Wednesday, 21 February 2018

Paying landowners to change land use

Economists recognise that people respond to incentives. If you increase the cost of doing something, on average people will do less of it. On the other hand, if you increase the benefits of doing something, people will do more of it. So, economists are less surprised than 'normal people' about things like this, as reported in the New York Times at the end of last year:
So often, activists and environmental campaigners settle on a 'command and control' model as their preferred policy to ensure positive environmental outcomes ('command and control' policies are policies that say you 'must do' some things, or 'must not do' other things). As the New York Times article makes clear, a market-based approach can be just as effective, if not more effective, in some circumstances. A market-based approach doesn't rely on compelling people to obey, it relies on changing the incentives.

In this case, if you offer landowners a payment for changing their land use for part of the year (e.g. flooding their fields to make wetlands), then landowners can choose whether they want to do so. Landowners who face a low cost of changing their land use (maybe because their land is not highly productive so they won't be giving up much production) will be more likely to do so (because the payment will exceed the costs of land use change). Economists refer to the value of the foregone production for these landowners as an opportunity cost - it is the cost (to those landowners) of choosing to change land use. In contrast, landowners who face a higher cost of changing their land use (maybe their land is more productive, so they would be giving up more production) will be less likely to do so. For these landowners, there is an opportunity cost of not changing their land use - they are giving up the payment they would have received from the environmental group.

How do you work out how much to pay the farmers to get the right number of them to change land use? The article explains:
Note that the reverse auction is a good way for the environmental group to ensure that they can achieve their desired change in land use at the lowest cost, provided the landowners are genuine in specifying their opportunity cost for changing land use as the lowest payment they would accept. The italicised bit in the last sentence is important. You don't want landowners to simply hold out for higher payments. One way to avoid that problem is to ensure that you invite more landowners (with more land) than would be necessary to achieve your desired amount of land use change.

Finally, it is worth noting that this type of market-based system can't make farmers worse off. Since farmers are not compelled to participate, they will only do so if the benefits to them outweigh the costs. Markets aren't a perfect solution for every problem, but sometimes they can solve problems in a surprisingly simple way.

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