Chapter 12 Market Failures and Biotic Resources

1. Chapter 12Market Failures andBiotic Resources Geog 3890: ecological economics

2. Outline of Topics • Stock Flow vs. Fund Service Biotic Resources • Sustainable yield and Maximum sustainable yield • Absorptive capacity • Per unit effort curve • Stable and Unstable Equilibrium • Maximizing Annual Profit vs. Maximizing Net Present Value • Exploitation of Wild vs. Bred (‘farmed’) popuations • Natural Dividend Question: Do biotic resources meet the criteria necessary for efficient market allocation?

3. Renewable Resource Stocks & Flows Renewable Resource stocks and flows are rival and potentially excludable depending on whether or not institutions exist that can regulate access to them. Renewable Resource Stocks and Flows are nonrival between generations as long as they are depleted at rates less than regeneration rates. Economic incentives can nonetheless lead us to deplete reenwable resources at rates greater than regeneration rates. There are many externalities associated with the depletion of renewable resource stocks and flows that are difficult to quantify, characterize, and place a dollar value on.

4. Sustainable Yield CurveNote: ‘K’ on x axis is carrying capacity where growth [y axis] is zeroMSY is Maximum Sustainable Yield. ‘S’ is a stable equilibrium point‘U’ is an unstable equilibrium point. At Q” QQ” is harvest, Q”Q’ is growth, net result is reduction of total Stock to R”. The different Y = qXE lines representdifferent levels of ‘Effort’ to catch fish. Note that there are unsustainable levels of effort e.g. E”

5. Maximizing Annual Profits from Renewable Biotic Resources Y axis is now total revenue (Price of Fish * lbs of Fish or Pf*N); N starts at 0 on the Right at ‘K’, and increases as you go left (thus N3 > N2 > N1). TC is total cost of ‘effort’ which is cost of effort times price of effort. In this graph TC increases linearly with size of catch (N). Profit (∏) is given by: ∏ = TR – TC. Profit is maximized at point N1. This occurs at the point where Marginal Revenue (MR – slope of TR curve) is equal to Marginal Cost (MC – slope of TC curve) – this our old ‘When to stop’ rule in action. Note that this is not at the MSY.

6. Some Comments on Maximizing Annual Profits (Previous Slide) • Even if harvest cost was ZERO the a profit maximizing owner of this renewable resource would not harvest beyond the sustainable yield. • This analysis only optimized ‘flow yield’. It did not optimize ‘Net Present Value’. If fish could be harvested and sold; and the profits put in a bank and those monies accrue interest at a rate greater than the growth rate of the fish it would be more profitable to harvest to extinction. • Question: Can you find the tacit assumption responsible for the happy result that profit-maximizing exploitation does not require much stock depletion?

7. Profit (Flow) Maximization in Wild vs Bred Populations • Maximum profits for fish catchers occurs at a stock that is greater than the stock that could produce maximum sustainable yield. • Maximum profits for fish farmers occurs at a stock that is lower than the stock that would produce maximum sustainable yield. • This has to do with their costs. Fish farmers pay to feed the stock (less $ when stock is small). Fish catchers pay to catch the fish (less $ when stock is large and fish are easier to catch)

8. Profit-Maximizing Harvest when Profits can be Invested: Net Present Value • Smart capitalists act to maximize Net Present Value or NPV. NPV is the value to us today of all cost and benefit streams from now into the future. • Economists calculate NPV by using a ‘discount rate’ to give less weight to costs and benefits the farther in the future they occur. • If you owned the rights to all of the world’s bluefin tuna and that stock grew at a lower annual growth rate than a savings account – SORRY CHARLIE* • (obscure Star-Kist reference Re “Sorry Charlie”  • http://www.youtube.com/watch?v=_El2_enNFaI ) • This only gets worse in an Open Access Regime $150,000 for a Bluefin Tuna?!

9. Global Fish Harvest Data

10. Goodbye Old Growth Forest • What are the implications of this scenario in an extreme but not at all unrealistic case where harvest costs (PEE) are negligible compared to harvest revenue (PYY), even for very low resource stocks? Timber is a good example. Say that a forest of redwoods not yet biologically mature increases in size and thus value by 3.5% per year. In contrast, the average real growth rate of money on the U.S. Stock market over the last 70 years was about 7%. Clearly, it makes economic sense to harvest the resource now and invest the profits in the bank. In fact, for any species that is relatively inexpensive to harvest and grows more slowly than alternative investments, it makes economic sense to harvest the species to extinction. In general, averaged over the time it takes to reach harvest size, many valuable species grow quite slowly relative to alternative investments, and technology tends to reduce unit harvest costs over time. And for such resources it is, once again, ‘goodbye golden eggs, hello bank’.

11. Renewable Resource Funds and Services • So far, we have only treated the idea of optimal harvests of renewable resources by treating them as stocks and flows of raw materials. • Many biotic renewable resources are also funds that proved ecosystem services. We cannot ignore the ecosystem service funds while we are allocating raw material flows. • The raw material flows (timber, fish, etc.) have some characteristics of market goods; however, the services generated by ecosystems typically do not. • Ecosystem services are generally nonexcludable and for many no feasible institutions or technologies could make them excludable. • Consequently, Free Markets will not produce these services. • They are also nonrival and noncongestible therefore selling them in the market would not equate marginal costs with marginal benefits. • A common approach is to treat the destruction of ecosystem services as a negative externality.

12. Optimal Harvest of renewable resources when accounting for ecosystem services • TPC (below) is ‘total private cost’; TSC is ‘total social cost’ which is TPC plus costs imposed on society via lost ecosystem services. TSC should go to infinity as harvest approaches critical depensation point CD. Optimal harvest is where MSC (slope of TSC) = MR (slope of TR). • In the graph below optimal social harvest is at N4 whereas the profit maximizing harvest is at N1 (if social costs are not born by harvester).

13. Ecosystem Service Valuation • Optimality requires micro-level internalization into prices of all ecosystem services. • Ignorance of human impacts is huge (we can’t even come close to agreement on relatively well understood phenomena such as global warming) • We are probably ignorant of many of the ecosystem services we are benefiting from (ozone hole story) • The marginal value of an ecosystem service changes with the quantity of the ecosystem service supplied. • The crude calculation in this paper involved a lot of work by economists, ecologists, and geographers: Costanza, R; d’Arge, R; de Groot, R; Farber, S; Grasso, M; Hannon, B; Naeem, S; Limburg, K; Paruelo, J; O’Neill, R; Raskin, R; Sutton, P; van den Belt, M; (1997) The Value of the World’s Ecosystem Services and Natural Capital Nature Vol 387 May 15 • The notion of calculating the constantly changing values of all externalities for all goods would be a Promethean Task. Once achieved, it would still require some institution to incorporate the fees into market prices. • And, attempting to do so would defeat the ‘magic of the marketplace’. • Attempting to internalize external costs is a flawed attempt to patch up the growing and glowing failures of the neoclassical economic paradigm

14. Geoffrey Heal: Valuing the Future • The ‘Green Golden Rule’ • We should seek to maximize well-being from renewable natural resources for the current generation without diminishing the capacity of future generations to benefit from those resources. • EE optimum harvest is at values less than those who would maximize Net Present Value. Varying Ecosystem Service valuations influence where the EE optima is; whereas, varying discount rates influence where the NPV maximizing optima is.

15. The Natural Dividend from Renewable Resources • A single owner of a renewable natural resource such as a forest or fishery can limit harvest to the profit maximizing level (NAPM). The natural dividend can be thought of as the value of the resource in the ground (or sea). To whom should the natural dividend belong? This is a political decision, more in the realm of just or fair distribution than efficient allocation.

16. Waste Absorption Capacity • Waste absorption capacity is the ability of the ecosystem to absorb and process pollution. • The economics of pollution is the predominant focus of neoclassical economics • Waste absorption capacity is a rival good. • “Cap and Trade” policy proposals are an attempt to make waste absorption capacity into a private excludable good. • Let’s not lose sight of the fact that pollution is a public bad. It is nonrival, nonexcludable, and undesirable. • The “Optimal Pollution Level” is not an oxymoron and it is not zero Needless to say, The great Pacific Garbage Gyre suggests the ocean is way past its waste absorption capacity for plastic garbage.

17. Waste Absorption CapacityMarginal External Costs (MEC)Marginal Net Private Benefits (MNPB) There are high levels of uncertainty and ignorance concerning waste absorption Capacity – Therefore the MEC curve below should be a broad fuzzy smear  There are aggregate total population effects on the MNPB curve. Marginal External costs Do go to infinity with the Collapse of the ecosystem Pollution permits will fail to Generate all the wonderful Properties associated with The free market because People are essentially forced To be price takers of a the Public Bad.

18. Biotic and Abiotic Resources:The Whole System • Read the last three paragraphs of the chapter on page 218 and 219. Fun TED talk by Barry Schwartz, author of “The Paradox of Choice” with a Significant criticism of neoclassical economics. Check it out. http://www.youtube.com/watch?v=VO6XEQIsCoM