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Discussion Paper

No. 2009-53 | December 04, 2009
Ex-Ante Regulation and Ex-Post Liability under Uncertainty and Irreversibility: Governing the Coexistence of GM Crops

Abstract

Ex-ante regulations and ex-post liabilities for using a new technology will induce additional costs for adopters. The standard model is advanced by including irreversibility and uncertainty and taking into account transaction costs of negotiating possible cost reductions. The case analysed is the coexistence policy for GM crops in the European Union. Results show, the design of the rules and regulations can provide strong incentives for regional agglomeration of GM and non-GM farmers.

JEL Classification

D81 L23 Q12 Q24 R3

Cite As

Volker Beckmann, Claudio Soregaroli, and Justus Wesseler (2009). Ex-Ante Regulation and Ex-Post Liability under Uncertainty and Irreversibility: Governing the Coexistence of GM Crops. Economics Discussion Papers, No 2009-53, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2009-53

Assessment



Comments and Questions


Koen Dillen - Some thoughts
January 11, 2010 - 12:12

First of all I would like to congratulate the authors with their original and interesting paper. For the first time in the literature on coexistence of GM and non-GM crops, the consequences of combined ex ante regulations and ex post liability are analyzed. This may be a further step in ...[more]

... explaining the observed GM adoption patterns, and more importantly aid policymakers in developing regulations that minimize the burden to farmers.
I would like to take this chance to introduce some thoughts that may complement their analysis or stimulate new work in the field.

• Recently a body of work was published on the impact of different ex ante regulations on the adoption of GM crops. These authors make an explicit distinction between rigid regulations (e.g. isolation distances) and more flexible solutions (e.g. cross pollination zones) (1,2). The authors conclude that flexible measures are to be preferred in order to minimize the burden to farmers. It may be interesting to the authors to evaluate this claim in a combination of ex ante and ex post regulations by specifying different fencing costs (r(z)).
• The authors show the discriminatory effect of ex ante regulations on small farms. However, farm size is only one of the spatial variables influencing adoption. As documented in both agronomical and economical literature, land fragmentation is key in explaining spatial adoption patterns.(3-6) In the framework of this paper this means that z0=f(z,landscape). This function may indicate directly that spatial aggregation bears economical benefits. In their paper, Demont et al. try to formalize this link via the shadowfactor.(1) Incorporating land fragmentation brings the framework closer to reality.
• Finally, it would be interesting to incorporate the possibility of hold-up problems in the negotiation of compensations as shown in Figure 4. As Vg and Vn are private to farmers and therefore non-observable by the GM farmer, there is a value for farmers to state their preference towards non-GM crops if they are located within distance z of a GM farmer. If they win the game they receive Vg and a compensation premium.

Reference List

1. Demont M, Dillen K, Daems W, Sausse C, Tollens E and Mathijs E, On the proportionality of EU spatial ex ante coexistence regulations. Food Policy 34 :508-518 (2009).
2. Devos Y, Demont M and Sanvido O, Coexistence in the EU, return of the moratorium on GM crops? Nat Biotech 26 :1223-1225 (2008).
3. Belcher K, Nolan J and Phillips PWB, Genetically modified crops and agricultural landscapes: Spatial patterns of contamination. Ecological Economics 53 :387-401 (2005).
4. Demont M, Daems W, Dillen K, Mathijs E, Sausse C and Tollens E, Regulating coexistence in Europe: Beware of the domino-effect! Ecol Econ 64 :683-689 (2008).
5. Devos Y, Thas O, Cougnon M, De Clercq E, Cordemans K and Reheul D, Feasibility of isolation perimeters for genetically modified maize on an intra-regional scale in Flanders. Agron Sustain Dev 28 (2008).
6. Sanvido O, Widmer F, Winzeler M, Streit B, Szerencsits E and Bigler F, Definition and feasibility of isolation distances for transgenic maize cultivation. Transgenic Res 17 :317-335 (2008).


Anonymous - Reply to the comments of Koen Dillen
January 15, 2010 - 13:02

We highly appreciate the comments by Koen Dillen. In his comments Koen Dillen did refer to some recent literature arguing for flexible solutions. The results of our paper indeed support this claim. In contrast to the papers mentioned our paper explicitly considers flexibility by allowing for bargaining solutions and considering ...[more]

... ex-post liability rules as an additional instrument. Our model does not consider land fragmentation explicitly, but this is also not the central pint of our paper. The results of our model, that mandatory minimum distance requirements discriminate against smaller farms is still valid. The implications for land fragmentation can immediately be deduced from our model. In a more fragmented landscape farmers may have more than one neighbor. This simply affects the legal barrier as illustrated in Figure 4. The hold-up issue is an interesting aspect, but applies to almost all problems involving bargaining solutions. The empirical evidence does not imply that the hold-up problem so far is of relevance (Skevas et al., Consmüller et al. cited in the paper). The hold-up problem arises after a deal has been made. In the case of GM crops in Europe a non-GM farmer may plant his crop close to the GM crops even so both have negotiated the non-GM farmer will plant his crop further away. In this case the GM farmer may face a problem if regulations require that he keeps a minimum distance resulting in legal problems. The non-GM farmer may not gain that much. Empirical studies illustrate cross fertilization rates for maize and corn hardly reach the 0.9% threshold level and the claim for not being able to sell the crop as a non-GM one is very low. Even in the case where the threshold level will be reached the economic loss will be low as so far price mark-ups for non-GM crops are not yet present. In case of an organic farmer this is different. In both cases the non-GM farmer would face the threat that he can not demand any additional money from the GM-farmer and has to use the court. Given this it his hard to believe this to become a real problem As mentioned earlier, empirical studies do not confirm this.
Nevertheless, the aspects raised by Koen Dillen will be considered in the final version.


Anonymous - Further clarification needed
January 27, 2010 - 16:07

The authors study the adoption of GM crops by using concepts of the New Investment Theory by Dixit & Pindyck 1994, Investment under Uncertainty, which is augmented by adoption and spatial agglomeration effects. Effects of minimum distance requirements and ex-post liability rules are analysed. Casuistic evidence from the German State ...[more]

... of Brandenburg is presented to demonstrate the ability of the model to explain low adoption rates due to regulatory and liability costs.

The paper addresses an interesting research question from a formal theoretical perspective. However, I have some reservations concerning the actual scientific value added by the paper:

1. Having read the paper, it was still somewhat unclear to me where its contribution to the literature is. My concern is that most of the material claimed to be new was already published by the authors elsewhere. In particular, the authors should make clear the progress beyond the results already available in the article by Soregaroli and Wesseler 2005 in Wesseler, Environmental Costs and Benefits of Transgenic Crops, Dordrecht. Much of the material in 3.1 and 5.1 appeared already there, other material comes from standard references, such as Dixit/Pindyck.

2. While many of the effects studied in the paper are intuitively plausible, such as farm size effects due to fixed costs, and costs of uncertainty and liability, others are less so. In particular, more evidence would be desirable supporting the idea of irreversibility. Given the high policy uncertainty surrounding GM adoption in Europe, most farmers are prepared to reverse to conventional production technologies. As machinery and most cultivation techniques remain unaffected by the new seed, reversal is relatively easy. The recent ban of Bt maize in Germany is not mentioned by the authors. It may be taken as evidence that even politicians who are otherwise ready to impose highly distorting policies to secure policy rents for their farming clientele were willing to abruptly halt GM cropping by decree without significant compensation. Reversal costs encountered by farmers apparently were regarded as irrelevant, at least by politicians.

3. Regarding the more plausible effects studied in the paper, it may be allowed to ask whether the formal complexity implied by the approach chosen is necessary for generating new insights. Arguments in favor of abstract formal modeling are that it allows the derivation of counterintuitive results or provides a useful motivation of empirical (econometric) analysis or testing. Nothing of this sort is mentioned in the paper.

4. Several sections were insufficiently clear to me and need further explanation. The interpretation of γ (small gamma) following eq 10 needs better motivation and more explanation. Figures 1 to 4 need to be presented more carefully and more in detail. What kind of decision situation is analysed here? What do the authors mean by “incremental benefit”? What is meant by comparative advantage in this context? The message of section 5.2 is unclear. The last sentence on p 21 seems logically incorrect.

Overall, the authors should clarify their contribution and revise a number of sections so that the reader can better assess the scientific merit of the article.


Justus Wesseler - Reply
February 09, 2010 - 22:04

The reviewer raises fur major issues:
1. clarification of scientific contribution
While the reviewer is correct in stating we have adressed the issue of coexistence in previous contributions the current paper advances our previous reseach. We expand the model by explicitly considering transaction costs, which so far has been ignored ...[more]

... by other authors investigating the relationship between coexistence policies and adoption of GM crops and discuss the implications for the comparative advantage of either being a GM or non-GM farmer. Our results show that ex-ante regulations and ex-post liability can induce regional agglomeration of the harm causing firms and can have important implications for regional growth as access to technical innovations can be hindered or supported by the regulators choice of ex-ante regulations and ex-post liability rules. While this has been mentioned by Beckmann and Wesseler (2007) the role of regulations on the irreversibility effect and in particular the relation ship between ex-post liability, transaction costs and the irreversibility effect has not been discussed in the relevant literature.

The effect has been modelled by using a combined geometric Brownian motion and Poisson process (see Dixit and Pindyck, 1994) applied to problems of ex-ante regulations and ex-post liability rules as in Soregaroli and Wesseler (2005) but extended by including transaction costs caused by regulatory policies. Results show these further increases the irreversibility effect and the costs of minimum distance requirements.

2. Relevance of irreversible costs
While the reviewer correctly pointed out policy makers (politicians) seem not to worry about irreversibilities potential adopters do. While irreversibility aspects are not considered by policy makers as the ban on GM maize in France, Germany and Italy illustrates, they seem to be relevant for farmers. In Germany and Italy famers have sued the government for not having the right to plant GM maize. One of the major arguments for the German farmers was the expenses they had for the GM seeds they now were not allowed to be used. They further claimed irreversible environmental benefits of using Bt maize as well as the higher fodder value of BT maize by reducing mycotoxins. On the other hand, farmers have expressed reluctance of adopting GM oilseed rape, if they face regulations requiring a longer waiting period before they can grow non-GM oilseed rape as well as if neighbours have a negative attitude towards GM crops (Breustedt et al., 2006), both indicating irreversible adoption costs are part of the adoption decision.

3. Is the formal complexity warranted.
As already mentioned before, yes indeed, otherwise we would have not been to show the effect of liabilities on ex-ante measures. Furhter, our results HAVE implications for empirical studies. This Investigations assessing the potential adoption of GM crops need to consider the ex-ante regulations as well as ex-post liability regimes. Further, ex-ante regulations and ex-post liability regimes need to be differentiated between reversible and irreversible benefits and costs as they have a different effect on adoption. The model we have presented allows a ranking of different liability regimes as discussed in section 5.2 with respect to the implications on adoption.

4. Some minor comments.

Incremental benefits have been explained on page 13. We now explicitly state them in the revised paper when they are first mentioned.

Comparative Advanatge: The GM farm has a comparative advantage in the production of GM crops as it can produce that good at a lower opportunity cost relative to the non-GM farm (and vice versa).

The sentence on page 21 has been corrected for the revised version.


Tihomir Ancev - Comment
January 29, 2010 - 09:17

See attached file


Justus Wesseler - Reply
February 09, 2010 - 22:15

We highly appreciate the comments by Tiho Ancev. His comments nicely stress the relevance of our paper and points out additional areas for future research. A question has been raised with respect to the motivation for the use of a geometric Brownian motion. As commonly done the differences in revenues ...[more]

... between the new and "old" technology are assumed to follow such kind of process. The "old"technology is the floor and it is assumed farmers can move back to the "old" technology if incremental benefits approach zero (incremental benefits do not get negative). Uncertainty measured by the variance rate is a result of incomplete knowledage about future yields, prices, and costs.
One may ask if this does not contradict the irreversibility assumption. This not necessarily has to be the case, but it may affect the irreversibility measure as discussed in detail by Dixit and Pindyck and in the context of Bt maize by Morel et al. (both cited in ouir paper).