Tuesday, February 24, 2015

11 Applying Economics to Forestry-II: Management decisions

Full paper available here (pdf)

Shortening of rotations under economic criteria

Is there any possibility of reconciling economic principles with long-term forestry? The author (like many another forester-turned economist) took up this conundrum in his doctoral work at the University College of North Wales, Bangor, taking the conversion to teak plantations in the Yellapur-Mundgod forests of Karnataka State’s Western Ghats as a case study (Dilip Kumar, 1988). Some of the models and results have been presented in the volume edited by Kerr et al. (Dilip Kumar, 1996), and some additional aspects on the social cost benefit side will be explained here. The details need not detain us; basically the growth model was based on the available yield tables for teak published by the Forest Research Institute, Dehradun (FRI, 1959).

If financial criteria based on costs and returns at usual market rates were applied, optimal rotations shrank drastically as discount rates rose, from the 80 plus years under the physical mean annual increment (MAI) criterion. On a SQ III hectare, the optimal rotation to maximize the net discounted revenue or NDR (of one rotation) stays above 80 years through discount rate of 4%, then at a discount rate of 5%, it drops to 55 years, and at 10%, to 20 years (it turns completely negative by 13%, which would thus be the maximum internal rate of return, IRR). Similarly, on SQ IV, the rotation of maximum NDR remains at above 80 years up to a discount rate of 4%, but thereafter the optimal rotation falls to 20 years at 5% (actually, this is the rotation of minimum loss). Rotations to maximize the soil expectation value SE (net present value of an infinite series of rotations) are even shorter.

Thus the long rotations of maximum MAI are not encouraged by the financial criterion at any medium interest rates. The whole decision, then, would hinge on the actual discount rate one applies. Samuelson (op. cit.) and other neo-classical economists argue that the forest sector ought not to be allowed to use a very low discount rate that would render long rotations profitable, just because of some (imagined) social benefit or ‘externality’. If the rest of society were indeed paying higher rates (usually a figure of 12% is used for this opportunity cost of capital), this is what should be applied, in which case long-term forestry has little chance of passing muster.

However, the discount rate in real terms falls if inflation is allowed for: maybe to less than 5%. This, for the teak plantations we examined, is a border-line rate as far as the fate of long rotations is concerned. One consideration, however, is that there is such a sudden drop in optimal rotations for a small change of discount rate between say 4% and 5%, that one may well decide to apply the criterion somewhat ‘conservatively’ (i.e. in favour of the longer rotation) within the margins of uncertainty of the data and assumptions, without running foul of the economists’ fiats.

The cost of extraction to the consumption centre may also be a material factor: the farther it is, the less economic pressure there will be to harvest early. Continuous increase in timber prices may also favour postponing the harvests (the price rise acts as a negative interest rate), although a one-time increase in prices will call for earlier liquidation (the opportunity costs of preserving the crop rise, especially if we compute the SE of an infinite series of similar crops). The cost of waiting will have a more pronounced rotation-shortening effect if there are no intermediate yields from thinnings (unlike teak).

Conversion of standing forest and economic criteria

A somewhat different problem is the linking of planting and harvesting decisions to the conversion from miscellaneous mixed forest to monoculture. If the conversion process were taking place under constant prices (timber flooding the market does not lead to a crash in prices), there would be little incentive under purely economic criteria to retain any portion of the old crop: the favoured policy would be to ‘cut and run’, as will happen if people are given a free run in the forest.  By separating the regeneration decision from the felling decision under the dictates of neo-classical economic theory, regeneration is liable to be abandoned if it is seen to be financially unviable (especially on the inferior hectares). In contrast, the traditionalist forester would probably leave the crop standing as a soil cover and potential seed source, if replanting were financially or administratively unviable; or work it on a financially less demanding system like the selection system, leaving it to nature to supply new recruits to the crop through natural regeneration and ecological succession. The business-minded manager, on the other hand,  would be justified in leaving the existing crop standing, only if the product were so inferior as to have no sale value at all, and if there were no other practical use for the land resources.

This brings us to the choice between different products like firewood and poles (small timber) versus lumber or saw-timber (large timber, logs). One of the factors that are pushing down the rotations in our teak case is that the thinnings and fellings are assumed to produce smallwood (poles and firewood) that has a positive market value. Indeed, at high interest rates, the very low optimal rotations imply that the crop is practically being worked for firewood. The higher valued saw logs are so distant in time, that they have relatively little impact on the present discounted value, like a mountain viewed from afar (with a wide angle lens!). Thus the application of any substantial discount rate is bound to act against the production of saw logs and in favour of more early, smallwood products.

Economics of converting old growth 

A consideration that may come to the rescue of the long rotations and slow conversion rates of existing crops may be the indirect services that are expected to flow from such natural crops, but this is likely to support longer rotations only if the stream of such benefits is shown to increase with age of the crop. If not, as in the case of carbon sequestration, it may also come about that a series of fast-growing crops may capture more carbon in a given time period, than keeping the already locked-in carbon in standing trees. Samuelson feels that such decisions should be left to “the electorate, by that same pluralistic process” which determines other fiscal decisions and allocation of budgets (Samuelson, 1974, p.486). We will look at the conversion problem next.

(For references, please see previous post)

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