THE ECONOMICS OF TERRACES IN THE PERUVIAN ANDES:

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THE ECONOMICS OF TERRACES IN THE PERUVIAN
ANDES AN APPLICATION OF SENSITIVITY ANALYSIS IN
AN INTEGRATED ASSESSMENT MODEL
By Roberto O. Valdivia 2002
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Introduction
The Andes

• Heterogeneous Topography

• Steep Slopes

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Introduction
Problem
Erosion in the Andes Hillsides
Decrease Productivity
Damages downstream
On-farm effects
Off-farm effects
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Introduction
Governmental and Private Institutions
. Incentives for farmers to adopt Conservation
Practices
- Information - Subsidies
. Seeking tools that help to understand the
production system and thereby increase
productivity and profitability. . Terraces are
being promoted, but what are the private, and
social benefits and costs?
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Objectives
To provide a better understanding of the
economics of terrace investments in the Peruvian
Andes

• Develop a method to conduct Sensitivity Analysis
  of an
• integrated assessment model

2. Conduct an Economic Analysis of the effects of
terraces on productivity
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Literature Review
Some Facts
. About 38 of the worlds agricultural land is
degraded.
. About 45 of South Americas agricultural land
is degraded

• . Degraded agricultural land in the Andean
  Countries
• - Ecuador 12 of the countrys agricultural
  land
• Peru 50 of the countrys agricultural
  land
• Bolivia 80 of the countrys agricultural
  land

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Literature Review
Conservation Practices
. Slow Formation Terraces are a widely used soil
conservation practice in the Andes.
. Slow Formation terraces will - decrease the
Superficial water run-off - increase water
infiltration - Intercept the soil sediment,
this process of accumulation of soil will
form the terraces.
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Literature Review
Terraces Structure
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Literature Review
Effect of Terraces on productivity
. Most of the literature reviewed compares
results where crops were cultivated in terraced
and non-terraced fields.
. In most cases productivity in terraces is
higher than non-terraced fields.
. There is a considerable variation in the
effects of terraces on productivity (from 5 to
261)
. Few studies estimate the economic returns to
terrace investments
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Theory and Methods

• A multi-disciplinary approach based on
  bio-physical and
• Econometric-process simulation model is used.
• The Tradeoff Analysis Model Software integrates
  the
• bio-physical and econometric-process models to
  implement
• integrated assessment

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Theory and Methods
General Approach TOA Model Structure
Data
Crop Models
Scenario definition
Economic Models
Environmental process models
Sensitivity Analysis/ Trade off Analysis
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Theory and Methods
Analysis of soil conservation investments The
case of Slow Formation Terraces
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Theory and Methods
Productivity effects of erosion and terraces
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Theory and Methods
Productivity as a function of slope
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Theory and Methods
Economic Analysis of terrace Investment
Estimation of NPV
T NPV ? Dt(NRt
MCt) FC0 t 1 Where T
number of crop cycles (each crop cycle have 6
months) Dt (1/(1r/2))t Discount rate and r
is the annual interest rate. NRt max(NRit)
maximum expected net returns for each crop
period MCt Terrace Maintenance cost for each
period FCo Fixed investment costs for terraces
on each land unit
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Theory and Methods
Sensitivity Analysis of Soil Conservation
Investments Using Integrated assessment models
. Monte Carlo Approach Y f(x, a), where a
N(µa, s2a), and x is a vector of exogenous
variables. To determine the effects of the
uncertainties from a parameter a with a known
probability distribution, one can use Monte Carlo
statistical methods. But these methods are
often difficult to apply to the vector of
exogenous variables x because their joint
distribution is not known.
. Scenario Analysis Specify ranges and
combinations of key parameters
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Case Study results
La Encañada Watershed
. Area 11,815 Ha
. About 77 of the area has slopes greater than
15. . Farm size Less than 3 Ha on average .
Main crops . Potatoes and Andean tubers .
Legumes . Cereals, and . Pastures
La Encañada, Cajamarca Peru 3,200 4,000 ma.s.l.
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Case Study results
Design of Sensitivity Analysis Key parameters
. BAEPROD Lower bound value for the effects of
erosion on productivity
. BAEPROD Upper bound value for the effects of
terraces on productivity
. Interest Rate Randomly generated using a
Triangular Distribution
. TERINV Fixed investment cost of establishing a
terrace
. TERMAN Terrace maintenance costs (variable
costs)
. TTIME Number of crop cycles required for a
slow formation terrace to mature
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Case Study results

• Scenarios
• Base case No erosion, no terraces
• Erosion Erosion effects on Productivity
• Terracing Terraces effects on Productivity
• Subsidies Effects of different levels of
  subsidies
• Interest rate Effects of different levels of
  interest rate
• Time of terrace maturity Effects of different
  values of
• the parameter TTIME.

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Case Study results
Base case
Scenario Erosion
Scenario Terraces
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Case Study results
Low Level of Productivity and Subsidies
High Level of Productivity and Subsidies
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Case Study results
Scenario Changes in interest rate for different
levels of productivity
Scenario Effects of the Time of maturity of
terraces
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Case Study results
Economic Analysis Results
. To understand the economics of terraces in a
spatially heterogeneous region we use the
field slope to account for heterogeneity
. Survey data contain economic heterogeneity in
prices
. Interest rates represent heterogeneity in
farmers financial XXXXX, attitudes.
PNPV is defined as the proportion of terraced
fields in high and low slopes that are
profitable, i.e. the percentage that have
(NPVT-NPVE)gt0
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Case Study results
Proportion of fields with profitable
terraces according to slope, productivity and
interest rate
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Case Study results
Subsidies Low Productivity Fields
Subsidies High Productivity Fields
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Case Study results
Subsidies High productivity fields with high
interest rate
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Case Study results
. Heterogeneity among farmers plays an important
role in the economics of terraces
. Policies such as interest rate subsidies or
subsidies for terrace construction and
maintenance can have a substantial impact on
farmers decisions to invest in terraces
. Generally terraces are most likely to be
profitable on steeply sloped fields
. Without subsidies farmers will tend to invest
in terraces where they are more socially
efficient
. If there still is an under investment in
terraces due to capital market distortion
Lowering the interest rate makes terraces
profitable for more fields with less steep slopes
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Conclusions
. Results provide an insight into the economics
of terrace investments and the important
factors that affect returns to this investment.
. Results also provide a methodological approach
to conduct sensitivity analysis with complex
models.
. This thesis demonstrates the importance of
sensitivity analysis to understanding and
interpreting the policy implications of
integrated assessment models.
. This thesis verifies the hypothesis that
returns to conservation investments such as
terraces are highly dependent on both physical
heterogeneity (e.g., slope of fields) and
economic conditions (e.g., interest rates and
capital markets).
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Conclusions
. In the conditions of northern Peru, terrace
investments are potentially profitable for, and
thus are likely to be adopted by, farmers on a
significant number of fields.
. Terraces are most likely to be profitable on
steeply sloped fields.
. Then, assuming that external damages to water
quality are also positively associated with
erosion rates, it follows that farmers will tend
to invest in terraces with the highest private
and social benefits.
. It does not follow that the socially optimal
number of terraces will be built by farmers.
. A complete examination of terraces investments
would require broader analysis that would
include possible externalities.
. This study provides the economic analysis that
could be the foundation for a broader study
that includes externalities.
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Picture Source Andes y Desarrollo Sustentable,
Gonzales de Olarte Trivelli, 1999