Category Archives: Environment

313 – Joining the dots versus growing the blobs

For the recent AARES conference in Adelaide, Maksym Polyakov did a wonderfully creative poster presenting our research on optimal targeting of ecological restoration.

There is a small image of the poster below, but if you want to see the details, go here. (Scroll down when you get there to see the poster.)

Not surprisingly, it won the prize for the best poster at the conference.

Abstract

The primary causes of biodiversity decline worldwide are habitat destruction, alteration and fragmentation resulting from human economic activities such as agriculture or property development. Public- and private-sector organizations allocate considerable resources to slow down biodiversity decline by developing conservation networks that preserve the remaining habitat. In this study we use simulation to compare several strategies to spatially target ecological restoration effort to create conservation networks, on private lands in a fragmented agricultural landscape. The evaluated targeting strategies are aggregation, connectivity and representativeness. The effectiveness of these targeting strategies is compared to the effectiveness of ecological restoration without targeting. We allow for heterogeneity of landowners’ willingness to participate in restoration projects and explicitly assume that that not all parcels within target areas will be restored. We model the probability of participation in restoration projects as a function of the private benefits of ecological restoration captured by the landowner. The results of the simulation are analyzed using regression analysis. Our results suggest that effectiveness of the targeting strategies depends on landscape characteristics (level of fragmentation) and species characteristics (habitat requirements and area of home range). On average, when uncertainty about whether landowners will participate is considered, for most analyzed species, the aggregation strategy outperforms the connectivity strategy with the representativeness strategy performing worst. This is contrary to the findings of previous studies and Government policy, that connectivity is the most effective strategy in fragmented landscapes. Accounting for the landowners’ behavior through a private benefits function improves the biodiversity outcome for most species.

312 – The economics of nitrogen in agriculture

The global challenge of feeding seven billion people would be more difficult without nitrogen fertilizer, but it causes pollution of rivers, lakes and coastal waters around the world, and it contributes to emissions of greenhouse gases. It increases the profitability of individual farmers, but it is over-applied in many cases, wasting money and needlessly worsening environmental problems.

These are, in large part, economic issues. In a recent paper I attempted to summarise the large and diverse research literatures on the economics of nitrogen in agriculture. Here are some of the key points.

At the farm level

The production function for nitrogen (N) fertilizer (the relationship between yield and the rate of nitrogen fertilizer) always exhibits diminishing marginal returns – it flattens out at higher fertilizer rates. In dry conditions, yield may even fall at high N rates.

The rate of nitrogen fertilizer that maximises expected profit is less than the rate that maximises expected yield, sometimes much less.

Here’s a really neat tool that shows the relationships between N, yield and profit for corn in the US. http://cnrc.agron.iastate.edu/

Visual effect of nitrogen fertilizer on corn

Risk

N fertilizer affects the riskiness of cropping. For two reasons, higher N rates are more risky (i.e. profits are more variable at higher N rates). One reason is that the grain price is itself risky. Since profit depends on grain price times yield, and yield usually increases with increasing N rate, the more N you apply, the more variable your profit will be. In addition, yield also tends to be slightly more variable at higher N rates.

Flat payoff functions

There always exists a range of fertilizer rates that are only slightly less profitable than the profit-maximising rate (i.e. a range where the payoff function is relatively flat), and in most cases, that flat range is wide. This means that the farmer has flexibility in choosing the fertilizer rate. If a lower rate would better satisfy another objective (e.g. risk reduction), the farmer can choose that rate with little sacrifice of profit. If regulators require a moderate reduction in fertilizer rate below the farmer’s economic optimum, the cost to the farmer will be small. Flat payoff functions also mean that the benefits of precision-agriculture technologies that spatially adjust fertilizer rates within a field will usually be small.

Nitrogen pollution

Typically, the marginal cost to farmers of nitrogen emissions abatement is low for low levels of abatement but increases at an increasing rate as the required level of abatement increases. As a result, modest targets for abatement can often be achieved at low cost, but ambitious targets can be extremely costly.

Spatial targeting of abatement effort (both at the regional and international scales) can generate much larger benefits than untargeted policies, although these additional benefits are likely to be offset to some degree by increased costs required to run a targeted program (costs of information and administration).

Policies intended to increase farmers’ incomes can have the unintended consequence of increasing nitrogen pollution by increasing the incentive to apply fertilizer.

Further reading

Pannell, D.J. (2017). Economic perspectives on nitrogen in farming systems: managing trade-offs between production, risk and the environment, Soil Research 55, 473-478. Journal web page

Gandorfer, M., Pannell, D.J. and Meyer-Aurich, A. (2011). Analyzing the Effects of Risk and Uncertainty on Optimal Tillage and Nitrogen Fertilizer Intensity for field crops in Germany, Agricultural Systems 104(8), 615-622. Journal web page ♦ IDEAS page

Schilizzi, S. and Pannell, D.J. (2001). The economics of nitrogen fixation, Agronomie 21(6/7), 527-538.

Pannell, D.J. and Falconer, D.A. (1988). The relative contributions to profit of fixed and applied nitrogen in a crop‑livestock farm system, Agricultural Systems 26(1), 1‑17. Journal web page ♦ IDEAS page

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. Journal web page ♦ IDEAS page

310 – Additionality can be tricky to assess

Many environmental policies and programs pay public money to people or businesses (or give them tax breaks or discounts) to encourage them to adopt more environmentally friendly practices and behaviours. A seemingly common-sense rule for these sorts of programs is that we shouldn’t pay people to do things that they were going to do anyway, without payment. But it can be quite a hard rule to apply in practice.

The idea that we shouldn’t pay people to do things that they were going to do anyway goes under the name of “additionality”. (It is also related to the with-versus-without principle in Benefit: Cost Analysis, and the concept of market failure – see PD272).

The idea behind “additionality” is that, when a program pays money to people to change their behaviours, the environmental benefits that result should be additional to the environmental benefits that would have occurred anyway, in the absence of the payments.

The reason this matters is that, if we are able to target payments to those behaviours that do result in additional environmental benefits, we’ll end up with greater environmental benefits overall, compared to paying for non-additional benefits – we’ll get better value for taxpayers’ money.

Some environmental programs do a poor job of checking for additionality. As I noted in PD272, much of the money given to farmers in US agri-environmental programs is not additional. In Australia, the Direct Action program for climate change doesn’t consider additionality well when selecting the winning bids in their reverse auctions (it compares practices before vs after signing up to the program, not with versus without).

So, environmental programs that allocate money to people or businesses should worry about additionality, but how? It can be harder than it sounds. It’s all very well to say, “only pay people if they would not have done it anyway”, but how do we know what they would have done anyway?

Sometimes it’s reasonably easy. There are cases where we can be pretty confident that people would not have done the environmental action, and will not start doing it in future, without a payment or regulation. I suspect that most of the work on Australian farms to fence off waterways to exclude livestock would not have happened without payments to cover the cost of fencing materials.

In the US, the Conservation Reserve Program pays farmers to remove agricultural land from production and plant environmentally beneficial species. This is probably mostly buying actions that lead to additional outcomes.

The nature of these additional activities is that they are things that are not normally done by farmers. This is largely because they cost the farmer money.

Judging additionality can be much trickier for environmental actions that also generate enough private benefits to be potentially worth doing by the private individuals or businesses. Zero tillage is a good example. Widespread adoption by farmers of zero tillage in Australia, Canada, the US and some other countries has substantially reduced soil erosion, with a range of off-farm benefits. But the reason this practice has been adopted so widely is that it can be very beneficial to the farmers who adopt it. Paying Australian farmers as a reward for doing zero tillage would be pointless, because most of them are already doing it. The public benefits would not be additional.

But imagine how it was in the early days of zero tillage. From the time when it was first developed, it took several decades for zero tillage to be taken up by most farmers. For the first decade, there were very few adopters. A program looking at subsidising zero tillage in 1990 would probably have judged that the payments would lead to additional benefits, and I would not have blamed them.

In fact, at that time, before the systems and technologies to make zero tillage work as well as it does now had been fully developed, payments in many cases would have satisfied the additionality condition. But only temporarily. At some point, the payments would have needed to be switched off, but judging when to switch them off would have been incredibly difficult. Most likely the payments would have continued for quite a while after additionality was lost.

For some practices, additionality comes and goes. For example, planting perennial pastures sequesters more carbon in soils than is found under annual crops, so it might be worth paying crop farmers to convert. But only if they would not otherwise have done so. The area of perennial pastures in Australia rises and falls over time in response to the prices of livestock products, the performance of available perennial pasture varieties, and the economic performance of cropping. If an agency started to pay farmers to plant perennial pastures, ideally they would keep a close eye on the economics of perennial pastures relative to cropping, in case additionality was lost. If it was lost for a period, then payments for that period are achieving nothing, and could be cut without losing the sequestered carbon.

But how would the agency know? The economics of a mixed farming system are very complex, and highly context specific. I worked on nothing but the economics of mixed farming systems for about 15 years, and it would take me quite a bit of effort to assess the additionality of perennial pastures on a particular farm. It would likely vary from paddock to paddock within the farm. The agency could potentially pay consultants to regularly assess the economics, but the costs of doing so on an individual farm would probably outweigh the value of the additional stored carbon.

What the Australian Government’s Emissions Reduction Fund does instead is a before-vs-after comparison of soil carbon, and it assumes that all of the increase is additional for the life of the agreement. This works initially, but the longer the agreement goes on, the larger the chance that additionality will be lost. If it is lost, then the public money allocated for converting to perennial pastures will just be a gift to farmers who would have done it anyway. The gifts could be small and short term or large and long-term; it’s impossible to know in advance. If it turns out to be large and long term, it is the farmer’s good luck – there is no mechanism in the program to turn the payments off.

Should the program have been designed differently? As I said earlier, rigorously assessing additionality on each farm over time is probably not feasible for this practice. It would cost so much that the investment in soil carbon sequestration was not worthwhile.

Additionality could be assessed for a region, rather than for many individual farms. That would make it more affordable, but given the high heterogeneity of the economics of perennial pastures within a region, or even within a farm, the assessment would be wrong in many cases. Still it might be judged to be acceptable as a compromise.

The other alternative is not to provide payments for soil carbon sequestration at all. Personally, that would be my recommendation. There are other problems with paying for soil carbon as well – leakage and permanence, not just additionality (Thamo and Pannell 2017) – and I don’t believe it’s possible to develop a sound policy that is worth the transaction costs.

Although assessing additionality can be difficult, I’m not saying that it is irrelevant. It is always worth thinking it through carefully when setting up an environmental program, and sometimes it is feasible to do a reasonably reliable assessment of it at reasonable cost. But not always. If not, then the program managers have to judge whether the risk of non-additionality is so high that it is not worth proceeding with the program. That’s a difficult judgement that should not be made lightly.

Further reading

Thamo, T. and Pannell, D.J. (2016). Challenges in developing effective policy for soil carbon sequestration: perspectives on additionality, leakage, and permanence, Climate Policy 16, 973–992. Journal web page

306 – Economics of green infrastructure in cities: some essentials

During the recent Conference of the CRC for Water Sensitive Cities in Perth, I was interviewed about some of the essential points that non-economists need to be aware of when thinking about the economics of water-related investments in cities. The video is now available.

My team has been part of the CRC since it started back in 2012. In the interview I talk a bit about the work we’ve already done and what we’re doing now, and then identify my three top tips for non-economists: that benefits from an investment relate to the differences in outcomes with versus without the investment (not before versus after); that the timing of benefits and costs can matter greatly to the economic results; and that you need to account to a range of risks that might cause any particular investment to deliver less than you’d hoped.

These issues are spelt out more in the video (13:50 long), which you can see right here.

Further reading

Pannell, D.J. (2015). Ranking projects for water sensitive cities – a practical guide, CRC for Water Sensitive Cities: here

Web site for our CRC project: here

305 – Feeling virtuous: what’s it worth?

We all like to feel good about ourselves. A product that makes us seem virtuous to others, or even to ourselves, would be worth paying more for than its strictly utilitarian value.

That was one of our hypotheses behind a surprising result in some recent research. We were trying to measure the benefits of installing a rainwater tank on an urban property in Perth. We did this by measuring the premium in house sale prices for houses that already had a rainwater tank installed, compared with similar houses that did not.

The results left us deeply puzzled. First, the price premium was enormous: around $18,000. Now the water in a typical tank, when full, is worth about $3, and a tanks lasts for about 15 years. That means that to use enough tank water to make the $18,000 price premium worth paying, you would you would have to use a full tank of water and refill it from rainfall about twice each day every day for the whole 15 years (assuming a 5% interest rate on your home loan). But that’s way beyond actual levels of rainwater use, and it doesn’t rain that much or that frequently in Perth anyway!

We were left scrambling for explanations for the high price premium. As I started off saying, an obvious one is the feel-good factor from knowing that one is contributing to water conservation. It could be a bit like organic food. Some of the price premium for that could reflect people’s concerns about environmental impacts of agricultural chemicals (as well as perceived health impacts).

Another possible explanation is that people may misjudge how much the water captured in the tanks is worth. Water from the tap really is most extraordinarily cheap, whereas the most common experience of paying for water for most people is bottled water, which is most extraordinarily expensive. So it would be understandable to some extent if people got this wrong. We cannot tell from the house sale data what is in peoples’ minds (e.g. about water cost), only the overall result.

A third explanation could be that our statistical analysis was faulty. If you look at the paper you’ll see that we tied ourselves in knots, testing the robustness of the stats in ways that are far beyond my own statistical skills (thanks co-authors), but we couldn’t make the result go away.

There was one more puzzle we couldn’t solve, as well. The price premium for rain tanks is far above the cost of installing a tank, so why doesn’t everybody with a house to sell invest in a rain tank? In fact only a small minority of houses sold do have them. I guess they aren’t aware of the potential price hike.

On the other hand, we don’t know what would happen to the premium if the proportion of houses with installed tanks was to increase substantially. It is likely that the greater supply of tanks would drive down the price premium to some extent.

Further reading

Zhang, F., Polyakov, M., Fogarty, J. and Pannell, D. (2015). The capitalized value of rainwater tanks in the property market of Perth, Australia, Journal of Hydrology 522, 317-325. Journal web site ♦ IDEAS page (includes link to freely downloadable version of the paper)