Improving cost-efficiency of conservation auctions with joint bidding

Abstract

Most current models of conservation auctions are incompatible with the assessment that there are environmental externalities and synergies between bidders. Yet, conservation auctions are usually set up for the very purpose of addressing problems associated with environmental externalities. Clearly, these models do not tell the whole story, and they consequently fail to identify waste and inefficiency in these auctions. This paper shows how externalities between bidders can be incorporated into our models of conservation auctions and uses this framework to investigate the cost-efficiency of the uniform-price auction when neighbours can bid jointly. Allowing neighbours to bid jointly allows them to internalise these externalities, but also reduces the competitiveness of the auction. The net effect on cost-efficiency is ambiguous, so we show how simulation can be used as a practical tool to determine in what circumstances joint bidding can be expected to reduce the payments needed to secure a given amount of ecosystem services.

Keywords:

• payments for ecosystem services
• multi-unit auctions
• externalities
• joint bidding

Acknowledgements

am grateful of Malcolm Pemberton's advise and encouragement in the preparation of the work that has formed the basis for this paper. I would also like to thank Christian Johansson, Antony Millner, Sam Fankhauser and Carmen Marchiori for their helpful comments on earlier drafts, as well as conference participants at the 4th World Congress of Environmental and Resource Economists and envecon2010. Finally, thanks to the editor and two anonymous referees for their suggestions. Remaining errors, naturally, are my own. Financial support for this work has been generously provided by the Jan Wallander and Tom Hedelius Foundation, the Grantham Foundation for the Protection of the Environment, and the Centre for Climate Change Economics and Policy, which is funded by the UK's Economic and Social Research Council and by Munich Re.

Notes

 1. There is also a literature on ecological agglomeration bonuses, such as those created by getting non-cooperative bidders in an auction to form contiguous habitats for biodiversity conservation (Parkhurst et al. 2002, Parkhurst and Shogren 2007, Saïd and Thoyer 2007, Banerjee et al. 2009). The issue addressed in this paper is more general, although the link between the two problems is considered a little more closely in the conclusion.

 2. A standard reference is Latacz-Lohmann and van der Hamsvoort (1997).

 3. For an application of interdependent valuations in a different but related context, see Irwin and Bockstael (2002).

 4. Notice that every possible graph with I vertices is nested in the complete graph obtained for L = I and can be obtained simply by letting some edges be associated with externalities of zero magnitude. Thus, this basic structure permits analysis of any graph the researcher may find of interest.

 5. If the size of externalities depends on scale of production, then

must satisfy whenever

. Otherwise, we have both υ ⁱⁿ  > υ ^jn and υ ⁱⁿ  < υ ^jn . This makes it very difficult to make any reasonable a priori guess about which neighbour in n will submit the highest bid (although we can analyse both possibilities), unless we have more information about the bargaining problem. Of course, the neighbourhood may be fully able to resolve the question whether or not we know enough to predict the outcome.

 6. In practice, of course, a particular individual will be associated with a given production technology and located in a particular environmental context, so that his individual valuation and externality is completely determined. However, the policy maker's problem is one of asymmetric information, and this set up allows us to analyse the problem when we only know about the distributions of individual valuations and externalities in the population.

 7. See Krishna (2002) for a proof.

 8. If neighbours merged their production activities, neighbourhoods could be treated as ‘individuals’, and there would be no externalities to start with. Notice that if we tried to achieve this artificially by designing the auction so that each neighbourhood could submit only a single bid covering the conservation activities of the entire neighbourhood, we would be forced to either award contracts to every member of a neighbourhood, or none. This would be inefficient because we could only award contracts on the basis of ‘aggregate neighbourhood bids’, rather than the ‘marginal bids’ of each individual within a neighbourhood.

 9. A proof that can be found in Noussair (1995).

10. Noussair (1995) considers a slightly different formulation of the underlying problem than presented here. First, what we call neighbourhoods, Noussair imagines as inseparable entities, which means that valuations do not have the structure of being sums of random variables. Second, he considers a standard auction (i.e. valuations are positive), while we are considering a reverse auction (i.e. valuations are negative). Third, there is a zero-payoff from loosing in Noussair's auction, while in our problem individuals still make a profit if they loose. Noussair's result is presented here with these alterations, but the form of the proof is unchanged.

11. Details of simulations are available from the author on request.