Pannell Discussions

No. 73, 1 May 2006

Public benefits, private benefits, and the choice of policy tool

Public benefits and private benefits are much discussed in environmental policy circles, but I'm not aware of any clear written explanation of their meanings, their significance, and their consequences for policy mechanism choice. Here is my attempt to provide one.  

In PD#22 I wrote about the distinction between public goods and public benefits and discussed some of the confusion that arises about these concepts. In talking with people involved with environmental policy in Australia, I find that there is quite a shallow understanding of public benefits and private benefits, and why the difference matters. When I sat down to try to get things straight in my own mind, I found that there is actually quite a lot to the issue, most of which I've never seen written down. So this is a start at writing it down.

The issue relates to cases where problems of environmental conservation or natural resource management require changes in land management on privately owned lands. Many government programs around the world have been created to attempt to encourage such changes. These programs use a range of mechanisms to encourage change, including education, awareness raising, technology transfer, research and development, regulation, subsidies and other economic instruments. In practice, the choice among these possible policy mechanisms is often not very sophisticated. Programs tend to rely primarily on a small number of mechanisms, sometimes as few as one. Here I show how the choice between policy mechanisms can be greatly helped by an appreciation of the levels of public and private net benefits that are likely to result.

The meanings of these terms are not universally agreed. I am defining them in very specific ways.  ‘Private net benefits’ refer to benefits minus costs accruing to the private land manager as a result of the proposed changes in land management. ‘Public net benefits’ means benefits minus costs accruing to everyone other than the private land manager. Defining them in these ways is helpful because the private net benefit dimension provides insight into the behaviour of the landholder, while the public net benefit dimension relates to the effects on everyone else that flow from the landholder's behaviour. Economists call these latter effects 'externalities' (see PD#35) and argue that their existence can be an important potential justification for governments taking action to try to influence behaviour.

The private net benefits of a project (i.e. a specific set of land-use changes) would depend on:

•  the financial returns from the new land uses;

•  the financial returns from the land uses that are replaced (the "opportunity costs");

•  any change in risks faced as a result of the change;

•  indirect impacts on other aspects of the farm system or on the farmer's lifestyle;

•  the farmer's own interest in the environmental outcomes.

The public net benefits would depend on:

•  the value or importance of the environmental assets that are affected by the changes;

•  the degree of degradation that the assets were facing or had already suffered;

•  the extent to which that degradation can be prevented or alleviated by the changes;

•  any lags in the response of the biological or physical system to the land-use changes.

In the graphs that follow, the net benefits relate to the benefits and the costs of the proposed land-use changes, assuming that those changes do occur. They exclude any costs borne by the environmental manager in the process of intervening to encourage the change in land management. This is to allow us to compare the benefits of an intervention with its costs, which we will do in a later PD.   

Having established the definitions, the starting point for the framework is the recognition that environmental managers can invest in a range of projects involving changes in land management or land use on private land, and that the available options vary widely in the levels of public and private net benefits they generate, potentially including negative net benefits.

Figure 1 illustrates a hypothetical sample of possible projects with various levels of public and private net benefits. The top half of the graph is for projects with positive public net benefits, while the right half is for projects with positive private net benefits. The figure illustrates that any combination of positive or negative public or private net benefits is possible.

 

Figure 1. Each point represents a potential project, involving specific changes in land management in specific locations.

 

Figure 2 shows the sets of potential projects that would generate positive net benefits overall: areas A, B, and C. In area A, public net benefits outweigh private net costs. In C, private net benefits outweigh public net costs. In B, there are positive net benefits for both.  

The six labeled areas in Figure 2 are relevant to the choice of policy mechanism, because a different mix of policy mechanisms can be identified as being most appropriate in each case. The range of policy mechanism categories is shown in Table 1.

 

Figure 2. Areas for which different policy mechanisms may be preferred. The units on each of the axes are dollars, and the line passing diagonally through the figure is at exactly 45 degrees to the axes.

 

Table 1. Table 1. Alternative policy mechanisms for seeking changes in management of private lands.

  Category Specific policy mechanisms included  
  Positive incentives Financial or regulatory instrumentsA to encourage change  
  Negative incentives Financial or regulatory instrumentsA to inhibit change  
  Extension Technology transfer, education, communication, demonstrations, support for community network  
  Technology development Development of improved land management options, such as through strategic R&D, participatory R&D with landholders, provision of infrastructure to support a new management option.  
  No action Informed inaction  

AFinancial or regulatory instruments include polluter-pays mechanisms (command and control, pollution tax, tradable permits, offsets) and beneficiary-pays mechanisms (subsidies, conservation auctions and tenders).

 

The aim is to identify which policy mechanisms are likely to be suitable for each of the six labelled areas in Figure 2. To start with, we use the simple assumption that landholders will adopt all land-management practices with positive private net benefits (projects in areas B, C, D), provided that they are able to learn about those practices. 

To select policy mechanisms, the following set of rules is proposed.

1. Do not use positive incentives for land-use change unless public net benefits of change are positive: no positive incentives for C, D, E.

2. Do not use positive incentives if landholders would adopt land-use changes without those incentives: no positive incentives for B.

3. Do not use positive incentives if private net costs outweigh public net benefits: no positive incentives for F.

Rules 1, 2, and 3 narrow the use of positive incentives down to area A.

4. Do not use extension unless the change being advocated would generate positive private net benefits. In other words, the practice should be sufficiently attractive to landholders for it to be ‘adoptable’ once the extension program ceases.  

5. Do not use extension where a change would generate negative net public benefits.

These rules narrow extension down to area B. This is referring to cases where extension is used as the main tool to achieve land-use change. Extension could also be used to support any of the other policy mechanisms, playing a supporting role, rather than being the main tool.

6. If private net costs outweigh public net benefits (area F), consider technology development to create improved (environmentally beneficial) land management options that can be made adoptable (with or without positive incentives).

7. If private net benefits outweigh public net costs (area C), the land-use changes should be accepted if they occur, implying no action.

8. If public net costs outweigh private net benefits (area D), use negative incentives.

9. If public net benefits and private net benefits are both negative, no action is necessary. Adverse practices are unlikely to be adopted.

10. In all cases, the suggested action needs to be weighed up against a strategy of no action.

These rules lead to Figure 3.

 

Figure 3. Recommended efficient policy mechanisms based on a simple set of rules.

 

This is quite a simple framework, but it's a good start. It significantly narrows down the range of policy tools that environmental managers should be considering depending on public and private net benefits in a particular situation. We can make it more sophisticated in various ways, including by allowing for uncertainty and for adoption lags, which we will look at another time.

As a preliminary look at one aspect of uncertainty, in area C if it is not known whether private net benefits are sufficient to outweigh public net costs, a relatively flexible negative incentive instrument might be used to communicate the public net costs to land managers (e.g. a pollution tax, or a property-rights-based approach such as tradable permits), leaving the ultimate decision about land-use change to the land managers. Inflexible negative incentives, such as command and control, should not be used in this case, as they might result in changes where the costs outweigh the benefits. Flexible policy instruments (if implemented properly) would not actually result in any additional public benefits (if the project was really in area C) as the positive incentive they created for land-use change would not be enough to outweigh the private costs of that change. Depending on the way they were set up, they might result in a redistribution of wealth (e.g. from polluters to pollutees).

Finally, it is worth noting that the rules underlying Figure 3 are based on an objective of efficiency (biggest environmental benefit per dollar spent). In practice, governments often also consider perceived equity or fairness in deciding how to spend their resources.

 David Pannell, The University of Western Australia, David.Pannell@uwa.edu.au

p.s. This version has been edited in response to helpful comments from Peter Sullivan (about the definition of public benefits) and Mike Young (about area C, property rights and equity - see the last two paragraphs). Thanks to both. It has also been revised in response to questions and comments from the audiences of several presentations.


Pannell Discussions are brief pieces on issues and ideas in economics, science, the environment, natural resource management, politics, agriculture and whatever else.

72.  Headaches  17 Apr 2006

74.  Public and private benefits and incentives  8 May 2006

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