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Going once, going twice . . .

Tuesday, March 31, 2015

For years USDA has tried to apply the power of market mechanisms to conservation program delivery. One of those mechanisms, reverse auctions, has been of particular interest to USDA.

In January 2015, USDA’s Economic Research Service (ERS) released the report, “Options for Improving Conservation Programs:  Insights from Auction Theory and Economic Experiments.” ERS argues that potentially significant program efficiency gains are possible with reverse auctions because USDA expends more than $5 billion annually on conservation programs that provide financial and technical assistance to farmers and ranchers.

An example of an attempt to integrate market mechanisms into conservation programs is the Environmental Quality Incentives Program (EQIP) provision, created in the 1996 Farm Bill. EQIP allowed farmers to increase the probability that their application for EQIP assistance would be selected by “bidding down” the cost share rate. Due to concerns about the advantage this would give more prosperous farmers, the bid-down provision was removed in the 2002 Farm Bill. Given the statutory and administrative barriers associated with cost-share programs, reverse auctions might be more suited for conservation programs that deal with land rights, such as the Conservation Reserve Program (evaluated by ERS in their report), the Wetlands Reserve Program, and the Farm and Ranchland Protection Program.

What are reverse auctions? Reverse auctions feature one buyer and many sellers. In general, reverse auctions are designed to include incentives that result in bids that fall in each successive round of bidding, thereby lowering program costs.

ERS evaluated two reverse auction designs: the reference price auction and the quota auction. The reference price auction assigns a nonbinding estimated monetary value to all potential offers. Offers are ranked based on the difference between the producer’s bid and the reference price. The quota auction groups similar participants—for example, groupings could be based on ecological attributes of the land being auctioned—and then limits the number of winning offers that can come from a given group.

The ERS report identifies two conditions that increase the probability that a reverse auction will improve program efficiency. First, the buyer—in this case USDA—has access to information about the sellers (farmers and ranchers) that allows the agency to manage the auction. For example, USDA could group sellers by the attributes of what they are selling or could set bid caps. Second, the reverse auction needs to be administered where there is no well-established market. The overall success of reverse auctions also requires that farmers and ranchers don’t have access to traditional conservation program participation.

Using reverse auction simulations and assuming 19.7 million acres are enrolled, the ERS concludes that a reference-price auction would reduce Conservation Reserve Program expenditures by 18% or $181 million annually, whereas a quota auction would reduce program costs by 14% or a $141 million annually.

However, as might be expected, there are issues associated with using reverse auctions to implement conservation programs. These issues include resistance on the part of program managers because of increased program implementation complexity and reduced flexibility selecting program participants. Additionally, since farmers and ranchers traditionally base program participation decisions on administratively set prices, moving to a bidding approach is likely to be largely unpopular. It adds complexity to program implementation and forces producers to compete among themselves, which can favor larger producers. Underscoring the concerns that sellers have with reverse auctions, Rep. Richard Hanna (R-N.Y.) recently introduced a bill that would limit the use of reverse auctions in federal procurement.

Although improved conservation program effectiveness and efficiency is always a laudable goal and reverse auctions, while tempting, could be a significant concern for both program managers and producers. Consequently, Congress would most likely have to mandate the use of reverse auctions in order for them to be implemented. The good news is that there are other ways of improving program effectiveness and efficiency that can be implemented through program fund allocation processes and the ranking of producer applications.


Doug Lawrence Doug Lawrence (doug.lawrence@blackwoodsgroup.com)
President, Blackwoods Group LLC
http://blackwoodsgroup.com
View more posts by Doug Lawrence

The views and opinions expressed in AgChllenge2050 blog posts are solely the opinions of the authors, and not those of Farm Foundation, NFP.