AGRICULTURE IN ECONOMIC DEVELOPMENT:

AN INTERNATIONAL PERSPECTIVE

WEEK 10

Agriculture, natural resources and the environment

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Agriculture, natural resources and the environment: outline

The problem: resource degradation and the tragedy of commons Dimensions

The root cause of the problem: market failure The extensive margin - open access – private property Common property resources and institutions

The theoretical analysis Output oriented model Input oriented model

Alternative policies to address environmental problems of agriculture Use of market incentives for stewardship of resources Price effects, expectations and price incentives

Governance issues and endogenous institutions

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Bibliography

Lichtenberg, E. (2000) Agriculture and the environment, in HBAE, Chapter 23

Hardin, G.(1968) Tragedy of the Commons, Science, Vol. 162, pp. 1243-1248

Ostrom, E. (1990) Governing the Commons: The Evolution of Institutions for Collective Action. Cambridge University Press, UK

Olstrom, E. (2001) Common-pool resources and institutions: Toward a revised theory in HBAE

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The links between agriculture and the environment

Resource base and conservation Agriculture involves extraction of yield from renewable resources

Productivity depends on natural resource base Economic incentives for conservation Intensification – weakening of incentives – break down of conservation

Positive externalities - Environmental amenities Open space and scenery

Negative externalities – Environmental problems Nitrate and chemical run-off Degradation of habitat and loss of wetlands and wildlife Animal waste Erosion – sedimentation of waterways Chronic illness from pesticide exposure

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The problem

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The root cause of the problem :Common Property Resources and

the tragedy of commons

Elinor Ostrom won the Nobel Prize in Economics in 2009 for her work in the economic governance of the commons

A “commons,” or more precisely “common-property resource” or “common pool resources” (CPR) as Ostrom refers to it, is a resource environment or domain that is characterized by an open access problem.

It is difficult to effectively bar other users from accessing and benefitting from that resource.

A “CPR is sufficiently large that it is difficult, but not impossible, to define recognized users and exclude other users altogether”

Hardin (1968) The tragedy of commons, Science The importance of institutions to ensure sustainable resource management

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The Tragedy of Commons

In 1968, Garrett Hardin published an influential paper outlining a problem that he called “Tragedy of Commons”

Hardin described the “tragedy of the commons,” in which humans overuse and deplete a CPR even though it is not in their best interest to do so.

This trend of over-exploitation of CPR is due to lack of individual ownership

The inability to restrict usage incentivizes actors to consume as much as possible of the shared resource before others do.

This race to consume traps actors in a vicious cycle of mismanagement and over-consumption that ultimately leads to

irreversible environmental degradation.

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The theory : market failure

Two formal models: An output oriented model with natural resources entering implicitly An input-oriented model which incorporates resources explicitly Environmental spillovers (externalities) can be considered as arising from

a multi-output production process ( agricultural products and environmental quality) produced simultaneously from the same vector of inputs.

Then, the problem is on the choice of technology that provides the socially desirable level of both outputs

The problem arises from the fact that prices exist for the first output but not for the second

Thus, producers have no incentive for the second output

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Output oriented model

Agricultural technology is then a set T = {(y,q,x): x can produce (y,q)}. The output-oriented model represents this technology using a joint cost

function Cost function : C(y,q,w) = min{wx: (y,q,x) E T}, w : input prices. Let U(y,q) society’s gross benefit from consumption of agricultural output

and environmental quality. We assume benefits strongly separable Optimal joint production of agricultural products and environmental

quality is found by choosing (y,q) to maximize net benefits U(y,q)-C(y,q,w). Necessary conditions are: (Subscripts denote partial derivatives.) Uy(y,q)– Cy(y,q,w) = 0 Uq(y,q)– Cq(y,q,w) = 0, i.e., the marginal benefits of agricultural output and environmental quality

should be equated to their marginal costs. If markets (prices) exist, both outputs will be optimal.

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Market failure – lack of property rights

If market (inverse) demands for agricultural output and environmental quality equal U y (y,q) and U q (y,q), respectively, then perfectly competitive markets will generate the socially efficient levels of agricultural output and environmental quality in equilibrium.

Problem arises because of market failure for environmental products Examples Farmers are not required to pay for disposal of sediment of nitrate, or

pesticides into surface or ground waters. Similarly, farmers cannot charge for the open space, greenery, and scenic views their farms provide

Both the environmental resources farmers provide and those they use are thus subject to open access exploitation.

At bottom, the lack of markets for these environmental resources is due to the extreme difficulty, or impossibility, of establishing and enforcing clear property rights.

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Agriculture’s public goods

Most scenic amenities from agriculture are public goods. The consumption of farm scenery is non-exclusive and non-rival. Moreover, since the marginal cost of providing scenery to an additional

consumer is minimal, leaving these scenic amenities unpriced can be efficient at the margin.

But leaving such amenities unpriced fails to provide farmers with incentives to forego development of their land, even when doing so is in the public interest.

Open access occurs in water pollution from agricultural emissions of nutrients, sediment, or pesticides for a somewhat different reason. Emissions of agricultural pollutants are diffuse and enter water bodies at numerous different points.

Furthermore, it is difficult to distinguish agricultural emissions of nutrients and sediments from those that occur naturally. It is impossible to restrict access to these water bodies, and hence impossible to levy charges for access to them.

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Lack of a market means zero price and zero price means free disposal

In the absence of markets for environmental quality, farmers tend to treat it as freely disposable.

In the multi-output production technology given previously, as represented by the cost function, assuming an unregulated market, the joint production of agricultural output and environmental quality will be characterized by the FOC of the cost minimization problem that are:

U y (y,q)– C y (y,q,w) = 0

C q (y,q,w) = 0, which imply too much agricultural output and too little environmental

quality. In other words, the level of agricultural output generated by competitive

markets exceeds the socially optimal level, while the level of environmental quality generated by competitive markets falls short of the socially optimal level.

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Input oriented model Often, environmental effects associated with specific inputs (fertilizers,

etc) Let z be specific input(s) of interest and v be the associated price(s). Let e(z) represent the environmental effects of input use, where e z > 0. Let the agricultural output technology be represented by a revenue function

R(p,w,z) = max x,y {py– wx: (y,x,z) T).  Decreasing marginal productivity of z implies increasing marginal income

foregone due to reductions in z. Formulation equivalent to one with increasing marginal cost of producing environmental quality.

 Let S(p,e(z)) be the social surplus accruing when the price of agricultural output is p and the level of environmental quality is e(z).

Under standard assumptions, S p = -y, that is, the derivative of S with respect to p equals the negative of demand for agricultural output, and S pp = -y/p > 0. S e is negative for adverse environmental effects and positive for beneficial ones.

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Input oriented model (cont)

  The socially optimal usage level(s) of z and agricultural output price(s) p in

this case maximize net social surplus S(p,e(z)) + R(p,w,z) – vz and is characterized by the necessary conditions

S p (p,e(z)) + R p (p,w,z) = 0

S e (p,e(z)) e z + R z (p,w,z)– v = 0. The first condition is the market clearing condition that the quantity of

agricultural output demanded (-S p )equals the quantity supplied (R p ). The second condition says that the value of the marginal product of z (R z )

should equal its unit price (v) plus (minus) the marginal social cost (benefit) of environmental effects arising from use of the input(s).

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Stewardship incentives -input-oriented model, Social surplus from consumption into three components:

off-farm surplus from the consumption of agricultural output, CS(p),

off-farm damage from use of the input of interest, D(e(z)), and

on-farm surplus from consumption of agricultural output and goods associated with the resource base of agriculture, L(p,e(z)), L p > 0, L e < 0.

In soil erosion z represents the erosion rate, e(z) denotes the long-run reduction in soil depth associated with erosion rate z, and D(e(z)) represents off-farm damage from sedimentation and nutrient pollution of waterways.

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Stewardship incentives -input-oriented model, (cont)

Assuming stationary prices for agricultural output, the value of agricultural productivity in the future can be written as L(p,e(z)).

When markets for agricultural land are well developed, L(p,e(z)) equals the price of farmland

In case of drinking water quality, z might represent fertilizers or pesticides and e(z) the corresponding concentration in well or stream water, while L(p,e(z)) represents farm families’ surplus from consumption.

In case of pesticides and farmer health, z would represent the toxicity, frequency of application, and/or pesticide application rate, e(z) the corresponding applicator exposure, and L(p,e(z)) the farm household’s combined demand for agricultural output and health status.

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In the absence of explicit markets for environmental quality, equilibrium is

CSp + Lp + Rp = 0 (1) and Leez + R z – v = 0 (2) Farmers’ unit cost of using the input z, v-L e e z , exceeds the

market price v by an amount equal to the marginal reduction in land value. It is conceivable that these incentives for stewardship are strong enough to replicate the social optimum.

Social optimum: CS p + L p + R p = 0 and [L e – D e ]e z + R z – v = 0.

The social and private optima coincide if D e (e(z)) = 0 at the profit-maximizing level of z, that is, if profit-maximizing off-farm damage remains below a threshold level

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Alternatively, incentives for stewardship arise from complementarity between environmental quality and agricultural output in production (C yq < 0) or in consumption (U yq > 0).

If environmental quality and agricultural output are complements in production, farmers will have incentive to increase environmental quality as a means of lowering the marginal cost of agricultural output.

If demand for agricultural output is greater when environmental quality is greater (environmental quality and agricultural output are complements in consumption), then there will likely exist equilibria in which improvements in environmental quality support increased agricultural production.

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Policy design - directions for policy intervention

Identifying the drivers of resource degradation Improving agricultural water management Greening the green revolution Managing intensive livestock systems Reversing degradation in less-favored areas Providing payment for environmental services Helping adaptation to and mitigation of climate change in

agriculture

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Drivers of resource degradation

Overcoming environmental problems requires a good understanding of private incentives of resource users and ways to manage resources more successfully from society’s point of view.

Many factors affect private incentives for managing resources, including information, prices, subsidies, interest rates, market access, risk, property rights, technology, and collective action.

Often resulting in both, onsite and offsite resource degradation, these factors can be modified through policy changes and public investment, although global forces are changing the drivers of resource degradation in new ways.

Global markets can leave a global environmental footprint, such as the impact of Asian demand for soybeans for livestock on deforestation in the Amazon.

Furthermore, climate change is increasing production risks in many farming systems, reducing the ability of farmers and rural societies to manage risks on their own.

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Poverty and population Two difficult drivers to manage are poverty and population.  When suitable technologies and institutions are available , population

growth can lead to adoption and sustain improvements in resource conditions and yields.

Because many natural resource management technologies are labor intensive (for example, terracing or contouring land, building irrigation structures), population growth can actually assist their uptake because it lowers labor costs.

When population pressure is combined with high initial levels of poverty and few technology options for boosting productivity, degradation and poverty can spiral downward. This is happening in some areas of Africa, where many farms are now too small to support a family, yield growth has stagnated, and job opportunities off the farm are rare.

These distressed areas can become breeding grounds for civil conflict, displacing environmental refugees and disrupting efforts to reach the very

poor and vulnerable.

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Increasing productivity without producing environmental problems

Productivity increase in irrigated agriculture and intensive farming systems: both are associated with severe environmental damages

 Irrigated agriculture: Use less water, growing water scarcities; stop unsustainable mining of groundwater; and prevent the degradation of irrigated land through water logging, salinization, and nutrient depletion. In intensive farming areas in general (irrigated and high potential rainfed areas), modern inputs like seed, fertilizer, pesticides, and water need to be managed to sustain high yields without damaging the environment.

 Intensive livestock systems. Management of wastes and disease risks. In less-favored regions with extensive farming systems, development

needs to support the livelihoods of local people and still be compatible with other environmental services on a fragile resource base.

In both high-potential and less-favored areas, payments for environmental services can be used when national and global social benefits exceed the opportunity cost of current land use and the management costs of the program.

   

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Improving agricultural water management Agriculture uses 85 percent of water consumed in developing countries,

mainly for irrigation. Even though irrigated farming accounts for only about 18 percent of the

cultivated area in the developing world, it produces about 40 percent of the value of agricultural output.

Moving toward integrated water management in irrigated agriculture Improving productivity of irrigation water -institutions Institutional reform of large-scale irrigation schemes is a challenge

everywhere, but subsidies for canal irrigation, power, and fertilizer in India, abetted by state procurement of output at guaranteed prices, led farmers to overproduce rice, wheat, and other low-value crops, using water-intensive cultivation and making excessive withdrawals of groundwater

Using water markets when water rights are secure Seizing windows of opportunity and making reforms happen Reforming irrigation systems and water allocations is inherently a political

process.

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Make intensive production environmentally friendly

Strong shift to high-input farming is behind agriculture’s intensification in transforming and urbanized countries.

Example, green revolution, high-input farming typically involves monocropping + package “new varieties, fertilizers, water, mechanization”.

Despite its success in increasing food production and avoiding the conversion of vast amounts of additional land to agriculture, high-input farming has produced serious environmental problems.

Alarming is mounting evidence that productivity of many of these intensive systems cannot be sustained using current management approaches.

Strong evidence that soil degradation and pest and weed buildup are slowing productivity growth.

The environmental cost of pollution can be reduced by better management of these inputs without sacrificing yields.

Integrated pest management, increase yields, reduce environmental damage Knowledge based management changes are win-win for farmers (e.g., pest-

resistant varieties, better timing and application of fertilizer and water, precision use, etc.)

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Managing intensive livestock systems Strong growth in demand for meat, milk, and eggs. Graduation effect, rising per capita incomes and urbanization .. Push for intensive livestock systems , large scale production units This intensification has been assisted by technological change, particularly

in animal breeding, nutrition, and health. The results—more productive animals; larger production units that capture

economies of scale; greater integration within the market chain, improving quality and lowering the costs of marketing and transport.

Environmental problems are linked to the move from dispersed production in rural areas to specialized livestock units in urban and peri-urban areas

Major environmental threats are: pollution of water and soil with nitrogen, phosphorous, and highly toxic heavy metals , risks of spreading animal diseases, also a threat to humans, especially where dense populations of animals and humans are close contact.

Policy measures include administrative directives, market-based instruments –incentives, cap-trade systems, etc

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Strategies for less-favored areas

Public policy interventions to reduce poverty and preserve the environment are warranted in many less-favored regions.

Many such interventions are neglected because of returns on public investments are better in high-potential areas

This was true during the early phases of green revolution in Asia and it is true in Africa today.

Public investments in roads, education, irrigation, and some types of R&D can produce competitive rates of return and positive outcomes for poverty and the environment in less-favored areas.

The form of policy interventions should depend on the type of less-favored region targeted and on the national economic context

Options include encouraging more out-migration, promoting income diversification into nonfarm activities, increasing recurrent expenditure on safety nets, and introducing payments for environmental services.

Nonagricultural options more viable in transforming and urbanized countries

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Payment for environmental services – positive externalities

Agricultural landscapes in both less favored and high-potential areas produce a wide range of valuable environmental services, such as sequestering carbon, harboring biodiversity, regulating water flows, and providing clean water downstream.

Farmers receive no compensation for providing these services (public goods) and so they tend to be under produced.

Many approaches to increasing environmental services are based on demonstrating to farmers the “right thing to do”—forgetting that it’s the “right thing” for others and not necessarily for the farmers.

Other approaches have attempted to regulate what farmers can and cannot do. Neither approach has worked well nor been sustained over time.

Occasionally, win-win technologies can generate both high returns for farmers and high levels of environmental services, but these are few and far between, and may not remain win-win over time as prices change.

Need to introduce incentives for producing these public goods The emerging approach of payment for environmental services (PES) aims

to address this problem.

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Governance issues and endogenous institutional change

Environmental problems induce institutional innovation The problems become the engines of institutional change Market incentives are used to encourage individuals to

produce public goods Environmental taxes also are market based instruments that

bring the desired result Communal institutions are designed to address the market

failure of Common Property Resources Privatization can provide property rights for better resource

use