Economics and the environment

Ben Balmford is a Business School PhD student whose work looks at mechanism design in the context of the environment; his research focuses on understanding how institutions can be developed to better facilitate efficient use of the natural environment. Ben’s supervisors are Prof Brett Day, Prof Ian Bateman and Dr Amy Binner

The environment is a precious resource

The environment is a precious resource that we all rely upon on a daily basis: from the oxygen you breathe to the enjoyment you experience being outdoors, all are influenced by wild nature. Clearly, society as a whole values nature hugely. The fact this isn’t reflected in the decisions people make is because of perverse incentives. We never pay for the carbon we emit – be that from flying or the food we consume. This concept, that someone’s welfare is changed by a decision they didn’t make, and that the third party doesn’t take account of those welfare changes when making their decision, is referred to as an externalities problem.

This question of mechanism design in the context of the environment is then all about squaring these externalities. How can we ensure that the decisions made, by both individuals and institutions, necessarily reflected the welfare changes they cause for other? My PhD focusses on this question, and looks at the case of water pollution from many different sources.

The focus of my PhD

In the first chapter of my PhD we explore how regulation can be developed which leads to optimal individual polluter abatement when monitoring individuals is costly. We find that a combination of a reward for meeting a group target (or fine for missing it) combined with the option for individuals to choose to purchase individual level monitoring, is enough to ensure all individuals should choose to put in optimal abatement. Better still, in theory, it happens without any individual ever needing to purchase individual monitoring. And we are even able to replicate the theoretical findings in the lab.

My later chapters focus on a related question. If we want to get polluters, in this case farmers, to reduce their pollution, who should we choose and how much do we need to pay them? The answers to these questions are relatively straightforward: we would want to pay everyone that could reduce their pollution at a cost less than the amount that people are willing to pay to do so, and we would want to set the price paid to them in such a way that ensured this outcome was achieved. But in practice achieving this outcome is far harder. How can we determine how much it would cost to do an action? If we simply ask someone to tell us, they could easily just say a very high number so that they would get paid a lot. We could also go round and negotiate with everyone in turn, rejecting prices that we deemed too high. Knowing we might walk away, people would have to say a reasonable price if they wanted to receive the payment. But typically there are lots of farmers we might want to work with, and negotiating in such a way would be enormously time consuming and costly. So is there another way?

EnTrade

Well, yes. Economics has dealt with this problem of setting a price when there is no established market quite a lot before. The solution is auctions. Auctions aren’t just used for buying things (eg EBay) but also selling products. The famous tuna auctions in Japan allow fishers to sell their produce to buyers; in the Netherlands, farmers sell tulips and other flowers to buyers through auctions. What if we could design an auction in which farmers could sell land management practices to funders that would like to buy reduced pollution?

Well, such auctions actually already exist. EnTrade runs one for farmers in the Poole Harbour Catchment that pays farmers to plant cover crops in order to reduce run-off. And a couple of years back EnTrade approached us for some advice: they were paying farmers the amount they asked for in their bids, but EnTrade was finding that many farmers found this unfair and time consuming for farmers. Different people would be paid different amounts for the same actions. Lots of farmers were also only bidding at the last minute displacing those that had bid earlier on, in a practice known as sniping. Working with them, we introduced a pricing rule which pays the first rejected bid to all farmers. Imagine we wanted to buy 10 units, we’d buy the 10 units with the lowest bids, but pay each the amount specified in the 11^th lowest bid. What we saw after changing the rule was that farmers now bid lower – they no longer need to include profit as they’ll get paid more than they bid anyway – and so EnTrade was able to pay for more areas to go under cover crops, and a greater improvement to water quality. They also found farmers to report the scheme to be fairer, and sniping was much reduced.

Looking to the future

Looking to the future, we currently working on better understanding these patterns by developing games which we can then play out with participants in the lab in highly controlled environments.

Like all PhDs, mine hasn’t been without challenges. But in doing my research I get to explore what I think are some really interesting questions and develop new theory about what decisions people make. Plus, I get the added bonus of seeing real world impact by engaging with stakeholders.