Transaction Costs, Collective Action and Adaptation in Managing Social-Ecological Systems

1. Transaction Costs, Collective Action and Adaptation in Managing Social-Ecological Systems Graham Marshall Institute for Rural Futures, School of Behavioural, Cognitive and Social Sciences, UNE 57th Annual AARES Conference, Sydney, 7 February 2013

2. Adaptation and neoclassical economics • Neoclassical economic focus is on adaptation through market transactions; i.e. private good transactions • Markets assumed to operate mechanistically ... only negative-feedback (diminishing-return) dynamics accounted for ... any disturbance leads to a single equilibrium adaptation ... and this adaptation can be evaluated through comparative statics and stochastic decision analysis

3. Adaptation in complex systems • World becoming more complex and uncertain ... increasing importance of collective action – collective goods provision – for adaptation (Adger 2003) ... ‘environmental’ problems increasingly concerned with social-ecological systems (SES) ... which are types of complex adaptive systems (CAS) rather than mechanistic systems • CAS: ... behaviour ‘emerges’ as parts adapt to each other and evolving state of system ... driven significantly by positive-feedback dynamics ... path dependencies and lock-in ... multiple or non equilibria ... unforeseen events (surprises) are ubiquitous, not exceptions ... Knightian uncertainty and bounded rationality ... stochastic decision analysis is ‘naive’ and may mis-identify optimal adaptation choices

4. Path dependencies • Path dependencies (PD) mean that ... past institutional choices increase costs of present policy reform ... present institutional choices increase costs of future policy reforms • PD are surprising, highly sensitive to random events ... even though some of the general dynamics might be anticipated (e.g. vested interests, crowding out, sunk costs, mental models) • Added costs from PD (lock-in costs) depend on the particular surprises that emerge to necessitate policy reform ... can’t be accounted for deductively/ stochastically; only via induction, bounded rationality and heuristics

5. Governance, institutions and their costs • Governance is crucial for large-group collective action ... involves the formation and stewardship of institutions (formal and informal rules) ... increasing uncertainties have led to a greater focus on ‘adaptive governance’ • Transaction costs are the costs of resources used to: define, establish, maintain, use and change institutions and organisations; and define the problems that these institutions are intended to solve • Institutional choices typically also affect technological choices, so the transformation (including abatement) cost impacts of institutional choices also need to be accounted for

6. Evaluating institutional cost-effectiveness • Benefit-cost analysis is ideal, but cost-effectiveness analysis (CEA) is typically more feasible for institutional choices • Institutional CEA (ICEA) involves comparing the total (transformation + transaction) cost impacts of institutional options ... both costs added and costs avoided ... relative to a common do-nothing scenario • Marshall (2005) built on Challen (2000) to propose an ICEA framework (ICEAF) distinguishing six types of costs ... where institutional and technological transition costs result mainly from the path dependencies arising from prior institutional choices

8. MDB environmental water recovery: illustrating the ICEAF • Two main institutional options implemented ... voluntary water buy-back programs ... subsidy programs for water-saving infrastructure upgrades • Economic evaluations to date have applied CEA ... accounted only for expenditures on buy-backs and infrastructure subsidies; i.e. for technological transition costs ... buy-backs found to be far more cost-effective • Productivity Commission (2010) ‘recognises that [infrastructure subsidies] can be seen as the price the Australian Government was prepared to pay to make progress... [They were] needed to convince the states to a truly Basin-wide approach to water planning and to elicit the irrigation sector’s support for increasing environmental water allocations’. • This ‘price’ refers to institutional and technological transition costs ... why weren’t they accounted for?

11. Challenges in applying the ICEAF empirically • Static transformation costs and technological transition costs reasonably easy to estimate • Static transaction costs and institutional transition costs are harder to estimate, and often neglected • Institutional and technological lock-in costs are sensitive to surprises, so cannot be accounted for stochastically • Ignoring lock-in costs constitutes naive CEA when the choice problem involves a CAS ... such naive analysis risks mis-identifying the most cost-effective institutional option ... this risk is greater the more that society values capacities for adaptation / transformation

12. A boundedly rational procedure for comprehensive empirical application of the ICEAF • Quiggin(2007, 2008) observed that decision makers can use heuristics to anticipate whether an option will lead to a domain of favourable or unfavourable surprises • The two-stage boundedly rational procedure he proposed for decision analysis of surprise-prone choices was adapted for application to the ICEAF • Apply ICEAF to options on a naive basis (i.e. ignoring lock-in costs) • Select as the preferred option the naively highest-ranked one that is not expected to lead to a domain of unfavourable surprises for either institutional or technological lock-in costs. If no such option exists, invoke the precautionary principle and retain the institutional status quo. • A domain of unfavourable surprises is one where lock-in costs are higher than under the institutional status quo • Marshall (2005, 2013) proposed a research strategy for improving the heuristics used to anticipate surprise domains

14. Concluding remarks • Transaction costs of institutional change are significant • CEA of institutional choices should account for transaction costs as well as transformation (abatement) costs • CEA studies that account only for transformation costs should be qualified accordingly • Lock-in cost impacts should at least be assessed qualitatively ...and preferably through the proposed boundedly rational procedure • ‘Ignoring important costs, which are obvious to the agencies involved, [makes] the economics profession … less credible’ (McCann et al. 2005 p. 528).

15. Paper to be soon published online in Ecological Economics special issue ‘Transaction costs and environmental policy’ http://www.sciencedirect.com/science/journal/aip/09218009

16. Transaction Costs, Collective Action and Adaptation in Managing Social-Ecological Systems Graham Marshall Institute for Rural Futures, School of Behavioural, Cognitive and Social Sciences, UNE 57th Annual AARES Conference, Sydney, 7 February 2013