Economics of Adaptation in Agriculture

Benefit-Cost Analysis for Climate Change Adaptation Policies in Agriculture

Giacomo BrancaAgriculture Economist - Tuscia University, Italy

What can you expect from this webinar? • Understand the logic of Benefit-Cost Analysis (CBA)• Reflect on the role of CBA in the NAP process• Learn the steps involved in carrying out a CBA of adaptation options

Outline

1.CBA: what is it?

2.The role of CBA in the NAP process

3.The basic steps of CBA

4.An example: CBA of an agriculture adaptation project in Malawi

1. CBA: what is it? (1/3)

• It is a policy/project assessment method • The terms policy and project are used interchangeably here• CBA applies to policies, programs, projects, regulations,

investments• Ex-ante methodology to identify efficient solutions in

allocating society’s scare resources• Efficiency: minimize costs or maximize benefits. Best use of

available resources

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• Individuals consider only their own costs and benefits• On the contrary, CBA considers all costs and benefits to society

as a whole: social costs (C) and social benefits (B)

1. CBA: what is it? (2/3)

1. CBA: what is it? (3/3)

• It monetizes the impact of policy/project to society • Aggregate value of a policy/project is: NB=B-C (net

benefits)• It measures whether the benefits of a

policy/project are bigger than the costs (NB >0)

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• Country governments engaging in NAP process

• Complex task – many elements

• Decision making tools are needed

CBA one such tool: rank and prioritize adaptation options in light of their costs and contribution to sustainable socioeconomic development

Provides complementary inputs for NAP process:• International agencies/financiers

require CBA be carried out at project design

• Useful to unlock funding for Climate Change adaptation projects (e.g. Green Climate Fund - GCF)

3. The basic steps of CBA (1/7)

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Table 1 The major steps of CBA 1 Specify the set of alternative projects 2 Decide whose benefits and costs count 3 Identify impact categories and select measurement indicators 4 Predict the impact quantitatively over project life 5 Monetize all impacts 6 Discount benefits and costs to obtain present values 7 Compute the net present value of each alternative 8 Perform sensitivity analysis

3. The basic steps of CBA (2/7)

Step 1 –Specify the set of alternative projects/policy options–Compare ‘With Project’ (WP) and ‘Without Project’ (WoP) scenarios–WoP is the counterfactual (or the baseline)–CBA compares the Net Benefits of investing resources in one particular potential project with the baseline

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3. The basic steps of CBA (3/7)

Step 2 •analyst decides whose benefits and costs should be included, i.e. define the boundaries of the analysis

– issues analysed from a global perspective: global climate change – issues analysed from a more local perspective: e.g. national

policies– local/national governments want to consider only costs and

benefits to local/national residents

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3. The basic steps of CBA (4/7)

Step 3 •Identify physical inputs/outputs of the projects: costs&benefits•Identify cause-and-effect relationship between physical outcome of the project and the utility of human beings of individuals within the boundary of analysis

Step 4 •Quantify all impacts in each time period

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3. The basic steps of CBA (5/7)

Step 5 •Monetize each of the impacts. •Where markets exist and work well, value can be determined from the appropriate market demand curve. Problems arise where markets do not exist (e.g. environmental goods) or do not work well (e.g. developing countries). •When market prices are no longer a good guide to social costs and benefits, specific methods can be used to measure such ‘non market’ values .

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3. The basic steps of CBA (6/7)

Step 6 •Future benefits and costs are discounted relative to present benefits and costs in order to obtain their Present Values (PV). •This is necessary since it is not possible to compare values which occur at different points in time. •A cost or benefit that occurs in year t is converted to its present value •The PV of the benefits and the costs will be respectively:

– PV(B) = ∑[Bt/(1+s)t]

– PV(C) = ∑[Ct/(1+s)t]

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3. The basic steps of CBA (7/7)Step 7 •Compute Net Present Value (NPV) of each alternative: NPV = PV(B) – PV(C).

– Decision rule : NPV > 0– Compare mutually exclusive alternatives: select option with the largest NPV

•An alternative indicator is the B/C ratio, i.e. the ratio of present value benefits to present value costs.

– B/C > 1 option viable in economic terms

• Analysts also compute the Internal Rate of Return (IRR) of proposed investments• IRR is a discounted measure of project worth• Selection criterion: accept a project with IRR greater than the average cost of

capital in the country

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4. A full example: ‘Enhancing the Resilience of Agro-ecological Systems’ Project in Malawi (1/3)

• Goal: enhance the provision of ecosystem services to improve food and nutrition security of rural communities in targeted catchment areas. – Funds activities aimed at improving the productivity and resilience of

agricultural systems of vulnerable rural poor

CBA is based on Household (HH) Models simulating the adoption of:– conventional farming under the WoP scenario (BAU)– improved agriculture practices and catchment management under the WP one– The analysis focuses on the catchment areas related to irrigated fields

benefiting a population of 16,600 HHs

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4. An example: ‘Enhancing the Resilience of Agro-ecological Systems’ Project in Malawi (2/3)

• Costs: estimated on the basis of planned Project activities• Economic benefits: increased net incomes of the HHs involved in Project

activities (yields increase & labour use reduction)

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Wop/WPReturn to family labour

NPV @ 25%

B/C ratio

Annual net income before family labor

Annual net income after family labor

USD/day USD USD USD

Maize_rainfed_conventional WoP 1.9 362 1.5 139 150 Groundnut_rainfed_conventional WoP 0.8 138 1.2 80 35 Maize_MSD_planting basins WP 5.2 759 1.8 256 192 Maize_MSD_ripping WP 4.0 791 1.9 249 200 Maize_MSD (ripping) & Agroforestry WP 3.7 719 1.8 231 182 Maize_MSD (ripping) & SWC WP 3.5 593 1.6 216 150

Project activities Model name

Baseline

Improved agriculture practices and catchment management

4. An example: ‘Enhancing the Resilience of Agro-ecological Systems’ Project in Malawi (3/3)

• IRR = 27.5% (> 25% = cost of capital in Malawi); NPV = USD 7 million (20-year)

• Also generate environmental benefits (carbon sequestration) @ price = 3 $/ton, with a consequent increase in the IRR (33%) and NPV (9 million)

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Useful material for further reading (1/1)

• Boardman A., Greenberg D., Vining A., Weimer D. 2014. Cost-Benefit Analysis. 4th Edition. The Pearson Series in Economics.

• Gittinger J.P. 1995. Economic Analysis of Agricultural Projects. 2nd edition. The Johns Hopkins University Press, Baltimore and London

• Zerbe R.O., Dively D.D. 1994. Benefit-Cost Analysis in Theory and Practice. Harper Collins College Publishers.

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Thank you!