Natural vs. financial insurance in the management of public-good ecosystems

In the face of uncertainty, ecosystems can provide natural insurance to risk averse users of ecosystem services. We employ a conceptual ecological-economic model in which ecosystem management has a private insurance value and, through ecosystem processes at higher hierarchical levels, generates a positive externality on other ecosystem users. We analyze the allocation of (endogenous) risk and ecosystem quality by risk averse ecosystem managers who have access to financial insurance, and study the implications for individually and socially optimal ecosystem management, and policy design. We show that while an improved access to financial insurance leads to lower ecosystem quality, the effect on the extent of the public-good problem and on welfare is determined by ecosystem properties. We derive conditions on ecosystem functioning under which, if financial insurance becomes more accessible, (i) the extent of optimal regulation increases or decreases; and (ii) welfare, in the absence of environmental regulation, increases or decreases.     

An ecological golden rule

Most renewable biotic resources are subject to random variability in natural growth. We investigate the implications of such variability for long-term management by a risk averse social planner, who maximizes expected long-run utility. In the canonical model of a stochastic fishery, we show that the optimal level of harvesting effort need not necessarily be reduced by variability in stock growth. However, optimal effort is reduced if variability of growth increases for smaller base populations, as suggested in the ecology literature.     

Sustainable management of extensively managed savanna rangelands

Classic rangeland theory advocates stocking rangelands at relatively low and constant levels. This theory has been labelled inappropriate for savanna rangelands, because savannas are strongly influenced by stochastic processes. Opportunistic strategies that force animal numbers to track available forage have been proposed as an alternative management paradigm. However, no studies have examined whether these opportunistic strategies are sustainable or optimal. We developed a simulation model of a savanna rangeland to identify optimal, sustainable strategies for the management of extensive rangelands. We optimised the utility of agents who are motivated by economic, production or ecological factors under both deterministic and stochastic conditions. In all cases we found that it was optimal to manage the system conservatively and not opportunistically. Moreover, it was optimal to manage more conservatively under stochastic conditions. Key elements of the conservative strategy were to stock at low levels and to use fire to control tree abundance and thereby maintain the system in a grass dominated state. We conclude that opportunistic strategies of range management although intuitively appealing are not optimal.     

The Economics of Clear Advice and Extreme Options

I study a principal–agent model in which the agent collects information and then chooses a verifiable action. I show that the principal can find it desirable to constrain the agent's action set even though there is no disagreement about the ranking of actions ex post . The elimination or penalization of „intermediate” actions, which are optimal when information is poor, improves incentives for information collection. I characterize optimal action sets when the agent is infinitely risk averse with respect to income shocks and optimal incentive schemes when the agent is risk neutral.     

The Impact of Regret on Exports

We examine optimal production and export decisions of a firm facing exchange rate uncertainty, where the firm's management is not only risk averse but also regret averse, i.e., is characterized by a utility function that includes disutility from having chosen ex post suboptimal alternatives. Experimental and empirical results support the view that managers tend to be regret averse. Under regret aversion a negative risk premium need not preclude the firm from exporting which would be the case if the firm were only risk averse. Exporting creates an implicit hedge against the possibility of regret when the realized spot exchange rate turns out to be high. The regret‐averse firm as such has a greater ex ante incentive to export than the purely risk averse firm. Finally, we use a two‐state example to illustrate that the firm optimally exports more (less) to the foreign country than in the case of pure risk aversion if the low (high) spot exchange rate is more likely to prevail. Regret aversion as such plays a crucial role in determining the firm's optimal allocation between domestic sales and foreign exports.     

ECONOMIC MODELLING OF SUICIDE UNDER INCOME UNCERTAINTY: FOR BETTER UNDERSTANDING OF MIDDLE‐AGED SUICIDE*

This paper formalises an individual's decision about suicide within a framework of lifetime utility maximisation models. This is in line with the literature on economic modelling of suicide. The novelty of the paper is to take into account income uncertainty. Income uncertainty reduces a risk‐averse individual's expected utility, making them more likely to commit suicide. On the other hand, income uncertainty creates a value to postponing suicide even when their income gets sufficiently low. This is because income uncertainty means that if things go well, they will get higher income in the future. Thus, income uncertainty has two opposite effects on suicidal behaviour. The main objective of this paper is to construct an economic model of suicide for investigating net impacts of income uncertainty on suicidal behaviour. For this purpose, it is assumed that the wage evolves according to a stochastic process. Then, the threshold wage, below which an individual commits suicide, is derived as a function of the parameters of the stochastic process assumed for the wage evolution. Impacts of changes in these parameters on the threshold wage are calculated. With the result, the paper shows how income uncertainty affects suicidal behaviour.     

Aspects of ecosystem persistence and the optimal conservation of species

Although ecologists have long recognized the salience of persistence in determining the static and the dynamic behavior of ecological systems, it is only very recently that economists have begun to study this concept in relation to the use of services that are provided by jointly determined ecological-economic systems (ecosystems). As such, there are very few studies of ecosystems that explicitly analyze the ecological and the economic aspects of this use issue. Given this state of affairs, this article has two objectives. First, a new method is used to formally describe and bound the notion of ecosystem persistence. This method explicitly incorporates the stochastic aspects of ecosystems. Second, the bound on persistence is used to study the problem of optimal species conservation.     

The demand of energy from an optimal portfolio choice perspective

This paper analyses the demand for energy sector by employing a model form strategic asset allocation literature and quantifying the welfare losses incurred by an investor due to sub-optimal asset allocation. Our sample group includes fifteen major oil producing and consuming countries. We analyze the short-run and long-run desirability of energy sector in the optimal portfolio of an investor with varying level of risk aversion; that is, risk averse and risk tolerant investors. Our results show that the portfolio demand for energy sector is myopic or short-run. For long-run investors, investing in a portfolio of equity market and government bonds is a better proposition. In addition, energy sector is more desirable for risk tolerant investors.     

Swidden Agriculture in Developing Countries

Small farmers in many tropical developing countries practice swidden agriculture. A key aspect of swidden agriculture is the time period during which the land is left fallow. This paper uses a new ecological–economic approach to study the fallow period and to determine the optimal length of this period in swidden agriculture. The authors first construct a theoretical model of a parcel of forest land that has been cleared for swidden agriculture. It is then shown how the dynamic and the stochastic properties of this cleared land can be used to derive two objective functions for a small farmer that are ecologically meaningful. Finally, using these two objectives, a probabilistic approach to the determination of the optimal length of the fallow period is discussed. In this approach, the focus of the small farmer is on maintaining the ecological and the economic sustainability of swidden agriculture on the cleared parcel of forest land (CPFL).     

Modelling economy-ecology linkages in mangroves: Economic evidence for promoting conservation in Bintuni Bay, Indonesia

Woodchip exports pose a potential threat to a 300 000-ha mangrove ecosystem in the Bintuni Bay area of Irian Jaya, Indonesia. The bay supports an important shrimp export industry, and coastal areas support 3000 households. Traditional non-commercial uses of mangroves have an estimated value of Rp20 billion/yr (US$10 million/yr); commercial fisheries are valued at Rp70 billion/yr (US$35 million/yr) and selective commercial mangrove cutting schemes have a maximum value of Rp40 billion/yr (US$20 million/yr).Forest management options, ranging from clear cutting to a cutting ban, are evaluated in a cost–benefit analysis incorporating linkages among mangrove conversion, offshore fishery productivity, traditional uses, and benefits of erosion control and biodiversity maintenance functions. “Linkage scenarios” are developed that reflect potential ecosystem component interactions in Bintuni Bay. Clear cutting is optimal only if linkages are ignored. A cutting ban is optimal if linear and immediate linkages between ecosystem components exist. Under a scenario with linear but delayed linkages of 5 years, selective cutting of 25% of the harvestable mangrove is the optimal strategy; it has a present value of Rp70 billion (US$35 million) greater than the clear cutting option, and more extensive cutting would yield no additional net benefits.Strong economic arguments exist for conservative mangrove clearing. Where strong ecological linkages occur, severe restrictions on clearing activities will be economically optimal. Where ecosystem dynamics are uncertain, programs reducing linkage effects – such as greenbelts, replanting, or selective cutting – will minimise potential economic losses.     

Background risk and the demand for state-contingent claims

Summary. We consider the demand for state-contingent claims, in the presence of an independent zero-mean, non-hedgeable background risk. An agent is defined to be generalized risk averse if he/she chooses a demand function for contingent claims with a smaller slope everywhere, given a simple increase in background risk. We show that the conditions for standard risk aversion, that is positive, declining absolute risk aversion and prudence, are necessary and sufficient for generalized risk aversion.Received: 13 February 2002, Revised: 10 February 2003, JEL Classification Numbers: D52, D81, G11. Correspondence to: Guenter FrankeWe are grateful to Louis Eeckhoudt, Christian Gollier, Harris Schlesinger and an unknown referee for valuable comments.     

Uncertainty and Amenity Values in Renewable Resource Economics

In this paper, we study the effects of amenities and uncertainty on the optimal exploitation of a renewable resource. First, if society displays a protection motive (in the presence of amenities), its optimal harvesting strategy will be more conservative. Second, we show that ecological uncertainty leads society to develop the opposite behavior, thus reducing its exposition towards risk. A stationary analysis is undertaken to analytically quantify and compare these two effects. With a Gompertz natural regeneration function and a proportional risk, the amenity effect is proved to prevail if and only if stochastic fluctuations on the resource stock are not too large.     

Economic/ecological tradeoffs among ecosystem services and biodiversity conservation

An integrated economic/ecological model is built to address tradeoffs between biodiversity conservation and two marketable rangeland ecosystem services: cattle grazing and elk hunting. The ecology is represented by an eleven species food web in which individual optimizing plants and animals engage in competitive and predator/prey relationships. The ecological model defines a steady-state set of sustainable grazing and hunting options, and for each option, biodiversity is measured using an index defined over the eleven species. In linking the ecology to the economics, social welfare depends on grazing profits and hunter net benefits. The problem can be stated as maximizing economic welfare over two ecosystem services, subject to their sustainable use and subject to a target level of biodiversity. A numerical application with economic and biological data from the Western United States is used to determine sustainable grazing and hunting options for alternative biodiversity levels, and to select the option that maximizes welfare.     

A Case Against Zero Capital-Income Taxation

This paper develops a dynamic general equilibrium model to investigate the optimal level of capital income taxation in light of stochastic endogenous economic growth. Although endogenous human capital is incorporated into our model, we restrict our investigation to the issue of optimal physical capital income tax; and the labor supply is also endogenously determined. This paper proves that the optimal capital income tax should be zero provided exogenous government expenditure on production; however, capital income should be taxed if we consider endogenous government consumption.     

MILITARY SPENDING,THREATS AND STOCHASTIC GROWTH

This paper analyses the impact of home military spending and foreign military threat on economic growth in a stochastic endogenous growth model involving the supply‐side and demand‐side effects produced by military spending. The paper states that an increase in home military spending affects economic growth through three channels, including the crowding‐out effect, the spin‐off effect, and the resource mobilization effect. The net effect which depends on these three channels is ambiguous. Hence, we demonstrate that there exists an optimal defence burden that maximizes the economic growth rate. Furthermore, the optimal defence burden depends on the degree of risk preference. Namely, the optimal defence burden of the risk‐loving agent is more than that of the risk‐neutral agent, and in turn is more than that of the risk‐averse agent. At the same time, we prove that the relationship between the volatility in military spending and economic growth also depends on the degree of risk preference. In addition, we show that greater volatility in foreign military spending leads to a decrease in home aggregate consumption, and hence speeds up economic growth in the home country.     

Risk preference interactions between individual farmers and small farmer groups: Experimental evidence from rural Ethiopia

The understanding of risk preference interactions among poor farmers in developing countries has important policy implications, as many programs that aim to alleviate poverty and address risk constraints are provided on a collective basis. We conduct a randomized field experiment in the drought-prone parts of Northern Ethiopia and elicit from poor, vulnerable farmers their hypothetical willingness to pay using individual and group lottery games. Analyzing the certainty equivalent ratios (CERs), we find that farmer groups are more risk averse than individual farmers. When the risk of the lottery is high, the group CER is primarily determined by the most-risk-averse farmer of the group, and to a lesser extent, by the least. The median farmer contributes to the group CER only when the lottery risk is moderate. After participating in the group elicitation, individual farmers also become as risk averse as the group on average. Specifically, the median and the least-risk-averse farmers become significantly more risk averse while the most-risk-averse farmer is unaffected. Our results show that policymakers should carefully consider how social interactions in rural communities affect individual and group risk preference and whether social interactions also affect the participation and effectiveness of development programs.     

Dual theory of choice with multivariate risks

We propose a multivariate extension of Yaari?s dual theory of choice under risk. We show that a decision maker with a preference relation on multidimensional prospects that preserves first order stochastic dominance and satisfies comonotonic independence behaves as if evaluating prospects using a weighted sum of quantiles. Both the notions of quantiles and of comonotonicity are extended to the multivariate framework using optimal transportation maps. Finally, risk averse decision makers are characterized within this framework and their local utility functions are derived. Applications to the measurement of multi-attribute inequality are also discussed.     

Contracts payments for ecosystem services: the case of bio-pospecting

We examine the economics of royalties in bioprospecting contracts between a pharmaceutical and genetic resource supplier (local), with an eye to understanding the relative advantages of indexing royalty payments to gross revenue or net revenue. We show a risk-averse firm facing only production or only cost risks will index royalties to net revenue. When facing both types of risk, the choice of royalty type depends on the relative magnitudes of the production and cost risk. In each case, the risk-averse firm chooses the royalty type that shifts as much risk as possible to the local. When the local is risk neutral, the pharmaceutical's and local's preferences are compatible. If the local is risk averse and there is only one type of risk, it will prefer a gross revenue royalty, and shift as much risk as possible to the firm: here the local and firm preferences are compatible only if the firm is risk-neutral, Lastly, we show if the firm sets the terms of the contract, and both agents are risk averse, the firm will not likely volunteer to implement the socially optimal royalty arrangement as it prefers to shift as much risk to the local, who now also prefers a more certain return. This last outcome is at the heart of the benefit sharing discussion and suggests if risk sharing and equity are a concern in benefit sharing, then the choice of royalty type can be an important part of negotiations between pharmaceuticals and locals for the phytochemical from nature for new drug discovery.     

Consumption Commitments and Employment Contracts

We examine an economy in which the cost of consuming some goods can be reduced by making commitments that reduce flexibility. We show that such consumption commitments can induce consumers with risk-neutral underlying utility functions to be risk averse over small variations in income, but sometimes to seek risk over large variations. As a result, optimal employment contracts will smooth wages conditional on being employed, but may incorporate a possibility of unemployment.     

Banking firm and hedging over the business cycle

This paper examines the behavior of a banking firm under risk. The banking firm can hedge its risk exposure by trading futures contracts. The banking firm is risk averse and possesses a utility function defined over its end-of-period income and a state variable that denotes the business cycle of the economy. We show that the banking firm optimally opts for an over-hedge or an under-hedge, depending on whether the returns on the futures contracts are negatively or positively correlated with the business cycle of the economy, respectively. Thus, the business cycle of the economy is an important determinant in shaping the banking firm’s optimal hedging strategy.