Environmental managers face the question of how large in scale to make their environmental projects. An important consideration is whether the projects would face diminishing marginal benefits as project scale increased.

This is a sequel to PD182, which covered increasing marginal costs of environmental projects. “Diminishing marginal benefits” is another fundamental concept in economics – one that is relevant to both production and consumption.

On the production side, the benefits from using more of a production input usually decrease as you use more and more of it. A classic example is the application of fertilizer to crops. The almost universal pattern is as shown in Figure 1 – yield increases steeply at first, but as more fertilizer is added, the rate of yield increase falls towards zero.

Figure 1. Diminishing marginal benefits from applying fertilizer to a crop.

On the consumption side, the pleasure that people get from consuming a unit of a good usually diminishes as they go to higher and higher levels of consumption. Personally, I don’t consume much milk, but the bit I do have (in my tea and on my breakfast cereal) is pretty important to me. However, if I were to increase my milk consumption beyond that, it would give me very little additional pleasure, if any. This pattern of falling additional pleasure from increased consumption is almost universal across all types of goods, not just food.

My question here is, as we devote more and more resources to generating environmental benefits of a particular type in a particular area (e.g. more agricultural land is managed to benefit the environment in the Loddon River catchment of Victoria), are we likely to see diminishing marginal environmental benefits – a flattening out of the benefits like in Figure 1?

Perhaps not in every case, but the evidence indicates that there are many cases where this occurs, either in production or consumption of environmental goods, or both.

Like the fertilizer example, it may be that a change in land management is initially highly effective in generating environmental benefits, but the gain in benefits falls as you increase the area of land that has been changed. For example, I was involved in some research in Germany that looked at the economics of riparian vegetation buffer strips of different widths (Seiber et al., 2010). We found a pattern very similar to Figure 1. It was estimated that buffer strips 3 metres wide would reduce pesticide movement into rivers by 61%, while 30-metre strips would reduce pesticides by 94%. Increasing the area devoted to buffer strips by a factor of 10 increased the environmental benefits by a factor of only 1.5. Increasing the width further to 50 metres made almost no further difference to the pesticide load in the river – a striking case of diminishing marginal environmental benefits. It’s not unusual for models of land management for other types of problems to show a broadly similar pattern, although rarely that extreme.

Like the milk example, people’s pleasure or happiness as a result of “consuming” particular environmental improvements often tends to flatten out. There is a wealth of evidence on this. Economists’ studies of intangible environmental values often find that people’s valuations of larger scale projects are not much higher than for small projects, implying that there are rapidly diminishing marginal benefits. For example, Bateman et al. (2005) could not find a significant difference in total values between protecting 4 and 400 lakes. Other studies do find benefits in going from small-scale to large-scale projects, but the additional benefits are often pretty small. To some extent, it may be that there are limitations in the research methods used in these studies, but even allowing for that, the evidence for diminishing marginal benefits is powerful.

Diminishing marginal benefits are the opposite of what tends to be assumed by the proponents of “landscape-scale change”. They seem to assume that, by fixing the whole landscape, you can get exceptional aggregate benefits, even if the benefits from fixing up parts of the catchment would be modest. Perhaps there are scale thresholds that need to be crossed before large benefits can be generated, resulting in increasing marginal benefits. Could that be true? I suppose it could for certain types of issues in certain situations.

The only clear evidence I’ve ever seen for increasing marginal environmental benefits on the production side was from a modelling study of revegetation to reduce dryland salinity in the Western Australian wheatbelt (George et al., 2001). This showed that there might be (slightly) increasing marginal benefits in some catchments, but not others. Thresholds are often talked about, but I’ve never seen clear evidence of them generating increasing marginal benefits. (If you know of some, I’d be keen to see it.) Given the clear evidence for “diminishing” in at least some cases, it wouldn’t be safe to just assume “increasing” without some evidence. (For some issues, the relationship is approximately linear – neither increasing nor diminishing.)

On the consumption side, I’m aware of one study that found increasing marginal benefits for the beneficiaries of a particular environmental project (Holmes et al., 2004). But this is a rare exception to the usual results.

Where we face diminishing marginal environmental benefits, the implications for environmental managers are the same as for increasing marginal costs. They mean that the greatest environmental benefits in aggregate can be achieved through a larger number of well-targeted, modest-scale projects, rather than a small number of huge projects. They are another reason why an enthusiasm for “landscape-scale change” is likely to be ill-conceived in many cases, especially given that environmental budgets are small relative to the levels needed for effective landscape-scale projects. Diminishing marginal benefits and/or increasing marginal costs mean that support for landscape-scale projects would reduce environmental benefits overall by drawing resources away from projects with higher marginal benefits.

On the other hand, this is not an argument for funding a multitude of tiny projects (the sort of “vegemite” approach for which the Natural Heritage Trust was criticised). Next week I’ll pull together these last two Pannell Discussions and suggest what they do mean for environmental programs.

David Pannell, The University of Western Australia

References

Bateman, I.J., Cooper, P., Georgiou, S., Navrud, S., Poe, G.L., Ready, R.C., Riera, P., Ryan, M. and Vossler, C.A. (2005). Economic valuation of policies for managing acidity in remote mountain lakes: Examining validity through scope sensitivity testing, Aquatic Sciences 67, 274-291.

George, R.J., Clarke, C.J. and Hatton, T. (2001). Computer modelled groundwater response to recharge management for dryland salinity in Western Australia, Advances in Environmental Monitoring and Modelling 2, 3-35.

Holmes, T.P., Bergstrom, J.C., Huszar, E., Kask, S.B. and Orr F. III (2004). Contingent valuation, net marginal benefits, and the scale of riparian ecosystem restoration, Ecological Economics 49, 19-30.

Sieber, S., Pannell, D.J., Müller, K., Holm-Müller, K., Kreins, P. and Gutsche, V. (2010). Modelling pesticide risk: A marginal cost-benefit analysis of an environmental buffer-zone programme, Land Use Policy 27, 653-661.