dgwilkinson

September 16, 2014

Ecosystem Limits to Sustainable Economic Output and the Use of Tradable Quotas – An Essential Lesson

A mistake often made in carbon markets and elsewhere is to impose predetermined permit/obligation prices, which have indeterminate effects on the environmental objective. The following stylised heuristic highlights the importance of setting quotas on externalities with reference to the environmental objectives that are to be met, and leaving the determination of a clearing price for such permits and/or obligations to the market. Provided property rights to the relevant factors of production are well defined and enforced, by establishing a quota on the production of externalities at or below the capacity of the ecosystem, and by providing tradable permits and/or obligations to produce those externalities, the market will determine a clearing price.

The following figure provides a simple representation of the relationship between economic output and the capacity limits of the ecosystem.

Ecosystem Limits Graph

The Transformational Efficiency Boundary (TEB) represents the most efficient available means of transforming natural capital and ecosystem services into goods and services.

T 0: Transformational Efficiency Boundary at time 0

T 1: Transformational Efficiency Boundary at time 1

An economy can function above the TEB, but not below it.

As an economy grows it moves along the TEB, while technical change shifts the TEB downward.

Technical change can include socio-economic and organizational improvements, as well as technological changes, that increase the efficiency by which natural capital and ecosystem services are used by the economy to produce goods and services.

The market price of permits and/or obligations will cause such technical changes to occur – T 0 shifts toward T 1 – and ensure the maximum level of environmentally sustainable economic output.

Conclusion: Rather than setting a price for permits/obligations that has unknown effects on the environmental issue, set the quota to deliver the environmental objectives and leave the market to find the clearing price for the permits/obligations.

May 18, 2008

Meeting the great 21st century land challenge

PART 1 – THE FOOD AND ENVIRONMENTAL SECURITY CHALLENGE

The Food Security Challenge:

Over the coming decade, there is a serious risk of global demand for food surpassing the ability of producers to supply it. By 2050 the world population is forecast to be approaching 9 billion, or some 2.5 billion more than at present. More importantly, ongoing economic development is improving the incomes of a growing number of the people who spend on average two-thirds of their extra income on food – compared with only 10% in the UK – and whose diets change as they get richer. With increased income, diets not only increase in the volume consumed, but also change from a largely plant-based diet to one that includes more meats and dairy products, which have substantially higher requirements for land and water. At the same time, concerns about energy security and climate change, have brought about policies encouraging the development of bio-fuels that use food crops, placing additional demand on limited food supplies. According to the FAO, some 10% of the recent dramatic increase in food prices can be explained by the increased demand from biofuels, while the IMF and IFPRI suggest the impact may be more like 20% to 30%.

Figure 1: Global Food Security Outlook

21st C Fig1

Figure 1 provides an outlook on global food demand and supply. Assuming incomes grow by only 1 percent per year, it suggests that food demand could be 50% higher within the next 25 years and more than double by the end of the century.

This outlook on global food supply is estimated on the basis of current land and water use and with current yield growth rates. This shows a significant short-fall developing with the next 10 to 15 years. Factoring in the expected negative affects of climate change on yields, the outlook for supply is even more worrying. Climate change will have even more effects on supply than by affecting yields. The temperature and precipitation effects will vary greatly around the planet, with many of the poorest areas worst affected. Increasingly volatile and extreme weather can be expected, while flooding and coastal erosion will affect most of the most productive lands. Heat stress will affect livestock production, while plant and animal diseases will be increasingly prevalent. Even without the problems of climate change, the availability of suitable additional land and water, together with the necessary infrastructure, pose significant and growing constraints on supply.

Doing the same analysis at the EU(27) level provides the outlook given in Figure 2.

Figure 2 – EU (27) Food Security Outlook

21st C fig 2

It is readily apparent that while global food shortages can be expected over the coming years, EU(27) will have significant food surpluses available. The clear lesson from this is that Europe must make a contribution to the global food security challenge commensurate to our ability to do so, and doing that means maintaining and improving the productive capacity of our land-based resources..

The Environmental Security Challenge:

Advances in food production over much of the past century or so has been enormous but with unintended environmental costs in terms of both natural resource depletion and pollution. Evidence for the impacts in the EU on soils, water atmosphere, and biodiversity, for example, is widely available. Far worse damages have occurred elsewhere in the world. These problems have caused a regulatory response by governments at all levels.

In light of the food security challenge, there is a real risk of unnecessary regulation being imposed by governments who fear that, as farmers respond to increasing global food demand, nutrient leaching into water supplies will increase, a range of water stresses will increase, soils will be further degraded, and biodiversity will be reduced. Because the productivity of agriculture is fundamentally dependent on the health of the natural ecosystems, this would lead to lower yields and thus to a downward spiral.

It is essential that we find a way of avoiding such a counterproductive downward spiral for three key reasons: natural ecosystems are reaching limits that must be respected, a healthy natural environment is essential to achieving the improved productivity required to meet the food security challenge, and regulation can impair the ability of businesses to respond to food security concerns. A new, more integrated approach to meeting both the food and environmental challenges, is imperative.

The Great 21st Century Land Challenge:

The Great 21st Century Land Challenge is to deliver both food security and environmental security – to improve the productivity of the land while increasing our stewardship of the environment – at the same time!

PART 2 – ANALYSIS OF THE CHALLENGE

Meeting this challenge will require addressing three key issues: food security, the implications of climate change, and environmental security.

Food Security: The key question concerning food security is the extent to which we can expect supply to respond to growing demand.

On one hand there are reasons to be pessimistic that farmers will respond fully. As prices rise, governments will seek to protect consumers by imposing a range of price controlling measures. This has happened in a large number of countries over the past few months. A result of these price controls is that price signals to farmers are muted and farmers do not respond as they might otherwise do. In Argentina, for example, it has been reported that wheat plantings are down 15% in 2008 as a result of government imposed price controls on cereals and oilseeds. At the same time, high oil and gas prices will make biofuels more commercially attractive, adding to the total demand for grains and oilseeds, while the marginal land that may be brought back into production is likely to be less productive than that already being used, and water supplies and infrastructure may not always be available where needed.

On the other hand, there are reasons to be more optimistic. A supply response will be helped by farm businesses achieving greater economies of scale and by adopting improved management and technology. Increasing global competition as a result of the liberalisation of agricultural trade has encouraged the development of more professional agribusinesses throughout the world. Investors from the UAE in Pakistan, China in Africa and South America, together with agribusiness investors in areas like the Ukraine, will all bring about more efficient and productive use of those valuable land resources in areas where the productivity of the land is currently very low. With improved profitability, farmers will be encouraged to reinvest in their businesses, and foreign direct investment in land can bring additional significant benefits. Over the foreseeable future, however, asymmetries in scale throughout the supply chain are likely to persist, so it will be important that competition policy is designed accordingly.

Finally, an adequate supply response will critically depend on yields. The analysis underlying Figure 1 suggests that, to meet growing global food demand, in the absence of substantial new land and water resources becoming available, yields across the four main arable crops – wheat, maize, rice, and soybeans – must improve each year by an average of over 2%, compared to current annual improvements of just 1.5% (and declining). Over the past decades, R&D into agricultural commodity production issues has been a very low priority for most governments, and the available budgets have declined dramatically as a result. Private sector work has continued but, to foster the significant improvements in yields that are required to deliver food security, government must lead a renewed and substantially better funded R&D campaign – in partnership with others – into improving environmentally sustainable agricultural productivity. At the same time, the public – especially in the EU – must have an open mind about and carefully evaluate of the potential of biotechnology. The extent to which these changes occur will be crucial to an adequate supply response.

Climate Change Mitigation and Adaptation:

Contributions of land managers to climate change mitigation include carbon sequestration, and improved management of greenhouse gas emissions by both arable and livestock producers. These will require significant investment in R&D and skills transfer to reach their full potential.

In addition, land managers can contribute significantly to the reduction of our dependence on fossil fuels, with benefits both for climate change and energy security and prices, by the development of a range of bio-energy technologies, including anaerobic digestion and wood fuels

Land managers must also play a leading role in climate change adaptation. In addition to ensuring flexibility of production, as the climate changes, farmers will also face increased risk of plant and animal disease. Beyond the adapting farming practices to the new environment, land managers will also be crucial to the management of natural resources, especially water. Pressures on both the quantity and quality of water resources are expected to increase with climate change.

A central feature of a future with a changing climate is uncertainty and volatility. For businesses such as farming and forestry that are long-term by their nature, this will pose a particular challenge. Flexibility and adaptability will be crucial to their success.

Environmental Security:

Meeting the environmental security challenge suggests that we will need to use our resources much more efficiently than we have done in the past. In turn, this suggests that production will have to intensify. The production of food and other land-based commodities will benefit from specialisation and scale. The production of landscape and certain other environmental features may benefit from more extensive production. This suggests a role for all sizes and intensities of farming businesses, provided they are profitable on the basis of their main outputs. At this time, unfortunately, most environmental outputs do not attract a sufficient return to make them profitable in their own right. Moreover, government attempts to regulate their provision are widely seen as burdens on the production of marketable goods or services. It is important to define clearly and understand properly the full extent and value of the environmental goods and services demanded by the public, and to identify those for which market solutions might be developed. Remaining demands should be seen as public goods the deliver of which would attract public payments that reflect the opportunity cost of their delivery.

Providing both food and environmental security at the same time will require new techniques and technologies that are yet to be developed. Government leadership in providing funding and coordination will be essential, as will developing a business environment that fosters, facilitates and rewards innovation.

PART 3 – OUTLINES OF A NEW APPROACH

The food and environmental security challenge is the greatest challenge for land managers of the first part of the 21st century. Meeting it means delivering at the same time higher productivity from the land and higher standards of environmental stewardship. While these challenges are global in scope and affect farmers and land managers everywhere, the analysis underlying Figure 2 suggest that Europe may be able to make a contribution to meeting those global challenges. What should a European response look like?

This is an historic challenge that will require a fundamental review of many of the attitudes and practices that have developed over the past decades; we need to reject past grievances and prejudices and agree that the challenge must be met! But how? There are a number of principles, features and themes that can guide this work:

1. New attitudes and priorities must be adopted in government: Farming and land management must become top priorities for government. To enable rural businesses to deliver the range of goods and services that only they can deliver, government must become a supportive partner. This means rejecting the belief in the necessity for central decision making, and embracing the flexibility and quality that only profitable businesses operating in properly functioning markets can deliver. Wherever markets cannot be found to deliver environmental outcomes – where public goods are demanded – public payments must be made that properly reflect the full opportunity cost of delivering those public goods. To do otherwise would be an erosion of private property rights, which might reduce food security and impair the market delivery of environmental goods or services.

2. We need a new Green Revolution: A critical, immediate priority for government is to provide leadership in the rapid development of new science and technology to provide the greater productivity and resource efficiency that are essential to meeting the food and environment security challenge. The budget required for this campaign of research and development, and the synergies possible through international cooperation, suggests that EU coordination and financing should be provided. National governments should also be encouraged to complement that work according to their ability to do so.

3. Profitable businesses are the essential foundation: Only profitable businesses can provide both the good and services from the land, and steward the environment. Enabling such private enterprises, and removing unnecessary obstacles to their development, must be a key objective. To have the flexibility to adapt to changing circumstances, especially given the expected implications of climate change, businesses will need
• A planning system that recognises the need for, and facilitates change. This means a planning regime that is more stable, and procedures that can deliver quicker, less expensive decisions
• A regulatory environment that doesn’t unnecessarily burden businesses – especially smaller businesses. All too often government and other authorities resort quickly to regulation in response to issues that arise. This is to show that they are “doing something”, give them some confidence that change will happen, and is seen as a cheap option, as little public money is usually required.
• Ongoing skills and training will be central aspects of successful businesses. With an increasing pace of change expected in the businesses options and opportunities confronting land managers, life-long skills development should become the norm for land managers.
• With increasing volatility, risk management will be essential to the viability and success of businesses. Certainly financial risk management should be central to land-based businesses, but all potential risks need to be understood and accounted for. Plant and animal disease, for example, can be expected to be increasingly prevalent as the climate changes.

4. Flexible, dynamic markets are of vital importance: All we can say with certainty is that the future will be more volatile and uncertain. We cannot predict when or where shortages or surpluses may occur. To ensure that decisions properly reflect the preferences of society, flexible and dynamic markets must play a leading role. To this end,
• Competition policy should take into account and accommodate the asymmetries in the food supply chain.
• Governments at both the national and European levels must recognise and exploit the essential contribution of international free trade and investment policy to diversifying supply and delivering global food security
• Essential public goods and services, such as supply chain infrastructure must be adequately provided and properly supported by government.
• Rural policies should not impair the ability of land managers to receive price signals clearly from the markets, nor restrict their ability to respond appropriately

5. New markets and new opportunities will arise: Too often the emphasis is placed on the risks of change rather than the opportunities presented. New markets for food, fuels, fibres, and pharmaceuticals will arise and need to be identified and accommodated as quickly as possible, while a more sophisticated view needs to be taken of the issues surrounding biotechnologies.

Markets have not developed for many of the environmental goods and services that are now increasingly in demand by the public. As a result many of these have been under-supplied by land managers, and governments have sought to introduce programmes of counter-measures, including regulation. All too often such programmes are inefficient uses of public funds, inconsistent with the range of other pressures on land-based businesses, and increasingly resisted rather than embraced by land managers.

Currently farmers receive significant sums of public money, for which a growing reporting obligation and interference by government in their land management practices and decisions appear to be the quid pro quo. The reduction, wherever possible, of such interference is important if private enterprise is to respond appropriately and efficiently to issues as they arise.

With the development of environmental markets, solutions to a growing range of environmental problems can be delivered without the need for heavy-handed government involvement or public funds. These include
• water quality,
• flood damage mitigation,
• natural habitat provision and species protection,
• carbon management.

A wide range of positive environmental outcomes can be provided by markets if the right conditions are brought about. There is no reason for the government to be responsible for delivering goods or services that the market can deliver. By the use of markets, the private sector can deliver things previously delivered by the government, thereby reducing the direct participation of the government in land management and providing important new business opportunities for land managers.

To enable markets to deliver these new public demands certain conditions must be brought about.
• Definition and stability of the desired outcomes is critical. It is important that the environmental goods or services demanded are closely defined.
• Property rights to the land resources must be recognised and enforced.
• Effective demand for the environmental outcomes must be introduced. This can be done by establishing caps and/or floors on externalities, as with carbon markets.

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