Agri-environment Policy Design With Hidden Information and Hidden Action: Input Quotas vs Input Charges

Abstract

Moxey, White and Ozanne (1999) have shown how transfer payments coupled with input quotas can be used to design optimal truth-telling mechanisms for voluntary agri-environmental schemes under hidden information about compliance costs. Ozanne, Hogan and Colman (2001) adapted the Moxey et al. model to analyze hidden action in such schemes, analyzing the relationships between input abatement, the cost of monitoring compliance and farmers’ risk preferences. White (2002) extended the Moxey et al. model to analyze the design of contracts under both hidden action and hidden information, but used an input charge/transfer payment approach rather than the original input quota/transfer payment one. In addition, he assumed that farmers caught cheating face a variable fine, related to the amount of input they apply in excess of the amount agreed in the contract, rather than a fixed fine as assumed by Ozanne et al. White argues that his results show that an input charge/transfer payment policy is more efficient than a quota when the regulator cannot observe compliance costs of individual farmers. This paper integrates the previous work, developing a model of both hidden action and hidden information in agri-environmental schemes based on the input quota/transfer payment approach of Moxey et al. (1999) and Ozanne et al. (2001), rather than the input charge/transfer payment approach of White (2002), but the variable fine of the latter rather than the fixed fine assumed by Ozanne et al. This integrated model shows that, contrary to White (2002), the input quota and input charges approaches lead to identical outcomes in terms of abatement levels, compensation payments, monitoring costs, probabilities and social welfare.