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The Productivity Commission has valued trees over lost farm incomes

By Ben Rees - posted Monday, 26 January 2004


Most farmers would agree with the findings of the Productivity Commission’s Draft Report on the Impacts of Vegetation and Biodiversity Regulations: that current policy direction and legislation have had negative impacts upon rural production and farm viability. The Commission’s confirmation of the inadequacy of the financial packages on offer will also come as no surprise to landholders.

However, within the Draft Report there are two major shortcomings that will allow the debate “off the hook” and reduce the opportunity for achieving constructive change to the established policy direction and structure. Failure to identify any direct link between farm decision-making and land clearing is a serious structural weakness that places property owners at a distinct disadvantage in the debate over vegetation management. The links are the underlying direction of rural policy and the long-term decline in industry terms of trade, with the consequence that farm management is forced to focus continually on the need to improve efficiency and increase productivity to maintain farm income and long-term viability. Clearing of standing timber becomes a logical management decision on underdeveloped properties as an alternative to farm build-up.

Second, the robustness of the analytical framework of the Draft Report is weakened considerably by limited application of the chosen analytical tool, Coase’s “Problems of Social Cost”; and failure to illustrate the relevant third Coase Theorem under which property rights are delimited by government regulation or legislation. It can be shown theoretically, under delimited property rights that a policy of zero land clearing will prove costly to the Australian community by lowering overall social welfare. The model of delimited rights is particularly relevant to the Queensland situation with its large tracts of remnant vegetation and a current temporary ban on remnant-vegetation clearing to become permanent from 2006.This requires an underlying assumption of fairness and impartiality by government.

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It is also possible to use the Coase analysis to structure a solution that would incorporate trading of property rights. Consequently, the initial inefficient delimitation of property rights can be moved to a more efficient and equitable allocation and increase social welfare of the Australian community to the optimum. This would require a fundamental change in direction of the current debate.

Forces Driving Farm Decision Making

While the Draft Report often refers to environmental policy, the underlying role of agricultural policy is not recognised. Consequently, it is difficult to find anything related to the role of agricultural policy direction and its impact at farm level upon profitability, viability and decision-making.

The direction of policy begun in the 1970s was to allow market forces to drive structural adjustment to create a viable market-orientated rural sector highly competitive internationally through increased efficiency and rising productivity. The Rural Adjustment Scheme and Agriculture Advancing Australia are examples of policy instruments specifically designed to assist the necessary structural adjustment demanded by the underlying policy direction.

It is a brave economist who is prepared to argue that underlying policy direction in any industry has no impact upon decision-making at enterprise level.

The Productivity Commission Draft Report (1999) on the effects of competition policy clearly recognised the role of industry terms of trade upon the farm sector.

Australia’s primary producers are generally "price takers" on world markets. They have little control over prices they receive and, hence, limited capacity to pass on cost increases

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For the record however, between 1960-61 and 2000-01 industry terms of trade fell from an index value of 222.9 to 99.6 (ABARE Australian Commodity Statistics, 2001). This represents an annualised averaged decline of two per cent in industry terms of trade.

A break down of the component parts of the terms of trade demonstrates the significance of terms-of-trade decline as an important factor influencing decision-making at farm level. Over the 40-year period to 2000/01, the prices-received index increased at the annual rate of 3.7 per cent while prices paid rose by 5.8 per cent. This left a gap between input prices and output prices of 2.1 per cent that had to be filled by increased real output. Real output actually did slightly better, rising by 2.7 per cent (calculated from value of GVFP and the Prices Received Index).

Despite this increase in real output, the index of real net value of farm production fell from 199 to 139 representing an annual average rate decline of 0.9 per cent. To increase real output under falling net real income, production had to be financed by credit; and RBA statistics on rural debt show that annualised indebtedness rose on average by 8.8 per cent. The inference from this is that rising cost imposts drive production decisions, which in turn are financed by increasing debt.

Under conditions of declining industry terms of trade, increasing farm efficiency and rising productivity become the keys to long-term survival for farm families. Rural literature is replete with recognition of the role of increased efficiency and rising productivity at both farm and industry level to overcome the historic differential between rates of change in input and output prices in the struggle to maintain farm income.

Given the established policy direction and subsequent industry acceptance of benefits flowing from increasing efficiency and rising productivity, it should come as no surprise that under conditions of long-term real commodity price decline, efficiency and productivity improvement become the focus of farm management decision making.

Improved management techniques, application of technology, reconfiguration of farm resource use, and purchase of additional land are the parameters for increasing efficiency and lifting productivity on fully developed properties. For underdeveloped grazing properties, bringing relatively unproductive timbered land into a more intense production system through improved pasture becomes a realistic alternative to farm buildup. For an underdeveloped agricultural property, clearing virgin timber from idle land is a more logical option than farm build-up. Very often equity reasons dominate the decision for further development of underdeveloped land relative to purchasing additional developed land.

An un-discussed side effect of a prohibition on clearing remnant vegetation will be the impact upon young farmer entry. “Starter blocks” for young farmers are generally underdeveloped properties that lend themselves to improvement through development. The rising income generated by development flows on to increase farm valuation. Over time, the young farmer consolidates financially. At some future point, the young farmer has the choice of continuing with the development program or cashing out and using his improved financial position to buy a fully developed property somewhere else. His start in farming is, however, made possible by tapping the potential of an underdeveloped property.

Failure to acknowledge the underlying forces that drive the decision-making process at farm level is a serious shortcoming of the Draft Report. Because no direct link is established with why farmers need to clear remnant vegetation on underdeveloped properties the position of the farm sector is considerably weakened in the current debate. Political parties with electoral support agendas are thereby given an opportunity to deny the real world at farm-gate level for urban electoral support. Further, failure to establish the link undermines The Draft Report’s valuable contribution to the debate by allowing the criticism that an adequate understanding of how the farm sector actually works in the real world is not demonstrated.

Analytical Framework – the Coase Theorems

In The Problem of Social Cost (pdf, 62Kb) Coase identifies the problem for analysis as:

Should A be allowed to harm B or should B be allowed to harm A?
The problem is to avoid the more serious harm.

What this means is: should the values of the environmental movement be allowed to structure the drive for efficiency, productivity and long-term viability of the rural sector; or should the drive for efficiency, productivity and long-term viability of the rural sector be allowed to erode values of the environmentalist movement?

Which harm will least damage overall social welfare of the Australian community?

The answer is found by determining whether the value of the damage to environmental values will be greater or lesser than the value of lost potential rural production and its flow-on effects right through to impacts on the balance of payments and the value of the $AUD.

Findings in the Draft Report suggest that the former will be more damaging than the latter.

Joseph Felder (2001) presented the Coase analysis in simpler terms as the Coase Theorems 1,2,3:

  1. Allocation of property rights tradable under zero transaction costs;
  2. Allocation of property rights tradable under non-zero transaction costs;
  3. Delimitation of property rights by government through regulation or legislation.

In the first two theorems, trading of property rights is demonstrated to move the economy to a more efficient allocation and use of resources by correcting the original allocation of property rights. Different outcomes emerge under zero transaction costs than under non-zero transaction costs. The difference being determined by how much transaction costs influence choice relative to a non-zero transaction costs situation.

The third Coase theorem, whereby government delimits property rights and no opportunity exists for market correction of the initial allocation, has two underlying assumptions:

  1. Governments can approximate and compare the welfare effects of alternative delimitations of rights at relatively low cost; and
  2. Governments act in a way that approximates fairness and impartiality.

A correctly structured graphical model of the problem will demonstrate theoretically that the optimal outcome between vegetation management and community environmental values is not zero land clearing. The Draft Report’s conclusions and recommendation are consistent with this theoretical analysis. Thus the underlying assumptions of fairness and impartiality are breached in Australian vegetation management legislation. It can be inferred therefore that the proposed current policy direction of zero land clearing in Queensland is more about politics than overall economic welfare of the community.

Delimitation of property rights prohibiting clearing of remnant vegetation will deny the community its right to the optimal solution between vegetation clearing and environmental values. Unless some common sense prevails, the proposed policy direction will be very costly in social welfare terms to the wider community. Delimitation of rights to include some form of property rights trading would solve this problem of excessive social welfare diminution. The question now becomes: how might this be structured?

Possible solutions

A possible solution lies in the second Coase theorem. Government delimits property rights that structure a framework under which environmental groups and rural producers could trade property rights. This would become possible if the proposed compensation package was made available to active environmental groups for the purpose of purchasing rural property rights directly from producers. Market forces would structure suitable and attractive financial contract conditions necessary to entice producers to forego proposed land clearing. In this way a market assessment of the community’s willingness to pay would be identified. Budgetary costs would be clearly identifiable in budget papers. Costs to the community would be measurable in terms of foregone provision of health, education, law enforcement and infrastructure expenditure. Accountability and transparency of the environmental problem would be established and might optimistically reduce the political agenda-driven solutions now on offer.

At the coalface, scientific identification of environmental issues would still be required. Local government would be ideally positioned to zone regional levels of risk according to scientific analysis and local knowledge. The environmental movement, armed with compensation monies, would be in a position to approach landowners in a risk situation with a desire to negotiate a suitable contract. Alternatively, at-risk landowners would be free to approach the environmental movement once their risk levels were known.

It would be sensible to require environmental contracts to comply with WTO Agreement on Agriculture exempt-payments provisions. As public monies would flow to the rural sector, WTO regulations would require this to be accounted for either as an exempt payment or included in Australia’s Aggregate Measure of Support (AMS) for agriculture. An awareness of this would avoid future problems with WTO regulations as AMS are reduced over time.

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Article edited by Betsy Fysh.
If you'd like to be a volunteer editor too, click here.

This is an edited version of Ben Rees's reponse to the Productivity Commission, Submission DR227.



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About the Author

Ben Rees is both a farmer and a research economist. He has been a contributor to QUT research projects such as Rebuilding Rural Australia. Over the years he has been keynote and guest speaker at national and local rural meetings and conferences. Ben also participated in a 2004 Monash Farm Forum.

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