APPENDIX 3: METHODS FOR EVALUATING THE NATIONAL BENEFIT FROM IRRIGATION
A3.1 Introduction
This section describes alternative methods considered that could be used to calculate GDP and identifies the reasons for choosing the adjusted gross margin method. The adjustments made to the gross margins are also outlined.
A3.2 Valuation of Water 12
The System of Environmental and Economic Accounts (SEEA) Manual13 lists three ways that water can be valued:
(i) Using the value of short-term or perpetual water right rentals.
(ii) Comparing farms without irrigation to identical farms with irrigation.
(iii) Using a cost approach: i.e., estimate the value based on the cost of supplying water.
The first method is impractical for New Zealand due to the absence of a market for water rights. The SEEA notes that the third approach is "the least satisfactory from a theoretical point of view". Method two is therefore the most satisfactory approach under New Zealand’s institutional framework. The SEEA notes practical problems with this methodology, particularly whether farms without irrigation can be validly compared to farms using irrigation, especially when land use changes as a result. However, provided equivalent farms are compared, the increase in farm value added can still be attributed to irrigation.
A3.3 Calculating contribution of irrigation to GDP
GDP is a measure of the performance of the New Zealand economy. It is an aggregate measure of the production of goods and services within New Zealand. Many goods and services provided by one producer are purchased by another for use in subsequent production (intermediate consumption) and are therefore deducted from gross output to avoid double counting. For individual producers gross output less intermediate consumption measures their value added and represents that producer's contribution to GDP. For industries, value added equals the value of gross output of each industry less the cost of goods and services used by it in production14,15.
In this analysis, two methods were considered for evaluating the contribution of present and future levels of irrigation to GDP. Input-output analysis was one, and the other was a direct assessment of changes in gross output and intermediate consumption using appropriately adjusted gross margins.
A3.4 Input-output analysis
An input-output (I-O) table is a model of the economy at a particular point in time. It illustrates the interactions and dependencies between industries. It can be used for economic analyses including: 16
(i) Identifying and measuring the composition and level of economic activity.
(ii) Understanding the inter-relationships between industries.
(ii) Studying the effects of changes in supply and demand throughout the economy including total economic activity (output), household income, value added and employment.
(iii) Analysing the flow of goods and services between industries and final users.
(iv) Providing the basis for the calculation of Gross Domestic Product (GDP).
Consideration was given to using I-O analysis as a tool for estimating the impact of irrigation on GDP, employment and total output from a region and the nation. I-O analysis has been used to evaluate the regional benefits of irrigation. For example, the Central Plains Water Enhancement: Economic and Social Impact of Proposed Irrigation Schemes17 report used I-O to analyse the impact of irrigation in Canterbury in terms of output, employment and value added. Specific multipliers were estimated on the basis of irrigated farm model budgets.
However, the limitations of input-output analysis are well documented.
1. I-O assumes that marginal changes are the same as average ones e.g., assumes that there are no price effects as a result of changed output from a sector. This is clearly inadequate in the case of the large-scale changes in agricultural output generated by current and possibly future expected levels of irrigation, at the national level.
2. I-O assumes that the supply of every input is perfectly elastic i.e., there is sufficient surplus capacity in the economy to deal with any increase in output e.g. processing capacity. This is not the case for many agricultural products, for example dairy factories would need to be expanded if output increased substantially.
3. I-O assumes linear production function technology – it doesn’t allow for substitution between factors of production (even if prices change), nor for economies of scale.
4. I-O assumes fixed technology and constant sector purchasing patterns.
The advantage of using I-O analysis in the current study would have been that an estimate of the flow-on effects through the economy of the increase in farm gate value of output and value-added could have been calculated using multipliers. Similarly, increased employment beyond the farm-gate could have been estimated. However, robust estimates of the appropriate multipliers are difficult to derive, requiring the development of irrigated and non-irrigated model farm budgets across the range of farming types (and in some cases, regions) covered in the study. This report calculates farm gate values only. An assessment of the flow-on effects of community irrigation schemes in Canterbury may be found in Ford (2002).
A3.5 Adjusted Gross Margin method
A gross margin is the total revenue associated with a particular production (income) less the costs that clearly vary in direct proportion to the level of production - the direct or variable costs associated with the enterprise. Gross margins are an accepted tool commonly used in the evaluation of farming enterprises. They have been used for the evaluation of the costs and benefits of irrigation18 in cost-benefit analysis. Assessing the change to the gross margin per unit area as a result of irrigation and then scaling this appropriately by the total affected area provides an initial estimate of the GDP change (at the farm gate) likely to occur as a result of irrigation.
This method of adjusted gross margin analysis accords with the SEEA recommendations (section 2) and provides a “best estimate” of the change in GDP generated by irrigation at the farm gate19. However, it should be noted that a large number of estimates and assumptions were required to estimate the impact on GDP, and the results should be interpreted with caution. In addition, the increased output from irrigated farms will have different flow-on effects in the wider economy, so the total impact on GDP is likely to be higher than the farm gate impact.
The Gross Margins were adjusted to take account of differences in overheads between land uses, and also for the treatment of wages and salaries to better approximate the way GDP is calculated in the National Accounts.
A3.6 Overheads
In a standard gross margin calculation, overheads20 (which typically do not vary significantly as production levels fluctuate) are excluded from the analysis. The underlying assumption is that overheads are similar between the enterprises being compared. However, for this analysis of irrigation GDP contribution, assuming unchanged overheads may result in significant over estimation of the net contribution. The different land uses assumed in the ‘with’ and ‘without’ irrigation cases usually have completely different fixed cost structures. Failing to recognise this fact, and adjust overheads accordingly between the with/without cases is therefore likely to produce an upwardly biased GDP estimate.
Therefore in this analysis the value of irrigation, as assessed by the change in gross margin analysis, has been adjusted to reflect expected changes to overheads arising from having the land irrigated. This adjustment has been based on known current overheads and typical fixed costs per enterprise21 in areas currently irrigated.
A3.7 Salaries and wages
A potentially even more serious source of error arises from the way “salaries and wages" are treated in GM calculations compared to their treatment in a GDP calculation. In a GM these charges vary in their treatment – sometimes they are treated as overheads and sometimes as direct costs of the enterprise being analysed.
To be consistent with how farmgate GDP is calculated in the National Accounts, a distinction has been made between those wages and salaries within the enterprise that would be part of Intermediate Consumption, and those salaries and wages that would remain within the farmgate GDP calculation.
In converting the GMs into a GDP the following rules have been applied. For dairying, arable farming or pastoral farming and process vegetables all labour has been assumed to be part of the permanent farm staff and wages/salaries paid to these have been added back into the relevant GM's. This adjustment has the effect of raising the farmgate value of GDP of these activities. For apples, kiwifruit and other horticultural crops it is more the norm to employ contractors to carry out operations and for these crops the unadjusted GM has been allowed to stand and GDP calculated as though all wages were part of intermediate consumption. That in turn may well mean that the farmgate GDP impact of increased irrigation of these crops is somewhat understated in the body of the report.
A3.8. Impact of increased output on price
Gross margin calculations also generally assume that a change in output has no effect on prices. While for small-scale changes at the individual farm level this may well approximate the truth, the large-scale land use changes generated by irrigation on the national scale are believed to be sufficient to have some measurable effect on output prices.
12 MAF acknowledges the assistance of Chase O’Brien of Statistics NZ in compiling this section.
13 The whole manual is freely available on http://unstats.un.org/unsd/environment/seea2003.htm
14 The sum of the value-addeds for each industry is not however equal to GDP, the difference being import duties, GST on production, and other taxes on production and imports not allocated to producers. Collectively, these duties and taxes are referred to as ‘unallocated taxes’. Unallocated taxes are levied on the purchaser of the taxed commodity and not on the seller, so they are not recorded in the production accounts as a charge against the value of output.
15 Source: http://www.stats.govt.nz/domino/external/omni/OMNI.NSF/outputs/Quarterly+Gross+Domestic+Product#Design
16 Source: Statistics NZ Regional Input-Output Study July 2003. http://www.stats.govt.nz/domino/external/web/aboutsnz.nsf/874ea91c142289384c2567a80081308e/d6ffed8e292493e2cc256be6000329ab/%24FILE/Regional%20Input-Output%20Study.pdf
17 Agriculture New Zealand, Butcher Partners Harris Consulting Resource Economists, and Taylor Baines, 2000. Central Plains Water Enhancement: Economic and Social Impact of Proposed Irrigation Schemes Report prepared for Central Plains Water Enhancement Committee, Selwyn District Council and Christchurch City Council.
18 Economics Division, Ministry of Agriculture and Fisheries, 1977. Cost Benefit Procedures in New Zealand Agriculture.
19 Pers comm Chase O,Brien and Barry Voice, National Accounts, Statistics New Zealand
20 Often referred to as fixed costs e.g. communication, insurance, accountancy labour, machinery and legal costs
21 Derived from MAF’s Farm Monitoring Report and Horticulture Monitoring Report 2003.
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