Transaction Costs, Collective Action
and Adaptation in Managing
Social-Ecological Systems
Graham Marshall
Institute for Rural Futures,
School of Behavioural, Cognitive and Social Sciences, UNE
57th Annual AARES Conference, Sydney, 7 February 2013
Adaptation and
neoclassical economics
• Neoclassical economic focus is on adaptation through
market transactions; i.e. private good transactions
• Markets assumed to operate mechanistically
... only negative-feedback (diminishing-return) dynamics accounted for
... any disturbance leads to a single equilibrium adaptation
... and this adaptation can be evaluated through comparative statics
and stochastic decision analysis
Adaptation in complex systems
• World becoming more complex and uncertain
... increasing importance of collective action – collective goods
provision – for adaptation (Adger 2003)
... ‘environmental’ problems increasingly concerned with socialecological systems (SES)
... which are types of complex adaptive systems (CAS) rather than
mechanistic systems
• CAS:
... behaviour ‘emerges’ as parts adapt to each other and evolving state
of system
... driven significantly by positive-feedback dynamics
... path dependencies and lock-in
... multiple or non equilibria
... unforeseen events (surprises) are ubiquitous, not exceptions
... Knightian uncertainty and bounded rationality
... stochastic decision analysis is ‘naive’ and may mis-identify optimal
adaptation choices
Path dependencies
• Path dependencies (PD) mean that
... past institutional choices increase costs of present policy reform
... present institutional choices increase costs of future policy reforms
• PD are surprising, highly sensitive to random events
... even though some of the general dynamics might be anticipated
(e.g. vested interests, crowding out, sunk costs, mental models)
• Added costs from PD (lock-in costs) depend on the
particular surprises that emerge to necessitate policy
reform
... can’t be accounted for deductively/ stochastically; only via induction,
bounded rationality and heuristics
Governance, institutions
and their costs
• Governance is crucial for large-group collective action
... involves the formation and stewardship of institutions (formal and
informal rules)
... increasing uncertainties have led to a greater focus on ‘adaptive
governance’
• Transaction costs are the costs of resources used to:
define, establish, maintain, use and change institutions
and organisations; and define the problems that these
institutions are intended to solve
• Institutional choices typically also affect technological
choices, so the transformation (including abatement)
cost impacts of institutional choices also need to be
accounted for
Evaluating institutional costeffectiveness
• Benefit-cost analysis is ideal, but cost-effectiveness
analysis (CEA) is typically more feasible for institutional
choices
• Institutional CEA (ICEA) involves comparing the total
(transformation + transaction) cost impacts of
institutional options
... both costs added and costs avoided
... relative to a common do-nothing scenario
• Marshall (2005) built on Challen (2000) to propose an
ICEA framework (ICEAF) distinguishing six types of
costs
... where institutional and technological transition costs result mainly
from the path dependencies arising from prior institutional choices
Table 1:
Definitions of the six classes of costs comprising the institutional cost effectiveness framework
Class of costs
Definition
Static transaction costs
The transaction costs incurred in operating under an institutional option.
Institutional transition costs
The transaction costs incurred in effecting change from existing
institutional arrangements to a new institutional option.
Institutional lock-in costs
The additional institutional transition costs incurred by ‘successor’
institutional options (i.e. those eventually chosen as adaptations,
transformations or replacements of the option under consideration) due to
the impact on institutional path dependencies of the institutional option
under consideration.
Static transformation costs
The transformation costs incurred in operating under the technologies or
practices that are adopted subject to the influence of the institutional option
under consideration
Technological transition costs
The transformation costs incurred in effecting change from existing
technologies or practices to those adopted subject to the influence of the
institutional option under consideration.
Technological lock-in costs
The additional technological transition costs incurred by ‘successor’
technologies or practices (i.e. those chosen under the influence of
‘successor’ institutional options) due to the impact on technological path
dependencies of the institutional option under consideration.
MDB environmental water recovery: illustrating
the ICEAF
• Two main institutional options implemented
... voluntary water buy-back programs
... subsidy programs for water-saving infrastructure upgrades
• Economic evaluations to date have applied CEA
... accounted only for expenditures on buy-backs and infrastructure
subsidies; i.e. for technological transition costs
... buy-backs found to be far more cost-effective
• Productivity Commission (2010) ‘recognises that
[infrastructure subsidies] can be seen as the price the
Australian Government was prepared to pay to make
progress... [They were] needed to convince the states to
a truly Basin-wide approach to water planning and to
elicit the irrigation sector’s support for increasing
environmental water allocations’.
• This ‘price’ refers to institutional and technological
transition costs ... why weren’t they accounted for?
Table 3:
Illustrating how the extended cost-effectiveness framework applies to the choice
between two institutional options for accumulating environmental water for the
Murray-Darling Basin
Fund a water buy-back program
Fund an infrastructure upgrade program
Cost class
Relevant cost items
Static
transaction
costs
Added costs incurred (a) in administering the
program and (b) by private entitlement holders
in transacting with the program
Added costs incurred (a) in administering the program
and (b) by prospective infrastructure upgraders in
transacting with the program
Institutional
transition costs
Added costs incurred in establishing the water
buy-back program in respect of: research and
stakeholder consultation; negotiating program
goals and design; lobbying for, legislating and
implementing the program; and negotiating
and institutionalising the rules and policies for
program administration
Costs of administering privately-owned water
entitlements that are avoided by buy-back
Added costs incurred in establishing the
infrastructure-upgrade program in respect of:
research and stakeholder consultation; negotiating
program goals and design; lobbying for, legislating
and implementing the program; and negotiating and
institutionalising the rules and policies for program
administration
Costs avoided in administering infrastructure made
redundant by the program
Institutional
lock-in costs
Costs added due to emergence of parties with
vested interests (e.g. public agencies
administering the program, prospective sellers
to the program) in opposing changes to the
program contrary to those interests
Costs associated with path dependencies
arising from existing water entitlement
arrangements that are avoided by reallocating
a
entitlements from private to public ownership
Costs added due to emergence of parties with vested
interests (e.g. public agencies administering the
program, irrigators and their input suppliers benefitting
from the program) in opposing changes to the
infrastructure upgrade program contrary to those
interests
Table 3 (cont): Illustrating how the extended cost-effectiveness framework applies to the choice
between two institutional options for accumulating environmental water for the
Murray-Darling Basin
Fund a water buy-back program
Fund an infrastructure upgrade program
Cost class
Relevant cost items
Static
transformation
costs
Nil. (Program is concerned with accumulating
environmental water, not with influencing the
technologies for applying this water.)
Added costs of operating and maintaining the
upgraded infrastructure and any new irrigation
technologies adopted due to this upgrading
Technological
transition costs
Economic rents from irrigated production that
are foregone due to sales of water entitlements
b
to the program
Added costs of the infrastructure upgrades supported
c
by the program
Costs of operating and maintaining irrigation
infrastructure and technologies that are
avoided when properties shift to less irrigation
intensive (or dryland) production due to sale of
water entitlements
Technological
lock-in costs
Costs associated with path dependencies
arising from existing investments in irrigation
infrastructure and technologies that are
avoided when producers shift to less irrigation
intensive (or dryland) technologies due to sale
of water entitlements
Costs associated with path dependencies
arising from investments in less irrigation
intensive (or dryland) technologies that are
added when producers shift to such
technologies due to sale of water entitlements
Costs avoided in operating and maintaining irrigation
infrastructure and technologies that are made
redundant by the program
Costs associated with path dependencies arising from
existing irrigation infrastructure and associated
technology that are avoided by upgrading this
infrastructure and technology
Costs added due to path dependencies arising from
investments in infrastructure upgrades and associated
adoption of new irrigation technologies.
Challenges in applying the ICEAF empirically
• Static transformation costs and technological transition
costs reasonably easy to estimate
• Static transaction costs and institutional transition costs
are harder to estimate, and often neglected
• Institutional and technological lock-in costs are sensitive
to surprises, so cannot be accounted for stochastically
• Ignoring lock-in costs constitutes naive CEA when the
choice problem involves a CAS
... such naive analysis risks mis-identifying the most cost-effective
institutional option
... this risk is greater the more that society values capacities for
adaptation / transformation
A boundedly rational procedure for comprehensive
empirical application of the ICEAF
• Quiggin (2007, 2008) observed that decision makers can
use heuristics to anticipate whether an option will lead to
a domain of favourable or unfavourable surprises
• The two-stage boundedly rational procedure he
proposed for decision analysis of surprise-prone choices
was adapted for application to the ICEAF
1. Apply ICEAF to options on a naive basis (i.e. ignoring lock-in costs)
2. Select as the preferred option the naively highest-ranked one that
is not expected to lead to a domain of unfavourable surprises for
either institutional or technological lock-in costs. If no such option
exists, invoke the precautionary principle and retain the institutional
status quo.
•
•
A domain of unfavourable surprises is one where lock-in
costs are higher than under the institutional status quo
Marshall (2005, 2013) proposed a research strategy for
improving the heuristics used to anticipate surprise
domains
Table 5:
Illustrative application of the ICEAF to a case with four institutional options
Institutional options available for achieving the on-ground
management target
Static transaction costs ($K)
Institutional transitional costs ($K)
Institutional lock-in costs (domain of surprises)
a
Static transformation costs ($K)
Technological transition costs ($K)
Technological lock-in costs (domain of surprises)
Naïve total cost impact of option ($K)
a
W
X
Y
Z
100
80
60
200
20
40
90
70
–
+
+
–
150
140
160
90
40
40
100
160
–
–
+
–
310
340
410
520
st
nd
Naïve cost effectiveness rank
1
2
Satisfies precautionary principle?
No
No
Preferred option
a
rd
th
3
4
Yes
No
√
Favourable and unfavourable domains of surprises for lock-in costs are indicated by + and –, respectively.
Concluding remarks
• Transaction costs of institutional change are significant
• CEA of institutional choices should account for
transaction costs as well as transformation (abatement)
costs
• CEA studies that account only for transformation costs
should be qualified accordingly
• Lock-in cost impacts should at least be assessed
qualitatively
... and preferably through the proposed boundedly rational procedure
• ‘Ignoring important costs, which are obvious to the
agencies involved, [makes] the economics profession …
less credible’ (McCann et al. 2005 p. 528).
Paper to be soon published online in
Ecological Economics special issue
‘Transaction costs and environmental policy’
http://www.sciencedirect.com/science/journal/aip/09218009
Transaction Costs, Collective Action
and Adaptation in Managing
Social-Ecological Systems
Graham Marshall
Institute for Rural Futures,
School of Behavioural, Cognitive and Social Sciences, UNE
57th Annual AARES Conference, Sydney, 7 February 2013