering the wrong motherboard, it was finally fixed again.

My work was a total shambles that month. I struggled by on a borrowed computer and, most painfully, I had to redo several pieces of urgent work even though I didn’t yet know whether my hard drive had survived the ordeal. Amazingly, when I finally did get the computer back, the hard drive was fine. My luck had changed.

Now I am genuinely disciplined and regular with my backing up. As I’ve always said, there are only two types of computer users: those who have had major losses of files, and those who will.

David Pannell, The University of Western Australia

35 – Thinking like an economist 11: Externalities and market failure

“Market failure” is defined as a situation where people acting independently and individually will not result in the greatest possible benefits for society, at least if the aim is to maximise the overall benefits rather than to redistribute them. Economists usually see market failure as being necessary for government action to be justified. For example, we want to see evidence of market failure before we would sanction the use of a regulation or an economic incentive to try to change people’s behaviour in a particular situation. Without market failure, the argument goes, government action can only make things worse, because a free market would result in the best possible set of outcomes.

The idea is an important one as it provides a safeguard against wasting public money by forcing each issue to be looked at from an overall perspective, not just from a narrow sectional perspective. Without the discipline provided by rules like this, the wasteful use of public funds would be that much greater.

One of the potential causes of market failure is an externality. An externality occurs when an activity undertaken by an individual has side-effects on others that are not taken into consideration by the first individual. There are two types of externality: negative and positive (also called external costs and external benefits).

For example, suppose pollution is generated as a side effect of an economic activity. In a free market, a negative externality such as this pollution is a potential problem because the level of the activity chosen by the polluters may be too great from a social point of view (in the sense that there exists the potential to improve the welfare of both the polluter and the sufferer). If the external costs could be factored into the polluters’ business decisions, the polluting activity would probably be undertaken at a lower level. In the absence of regulation or some form of government imposed incentive, the group of polluters generates more pollution than is socially desirable because they do not consider the costs it imposes on others.

A positive externality is also a potential problem, but this time because the level of the activity is too low. For example, if planting trees on a farm has a side effect of lowering salinity on neighbouring farms, the level of tree planting may be lower than would be optimal overall.

Economists’ classic prescription for externalities is to “internalise” them; that is, to create a market in the externality so that price incentives can operate, or to use taxes or incentive payments to cause the instigator of the costs or benefits to factor them into their own decision making. Government responses to externality problems may also include direct regulation, negotiation, and use of peer pressure.

Economists have become so used to linking externalities to market failure that they sometimes speak as if the two are synonymous: as if the only really worthwhile cause of market failure is an externality, and as if any externality you observe necessarily is a cause of market failure. Both views are in error.

The first of these errors is just silly, as there are a number of other possible causes of market failure (e.g. information failure, monopoly, public goods) so it is surprising how often one comes across it.

The second of the errors (that any externality is a cause of market failure) is just sloppy economics, but it is one I have confronted frequently in my discussions with other economists.

In fact, as Alan Randall has pointed out, externalities are not an economic problem at all unless they also have non-rival or non-price-excludable characteristics. For example, an individual who over-exploits a non-price-excludable resource causes a negative externality to others through excessive depletion of the resource stocks, but it is the non-price excludability that allows the problem to occur.

Even if there are public-good characteristics to an externality, it still doesn’t follow that there must be market failure. For example, if pollution is occurring, it does not follow that each individual polluter should be forced to cut back. It is reasonably likely that some polluters are polluting more than can be justified (i.e. the costs to them of cutting back would be less than the costs to others if they do not do so). But you have to look at the two sets of costs for each individual polluter to see whether they are in the market failure category or not. In the case of dryland salinity, for example, we have found that many are not – that for many farmers, the costs of cutting back their off-site salinity impacts are high, and that the benefits to others of doing so are low.

The error is reflected in the calls by some (including by some economists) for all farmers to be forced by regulation to limit off-site salinity impacts. Given the current technologies available to farmers, such a regulation would actually be a net cost to society, in the sense that the resulting costs would exceed the benefits. If applied as a blanket measure, it would result in an overall benefit for some farms, but a large overall cost for a lot more.

So don’t jump to the conclusion that externalities are synonymous with market failure. You need to consider (a) whether they have public-good characteristics and (b) whether taking the actions needed to manage the externality would result in positive net benefits.

David Pannell, The University of Western Australia

Further reading

Pannell, D.J. (2004). Thinking like an economist 5: Public goods and public benefits in NRM, Pannell Discussions No. 22, 18 October 2004,

Randall, A. (1981). Resource Economics, An Economic Approach to Natural Resource and Environmental Policy, Wiley, New York. (There is also a 2nd edition from 1987, but I prefer the original).

34 – Thinking like an economist 10: Values in the very long term

Discounting for short-term benefits and costs (within say 20 years), or for purely commercial investments, is theoretically uncontroversial. Discounting for investments that pay off over the very long term (say, 100 years or more) is a more difficult matter, and in my view, has not been well resolved theoretically.

To get a feel for the issue, consider the following example. Suppose that there is some foreseeable catastrophic threat that would have its impacts in 200 years time. Suppose that this foreseeable threat could only be prevented by some action taken right now. Perhaps the problem is due to a comet that is passing by currently, and is forecast with a high degree of certainty to strike the earth on its next orbit, in 200 years.

Assume also that:

  • World GDP will grow by 3 percent per year to $8 quadrillion (15 zeros) by 2205;
  • The discount rate is 7.5 percent (that’s the sort of rate routinely used by bodies such as government departments);
  • The value of all damage (including loss of life and environmental damage) is $4 quadrillion, in 2205 dollars – half the global GDP.

Now, the question is, what is the most that the current generation should be willing to pay to prevent this forecast catastrophe? To make it easy to comprehend the size of the result, express it as the value per head of current population. In other words, if we were to fund the preventative action with a levy on each of the current six billion people on earth, what is the most that it would be reasonable to ask them to pay (on average)?

Using standard discounting methods, the answer is 35 cents each. If you doubt this, do the following calculation: 4 x 1015/(1.075200 x 6 x 109).

Can that be right? It seems to imply such callous disregard for the welfare of our distant descendents. The implied rationale is that an expenditure of any sum greater than 35 cents each ($2.16 billion in total) could be set aside in investments that would yield 7.5 percent return per year, and that this would compound to a value greater than the $4 quadrillion that is under threat. But would it? Why would this $2.16 billion grow more rapidly than the rest of the world economy (which, remember, is growing at 3 percent)? Perhaps it might do so early in the time period when it is a tiny proportion of the world economy, but what about late in the period when it will be (theoretically) a large share of the world economy? It is simply not plausible to suppose that it could keep growing at 7.5 percent while the rest of the economy grows at 3 percent.

Clearly, discounting in this way produces a nonsense answer. Perhaps we should apply a discount rate of zero. This has been seriously suggested by some. However, this implies that the average personal cost to current individuals could be as high as $667,000, which is about 180 times the current average GDP per person. Zero discounting doesn’t produce a workable and reasonable answer either. Why should we give up absolutely everything (and more) now to prevent a partial loss in the future?

How about discounting at the expected rate of growth of the world economy: 3 percent, for the sake of this discussion. This has been suggested by some eminent economists as the appropriate approach for large long-term public investments. It would yield a value of $1800 per head, half the global average GDP per head. This at least has some intuitive relationship to the event it is intended to prevent: it implies that to avoid losing half the world GDP in 2205, we should be prepare to give up as much as half the world GDP in 2005.

But is that reasonable? The idea raises all sorts of difficult questions?

  • How certain can we be that the comet would actually hit? In reality, it might be deflected slightly by gravity as it passes another planet and miss us by a long way. Or it might not cause as much damage as predicted. Either way, our sacrifice might turn out to be more than could be justified.
  • What might happen with technology over the next 200 years? The extraordinary advance in technology from 1805 to 2005 will probably seem small compared to the advance from 2005 to 2205. Diverting the comet in 2205 using some currently unimaginable technology might be a simple matter. We (the current generation) would have given up so much for so little gain to anyone.
  • What is the risk of the earth being destroyed in between time by some other cataclysm?
  • Is it fair to expect people today to give up half of our current wealth to prevent a loss that would still leave the world economy vastly larger than it is today (around 200 times larger, even after losing half of it)?
  • On the other hand, is it fair not to give up an amount of wealth now in order to avoid a future generation losing 400 times as much?
  • Is it simply a matter of wealth? Even with 400 (or 200) times as much wealth, the future generation would probably not be that much happier or more satisfied than we are today? Should we account for that, and if so, how?
  • In what real sense could we consider $1 x 1013 in 2005 to be equivalent to $4 x 1015 in 200 years time? Given the likelihood of dramatic changes in technology, health, wealth, institutions, culture, religion, age distribution, and so on, surely it is a case of comparing apples and oranges.
  • The losses would include loss of life and damage to environments on a world scale. How should they be valued? In thinking about our investment in comet diversion, should we value them from the point of view of the current generation, or their contemporary generation, or aggregate over a whole lot of generations? If the latter, who should be included and why? And even if we are happy with non-market valuation methods for current generations, how can we anticipate how future generations might value human life and the environment?

Overall, the question is vastly more complex and subtle than just choosing which discount rate to use. It pulls economics into areas of ethics and morality which we have not usually handled well, and it forces us to deal with the deepest uncertainty about future outcomes and values. My guess is that we will make further progress in clarifying the issues, but that it will probably always remain a problem with no clear answer.

David Pannell, The University of Western Australia

33 – Thinking like an economist 9: Time is money

The old saying, “time is money” is a reminder not to waste your hours when you could be getting on with making profits. However, it also could be interpreted in an almost literal sense. Money invested in a project or merely left alone in a bank account does, one hopes, grow with the passage of time, so in that sense, time generates money. I remember my delight as an eight-year-old at the amazing realisation that the bank would actually give me money for nothing, it seemed, if I let them look after my few dollars of cash. Almost too good to be true it seemed, notwithstanding the pitiful rate of interest they paid. It was safer than leaving the money at home anyway, given the risks of Mum being short of petrol money one day, or little brother deciding to bury it in the sandpit.

A question that manages to confuse many people is, how should time be accounted for when comparing different projects that involve different costs and benefits at different times? The only thing that is really obvious is that you can’t ignore the issue. You can’t just pretend that a dollar now is equivalent to a dollar in ten years time, because the dollar now can at least earn interest in a bank account, if not higher rates of return in an alternative investment.

This insight actually points the way to part of the solution. The first thing you need to know (or decide or guess) is what you would do with the money, and what the benefits of that use would be, if you did not put it into this new investment your are considering – let us call it investment X. The strategy that you would have pursued provides a benchmark for comparison. Economists call the benchmark the “opportunity cost”, since it is an opportunity you have to give up in order to pursue investment X.

The new option, investment X, has to be “better” than what you were already planning to do. Presumably, you weren’t planning to leave the money in a cardboard box under your bed, which is the sort of thing you would have to do to break the link between time and money. The choice of a realistic benchmark already implicitly includes some aspects of time, because the benchmark use of your money would have involved some growth of the asset over time.

The second thing you need to decide is what “better” means at the start of that last paragraph. What rule will you use for judging it? In economics and finance, the universally-used rule is: the better option is the one that generates the greater accumulated benefits by the end of the time period. We imagine that the investment, whatever it is, is like a bank account that starts with a zero balance, and that all costs and benefits are taken out of or put into that account. If the current balance is positive, you earn interest, and if negative you pay interest. The final balance is a combination of benefits, costs and interest.

Now, while this rule has a lot of intuitive appeal, it has to be admitted that this is not the only conceivable rule you could use. Nevertheless, it is the standard approach, and we’ll stick to it for purposes of this explanation. It is a rule that gets us into some difficulties when we get to really long-term investments, but we’ll worry about that (and some other complexities) another time.

That is pretty much essence of the solution. Things do get more complex when you try to put it into practice, but understanding the essential idea is not that hard. Assets compound in value over time to some final value. Which investment option grows to the largest final value? The benchmark investment that you were going to do, or the new option, investment X?

Unfortunately economists then confuse matters mightily by turning around the direction of time, and talking about asset values as if they shrink as time passes backwards!! I kid you not, they really do.

This kind of negative growth is the idea behind “discounting”, with the notional interest rate (the average rate of compound growth) reinterpreted as a “discount rate”. We “discount” future benefits and costs back to the present (giving us their “present value”) and then we can compare them validly because we have factored time and interest out – the opposite of what we did above, which was factoring time and interest in.

Discounting to calculate a “present value” is exactly equivalent to the “largest final value” approach that involves compounding benefits and costs through to the end of the planning period and comparing them at that point in time. If you do them both properly, they will always give the same ranking of the options.

In fact it doesn’t matter which point in time you choose to make the comparison. It could be somewhere in the middle of the time period if you wish, requiring discounting of later values, and compounding up of earlier values. It will work out, as long as you choose a single point in time and use it to compare all of the benefits and costs. Economists always choose the present, but this is arbitrary.

Note that this discussion is not about inflation. The usual approach is to factor inflation out of all the costs and benefits before you start the above calculations, expressing them in “real” terms. Of course you then have to factor inflation out of the discount rate used as well. So we are talking about growth of benefits and costs beyond the inflation rate, due to the opportunity cost of money: its value in generating real benefits over time.

Some people get really worried about the use of discounting. It just doesn’t feel right, somehow. Part of the problem is that it has such dire implications about the present value of benefits in the future. Some people find it objectionable that a dollar of benefits in 30 years time should only be considered to be worth about 5 cents in the present. It seems almost immoral! If you are one of those people, think about it as being effectively the same as choosing the “largest final value”, and perhaps you will feel more comfortable about it. The dollar in 30 years time will then still count as a dollar, but the dollar earned in year one will have accumulated enough interest to be worth say $20. Same effective result, but maybe it feels more reasonable.

One colleague working in biological science once objected to me that we are assuming that the money earned will actually be reinvested at the going rate and will continue to accumulate interest until the end of the period. What if this doesn’t actually happen? What if the investor did not reinvest the proceeds, but took some of them part way through the period and used them to pay for CDs or hold a big party?

He had in mind that this should reduce the discount rate used, so that future benefits would not be so diminished in the present. However, the logical implication is quite the opposite.

If I buy CDs, rather than leave money in the bank (which is pretty much how I actually behave, mostly), it is because I am judging the overall benefits to me of having the CDs to play is greater than the benefits of letting the money accumulate interest in the bank. In effect, the benchmark for me is a better option than using the bank, so the effective rate of inflation of benefits over time is higher! Or equivalently, the rate of deflation of future benefits to the present (the discount rate) should also be higher.

David Pannell, The University of Western Australia

Further reading

Pannell, D.J. (2004). Avoiding simplistic assumptions in discounting cash flows for private decisions, In: D. Pannell and S. Schilizzi (eds.), Discounting and Discount Rates in Theory and Practice, Edward Elgar, (forthcoming). full paper (45K)