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4.4 Measuring Farm-Specific Internalization of Environmental Externalities

Two problems arise in trying to account for the fact that some farms pollute more per unit of output than others. The environmental externalities of livestock production are hard to measure, and in many cases, are determined simultaneously with the level of actual profit per unit. An externality is defined here as a return to an economic agent where part of the cost (or benefit) of undertaking an activity accrues to another entity that is not compensated (or charged) in the market. Negative externalities may be created in the production process for animal agriculture through odor, flies, and the nutrient-loading effects on soil of manure that is either mishandled or supplied in excess. Producers capture the benefit of negative externalities by receiving payment for livestock output, while not bearing the full costs of their enterprise, in terms of the impact on surrounding communities of odor, flies, poor water quality, etc. Producers who do not pay the full cost of production per unit may show up as "more efficient" (in financial terms) than producers who are otherwise similar but internalize some of the externality by cleaning up after the enterprise, or making compensatory payments to surrounding communities.

The first problem is how to measure the value of not paying for pollution created, particularly if this differs by scale of farm, since it will lead to erroneous comparisons of unit profits across scale categories. Externalities of the sort involved are exceedingly difficult to measure. There is the difficulty in determining which farm the pollution in the river came from. There is the issue that farmers themselves suffer some of their own pollution, and this needs to be netted out of the externality. There is the issue that the negative effects of pollution carry over into future time periods. Physical measurements of costs in terms of decreased sustainability are also very difficult. Furthermore, the true consequences for sustainability of a given amount of manure will differ by soil type, temperature, rainfall, and so forth.

In view of these many difficulties, it is not practical in the present study to attempt to measure actual negative externalities. Instead, we focus on differences across farms in the amount of externality "internalized" when a farmer invests in pollution abatement, through handling manure and dead stock in an ecologically sound manner. Higher expenditure per unit of output on a given farm for abatement of environmental externalities, other things equal, should be inversely correlated with the incursion of net negative environmental externalities per unit of output, under the assumptions above. Thus a farm that spends more per unit of output on environmental abatement is postulated to incur less negative environmental externalities than a farm that spends less on environmental services per unit of output.

The heroic assumption that allows us to proxy environmental mitigation with the money value of manure management is that a given amount of manure of a given sort is equally polluting whatever farm it comes from, as long as it is not spread on fields (one's own or someone else's). This assumes that spreading manure on crops is uniformly good (despite run-off into watercourses in some cases), and ignores the fact that farms close to population centers and watercourses probably produce more ecological harm per ton of manure than those far from people and watercourses, other things equal. By the same logic, if we are willing to assume that the relationship is cardinal as well as ordinal -US$1 per 100 kg of output in abatement on farm A is twice as environmentally friendly as US$0.50 per 100 kg of output on a different farm-we have a workable index that differentiates (inversely) across farms in the amount of negative environmental externalities incurred. The assumptions are not perfect, but the only feasible alternative of ignoring negative externalities altogether in econometric production work seems worse.

The components that go into a measure of environmental mitigation include all costs of disposing manure, such as water treatment costs, investment in lagoons, labor spent collecting and drying manure for sale (evaluated at market rates), rental cost of machinery used for manure disposal, existence of regulations, taxes paid for abatement, and cost of compliance in dealing with environmental problems. In addition, the spreading of manure on crops is considered to transform a potential externality (pollution) into a positive contribution to soil structure and fertility. Costing this benefit is hard to do with accuracy. The simple approach adopted is to value all manure sold for spreading on the fields of others (the reason it is purchased) at its sale value at the producing farm gate. Manure spread on one's own fields is valued at what it could have been sold for, at the farm gate. Thus, if manure is spread in the field and has any market value (i.e. people are not just dumping), the latter is included in the internalization of the externality. The worst that any farm can do under this approach is to have no abatement expenditure at all per unit of output, and this is in fact the case for many farms.

Having a working index of environmental mitigation creates a new problem and a new opportunity. The new problem is that this index, measured in currency units per kg of output, is in many cases simultaneously determined with profits per unit. Thus profit per unit depends on environmental mitigation expenditures, but environmental mitigation expenditures are also influenced by profit. The new opportunity is the solution to the econometric problem; this is to create an instrumental variable for environmental mitigation by regressing it on a series of exogenous determinants of environmental mitigation. Opportunity lies in the insights that this also gives into why some farms are more prone to spend more on environmental mitigation than others.

Among the factors accounted for in this study that might influence the difference in the amount of environmental mitigation expenditure across farms are differences across farms in access to assets and information (transactions costs), other farm characteristics such as location, and policy subsidies. Examples of such variables are education; experience; age; gender; access to credit and technical assistance; access to radio, television, and newspapers; proximity to waterways; distance to nearest market; and other locational variables. The predicted value of the dependent variable from these regressions-environmental mitigation-can then be used as an explanatory variable in the second stage regression that explains why some farms are closer to the profit frontier than others.

A final complication with this approach arises from the fact that some farms will have no environmental mitigation expenditures, leading to dependent variable observations that are zero in the environmental regressions. This results in censoring of the error term if such farms are numerous. The solution in this case is to use Tobit analysis and MLE for the environmental regression, with an otherwise similar instrumental variable approach.

The measurement of environmental mitigation by the procedure above is only one approach to measuring the important environmental impact of livestock. It was motivated by the need to incorporate environmental factors in the analysis of efficiency. However, more direct measures of environmental impact are possible outside this framework. The next section explores a methodology for directly assessing the interaction of animal density and environment.

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