Direct allocation of resources and cost-benefit analysis in fisheries: an application to pacific whiting

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U T T E R W O R T H I N E M A N N

0308-597X(94)00005-0

Marine Poli¢T, Vol. 19, No. 3, pp. 199-211, 1995 Elsevier Science Ltd Printed in Great Britain 0308-597X/95 $10.00 + 0.00

Direct allocation of resources and costbenefit analysis in fisheries An application to Pacific whiting

Stephen Freese, James Glock and Dale Squires

Allocating among competing users is one of the most difficult and vexing problems in fisheries management, and direct allocation under open access is especially contentious, since groups gain only at the direct expense of others. This paper evaluates the direct allocation of Pacific whiting (Merluccius productus) among competing offshore and onshore user groups that fish off the coast of Washington, Oregon, and California in the USA, the process of achieving that allocation, and the value of economic analysis in the process. The paper also discusses the technique of cost-benefit analysis for direct allocation of total allowable catches among competing user groups and access to the resource. The paper concludes with observations on the role of economic analysis for fisheries management decisions.

Stephen Freese is with the National Marine Fisheries Service, Trade and Industry Services, Northwest Region, Seattle, WA, USA. Fax: +1 (206) 526 6544. James Glock is with the Pacific Fishery Management Council, 2000 SW First Avenue, Suite 420, Portland, OR 97201-5344 USA. Dale Squires is with the National Marine Fisheries Service, Southwest Fisheries Science Center, PO Box 271, La Jolla, CA 92038 USA. Fax +1 (619) 546 7003. Internet [email protected].

Allocation among competing users is one of the most difficult and vexing problems in fisheries management, and direct allocation under open access is especially contentious, since groups gain only at the direct expense of others. This paper addresses a particular direct allocation, the process of achieving that allocation, and the value of economic analysis in the process. Several basic allocation systems exist. Individual transferable quotas are drawing increasing interest as a means of allocation among competing user groups. 1 Christy proposed territorial use rights to fisheries (TURFs), relying on cooperative behaviour among operators when numbers are sufficiently small and gains are clearly evident. Other recent suggestions are forms of 'fishery self-government'. These alternatives include traditional self-governing management, co-management of common property fisheries, or corporate g o v e r n a n c e f Under unregulated open-access conditions, allocations are made essentially on a first-come, first-served basis. Hence, a formal allocation system is lacking, but an implicit system nonetheless exists by default since, by definition, access to the resource is open to all. Under open access, several allocation mechanisms are commonly used. Trip or effort limits place quantitative restrictions on the quantity of trip landings, trip frequency, or number and size of vessels (licence limitation systems). 3 Quotas on landings and trips frequency limits regulate resource removals, and hence allocate indirectly, but do not directly allocate access to the resource. Licence limitation directly regulates access to the resource rather than resource removals, because boats without licences cannot participate. Access to the resource is further restricted if licences are not transferable, but often most historical participants are eligible for participation 199

Direct allocation of resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires Authorship is alphabetical and equally shared. The authors are grateful to John Gauvin, Susan Hanna, Jim Hastie, Larry Jacobson, Gil Sylvia and Dick Young for numerous discussions and helpful comments on the analysis. All errors remain the responsibility of the authors. 1Initial allocation may be by auction, in which case the initial allocation is by the market. Initial allocation may also be gratis on the basis of historical participation, in which case it is non-market. The initial allocation affects the initial distribution of wealth but not subsequent opportunities to access the resource, nor overall economic efficiency. See W. Montgomery, 'Markets in license and efficient control programs', Journal of Economic Theory, Vol 5, 1972, pp 395-418. 2Co-management refers to a system of shared responsibility and authority between a local group of fishers and government with a constitutional mandate. For additional discussion see S. Jentoft, 'Fisheries co-management: delegation government responsibilities to fisherman's organizations', Marine Policy, Vol 13, pp 137-157, 1989 and E. Pinkerton, ed, CoOperative Management of Local Fisheries, University of British Columbia Press, Vancouver, 1989. Corporate governance refers to a corporate structure with stockholders. For further discussion, see R. Townsend and S. Pooley, 'Towards corporate models and fisheries governance,' Human Systems Management, in press. F. Christy Jr, Territorial Use Rights in Marine Fisheries: Definitions and Conditions, FAO, Rome, FAO Fisheries Technical Paper 227, 1982 presents the idea of TURFs. For discussions of self-governance see E. Ostrom, Governing the Commons: The Evolution of Institutions for Collective Action, Cambridge University Press, New York, 1990; G. Palsson, 'From commons to quotas: inequality in the Icelandic fishery', Mimeo, University of Iceland, 1993; and A. Scott, 'Obstacles to fishery self-government', Marine Resource Economics, Vol 8, pp 187-199, 1993. aComprehensive reviews of these issues in fisheries management are provided by M. Sissenwine and J. Kirkley, 'Fishery management techniques: practical aspects and limitations', Marine Policy, Vol 6, 1982, pp 43-57 or G. Munro and A. Scott, 'The economics of fisheries management', in A. Kneese and J. Sweeny, eds, Handbook of Natural Resource and Energy Economics, North-Holland Press, Amsterdam, 1985. 4This occurs in Indonesia. For the Malaysian case, see Ishak Haji Omar, Market Power, Vertical Linkage and Government Policy: The Malaysian Fish Industry, Oxford University Press, Singapore, forthcoming. 5See S. Herrick et al, 'Application of benefit-cost analysis to fisheries allocation decisions: the case of Alaska pollock and continued on page 201

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so that resource access is effectively open. Resource access for qualifying participants is mediated by the market if licences are transferable. In direct allocation of a resource amongst competing user groups under open access, group may be pitted against group. Regulators must explicitly allocate resources a m o n g individual user groups rather than rely on the comparatively anonymous 'invisible hand' of a market. Some examples include access to extended economic zones ( E E Z s ) by foreign fishers, bans on inshore trawling to protect traditional fisheries, 4 offshore and inshore catchers and processors of Alaskan pollock (Theragra c h a l c o g r a m m a ) , 5 and allocation of sablefish ( A n o p l o p o m a f i m b r i a ) between fixed gear and trawler vessels and Native Americans by the Pacific Fishery M a n a g e m e n t Council. Perhaps the most prominent direct allocation is that of total allowable catches or national quotas a m o n g m e m b e r s of the E u r o p e a n Union as part of the c o m m o n fisheries policy. One c o m m o n (although not strictly necessary) condition for direct allocations is overcapitalization of the fishery and its frequent companion, threatened resource stocks. A second condition is distinctive and coherent user groups that are sufficiently well-defined and directly compete for the limited resource. Allocations generally involve a fishery resource inside a nation's E E Z , since no authority exists in most other cases directly to oversee the allocation. In practice, another condition exists, that the value of the resource is sufficiently large to m a k e it worthwhile for fishery managers directly to allocate access to the resource. The process by which allocations are made is important because of the contentious nature of the problem and the prospect that losers may face financial losses, or even bankruptcy, 6 or be forced to leave the industry. Thus an open process can help to ensure compliance and p r o m o t e fairness. Moreover, in the absence of a market to ensure economic efficiency of the allocation, such as that found with individual transferable quotas or transferable licences, the allocative process should ensure that economic efficiency, as well as political and social factors, are considered in the allocation. 7 When economic efficiency suffers in an allocation, there is less economic surplus (rent) available. A loss of economic surplus can aggravate the tensions amongst competing groups, since there is even less economic surplus to go around, as well as lower the gains to society as a whole. The issues of perceived equity and fairness are important in any allocation, but are particularly so indirect allocations. Success in meeting these two conditions helps ensure industry compliance and approval by government bodies. Social issues, including e m p l o y m e n t and social cohesion and integrity of communities, can also play an important role in many instances. Resource conservation is also important, although the inherent tendency in direct allocations is to stretch the total allowable catches to the m a x i m u m permissible by the resource assessments or even to exceed them. In the final analysis, decisions may well involve a politically inspired compromise that fails to optimize any single concern but which should satisfy at least the minimum standards of economic efficiency, distributional equity, and formal requirements of legality, social impact analysis, resource conservation or optimization. Cost-benefit analysis is an appropriate approach to evaluate the

Direct allocation of resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires

continued from page 200 cod', North American Journal of Fisheries Management (in press). 6At least in the Western world and compared to other areas, institutions are frequently more formalized and may be less personal, and the formal rule of law may be more relied upon. 7In the USA, Executive Order 12866 of 30 September 1993 states that federal agencies, in choosing among alternative regulatory approaches, should select those approaches that maximize net benefits. These benefits are the assessment of the potential economic, environmental, public health and safety, and other advantages of each alternative regulatory approach,. The analysis of each approach is to also address distrributive impacts and equity. 8For recent surveys of cost benefit analysis see: J Dreze and N. Stern, 'The theory of cost-benefit analysis', in A.J. Auerbach and M. Feldstein, eds, Handbook of Public Economics, Vol II, Elsevier Science, Amsterdam, 1987; J. Dreze and N Stern, 'Policy reform, shadow prices, and marketprices', Journal of Public Economics, Vol 42, 1990, pp 1-45; and L. Squire, 'Project evaluation in theory and practice', in H. Chenery and T.N. Srinivasan, eds, Handbook of Development Economics, Vol II, Elsevier Science, Amsterdam, 1989. 9See K. Kohli, Economic Analysis of Investment Projects: A Practical Approach, Oxford University Press, 1993. 1°Consumer utility (the consumer's wellbeing or satisfaction) is unobservable and ordinal. The consumer's willingness to pay offers an observable, money measure of consumer satisfaction and preferences for goods and services, conditional upon the distribution of income and wealth, as revealed by consumer activity in the market. Willingness to pay for non-market goods and services can also be measured by various techniques; see A.M. Freeman III, The Measurement of Environmental and Resource Values, Resources for the Future, Washington, DC, 1993. 11Consumer surplus is the area under the demand curve and above the price line and producer surplus is the area above the supply curve and below the price line. Producer surplus is equivalent to quasirent or variable profits. See R. Just, D. Hueth, and A. Schmitz, Applied Welfare Economics, Prentice-Hall, Englewood, Cliffs, NJ, 1982; A. Dasgupta and D. Pearce, Cost-Benefit Analysis, Macmillan, London, 1978, R. Boadway and N. Bruce, Welfare Economics, Basil Blackwell, Cambridge, MA, USA; or E. Mishan, Cost Benefit Analysis, 4 ed, Unwin Hyman, London, for discussions of these topics and cost-benefit analysis in general.

economic efficiency effects for direct allocations of the resource among competing user groups. Cost-benefit analysis is an economic technique which systematically and formally evaluates that economic costs and benefits of the public policy, such as a direct fishery allocation, to maximize the net economic benefits to the nation as a whole. The balance of this paper discusses the technique of cost-benefit analysis for direct allocation of total allowable catches among competing user groups, and access to the resource. The approach is illustrated by a case study of a direct allocation of Pacific whiting (Merluccius productus) among competing offshore and onshore user groups that fish off the coast of Washington, Oregon, and California in the USA. Reflecting the growing globalization of fishery markets and investment found in many fisheries, significant foreign ownership and export markets are involved, which further complicate the issue and its resolution. The next section reviews the essentials of cost-benefit analysis that are relevant to direct allocations. This is followed by a discussion of the background of the allocation and the industry for Pacific whiting. The empirical findings and the implications for public policy are then discussed. Finally, concluding observations on the role of economic analysis for fisheries management decisions are offered. Cost-benefit analysis The objective of cost-benefit analysis is to measure the net national economic benefits or losses that would follow from alternative public policies such as allocations. 8 The proper comparison is 'with the policy' to 'without the policy' rather than 'before the policy'. For instance, certain changes may occur even without the project. These changes, to the extent they can be anticipated, should not be attributed to the policy and should be excluded from the estimate of costs and benefits. 9 Cost-benefit analysis evaluates the net benefits arising from changes in both consumer and producer net benefits. Because consumer and producer behaviour is expressed through the medium of monetary exchanges in markets, these benefits are measured in terms of money. Consumer benefits are measured by consumer surplus, m Consumer surplus is the difference between the price consumers are willing to pay for a product and the price they actually pay. Producer benefits are measured by producer surplus. Producer surplus is the difference between the price that producers are willing to supply a market and the price they actually receive. 11 The sum of changes in consumer and producer surplus less management and enforcement costs is the net benefit to the nation for allocating the resource. Consumers can gain or lose by the proposed allocations if the allocations change the quantity, price or quality of the product. Consumer benefits may change in three ways: (1) lower price for the same product (which involves transfer of value from producers to consumers); (2) changes in the amount of product (additional product is a net gain to society); and (3) allocation to producers that creates a higher quality, and hence higher valued, product. Several factors complicate measurement of consumer surplus changes. The number of different products and possible price changes would make estimation of changes in consumer surplus difficult. A 'path-dependency problem' might arise with multiple price changes since the measure of costs and benefits would depend not only on the

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12Unless the consumer's preferences can be represented by a homothetic or a quasilinear utility function, areas to the left of the consumer's Marshallian demand curves cannot be used to evaluate the consumer welfare change (P. Johansson, An Introductiuon to Modern Welfare Economics, Cambridge University Press, Cambridge, UK, 1991). R.D. Willig, 'Consumer surplus without apology', American Economic Review, Vol 66, 1976, pp 589-597, showed that (Marshallian) consumer surplus can satisfactorily approximate compensating or equivalent variations, which represent the correct Hicksian measures of welfare change, in many instances when the Marshallian consumer surplus is small relative to the consumer's income and when the income elasticity of demand is small. Measurement of compensating or equivalent variation requires estimation of Hicksian (income compensated) demand curves or estimating the Slutsky equation from Marshallian (ordinary) demand. See Just et al, op cit, Ref 11, and Boadway and Bruce, op cit, Ref 11. 13See D. Pearce, Cost-Benefit Analysis, 2 ed, Macmillan, London, 1983. 1"See R. Willig, op cit, Ref 12, Just, Hueth, and Schmitz, op cit, Ref 11, and Pearse, ibid. Intuitively, the problem is that we are measuring an area under a demand curve and calling it a gain in utility when one of the factors affecting the way utility is measured, namely nominal income, is itself changing. That is, utility is measured with a money indicator which itself changes as the price of the good changes. 'Compensated' demand curves remove this problem, since they indicate how utility varies with price but with money (nominal) income varied to control for this real income effect (keep the consumer on the same indifference curve). Consumer utility is then measured by compensating or equivalent variation. 15See Freeman, o19 cit, Ref 10, chapters 2 and 4.

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terminal prices but also on the paths to terminal price. That is, the change in total consumer surplus cannot be simply calculated by the change in consumer surplus in each market and summed since the order by which prices in each m a r k e t are changed gives different m o n e y measures of consumer surplus unless fairly restrictive conditions hold. ~2 A related problem occurs when a price change causes the demand curves of other products to change, which in turn alters the d e m a n d curve and consumer surplus measure in the m a r k e t of interest. ~3 If consumer surpluses change on the other products, they should ideally be taken into account. Still another similar problem is that the measuring rod of m o n e y changes as prices change, which can cause errors in consumer willingness to pay for a good. t4 In practice, there are not large margins of error if the simple measure of consumer surplus represented by the area under an ordinary ('Marshallian') d e m a n d curve is adopted. Some consumer benefits are non-market (there are no existing markets), so that deriving a monetary measure poses another complication. Some examples are environmental services or public goods (goods jointly consumed by the public such as national defence). Effectively, a monetary measure is indirectly or inferentially obtained based on some hypothesized relationship between the observable demands for marketed goods and the unobservable demands for non-market measures. The indirect observable methods are based on actual observations of behaviour, while the indirect hypothetical methods are based on responses to hypothetical questions about choices and activities under alternative circumstances. ~5 Producer surplus can be affected by an allocation if a producer: (1) enjoys lower production costs; (2) produces a higher quality product, and hence receives a higher price; or (3) produces a greater quantity of output. Cost-benefit analysis is an economic, rather than financial, analysis. An economic analysis focuses on the costs incurred, and benefits enjoyed, by society from real resource use measured at the actual time of expenditure or receipt. Financial analysis focuses on the costs and benefits faced by private firms and individuals. To estimate economic costs and benefits, several adjustments are made to financial costs and benefits. First, some payments that appear in the cost data for financial analysis do not represent direct claims on the country's resources. These financial payments merely reflect a transfer of resources from one m e m b e r or sector of society to another. From the perspective of society as a whole, these transfer payments are irrelevant and are not considered in benefit-cost analysis. Transfer payments excluded from the analysis include taxes, interest payments, and depreciation. These are merely transfers from firms to the public sector and are excluded from the analysis, unless the taxes are payments from foreign firms (otherwise lost as foreign leakage). Subsidies, in contrast, represent real resource costs to society and must be accounted for. Principal and interest repayments on domestic loans simply transfer purchasing power to the lender and are not included in an economic analysis of net benefits to society. The financial cost of a loan occurs when the loan is repaid, but the economic cost occurs when the borrower actually spends the loan. Depreciation allowances may not correspond to actual use of resources, and should therefore be excluded from a benefit-cost analysis.

Direct allocation o f resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires Table 1. Key differences between economic and financial analysis.

16See L. Squire and H. van der Tak, Economic Analysis of Projects, Johns Hopkins University Press for World Bank, Baltimore, 1989 for a more comprehensive discussion of this approach. However, in an era of increasingly globalized fishery markets (vessel, harvesting rights, exvessel and processed products) the applicability of this accounting stance may become more questionable. It also favours an autarkic (closed) economy and does not fully capture the gains from trade. 17Most fisheries are examples of a situation with external costs due to incomplete property rights leading to open access. This includes a fishery under licence limitation, since property rights remain incomplete. See and G. Munro and A. Scott, op cit, Ref 3, and P. Neher, Natural Resource Economics, Cambridge University Press, Cambridge, UK, 1990, for further discussions. A distinction is increasingly drawn between open access and common property resources. G. Stevenson, Common Property Economics, Cambridge University Press, Cambridge, UK, 1981, notes that common property limits the number of users and implies limited use by a definable group of co-owners. As a resource management institution, common property lies between open access and private property. 18See Kohli, op cit, Ref 9. ~gTechnically, these are pecuniary externalities which arise from changes in relative prices following a project or policy. For example, prices for some economic inputs may rise, causing an increase in incomes. 2°An opportunity cost is the cost of the next best alternative. It represents the economic cost of any situation. When markets are competitive, market prices represent opportunity costs. Willingness to pay represents the amount of money consumers would pay for a commodity. Marginal willingness to pay is measured by market prices. 21These secondary costs and benefits are frequently measured by economic impact multipliers from input-output analysis, which measure the secondary impacts as changes in income and employment from an initial dollar of spending.

Item

Economic

Financial

Taxes by domestic firms Taxes by foreign firms Subsidies Benefits to foreign firms Interest Depreciation

No Yes Yes No No No

Yes Yes Yes Yes Yes Yes

Leakages of net national benefits (positive or negative) that accrue to foreign owners are not generally included in the present value of net benefits, unless these benefits are reinvested. 16 That is, the accounting stance is the present nation state. Tax payments by foreign owners would nevertheless accrue as a benefit to the nation and hence are transfer payments are that would be included in the net benefit stream. A n y gains in consumer surplus enjoyed by consumers in other nations are also excluded in the conventional practice. Table 1 summarizes the key differences in terms of transfer payments, between an economic and financial analysis. The table indicates whether or not a cost or benefit is economic or financial. In practice, financial cash flow data on costs and benefits streams are adjusted according to the table to provide the stream of economic costs and benefits. A second broad adjustment to financial costs and benefits is to recognize that cost-benefit analysis evaluates net benefits from the standpoint of the nation. Hence, all costs and benefits both private and external, must be considered. An external (production) cost is said to exist if the actions of one producer adversely affect other producers or consumers without the mediation of a market. U n d e r these circumstances there is said to be an 'externality' giving rise to a ' m a r k e t failure'. 17 In sum, these external effects are not reflected in the financial accounts of firms but are real costs or benefits to the nation and must be counted. A third broad adjustment to financial costs and benefits follows from recognizing that the financial and economic boundaries of a project may differ. In financial analysis, the boundary is defined by the policy or project's output, while in economic analysis, the boundary is defined by the policy or project's benefits. All costs required to be incurred to achieve the project's benefits should be taken into account, irrespective of whether or not they are included in the financial cost.18 For example, the economic costs of individual transferable quota p r o g r a m m e s include all costs incurred for enforcement, monitoring, and resource assessment. An issue related to the boundaries of a policy or project is secondary costs and benefits.19 These are increases or decreases in the incomes of factors of production providing services to beneficiaries from the output of a project, or providing services to those who supply inputs for the operation of a project. These are not included in cost-benefit analysis when opportunity cost or willingness to pay is used to measure value costs and benefits because all costs and benefits are adjusted to reflect their effect on national income, z° Inclusion of increased output and incomes through secondary spending would be double counting, since the valuation already reflects the gains to suppliers and processors. 2x These secondary costs and benefits are frequently transfer payments in economic rents from one sector of society to another, and are therefore

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Z2Specifically, market prices may not accurately measure (marginal) opportunity cost or (marginal) willingness to pay. Shadow prices, in theory, do provide accurate measures but are seldom calculated in practice. The primary exception is in applications to countries with severe imperfections in markets for capital, labor, or foreign exchange. For additional discussion, see Dreze and Stern, op cit, Ref 8, Squire, op cit, Ref 8, and Squire and van der Tak, op cit, Ref 16. 23For further discussion, see Squire and van der Tak, op cit, Ref 16; C. Clark, H. Clarke, and G. Munro, 'The optimal exploitation of renewable resource stocks: problems of irreversible investment', Econometrica, Vol 47, No 1, 1979, pp 25-47; and R. Pindyck, 'lrreversibility, uncertainty, and investment', Journal of Economic Literature, Vol XXlV, No 3, 1991, pp 11101148. 24The interest rate for financial analysis is derived from the real cost of borrowed funds. The discount rate in economic analysis is determined by either the social opportunity cost of capital or the social rate of time preference. The former reflects the community's real rate of time preference and the latter reflects the real productivity of capital. When capital markets are undistorted, the two measures are equivalent, but in practice one is typically favoured over the other depending on the application and location. The discount rate is 'real' or inflation free. For a comprehensive discussion, see R. Lind, 'A primer on the major issues relating to the discount rate for evaluating national energy options', in R. Lind, ed, Discounting for Time and Risk in Energy Policy, Resources for the Future, Washington, DC, 1982.

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not included in a cost-benefit analysis which uses opportunity cost or willingness to pay. A fourth broad adjustment to financial costs and benefits is valuation of them in terms of economic prices which are also adjusted for the effects of inflation. In some instances, such as important distortions in trade (eg quotas, tariffs) or markets for intermediate inputs or capital, market prices may not provide the appropriate basis for economic valuation. 22 Instead, 'shadow prices' are used to measure the economic value accurately. It is sometimes held that fishers may have few meaningful e m p l o y m e n t opportunities outside fisheries, despite sometimes high m o n e t a r y returns to crewmanship, so that the 'shadow' or economic price (the real marginal opportunity cost) of labour is low. H o w e v e r , shadow prices are difficult and expensive to calculate, often lack credibility, and are r e c o m m e n d e d against except in some countries with highly distorted labour markets or persistent high rates of regional unemployment. One cost item which merits special attention in fisheries is sunk costs. Sunk costs are defined as those costs which have been incurred before the policy action and cost-benefit analysis that cannot, therefore, be avoided. Sunk costs should be excluded from the cost-benefit analysis since only costs that can still be avoided m a t t e r Y Capital costs of vessels and processing facilities could be excluded in an analysis if these investments have mostly already been made. The cost-benefit analysis would then focus primarily on operating (variable) costs. Nonetheless, new investment and terminal (scrap) value would be included as a real economic cost in the analysis. A form of double counting of costs and benefits occurs when increases in wages, incomes, and e m p l o y m e n t are counted as policy benefits. F r o m the standpoint of the nation, these are counted as economic costs since they involve expenditure of real amounts of scarce resources to produce the policy or project outputs and benefits. Cost-benefit analysis frequently uses a budgeting approach, allowing analysis on electronic calculators or spreadsheets. This inherent linear model implicitly assumes constant returns to scale, ie that unit production costs are constant for any level of production. This assumption is reasonable for allocation options that are not too different from the status quo. The approach also allows greater transparency than do more complicated econometric or mathematical p r o g r a m m i n g models of the method and results to policy makers and user groups, thereby enhancing the confidence in the analysis necessary for successful public policy. A fundamental problem in cost-benefit analysis is that resources are used or benefits are created at different times. A dollar of net benefit in a future year is worth less to society than a dollar of net benefit in the current year. Hence, to give standard units to net benefits over a n u m b e r of years, future benefits are discounted to place all dollars of net benefits in present value. The general formula for net present value is: Zt=0 . . . . . T N B t NPV

=

(1 + 6)' where N P V = net present value, t = 0 is current time, T is terminal time, N B t is net benefits in time t, 6 is the interest rate, and q~ = 1/(1 +~))t is the discount factor. 24 Net benefits in time t (NBt) = B t - Ct, where Bt is the monetary value of benefits at time t and Ct is the

Direct allocation of resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires

25For the case of budget constraints, see R. Sugden and A. Williams, The Principles of Practical Cost-Benefit Analysis, Oxford University Press, Oxford, UK, 1978. =SWhen equal weight is given to all gainers and losers of a public policy, it is felt that the gainers can compensate the losers and society still remain better off (a Pareto improvement). This is often called the potential Pareto or Kaldor compensation principle. See Just et al, op cit, Ref 11, and Boadway and Bruce, op cit, Ref 11, for additional discussion. For a systematic approach to selective weighting of different societal groups to incorporate distributive issues, see Squire and van der Tak, op cit, Ref 16. For an excellent application to fisheries, see S. Mishra and J. Beyer,

Cost-Benefit Analysis: A Case Study of the Ratnagiri Fisheries Project, Hindustan, Delhi, 1976. However, with the role of the state in capital accumulation diminishing, and primary resonsibility for accumulation and growth resting with the private sector, the state will increasingly provide supportive services and less investment. The state cannot be expected to carry the burden of bringing about distributional changes in the economy when its role is diminished. See Kohli, op cit, Ref 9. 2VSee J.P. Gittinger, Economic Analysis of Agricultural Projects, Johns Hopkins Press for The World Bank, 1982, for the single most accessible book on this and all issues of applied cost-benefit analysis. Risk analysis provides a more sophisticated and difficult treatment of uncertainty. Risk analysis determines probabilities of occurrence, which are determined for all critical policy elements, and by Monte Carlo analysis repeated computations of net present value are made. Each element enters in successive computations according to its probability of occurrence. The result is typically reported in a cumulative probability curve. See L. Pouliquen, Risk Analysis in Project Appraisal, Johns Hopkins Press, Baltimore, MD, 1970 and Mishra and Beyer, op cit, Ref 26.

monetary value of costs in time t. The decision criterion for cost-benefit analysis of public policies which are not affected by an overall budget or investment constraint on public spending is to maximize net present value. 25 The time horizon used to compute present value could be very long or even infinite. For example, the resource stock might be expected to reach its long-term equilibrium level soon or the economic life of the investment might be long. The net present value of an asset over an infinite time horizon (or a very long time period) for a stream of equal annual net benefits is the value of an annuity, N B t / 6 . The allocation which maximizes net present value generates the greatest net benefits to society and is optimal if the sole concern is to maximize economic efficiency. Typically, however, distributional concerns replace economic efficiency as the most important goal for decision makers in fisheries. Standard cost-benefit analysis gives equal weight to all gainers and losers in society, although it may be felt that some groups in society should receive greater or lesser weight. 26 There may be considerable uncertainty about several of the variables important to a cost-benefit analysis. Some of the most important areas of uncertainty for a fishery might include product recovery rates, variable (operating) costs, product and fuel prices, and discards. Simple averages of important variables are often available but may not fully represent the diversity seen in a fishery. In addition, markets, biomass, total allowable catches, and production conditions might be subject to considerable fluctuations so that simple averages or projections based on a limited number of observations might not fully capture the full range of possible resource, market, and production conditions. Sensitivity analysis investigates effects of variations in key variables and central assumptions on net benefits. The value of key parameters are varied in a systematic manner to evaluate the effects upon estimates of net benefits to the nation. 27

The pacific whiting fishery Pacific whiting is a cod-like species occurring along the west coast of North America from northern Mexico to Canada. There is a separate stock found within Puget Sound, Washington and British Columbia, but that stock is not involved in this discussion. Whiting have been found from the surface to a depth of 500 fathoms, with most of the population found in waters 25 to 275 fathoms deep over the continental slope and shelf. The coastal stock of adults migrates seasonally, wintering and spawning along the continental slope and offshore from Baja California, Mexico to Point Conception, California. During the summer, they move northward as far as northern Vancouver Island (Queen Charlotte Sound), British Columbia and inshore, influenced by food and currents. In fall, the stock returns southward and offshore to spawn. Because of their migratory nature, the fish are not uniformly available either geographically or temporally. Whiting may reach three feet in length and exceed five pounds, although fish of this size are unusual. The average size of whiting taken in the commercial fishery varies from year-to-year as a result of variation in growth, size-dependent migration and fishing location, and recruitment of stronger year classes which may reduce growth. Pacific whiting is the single largest groundfish stock managed by the

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Direct allocation o f resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires"

Pacific Fishery Management Council (hereafter the Council). The whiting fishery uses mid-water trawl gear and targets on whiting in dense feeding aggregations of fish along the shelf break from April to November. Traditionally, the foreign and joint venture fisheries followed the migrating stock, usually starting off from central Oregon in early to mid-April and working northward. Because Pacific whiting disperse through the water column at dusk and remain near the surface at night, fishing traditionally took place during daylight hours. With the advent of surimi technology, participation by high-volume processors, and increased harvest and processing capacity, the traditional fishing pattern was replaced by a fast-paced fishery concentrating earlier in the season and further south. During the 1970s and early 1980s, most of the Pacific whiting harvest was taken by foreign fishing and processing operations. Beginning in the 1980s, US fishers took an increasing share of the harvest, mostly delivering to foreign processing ships but also a relatively small amount to domestic processing plants on shore. In 1991, facing increased competition and reduced opportunities in Alaska, large US processing vessels and catcher-processor (factory trawler) vessels entered the whiting fishery. This entry displaced all foreign activities and reduced opportunities for domestic vessels that had previously harvested whiting for delivery to foreign processing ships. US shore-based processing plants, which historically had limited participation, did not want to lose their opportunity to expand into this fishery as well. The Council and the federal government tried to develop an allocation for managing this rapidly developing and evolving fishery. In July 1993, the Council appointed a committee representing each sector of the industry to try to develop a framework for resolving the allocation issue. That committee negotiated an agreement for 1994-96 and each member pledged to support the agreement before his constituents as an acceptable plan. The Council considered three alternatives for allocating whiting. Alternative 1, the Council's and industry's preferred alternative, made the first 60% of the whiting harvest guideline available to all vessels under an open competition. The remaining 40% was reserved for shore-based activities. When the 60% was harvested, no further at-sea processing would be allowed for the remainder of the year or until 15 August, when an additional portion of the harvest guideline might be made available. Alternative 2 would have continued the 1992-93 percentage shares (30% for vessels delivering shoreside, 70% for at-sea processing). When at-sea operations landed 70% of the harvest guideline, further at-sea processing would be prohibited for the remainder of the year or until an additional amount of whiting was made available. When the remaining harvest guideline was taken, a trip limit would be implemented to terminate directed fishing and allow only incidental landings for the remainder of the year. Alternative 3 was the status quo. Under this option, there would be no allocation after 31 December 1993. The 1994 season would open on 15 April with open competition until the harvest guideline had been taken. At that time, a trip limit would be implemented to terminate the directed whiting fishery but allow for continuing incidental landings.

Cost-benefit application The cost-benefit analysis focused upon net changes in producer surplus

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Direct allocation o f resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires

28The market for white fish products among the USA, Europe, and Japan is today an international market without significant trade barriers in the form of quotas and tariffs. There is a high degree of substitution between products of different species and between different products made from the same species.

following each option for allocating Pacific whiting. Changes in consumer surplus were largely ignored. There were several reasons for this approach. Most of the whiting production by at-sea and shore-side operations is for surimi which is usually exported. Export sales do not benefit domestic consumers (through consumer surplus) and can be excluded from the analysis. Minor amounts of fillets and headed and gutted ( H & G ) whiting products are produced and consumed domestically. Changes in consumer surplus due to production of fillets and H & G products would probably be small, however, because the market for these products is small. Another reason for the focus on producer surplus was that processed products made from Pacific whiting, especially fillets and surimi, are sold in very competitive markets with a number of substitutes so consumer prices are not likely to depend on supply of whiting. Markets for whitefish products, especially surimi, are global and Pacific whiting accounts for only a very small market share. 2s Alaska pollock, for example, is often substituted for whiting so changes in supply of H & G whiting or fillets would probably be made up for by pollock with no impact on consumers. Furthermore, surimi sources are expanding to include additional species from other parts of the world. Hence, it is reasonable to assume that prices to consumers will not be affected by allocation of Pacific whiting. If Pacific whiting prices are unaffected by the allocation, there will be no change in consumer surplus. One external cost was explicitly valued, by-catch (fish caught with the whiting). By-catch of species other than whiting represents an external cost because when discarded, and suffering high mortality rates, it cannot be harvested by other fishers. This external cost was calculated as an opportunity cost of the lost gross revenue from discarding. This approach overstates the external cost since net revenue foregone is the appropriate measure, but calculation of this measure aquires unavailable estimates of operating costs of all impacted gear groups. Other external costs exist, but there was no clear way to estimate them. These additional external or social costs include: (1) possible congestion or pollution effects from rapid growth of onshore processing and the subsequent expanded demand for labour; (2) marine pollution from both onshore and offshore processing plants (possible adverse impacts on marine life or tourism, hazards to human health, and reduced water quality). These factors were considered by decision makers but not included in calculations. External costs which are equally shared by both the offshore and onshore sectors may also exist. Example of these costs include effects upon the ecosystem, and hence the production of other species, losses to any recreational fisheries, etc. Additional external costs may be generated by the allocation decision. Early harvesting of whiting by the offshore sector may affect: (1) catch per unit effort (productivity); (2) seasonal trends in rockfish by-catch; and (3) whiting sex ratio. These issues were beyond the scope of the analysis. Foreign ownership and financing of both offshore and onshore were acknowledged but not evaluated due to difficulties of untangling ownership. The analysis assumed that the present state of technology and market environment would persist. The analysis assumed that the annual allocation would be entirely harvested in each year. The analysis further assumed that no new vessels or processing plants would be constructed. Thus, it was assumed that sufficient capacity exists among all groups to

207

Direct allocation o f resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires Table 2. Present value of net economic benefits observed surimi prices ($'000 000).

Notes: C/P = catcher-processor; C/P as mothers

Alternative

C/P

C/P as mothers

Shoreside

Mothers

Total

Rank

= catcher-processors functioning as mothers under licence limitation; shoreside = head-andgutted, fillet, surimi, waste processing and catching; Mothers = mothership and catchers.

1 2 3

3.741 3.950 4.763

6.615 6.749 8.497

10.304 9.748 2.583

6.439 6.572 8.252

27.099 27.019 24.094

1 2 3

preclude additional, new investment. The analysis assumed that replacement investment of plant and equipment was the same among all groups. Neglecting replacement investment biases net benefits upward but equally for all groups. Minimal replacement investment was expected, however, because the planning horizon was only three years. The analysis assumed, with some modifications for the effects of licence limitation, that the conditions of 1992 and 1993 would continue for the next three years. A 5% real discount rate was applied. 29 Data on costs, earnings and the production for 1992 were obtained from cost and production surveys of: (1) offshore catcher-processors; (2) mother ships and catcher vessels; and (3) onshore processors, catcher vessels, and plants producing fish meal and pellets for fish and animal food. Cost and production data for 1993 were obtained partly by plant or headquarters visit, partly by cost and production survey, and partly as an adjustment to existing 1992 data. Surimi prices in 1992 were from the National Marine Fisheries Service Processed Products Survey. All data were valued in 1993 dollars by use of the gross national product implicit price deflator. In general, averages weighted by proportion of total harvest over 1992-93 were used in the analysis. Pacific Fishery Management Council (1993) provides additional details. 3°

Results of cost-benefit analysis and policy implications

29The real interest rate is defined by: 1 + r = (1 +R)/(1 + g ) , w h e r e r is the real interest rate, g is the rate of inflation, and R is the nominal interest rate. As an approximation, r = R - g. S e e P. Johansson, An Introduction to Modern Welfare Economics, Cambridge University Press, Cambridge, UK, 1991. 3°Pacific Fishery M a n a g e m e n t Council,

Pacific Whiting Allocation: An Analysis of the Anticipated Biological, Social and Economic Impacts of a Proposal to Allocate the Resource in 1994, 1995, and 1996, Portland, OR, 1993.

208

The cost-benefit analysis evaluated the three alternatives over 1994-96 to measure the net economic efficiency benefits (EEB) to the nation of allocating Pacific whiting among offshore catcher-processors, offshore motherships and their catcher vessels, and onshore harvesters and processors of surimi, headed and gutted, and fillets. The net E E B were measured as the present value of producer surplus. These net economic benefits per round tonne allocated were derived by multiplying the net economic benefits per round tonne by the round metric tonnage allocation. The results, reported in Table 2, indicate that Alternative 1 was preferable to Alternative 2 which in turn was preferable to Alternative 3, ie the rank of net E E B to the nation was: (1) Alternative 1; (2) Alternative 2; and (3) Alternative 3. However, the net E E B differences between Alternatives 1 and 2 were slight, and given the uncertainty in the data and markets, should be considered indistinguishable. In sum, Alternatives 1 and 2 generated equivalent net E E B and Alternative 3 generated slightly lower net EEB. Hence, both new management options generate higher net E E B to the nation than an unmanaged, status quo open-access fishery. Net economic benefits per round pound and tonne of Pacific whiting harvested shed additional light on comparative economic efficiencies between groups. These values were from highest to lowest (Table 3): onshore production of headed-and-gutted and filleted whiting; (2) offshore catcher-processors; (3) mother ships; and (4) and onshore producers of surimi and fillets.

Direct allocation o f resources and cost-benefit analysis in fisheries: S Freese, ] Glock and D Squires Table 3. Net economic benefits ($) per round poud of Pacific whiting ($/Ib) observed surimi price. Offshore Mothers

Onshore Surimi & fillet

0,7504 0.1122

0,6521 0,07942

0.2284 0.0102 0.0488 0.1492

0.1271 _a _a 0.2564 0.0201 0.0321 0.1392

0.0473

0.0434

_a 0.1560

0.5896 _a 0.1560

0.1001 0.0002 0.1003

0.1046 0.0002 0.1048

0.1016

0.1500

0.1016 0.0026

0.1500 0.0026

0.0183 40.419

0.0175 38,596

0.0066 16.479

0.0818 213,484

C/P

aConfidentiality precludes reporting. Information is the average of 1992 and 1993 data.

Total revenue per Ib Surimi Surimi rnd wt Head-and-gutted Head-and-gutted rnd wt Fillets Fillets rnd wt Meal and oil Meal, oil, compost rnd Catchers in rnd wt PRR Su rimi PRR Head-and-gutted PRR Fillets PR R Meal Variable Economic Costs per Ib rnd wt No external costs Bycatch external costs All Costs Bycatch external benefits Net Economic Benefits Per Ib rnd wt Per mt rnd wt

0,7837 0.1111

0.2355 0.0076 0.1449

H&G, fillet

0.3309 0.1271 _a _a 0.2564 0.0524 0.0422

The key factors varied among groups and were critical in the analysis: (1) surimi price; (2) net economic benefits per round tonne of whiting of waste utilization; (3) and net economic benefits from onshore production of head-and-gutted and fillets. Product recovery rates for surimi were very close for all surimi processors and hence did not play a substantial role in affecting the sensitivity of the results. A sensitivity analysis was conducted for each of the three critical factors. First, the offshore catcher-processors and motherships enjoyed somewhat higher surimi prices than did the onshore processors. Surimi price differentials between the onshore and offshore sectors proved highly contentious and provoked considerable debate on issues of quality, consignment, marketing channels, and other causal factors. Because no consensus was ever reached by all industry groups, the sensitivity of ranking of present value of net benefits were evaluated by employing a common surimi price of $0.65 per pound but the rankings of options was unchanged (Table 4). The second key factor, net economic benefits per round tonne of Pacific whiting from waste utilization, added important economic benefits to onshore whiting processing. Waste includes whole fish not accepted for processing (eg poor condition), called 'weighbacks', and offal. The onshore sector, required by law to utilize waste fully, produced fish meal and oil, compost, potting soil, transplant mix, and fish food pellets. Waste utilization generated about $0.02 per round pound of net benefits for the onshore sector as opposed to about $0.01 per round pound for onshore catcher-processors and motherships. A sensitivity analysis applying an equal price for products made from the Table 4. Present value of net economic benefits $0.65/Ib surimi price ($'000 000).

Notes: C/P = catcher-processor; C/P as mothers = catcher-processors functioning as mothers under licence limitation; shoreside - head-andgutted, fillet, surimi, waste processing and catching; Mothers = mothership and catchers.

Alternative

C/P

C/P as mothers

Shoreside

Mothers

Total

Rank

1 2 3

0.127 -0.134 -0.162

0.943 0,962 1,211

10,236 9.683 2,566

0.918 0,937 1,176

11.969 11.447 4.791

1 2 3

209

Direct allocation o f resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires Table 5. Present value of net economic benefits, offshore waste price same as onshore

($'000 000). C/P as Notes: C/P = catcher-processor; C/P as mothers

Alternative

C/P

mothers

Shoreside

Mothers

Total

Rank

= catcher-processors functioning as mothers under licence limitation; shoreside = head-andgutted, fillet, surimi, waste processing and catching; Mothers - mothership and catchers.

1 2 3

3.878 4.095 4.937

7.526 7.678 9.667

10.304 9.748 2.583

7.325 7.477 9.388

29.038 28.997 26.574

1 2 3

Table 6. Present value of net economic benefits, nine catch-processors as mothers, three mothers ($'000 0OO). C/P as Notes: C/P = catcher-processor; C/P as mothers

Alternative

C/P

mothers

Shoreside

Mothers

Total

Rank

= catcher-processors functioning as mothers under licence limitation; shoreside - head-andgutted, fillet, surimi, waste processing and catching; Mothers = mothership and catchers.

1 2 3

0 0 0

15.353 15.653 20.994

10.417 9.866 0.291

1.201 1.235 1.690

26.972 26.754 22.975

1 2 3

waste for both the onshore and offshore sectors indicated no change in rankings of options in terms of net present value (Table 5). The third factor was the relatively high value for net benefits per round pound of whiting from headed-and-gutted and fillets, $0.08. While market opportunities may be limited, this process generated relatively high net benefits per round tonne. A sensitivity analysis was not performed on this factor since the price was deemed reasonable and stable by all parties, the proportion of total production was comparatively small, and this market niche represented traditional use not in direct competition with onshore or offshore surimi producers. The effects of a licence limitation programme on groundfish trawlers beginning in 1994 were exceptionally difficult to evaluate and factor into the analysis since the programme had not yet begun at the time of analysis. Purchases of permits by offshore vessels not qualifying represent transfer payments from one group in society to another and as such do not alter net benefits to the nation as a whole. The analysis assumed that catcher-processors not purchasing permits would function as mother ships, and in light of no existing information or even wellformed opinions by industry participants, were assumed to have the same costs as mother ships. Because of the extreme uncertainty over the whiting sector under licence limitation, sensitivity analysis allowed for nine catcherprocessors functioning as mother ships along with three other ships. The results did not change the rankings of net present values (Table 6). Resource assessments and harvest guidelines represent another important source of uncertainty. A sensitivity analysis indicated that the rankings of net present value were again robust when the 1994 harvest guideline was followed in all three years (Table 7). In sum, the rankings of net present value of net benefits to the nation remained constant under all sensitivity analyses. Under all scenarios, Alternatives 1 and 2 were similar, with Alternative 3 placing a consistent third. Table 7. Present value of net economic benefits 1994 harvest guideline all years ($'000 O00). C/P as Notes: C/P - catcher-processor; C/P as mothers

Alternative

C/P

mothers

Shoreside

Mothers

Total

Rank

- catcher-processors functioning as mothers under licence limitation; shoreside = head-andgutted, fillet, surimi, waste processing and catching; Mothers - mothership and catchers.

1 2 3

4.733 4.733 5.613

8.408 8.408 9.984

10.417 10.244 3.646

8.198 9.198 9.774

31.755 31.581 29.017

1 2 3

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Direct allocation of resources and cost-benefit analysis in fisheries: S Freese, J Glock and D Squires

Concluding remarks

31For example, the recent French disturbances in their fishing industry can be viewed as a reaction to increasingly globally integrated ex-vessel and processed product fish markets. Protests and problems in competition against inexpensive imported fish illustrate the problems increasingly facing many fisheries as they must operate in highly competitive globally linked markets. 32perhaps the future role of individual transferable quotas will be to foster the economic competitiveness required to compete in global fish markets. High-price local fish will increasingly face stiff competition from high quality imports.

This paper reviewed the essential elements of cost-benefit analysis and applied this approach to a case study of a direct allocation of Pacific whiting in the USA among three competing user groups. The study found only minimal differences in present value of net benefits to the nation amongst the three policy options evaluated, although this would not necessarily be the case for cost-benefit analyses of other public policies or fisheries. In comparison to the status quo, all options represented a real gain in the present value of net economic benefits to the nation. Encouragingly, any politically and socially acceptable policy compromise following the Alternatives to the status quo raises economic efficiency and net benefits. The approach can be applied to many forms of fishery resource allocations among competing national or international user groups. For example, cost-benefit analysis may be helpful in allocating total allowable catch and national quotas amongst nations of the European Union, particularly should resource-rich nations such as Norway elect to join the Union. The actual importance of economic analysis and economic efficiency varies depending on the situation. In practice, in the USA economic efficiency frequently plays a smaller role than the socio-economic issues of income and employment, particularly since many fisheries may serve as the employer of last resort for residents of small local communities. In addition, because the total economic value of most fisheries is usually small in comparison to the total economy, losses in economic efficiency for distributional gains are felt to be inconsequential. Political, legal, and social issues tend to weigh heavier in practice than economic efficiency, albeit frequently on an implicit rather than explicit basis. Concerns of biological yield and conservation also play central roles in any form of fisheries management, including direct allocations. These latter concerns, along with economics, frequently tend to serve as de f a c t o constraints limiting the terrain over which political, legal, and social concerns can range. In short, the proper role for economic efficiency and cost-benefit analysis in fisheries may often be as a guide for comparing alternatives in light of their effects on economic efficiency, not to optimize net economic benefits, but rather to ensure that alternatives under active consideration comply with acceptable standards of economic efficiency. The importance and role of economic efficiency and economic analysis may change in the future. As fisheries throughout the world are increasingly coupled through globally integrated markets for ex-vessel and processed fish, fuel, capital (affecting interest rates and loan availability), and even vessels, fisheries management formulated in neglect of globalization faces the risk of increasing ineffectiveness. Economic efficiency can be expected to grow in importance to foster the economic competitiveness required by the increasing market governance of the world's fisheries. 3~ It will become increasingly difficult to manage the world's major fisheries in isolation and with continued disregard for economic efficiency. 32

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