Monthly Archives: November 2006

89 – Farmers as “consumers” of nature conservation

Many farmers put a high value on improving environmental conditions on their farm. In other words, government programs for land and water conservation in rural areas generate private, as well as public, benefits.

When I started work for the Department of Agriculture in Western Australia in 1983, the link between farm management and nature conservation was not a prominent policy concern. I don’t recall it being mentioned once during my four-year degree in Agricultural Science.

Things have changed. Twenty five years ago, the main aim of agricultural policy was, in various ways, to improve the economic performance of farms. These days, a big chunk of agricultural policy is concerned with “sustainable” management of resources.

To a significant extent, the aim now is to protect or generate public benefits, as opposed to the former focus on private economic benefits. For example, the Natural Heritage Trust provides funds to encourage farmers to do things that enhance nature conservation, and generate public benefits.

However, it is important to recognise that a farmer’s actions to enhance nature conservation may also provide benefits for that farmer, in the form of personal satisfaction or as benefits to agricultural production. These are, in a sense, private “consumption” benefits. Michael (2003) proposes that “the literature usually overestimates the opportunity costs of preservation” (p. 243) because it fails to take account of the willingness of farmers to bear some of the costs, reflecting the personal satisfaction that they gain by contributing to conservation, or perhaps gains in productivity on their land. This suggestion is supported by empirical evidence from the BushTender trial in Victoria, where landholders submitted bids in an auction, specifying the level of financial support they would require in order to undertake specified works to protect remnant vegetation.

“The diversity of bids, particularly the fact that some landholders offered low bids per hectare, implies that some landholders were probably prepared to share costs with the government to conserve biodiversity. Other landholders, it seems, charged NRE [the Department of Natural Resources and Environment] the full opportunity cost of land-based activities.” (Stoneham et al. 2003).

In the Landcare and Natural Heritage Trust programs, we have observed farmers contributing considerable time and resources to on-ground works intended to promote nature conservation (e.g., Doley 2003; English 2003; Lloyd and Butterworth 2003; McFarlane and McFarlane 2003). Under an economic interpretation, one of the objectives of Landcare could be expressed as increasing the farmers demand for (i.e., willingness to pay for) environmental improvements. These programs succeeded to some extent. I would hazard a guess that farmers now spend more per head on nature conservation than any other group in society.

On the other hand, at least some farmers object in principle to proposals to reduce clearing, even if compensation is offered, and especially if the proposal involves compulsion. The “willingness to pay” for nature conservation by some farmers seems to fall to zero when they are forced.

Even when there is no compulsion, we need to have realistic expectations about the extent of farmers’ willingness to pay. To a greater or lesser extent, almost all farmers are willing to make financial sacrifices for the good of their land or the environment, but they also must give priority to remaining in business and meeting other family and social objectives. The point is that the community can benefit from the generosity and environmental concerns of farmers, but that there are limits to what can realistically (or reasonably) be expected.

A common finding in economics is that most consumers of most goods experience “diminishing marginal utility” as their level of consumption increases. This means that the level of satisfaction for each additional unit of consumption falls as consumption reaches higher and higher levels. This is reflected, for example, in the fact that as the price of a good rises, consumers tend to choose to purchase less of the good (demand curves slope downwards). Turning that observation around, to encourage consumers to purchase more of a good (assuming tastes and preferences are fixed) one must reduce the price of the good.

It seems to me that the extent to which farmers have given of their time and money for environmental works in the recent past is a good indication of their personal benefits as consumers of environmental benefits. Attempts to encourage farmers to expand their contributions will come up against the influence of diminishing marginal utility. Substantial increases in the demand for nature conservation by farmers on their land may require substantial falls in the “price” to them. Two possibilities for achieving this are: provision of more substantial subsidies by the public, and development of less costly technologies that aid conservation (e.g., woody perennials that are more commercially attractive and so have lower opportunity costs). This is not to deny that there is scope for increased voluntary contributions from some farmers. Deeper knowledge of environmental issues from participation in government programs can be a strong motivating force for some farmers. In economic terms, this is an increase in demand, rather than a decrease in cost of supply.

David Pannell, The University of Western Australia

Further Reading

Doley, A., 2003. “Koobabbie”: ecological and economic sustainability. Pacific Conservation Biology 9: 42-48.

English, G., 2003. “Jangarri”: economics, environment, society. Pacific Conservation Biology 9: 36-38.

Lloyd, T. and Butterworth, J., 2003. Eden Valley Farm: an integrated approach to a sustainable future. Pacific Conservation Biology 9: 32-35.

McFarlane, M.R., and McFarlane, S.M., 2003. Dangemanning Farm: a holistic development. Pacific Conservation Biology 9: 39-41.

Michael, J.A., 2003. Efficient habitat protection with diverse landowners and fragmented landscapes. Environmental Science and Policy 6: 243–251.

Pannell, D.J. (2004). Heathens in the chapel? Application of economics to biodiversity, Pacific Conservation Biology 10(2/3): 88-105. Full paper (109K)

Stoneham, G., Chaudhri, V., Ha, A. and Strappazzon, L., 2003. Auctions for conservation contracts: an empirical examination of Victoria’s BushTender trial. Australian Journal of Agricultural and Resource Economics 47: 477-500.

88 – Thinking like an economist 24: Flat-earth economics

Economists are often interested in finding the optimal solution to economic problems, meaning the strategy or decision that gives the highest possible payoff. In reality, in many cases, the best possible economic decision is barely any better than a large number of alternative decisions. This has big implications that economists should highlight, but which they mostly ignore.

When I was doing my degree in agricultural science in the early 1980s, while looking through the Journal of the Australian Institute of Agricultural Science for an article I needed to complete an assignment, I chanced across “One More or Less Cheer for Optimality” by Jock Anderson (1975). Intriguing title, so I read it. It was the first piece by Jock that I had read, and it was terrific. For one thing, I was very impressed that Jock could write in an entertaining and readable way in a research journal.

More importantly, I was impressed by the content, which was about the way that economic payoffs can often be quite insensitive to changes in management. For example, if you vary the rate of nitrogen fertilizer applied to a wheat crop, field measurements and some simple economic calculations show that there is usually quite a wide range of nitrogen rates that result in almost as much profit as the profit-maximising nitrogen rate. In other words, the payoff function is flat near the optimum, often over quite a wide range. In response to someone who had pointed this out in an earlier article, Jock was more-or-less saying, yes, so what?, agricultural economists have always known that. He pointed out that it is a really common phenomenon in economic models generally.

Now, I was in my honours year studying agricultural economics at the time, and I’d also done a number of units in the Economics Faculty, but nobody had ever pointed this out to me. It struck me as a hugely important observation, and a remarkable omission from my economics education.

It turned out that Jock’s paper was part of a series of comments and replies about flat payoff functions, involving a number of authors. It had been, briefly, a hot issue.

The remarkable thing – actually the astounding thing – is that, as far as I can tell, that debate in 1975 was the last time the issue of flat payoff functions was discussed in any detail in a journal. I’ve spent a long time searching, and all I’ve been able to find in the past 30 years of journal articles in economics or agricultural economics is a few brief mentions of the issue. Mostly it is completely ignored, even though it is present in most optimising economic models that are published. I’ve not seen it mentioned in any economics text book apart from a couple of specialised ones on response functions by Jock and his colleagues.

I say this is astounding because flat payoff functions are so very common, and they have such huge implications. In fact I reckon you could make a good case that the common existence of flat payoff functions is one of the most important empirical results in all of economics. And yet, all over the world, students of economics are graduating without it being highlighted, or even mentioned, to them.

How flat is flat? Figure 1 shows one example that is not at all unusual. This is a graph of gross margin (a measure of economic payoff) as a function of lime application to crops on acidic soils in one particular situation in Western Australia (taken from O’Connell et al., 1999). The profit-maximising rate of lime in this example is 2.7 tonnes per ha, but for any rate between 1.8 and 4.3 tonnes per ha, the payoff is within 5% of the maximum!

flat

Figure 1. Gross margin (~profit) as a function of lime rate in the Western Australian wheatbelt.

It really doesn’t matter a hoot that the optimal rate is 2.7 tonnes per ha. (It probably isn’t really, given the inevitable measurement errors, sampling errors and sheer guesswork that go into creating a graph like this.) What matters is that if you apply anything between about 2 and 4 tonnes, you’ll make about as much money as it’s possible to make from lime application. Applying 2 to 4 tonnes is vastly better than none at all, but the choice between 2, or 4, or 3.3 or 2.7 matters not one jot.

If I was applying lime, I’d want to know this. It would mean that I could consider other issues, like say risk, or liquidity, when choosing my rate. It also means that as a manager I have a margin for error, which is worth knowing since it may cost more to be precise. If I was an economist analysing this issue, I would focus on where the flat section of the curve is, and how wide it is.

By contrast, economists are commonly obsessed with finding optimal solutions. Economics journals are chock full of studies where either calculus or numerical methods have been used to find optimal solutions to economic problems. This obsession with optimisation seems to have created a huge blind spot. In 1975, Jardine noted that on presenting information to agronomists about flat profit curves for fertilizers, he “observed such reactions as complete disbelief, blank incomprehension, incipient terror, and others less readily categorized”. It would be very interesting to see how many economists today would react similarly. I’m not saying that optimisation methods should not be used, but there are implications for how they should be used.

Flat payoff functions are not important solely because of the “margin for error” issue. They also have big implications for issues as diverse as risk management, precision farming, and the value of research. I’ve written about those issues in Pannell (2006), just out in the Review of Agricultural Economics.

David Pannell, The University of Western Australia

Further Reading

Anderson, J.R. “One More or Less Cheer for Optimality.” J. Aust. Institute Agr. Sci. 41(September 1975): 195-197.

O’Connell, M., A.D. Bathgate, and N.A. Glenn. (1999). “The value of information from research to enhance testing or monitoring of soil acidity in Western Australia.” SEA Working Paper 99/06, Agricultural and Resource Economics, University of Western Australia.

Pannell, D.J. (2006). Flat-earth economics: The far-reaching consequences of flat payoff functions in economic decision making, Review of Agricultural Economics 28(4), 553-566. Prepublication version here (44K).