14
Economics

Clem Tisdell

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CHAPTER MENU

1. 14.1 Introduction
2. 14.2 Profitability from a Business Viewpoint (Farm Models)
3. 14.3 Markets and Marketing
4. 14.4 Economies of Scale and Similar Factors
5. 14.5 Allowing for and Coping with Business Risk and Uncertainty
6. 14.6 Economic Assessment from a Social Standpoint
7. 14.7 Summary
8. References

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14.1 Introduction

Economics plays an important role in the survival and development of aquaculture. Technical ability is a precondition for the successful aquaculture of any species, but its aquaculture will fail to develop and survive (in any meaningful sense) if it is commercially uneconomic. Economic failure of an aquaculture project may stem from production, technical or cost problems, or from marketing problems (Figure 14.1). Therefore, those who want to have a commercially successful aquaculture enterprise must pay considerable attention to economics, including marketing issues. Furthermore, aquaculture’s economic value often needs to be assessed taking into account its social or community‐wide impacts.

Figure 14.1 A simple example of stages in an aquaculture product chain. These chains can be quite long and complex in modern economies and the nature of market competition can vary in their different stages.

Source: Reproduced with permission from Clem Tisdell.

Aquaculture economics is now a specialised subject, and its whole range cannot be covered in depth in a single chapter such as this. Therefore, the purpose of this chapter is to highlight, for non‐specialists in economics, selected important issues that need consideration:

• in developing aquaculture commercially;

  and

• in assessing aquaculture from a community‐wide economic perspective.

Readers who require further in‐depth coverage of this subject can consult specialized books on aquaculture economics such as Engle (2010). However, a limitation of currently available aquaculture economics texts is that they pay little attention to the social and community‐wide consequences of aquaculture.

Aquaculture economics can be applied in many different contexts. It can be used to improve the business performance of individual aquaculture businesses (e.g., their profitability), to assess the economic performance prospects of sectors of the aquaculture industry (e.g., economic prospects for edible oyster production), to determine the value of aquaculture from a national perspective and even to evaluate aquaculture from a global point of view.

In most countries, profitability is likely to be the major economic concern of an individual business, whereas overall net national benefit should be the main focus from the national viewpoint. The profitability of a business or industry does not necessarily measure net national economic benefit. For example, if an industry has adverse environmental effects, profits in the industry are likely to overstate its national economic benefit because the social costs of its production exceed the costs paid by individual firms. Even in non‐profit maximising situations, a discrepancy between the private and social economic benefits of aquaculture can occur.

If aquaculture businesses are to be profitable in market economies, most must actively market their product and do so effectively. For established products, this can be relatively easy because existing marketing networks can be tapped. Established food processors, transport and distribution channels may be used. Engle and Quagrainie (2006) provide a useful overview of marketing channels for aquaculture. Marketing of new aquaculture products can, however, be quite difficult, especially in the absence of appropriate existing marketing networks.

Profitability is influenced not only by the market for a business’s product but also by the firm’s costs of production. The latter depends on, among other things, the culture techniques used and the costs of inputs to the production process. These costs vary according to whether the business is involved in the hatchery phase, the grow‐out phase or both and whether aquaculture is performed in artificial enclosures requiring pumping of water or in natural water bodies.

Modelling the economics of aquaculture is complex, but some insights can be obtained by considering simple economic models. Thus, this chapter will successively consider models analysing:

• the profitability of a business;
• the market;
• the nature of production costs;
• methods by which a firm can assess and cope with business risk and uncertainty; and
• the social economic evaluation of aquaculture.

Economic terms used in this chapter, which are not explained in the text are highlighted (in italics) and explained in Table 14.1.

Table 14.1 Explanations of some economic terms.

Discounted benefits	Future benefits from a project reduced to equivalent present values
Discounted costs	Future costs of a project reduced to equivalent present values
Discounted realizable value	The sum, reduced back to its equivalent present value, that could be realised by a business selling out at the end of its planning period.
Discounted value of future profits	This is the sum of profits during the firm’s planning period with future profits reduced below their actual future values. The reduction of future profits reflects the fact that a dollar available in the future is worth less than a dollar available now because a dollar available now can be invested at a going nominal rate of interest to earn more than a dollar in the future. So a future dollar is equivalent to only a fraction of a dollar now.
Equity	The proportion of a firm’s assets or capital belonging to the owner(s) of a business.
Internal rate of return (IRR)	Indicates the percentage rate of return on funds employed by a business or a project. It is a useful indicator of the degree of profitability of a business or a project. Estimates of IRR take into account the time‐pattern of returns.
Market transaction costs	Costs involved in arranging market exchanges, e.g., cost incurred in searching for potential buyers in arranging contracts, agency costs and so on for a sale of aquaculture products.
Nominal rate of interest	This is the rate of interest payable, not adjusted for price inflation. The nominal rate of interest tends to rise with the rate of inflation.
Present discounted value	The sum of money that, invested now, would accumulate with the addition of interest to a stated future sum of money.
Real rate of interest	This is the rate of interest reduced for price inflation. The greater the rate of inflation, the larger the reduction in the rate of interest needed to obtain the real rate.
Spillovers (externalities) from business activity	These are side‐effects of the activities of a business on other businesses or entities for which no economic payment (e.g., compensation) are involved. They can be favourable or unfavourable.

14.2 Profitability from a Business Viewpoint (Farm Models)

For a single period, say a year, a firm’s profit can be obtained by taking the difference between its revenue and its total costs. Its revenue is equal to its volume of output multiplied by the price at which units of this output are sold.

If the market in which the firm sells its product is very competitive, the firm will need to sell at the going market price per unit of the product. This, for example, is likely to be the case for the sale of table oysters and for shrimp on the international market. Clearly, other things being equal, the higher the price for the aquaculture product, the higher will be the profit of the business. Sometimes, however, there may be few or virtually no competitors in the market for the cultured product and, up to a point, an aquaculture business selling this product will be a price‐maker (as opposed to a price‐taker, e.g., the above examples of businesses, selling table oysters and shrimp). Price‐making has been true of the Japanese cultured pearl industry but is no longer the case. It is currently true in Australia for producers of pearl‐oyster seed, and the two dominant Australian suppliers of Pacific pearl oysters now have some market power in the sale of South Pacific pearls (Tisdell and Poirine, 2008).

Note that the economic concept of cost differs from that of accounting costs, the latter considers only actual costs (including purchases, salaries and depreciation). Economic costs take account of opportunity cost, that is the economic benefit forgone by not choosing the best alternative to the choice which is actually made. For example, if family labour is supplied to an aquaculture business free of charge, this would not be included in the accounting cost of the business. However, if that family labour could earn an income if employed elsewhere, the highest income that it can earn elsewhere is its opportunity costs. In order to calculate economic cost, this opportunity cost would be included and ascribed to the family labour employed.

In general, we are interested in the profitability of an aquaculture business not only in a single period, but for an interval of time spanning several periods, and economists usually assess the firm’s profitability for a planning period covering several time intervals, e.g., for a 10‐year period covering 10 annual intervals. The appropriate planning period is likely to vary with the enterprise at hand. However, a very long planning period, say 50 years, is likely to be too long because the discounted value of future profits (defined in Table 14.1) and uncertainty will mean that events 50 years hence have little consequence for current decisions.

The optimal business strategy from the point of view of an aquaculture business is, according to standard economic theory, that which maximises the business’s net present value. It is the present discounted value of its stream of profits over its planning period plus the discounted realisable value of the business.

A unit of currency (e.g., a dollar) available in the future can be expected to be less valuable to a business than a dollar available now. There are two reasons:

1. If there is price inflation, the purchasing power of a dollar in the future is less than now.
2. A dollar available now can be invested at the going nominal rate of interest with relative safety to earn income from interest and so, in the future, returns the initial capital invested plus interest. Even in the absence of price inflation, this makes it more valuable than a future dollar that has not been invested.

Furthermore, the higher the market rate of interest, the lower is the net present value of a dollar available in the future.

Usually the market rate of interest on government bonds or similar safe investments is used to take account of the minimum opportunity cost (economic actual costs) of committing funds to a business. This takes account of a relatively safe alternative profit that is forgone in committing funds to the business. For some businesses, however, the opportunity costs are higher than the returns from this alternative investment, or, if they are borrowing funds, they may also have to pay a higher rate of interest. Therefore, a higher rate of discounting of future monetary amounts would be appropriate. Some judgement is required in determining the appropriate discount rate to apply. Here it is only possible to bring attention to this issue, which forms a part of a study of finance. Nevertheless, it should be clear that discounting of future income flows is appropriate when determining the financial returns of an aquaculture business.

If the net present value of a project is positive, it is profitable from an economic point of view because it earns more than the relevant rate of interest. This principle is applied to cost‐benefit analysis. If the net present benefit from investment in a project is positive after being reduced using the appropriate rate of interest, it is economic. This also implies that its discounted benefits divided by the discounted costs exceed unity, or, in other words, that its benefit‐cost ratio exceeds unity (Engle, 2010).

If the net present value of a project or enterprise is zero, then it is marginal because it earns only the going rate of interest, and if this value is negative, the project is unprofitable because it returns less than the going rate of interest on the finance required for it. In the latter case, an actual loss will be made if the farmer borrows to finance the project or it is self‐funded: income will be forgone by investing the funds in this project rather than elsewhere at the going rate of interest.

Alternatively, the profitability of an aquaculture project or enterprise can be specified by its benefit‐cost ratio. Benefit‐cost ratios have the advantage that they make for easy comparisons of the relative profitability of different projects and enterprises, but, at the same time, they are a reflection of the net present value of a project or enterprise. This follows because the net present value of a project or enterprise equals the discounted value of its benefits less the discounted value of its costs. Consequently, if the net present value of a project is zero, its discounted benefits equals its discounted cost and therefore, its benefit‐cost ratio is one. Hence, unity is the critical value of the benefit‐cost ratio for determining the profitability of a project. If this ratio exceeds one, the project is profitable, it is marginal if the ratio is unity; and it is unprofitable if the ratio is below one.

Weston et al. (2001) completed a study of the profitability of farming six selected species for aquaculture in Australia and reported the most likely benefit‐cost ratios for representative farms assuming a 20‐year planning period. For discounting financial flows, they employed an interest rate of 6%, which would have been realistic at the time of the study. For abalone farms producing 100 t annually, they reported a most likely benefit‐cost ratio of 1.48 and for farms producing 200 tonnes per year, 1.58. For typical farms supplying mussels they estimated that these farms producing 100 t of mussels per year would most likely have a benefit‐cost ratio of 1.07 whereas those supplying 100 t annually would most likely have a benefit‐cost ratio of 1.37.

Various implications follow from these results. First, abalone production is predicted to be substantially more profitable than the farming of mussels. Secondly, profitability in both cases tends to rise with the scale of annual production. Furthermore, a mussel farm producing 100 ts of mussels annually is expected to be barely profitable. Economies of scale in mussel aquaculture have resulted in the evolution of large‐scale enterprises operating in this industry, e.g., Spring Bay Seafoods’ production activities in Tasmania (Courtney, 2013).

An alternative (but compatible) procedure for determining a farm’s profitability (or the profitability of an investment project) is to calculate its internal rate of return (IRR) (see, for example, Engle, 2010). As in the case of benefit‐cost ratios, the use of IRRs enables comparative analysis of profitability to be completed easily. However, IRR specification has the additional advantage that the net profitability of a project can be readily compared with different levels of the rate of interest, whereas if benefit‐cost ratios are used, they have to be recalculated when different rates of interest apply. If the IRR of a business exceeds the relevant rate of interest, the business is profitable, and it is more profitable as the IRR increases in relation to the rate of interest.

It is not uncommon for economists to make estimates of internal rates of return for the culture of different species. Treadwell et al. (1992) estimated the IRR from cultivating various aquaculture species in Australia. To make these estimates, they considered model (or representative) aquaculture farms and specified their annual operating costs and capital cost. These costs, together with predicted levels of revenue, provided the basis for estimating net benefits and subsequently the IRR values for the different types of farms. An aquaculture business’s planning interval was assumed to be for a 20‐year period. A similar approach was adopted by Weston et al. (2001) in their later study of the profitability of aquaculture of different species in Australia but they estimated benefit‐cost ratios rather than IRRs.

From this assessment of aquacultured species in Australia, Treadwell et al. (1992) estimated the mean internal rate of return (IRR) on a model mussel farm to be the highest: 12.3% with a wide likely range of 1–22.7%. For this species (the blue mussel, Mytilus galloprovincialis) the profitability of farms of different sizes was not calculated by Treadwell et al. (1992), but Weston et al. (2001) found that the benefit‐cost ratios of such farms rose with their size. However, this was done by Treadwell et al. (1992) for two other cultured species. The mean IRR for small grow‐out farms of saltwater crocodiles (Crocodylus porosus) was estimated to be 10% and for large ones 14%. In the case of Atlantic salmon grown in 60 m diameter cages, the predicted mean IRR for a model farm with 40 000 smelt was 5.5%, and for ones with 150 000 smelt was 12.5%. In both cases, the relative profitability of model farms increased with their size.

The above types of analysis of profitability mostly assume that the capital (finance) market is perfect and give limited attention to uncertainties. Ways of allowing for uncertainties are a focus of a later section of this chapter. In practice, a firm may need to give special attention to its liquidity (cash availability) to ensure its continuing viability. It may, therefore, be concerned about how quickly a business enterprise can pay back the investment in it and about how large its debt may become during the planning period: the larger its debt, the greater are its risks.

14.3 Markets and Marketing

The markets for aquaculture products are influenced by supply and demand conditions and changes in these (Engle and Quagrainie, 2006). For products of aquaculture businesses that are price‐takers rather than price‐makers, the standard economic analysis of purely competitive markets is relevant. Most suppliers of aquaculture goods are price‐takers but there are exceptions, as in the case of South Pacific pearl oysters (Tisdell and Poirine, 2008).

Because there are often several stages in the aquaculture product chain, (Figure 14.1 provides an example), the degree of market competition can vary at different stages in this chain. When this is taken into account, the degree of imperfect market competition in aquaculture can be much greater than appears to be so at first sight. For example, small‐scale aquaculture producers of shrimp, fish or seaweed may be faced by a single buyer in their geographical area who acts as a middleman in the marketing process by buying and preparing this produce for sale. This middleman is likely to have some market power as a buyer of products from small‐scale producers but may lack market power in selling this produce.

Another economic feature is that not all those involved in aquaculture markets may find it profitable to engage in marketing (promotional) activities. This involvement is likely to vary at different stages of the product chain and with the size of the enterprise involved. It is probable that larger‐sized enterprises involved in the later stages of the aquaculture product chain find it more profitable to engage in product promotion than those whose activities are limited to the earliest parts of this chain.

Basic economic models of markets do not pay attention to product chains but do identify important features of markets which affect their terms of trade and the quantity supplied of traded products. These models can be applied to predict the economic consequences of variations in market competition along the product chain.

It is worthwhile considering the consequences for aquaculture of the simplest model of market operations. This relies on market demand and supply analysis and assumes that the market is competitive, but it also highlights features that are relevant to all markets, such as the effects of shifts in market demand and supply relationships. Consider first factors which influence the quantity demanded of an aquacultured product and then influences on the quantity supplied.

Many factors influence the quantity demanded of an aquaculture product. These include its price per unit, the income levels of buyers, the prices of substitutes, and tastes. Usually, as the price of a commodity is reduced, the demand for it increases, all other factors remaining constant. This can be illustrated diagrammatically. However, it should be noted (in advance of the following diagrammatic outline) that, in illustrating market relationships, economists conventionally put the independent variable on the Y‐axis and the dependent variable on the X‐axis. This convention is followed here and differs from the convention in natural science. So, in the discussion that follows, the independent variable, in this case the price per unit of the aquacultured product, is shown on the Y‐axis and the market quantity of the product is shown on the X‐axis.

Normally the demand curve in a market is downward‐sloping (Figure 14.2, D₁D₁) indicating that buyers purchase more of the product as its price is lowered. The market supply of the product is usually upward‐sloping indicating that greater supplies only become available if producers are paid higher prices (Figure 14.2, S₁S₁). The quantity demanded of a product as a function of its price represents the market demand curve for a product, all other things being constant. The quantity supplied of a product as a function of its price represents its market supply curve, all things, other than its price, being held constant. The point at which these two curves cross represents the market’s equilibrium and the corresponding price is the equilibrium price and the corresponding quantity traded is the market equilibrium quantity. Economists believe that in most cases market prices and quantities traded tend towards their equilibrium values. In Figure 14.2 for instance, the demand curve D₁D₁ might represent the demand for shrimp in Japan in July 2016 and S₁S₁ might represent the supply curve of shrimp. Market equilibrium would be established at point E, with the equilibrium price of shrimp being /kg with t of shrimp being supplied. Supplies may be drawn from cultured shrimp (the supply curve for these may be as indicated by the curve marked S₀S₀) and from captured shrimp, the supply function of which is the difference between curves S₁S₁ and S₀S₀. In the case shown, in the market equilibrium of supply comes from cultured shrimp and from captured shrimp.

Figure 14.2 A theoretical market model for marine shrimp in Japan illustrating market equilibrium and dividing supply into capture and culture components. As mentioned in the text, economists conventionally place the price variable, in this case the independent variable, on the Y‐axis and the dependent variable, in this case the quantity of the product demanded or supplied, on the X‐axis. This differs from the normal convention in the natural sciences.

Source: Reproduced with permission from Clem Tisdell.

It is clear from Figure 14.2 that, if the demand curve for shrimp moves upwards (and everything else remains constant), the equilibrium price and quantity traded will rise. It becomes more profitable for businesses to supply shrimp. Other things held constant, the market demand curve for shrimp may rise, for example, if:

• incomes in Japan rise and, more generally, incomes in market outlets for shrimp rise;
• the prices of shrimp substitutes rise;
• the human population increases; and
• tastes alter in favour of the product.

It is important to be able to predict such trends and their influences on demand.

Sometimes, the demand curves for aquacultured products are stated in terms of the average consumption per head of population or per household. This is the case with the relationship between the consumption of shrimp by households in Japan and the price of shrimp on the basis of annual data for 1980–89. Consumption per household rose from ca. 2.4 to ca. 3.4 kg/yr as the cost of shrimp per 100 g declined from ca. 280 to 220 yen. Other data also showed that a rise in Japanese incomes led to a significant rise in the per capita consumption of shrimp in Japan.

A shift downward in the supply curve (that is increased supply for any given price), other things unchanged, tends to lower the equilibrium price for the aquacultured product, in this case shrimp. Other things constant, the supply curve of an aquacultured product may shift downwards, because, for example:

• the price of one or more inputs falls, e.g., fish food.
• New technologies are discovered that lower production costs, e.g., techniques that greatly reduce food wastage, such as have been developed for the culture of Atlantic salmon (Asche et al., 1999).
• Improved methods may be found to reduce the incidence of pestilence or disease in aquaculture.
• Genetic selection and breeding may raise the productivity of cultured organisms such as tilapias; and
• High returns in the industry may result in new businesses entering and investing in the industry thereby raising supplies.

As indicated above, most aquacultured products compete with supplies of substitutes from the capture fishery. Sometimes, these are perfect or near perfect substitutes. Hence, a reduction in supplies of substitutes from the capture fishery usually raises demand for the farmed product. A rise in supply from the competing capture fishery has the opposite effect. Nevertheless, there is evidence that increased supply of aquaculture products is not completely at the expense of sales of the capture fisheries because market segmentation exists between farmed and wild‐caught products (Asche et al., 2001).

Trends or expected variations in relation to all the above‐mentioned demand and supply matters need to be considered in predicting future prices and markets for aquaculture products. To do so accurately can be very difficult, especially if a long planning period is being used.

There are also marketing decisions to be made at business level. These include the quality of the product to be supplied and how far to process it. In established industries, middlemen are often present to facilitate marketing and distribution (Engle and Quagrainie, 2006), but one of the difficulties sometimes encountered in developing a market for a new aquaculture product is the absence of suitable networks for its distribution and sales. For example, the sale of giant clam for human consumption in Australia was hampered by the absence of suitable distribution networks for this. On the other hand, the sale of Australian cultured giant clams as aquarium specimens initially progressed quite rapidly because of the existing network of wholesalers and distributors of aquarium specimens. In the absence of suitable distribution and marketing networks, considerable costs of marketing activities will fall on the innovating aquaculture business. These costs will include advertising the product, its presentation, search for market opportunities and information transfer (Tisdell, 2001).

Many cultured species progress through a typical product cycle (Figure 14.3 and Table 14.2). In the early stages of this cycle, new production techniques are developed, and to a large extent the market is uncertain. Only innovators or adventurers enter the industry at this stage. At the next stage, sorting of techniques tends to take place, with the least effective ones being discarded, and market penetration may proceed rapidly. The industry goes from a position of earning low and uncertain profits to one of high profit if the new product is well accepted. This induces followers to enter the industry and eventually the industry becomes well established with ‘appropriate’ techniques settled, and potential markets fully tapped. This is the mature stage in which profitability tends to fall to the average level of business profitability in the economy. Channel catfish culture in the USA is in the mature phase (Chapter 19). Atlantic salmon culture is in the mature phase in Europe. The culture of southern bluefin tuna in Australia is still in a relatively early stage. Redclaw crayfish culture in Australia was also in an early stage in the 1990s and since returns in 1991 seemed relatively high for little risk, one would have expected considerable entry into the industry, resulting eventually in a fall in returns due to increased supply. However, returns may not fall substantially at first because demand might also expand as consumers become more aware of this product and it gains greater acceptance. There are many instances in which this has occurred. For example, when tilapia culture was first introduced to Fiji, local demand for this introduced fish expanded slowly. However, it is now a sought‐after fish.

Figure 14.3 Product cycle showing typical stages which aquaculture industries pass through if they succeed economically and the approximate stage in which some of these industries are now. The demand and volume of supply for all these industries does not decline but stabilises for some as upper limits to production and demand are approached.

Source: Reproduced with permission from Clem Tisdell.

Table 14.2 Approximate product cycle stage (see Figure 14.2) for some aquaculture industries.

Stage	Aquaculture industry
Introduction	European eel	(Anguilla anguilla)
	Murray cod	(Maccullochella peelii)
	Red porgy	(Pagrus pagrus)
	Southern bluefin tuna	(Thunnus maccoyii)
	Spiny lobsters	(Panulirus species)
Growth	Abalone	(Haliotis species)
	Atlantic salmon	(Salmo salar)
	Chinese mitten crab	(Eriocheir sinensis)
	Common carp	(Cyprinus carpio)
	Groupers	(Epinephelus species)
	Milkfish	(Chanos chanos)
	Mud crabs	(Scylla species)
	Nile tilapia	(Oreochromis niloticus)
	Red seaweeds	(Eucheuma species)
	Sargassum seaweed	(Sargassum fusiforme)
	Silver carp	(Hypophthalmichthys molitrix)
	Sea cucumber	(Apostichopus japonicas)
	Swimming crabs	(Portunus species)
	Whiteleg shrimp	(Penaeus vannamei)
Maturity	American cupped oyster	(Crassostrea virginica)
	Giant tiger prawn	(Penaeus monodon)
	Gilthead seabream	(Sparus aurata)
	Japanese eel	(Anguilla japonica)
	Soft‐shelled turtle	(Pelodiscus sinensis)
Stabilisation	Channel catfish	(Ictalurus punctatus)
	Kuruma prawn	(Penaeus japonicas)
	Mediterranean mussel	(Mytilus galloprovincialis)
	Pacific cupped oyster	(Crassostrea gigas)
	Rainbow trout	(Oncorhynchus mykiss)
	Yesso scallop	(Patinopecten yessoensis)
Decline	Atlantic cod	(Gadus morhua)
	Blue mussel	(Mytilus edulis)
	European flat oyster	(Ostrea edulis)

When a market needs to be developed or a business plans to supply a new market, a variety of methods may be used to determine the nature of the market and to foster it. These include trials of the product such as taste‐testing of a new aquaculture product, pilot or trial marketing, interviews and various types of surveys and examination of the demand for substitute products. Because giant clam farming was so new in the 1990s, it was necessary to use all these methods to assess potential demand for cultured giant clams for eating (Tisdell et al., 1994).

As a market expands, it becomes increasingly necessary to standardise the cultured product, or its grades, in order to reduce market transaction costs and increase market penetration. Supermarkets, which have become the dominant form of retailing in developed countries, demand standardised products. The industry may itself set standards or a government marketing body may do so. Furthermore, large retail chains often specify the standards they require. There can be an economic benefit to an aquaculture industry in imposing financial levies on its businesses in order to have its product promoted by a ‘government’ or a co‐operative marketing authority (Engle and Quagrainie, 2006). This is so even though members of the industry as individuals would not be prepared to spend so much on promotion, because others would benefit considerably by their promotion of a relatively generic product, e.g., Atlantic salmon, Pacific oysters, channel catfish.

14.4 Economies of Scale and Similar Factors

The costs per unit of production of an aquaculture business are likely to vary with the size of the undertaking. There are economies of scale or decreasing costs per unit of production for many species, up to some annual volume of output. After this point, costs per unit of production may begin to rise with greater volume of output (Figure 14.4) or they may rise after remaining stationary over a range.

Figure 14.4 U‐shaped average cost of production curve. Businesses having a level of production less than the minimum efficient scale can reduce their costs per unit of production by expanding their level of production.

Source: Reproduced with permission from Clem Tisdell.

The scale (volume of annual production) at which a business obtains its minimum cost per unit produced is called its minimum efficient scale. If a business is operating below this level and is a price‐taker, it will usually be at an economic disadvantage compared with businesses operating at their efficient scale. Consequently, its rate of profit can be expected to be lower than that for the latter businesses. Nevertheless, in some market conditions, the most profitable level of production by an aquaculture farm can be for a level of production less than that corresponding to minimum efficient scale. This occurs, for instance, when markets are not perfectly competitive and individual suppliers of products have downward‐sloping demand curves for their products. In such cases, the limited size of their market restricts the ability of firms to take advantage of economies of scale in production.

Economies of scale are likely to be significant in land‐based aquaculture operations involving the pumping of water to tanks, raceways or ponds and requiring water circulation. This is mainly because of engineering relationships, e.g., the volume tends to increase at a faster rate than the circumference of a container, but there may be other economies of scale, for example in being able to use more effectively the services of specialised personnel who can be employed. Economies of scale can also be present for farming in situ, e.g., as the case of Atlantic salmon farming indicates. The minimum efficient scale (size of production operations) of an Atlantic salmon farm has tended to increase with the passage of time. Significant economies of scale in production exist for hatchery/nurseries engaged in land‐based production, e.g., in the supply of giant clam seed (Tisdell et al., 1993). However, in the case of seaweed production in developing economies, economies of scale do not appear to be significant in the initial production stage.

The above discussion (centred on Figure 14.4) implies that it is desirable when considering the economies of the scale of operation of an aquaculture farm not only to take into account production economies but also to market demand conditions. Furthermore, for some enterprises economies of scale in distribution and marketing can be important. Therefore, a more general approach to assessing the economics of the scale of operation of an aquaculture enterprise is to take account of how its internal rate of return or its benefit‐cost ratio varies with its scale of operation. The enterprise’s scale of operation can be measured in different ways, but commonly it is measured by the volume of its annual production.

As noted earlier, Treadwell et al. (1992) found (for the scales of production which they assessed), that the internal rate of return for crocodile breeding farms and for crocodile grow‐on farms, as well as for Atlantic salmon farms, increased with their annual volume of production. Similarly, Weston et al. (2001) found that the benefit‐cost ratios for abalone farms and for mussel farms in Australia rose with their annual volume of production, for the production range assessed. Consequently, smaller farms tended to be less economic than larger ones for the production ranges considered. The likely economic situation of very large farms (outside the range examined) is unspecified.

The general situation can be illustrated by Figure 14.5 assuming that the IRR of an aquaculture farm at first rises with its value of production but falls if its annual volume of production becomes quite large. In Figure 14.5, the curve ABC represents the rate of change of the IRR of a farm in relation to its annual level of production of an aquaculture product and curve HJK represents the farms IRR per unit of its output (IRR/x) for its planning period. This implies that the IRR of the farm is at a maximum when its annual value of production is x₆. However, the net profitability of the farm depends on the discount rate (the rate of interest). The discount rate is independent of the level of output. If the discount rate is OD, the farm will not be economic unless it operates at a scale of at least x₁, and its most profitable scale of operation will be for an annual volume of output of x₅. At x₅, the benefit‐cost ratio for the farm is at a maximum. Should the discount rate rise, for example, from OD to OF, other things held constant, the minimum scale of production at which the farm will just break‐even rises from x₁ to x₂ and the annual volume of production for which it maximises its net return falls from x₅ to x₄. Note that the level of output that maximises profit per unit of output, x₃, is not the firm’s most profitable level of output.

Figure 14.5 Diagram illustrating a case in which the scale of aquaculture production by a farm alters its profitability.

Source: Reproduced with permission from Clem Tisdell.

Given the type of IRR relationship shown in Figure 14.5, very small scales of production are likely to be unprofitable. However, there can also be economic disadvantages of the firm being too large. Diseconomies of scale may eventually occur for several reasons. For example, the coordinated management of a large enterprise may become more difficult and it may be necessary to begin using sites for expansion that are ecologically inferior, more distant from markets or more expensive to acquire. In the case shown in Figure 14.5, if a firm produces more than x₄ annually when the rate of interest is OF (Figure 14.5), it will be forgoing profit. If it produces a large enough volume of output, it can actually make a loss. Note that the above model is a simple one because it assumes steady states, as does the implicit modelling done by Treadwell et al. (1992) and by Weston et al. (2001).

Apart from the economies of producing a greater volume of a particular species, other types of economies may exist. These include economies of scope (or diversification) and economies of specialisation. To a large extent, these are the opposite sides of the same coin. To take advantage of economies of scope, if they exist, the firm engages in the supply of multiple products or services and this can include polyculture. There may be biological synergies (complementarity) in the production of more than one species so that mixes of aquaculture of species are the most profitable. In land‐based facilities, it may be possible to spread overheads, e.g., those involved in pumping water, or the employment of specialists, by producing different species in different ponds or containers of various kinds.

Economies of diversification, however, need to be balanced against possible economies from specialisation. Even if specialisation by production of species is absent, there is often specialisation by stages in the culture of a species. For example, some businesses may specialise in the hatchery/nursery stage culture of a species, whereas others may confine themselves to the grow‐out stage, or even just a part of it. This pattern has been developed, for instance, in Taiwan, with a series of small businesses specialising in successive stages of fish aquaculture. As a result, the industry can take advantage of maximum economies of scale at different stages in the culture of a species.

Economies of scope or of diversification may be important at the hatchery/nursery stage. Casual observation indicates that many hatcheries/nurseries supply a range of aquaculture species or varieties of these, even though the range may be restricted to closely related species.

Possibilities for economies of scale, scope and specialisation are limited by the available techniques of production and by resource availability. The appropriate choice of technique from those available is partly an economic matter. In countries where labour is cheap relative to capital, labour‐intensive techniques are likely to be more economic than capital‐intensive ones. However, in developed countries, where labour is relatively expensive, the reverse can be expected.

The location of an aquaculture business is likely to have a significant influence on its cost of production and profitability. The location of an aquaculture business’s facilities will affect its cost of access to markets, its availability of inputs and their costs. A good location ecologically may be uneconomic if it is distant from markets and lacks available human resource or services for its support.

14.5 Allowing for and Coping with Business Risk and Uncertainty

Uncertainties about economic prospects are a major consideration for all aquaculture farmers. Farmers need to consider how they should allow for uncertainty in their economic planning and how they ought to adjust their business operations to best cope with it, because some level of economic uncertainty is unavoidable. In the planning process, it is useful to identify the sources of uncertainty that are likely to impact on the business prospects of a farm (Engle, 2010). These may be essentially of an economic nature (such as uncertainty about the levels of prices, wages or the rate of interest) or of a non‐economic type such as the likelihood of different levels of morbidity and mortality occurring in farmed stocks, or the likelihood of unfavourable weather patterns prevailing. Variations in the latter variables alter the productivity of aquaculture and consequently, the profitability of a farming enterprise.

Once the sources of uncertainty affecting the business profits of an aquaculture farm are identified, decisions need to be made about how and to what extent efforts should be made to predict the likely values of the uncertain variables. How far to go in this regard is partly an economic decision. This is because costs are incurred in improving predictions and the anticipated extra economic benefit of improved predictions should be compared to the extra cost involved in sharpening the predictions. Even if certainty is theoretically possible, it is rarely economical to achieve it. The basic rule is that predictions (about variables of economic relevance) should only be improved up to the point where the extra cost incurred equals the extra benefit obtained.

In any case, the process of improving predictions will halt at some point, namely the point at which an actual business commitment must be made. The question then arises of how best to specify the remaining uncertainties. Sensitivity analysis can be used to provide information on the range of possible economic payoffs, taking into account the estimated range of possible uncontrolled (exogenous) events. In effect, sensitivity analysis specifies a payoff matrix of the type commonly used in game theory. This can be useful to a decision‐maker, but it stops short of specifying the probability of the uncontrolled events or ‘states of nature’ judged to be possible.

Considerable debate exists about how accurately the likelihood of uncertain events can be specified and about how best to estimate the probability of these events, if these probabilities can be meaningfully estimated at all (Tisdell, 1968). Economic events (and path‐dependent events generally) often fail to satisfy the statistical conditions needed to estimate objective probabilities. In these circumstances, some analysts recommend the use of subjective (personal) probabilities as an alternative and suppose that these accord with the usual statistical probability axioms. This approach leaves open the possibility of applying risk analysis using objective probability distributions if they are available, or subjective probability distributions if objective estimates are unavailable. In the latter case, the accuracy of predictions will depend on the accuracy of the subjective probability distributions used for the analysis.

Treadwell et al. (1992) and Weston et al. (2001) used risk analysis to specify the economic risks faced by farmers involved in the aquaculture of different species in Australia. Treadwell et al. (1992) consider the probability distributions of internal rates of return for model farms and the latter do this for benefit‐cost ratios. The latter specify the estimated probability of a model (or representative) farm having a benefit‐cost ratio of less than unity, that is of failing to break‐even. An interesting result from these empirical studies is that larger farms appear to be less likely to make a loss than small farms when scale economies are significant. For example, Treadwell et al. (1992) report that a 100 t mussel farm with an annual capacity of 100 t has a 10% chance of failing to break‐even whereas, for a farm with 200 t capacity, the chance of this is only 2%.

While risk analyses have the appearance of being very accurate because of their precise quantitative statement of predictions, caution should be exercised in drawing conclusions from these. For example, the underlying probability distributions used to make the predictions may be subject to significant error or shift. Furthermore, fundamental uncertainties may exist that are not amenable to specification in terms of statistical probabilities. When this is the case, it may be necessary to rely on decision‐making criteria that do not make use of probability distributions. These include the minimax gain criterion and the minimax regret criterion (Tisdell, 1968).

Uncertainty about economic variables, such as future prices, and about levels of productivity (which can arise from possible environmental changes, disease, etc.) makes aquaculture a risky business. Most aquaculture businesses need to adapt to such uncertainties to survive and minimise their possible losses. Some methods of coping with uncertainty include:

• product diversification (not relying on a single product);
• diversification in techniques used for production (e.g., if some techniques are unproven or more variable in their productivity than others);
• incorporation of flexibility into the capital equipment or facilities used in order to keep options open (for example, installing equipment that has multiple uses rather than a single use);
• expanding cautiously into a new business area to leave time for learning‐by‐doing;
• making sure that the business has limited liability where this is an option;
• increasing the number of shareholders or partners in the business;
• making sure that the business’s debt to equity (or ownership) ratio does not become so high as to jeopardise its ability to repay loans if its economic performance is below expectation;
• ensuring that the fixed (overhead) costs of the business are low so that a substantial economic loss can be avoided if the price of, or demand for, the aquaculture product falls, or if production is below that planned, or if the cost (e.g., price of an important input) is above expected levels; and
• insuring when this is an option.

In most cases, an aquaculture business incurs extra costs by adopting strategies which lower its economic risks. If the enterprise adopts a very conservative approach to risk‐taking, it can forego a considerable amount of profit and in extreme cases can also suffer a loss as a result of the cost‐burden of risk avoidance.

Fixed costs tend to be high when a production technique is capital‐intensive, that is, uses a lot of equipment and fixed investment relative to other resources. When capital‐intensive aquaculture techniques are adopted by a business, the business must make sure that economic conditions are favourable for this. For example, conditions are more likely to be favourable if the product is of high value or there is a high volume of demand for the business’s product or the technique considerably reduces per unit operating costs. Also, the risk of production falling markedly below planned levels should be low, for instance as a result of environmental occurrences.

An intensive shrimp farm on Okinawa, Japan, produces very high‐value shrimp and can operate profitably even though its capital, overhead and operating costs are high. A semi‐intensive shrimp farm near Shenzhen in China, feeds its shrimp by collecting shellfish from a nearby bay. Both its operating and its capital costs are lower per hectare than in the Japanese case. The shrimp are exported, but the price received is lower than for the Japanese farm. A seasonal extensive freshwater prawn farm (Macrobrachium species) in Bangladesh requires very little capital investment and has even lower operating costs. The economics of operation of the farms is hampered by the occurrence of typhoons, which result in the escape of shrimp stocks in some years, causing an economic loss. In the Bangladeshi case, both capital costs and operating costs are extremely low because the prawns are not given supplementary feeding, but rely on organisms naturally present in the water, which is interchanged with the nearby brackish river system. In this case, the business risks are relatively low.

Diversification of production is a common risk‐aversion strategy. If returns from different products are not perfectly correlated, this will tend to reduce the variability of the business’s total returns. The same is true of production using different techniques, e.g., juvenile giant clams may be cultured in onshore tanks as well as in floating cages, so reducing the likelihood of a major loss of supply if adverse weather conditions occur. Capital equipment used to farm a range of species needs to be flexible or adaptable. It may be more sensible, taking into account business risks, to use such equipment in culturing a species, than to use equipment specifically designed for the species. Although specific equipment results in lower cultivation costs for a given species it may have little alternative use. Should the culture of the species prove to be uneconomic, flexible equipment can be used to cultivate other species and will have a higher resale value.

Businesses engaging in the culture of a species unfamiliar to them generally go through a period of learning‐by‐doing. With the passage of time and with the experience gained, their productivity and economic performance in cultivating the species improves. In the early stages, therefore, they might do well to proceed cautiously, e.g., use small‐scale or pilot plants, and install flexible or cheap short‐lived capital equipment (section 2.7.2.1). A late start can be a particular disadvantage for a new entrant to an aquaculture industry in which substantial economies of scale exist. If the entrant tries immediately to produce at the minimum scale of efficient production, this involves considerable risk since it does not allow time for learning by the business.

Institutional arrangements such as the limited liability form of company ownership can reduce personal business risks, and if risk is shared among a large number of shareholders or partners in a business, losses are easier to bear. In addition, the management needs to give continuing attention to the debt‐equity ratio of the business. The higher this ratio is, the greater the risk to the business in the event of unfavourable economic performance. This ratio (debt‐equity) is sometimes called the firm’s gearing ratio, and if equity is low relative to debt the firm is said to be highly geared. A highly geared business can have a high risk of not surviving. On the other hand, a firm with a high IRR in relation to the rate of interest may be unnecessarily forgoing profitable business opportunities if its equity/debt‐gearing ratio is low.

A more detailed coverage of risk management is available in Tisdell et al. (2012). This article gives particular attention to the potential of insurance schemes to reduce economic risks in aquaculture development. It also examines factors that limit the scope for insuring against business risks in aquaculture.

14.6 Economic Assessment from a Social Standpoint

Although an aquaculture business may be privately profitable, and an aquaculture industry may be economically thriving, this does not necessarily indicate its economic value from a social point of view. The social value of production by the industry will, for example depend upon whether social costs of production are greater than private costs. If they are, private gains overstate social net benefits.

Social costs will exceed private costs of production by businesses if the aquaculture industry results in unfavourable environmental spillovers (externalities) that impose costs on others for which they are not compensated. For example, consider shrimp farming in some less developed countries. In some, e.g., in Ecuador, Thailand, the Philippines and parts of Bangladesh, wetlands are impounded to create ponds for the cultivation of shrimp. Vegetation (such as mangrove trees) is lost and the breeding grounds and food supplies of wild fish stocks are destroyed, with an adverse impact on local fishing communities. When ponds are stocked with captured young shrimp, as in Bangladesh, this may subsequently reduce the population of large shrimp available to the capture shrimp fishery. Furthermore, by converting coastal areas that play an essential role in the life cycle of wild shrimp populations to private shrimp ponds, the aquaculture farms further reduce wild stocks.

By contrast, aquaculture can sometimes give rise to favourable spillovers and when this happens, the profits of fish farms understate the social economic benefits of their activity. The activity might then be on a smaller scale than is socially optimal. Waste from marine fish farms causes nutrient enrichment of surrounding waters. Up to some level, this may enhance the growth of surrounding wild fish or benefit mollusc production. But, beyond some point, this positive effect can become negative. Nevertheless, there are also circumstances in which nutrient depletion occurs and the consequences can be analysed by means of economic analysis (Tisdell, 2003).

The economic theory underlying this matter is illustrated in Figure 14.6. Curve OAB represents the profit from farming a fish species, e.g., sea bass, in a particular area as a function of the quantity produced annually. In this area, however, the farming of the species gives rise to negative environmental effects, so the social benefit curve is OCD. This curve is lower than curve OAB and the difference represents environmental spillover costs not paid for by the sea bass farmers. In order to gain maximum profit, fish farms in the focal area will produce X₂ t of the farmed fish annually. This is an excessive amount from a social economic viewpoint. Social net benefit is maximised when only X₁ t of the species is produced each year. Therefore, because of the occurrence of adverse environmental effects, the market mechanism fails to ensure a social economic optimum. Hence, it may be desirable for the government to adopt policy measures to restrict production of this farmed species, or the methods used to farm it in the focal area. The opposite situation can arise if the farming of a species generates favourable environmental spillovers.

Figure 14.6 Environmental spillovers from fish farming sometimes result in private decisions being at odds with social economic benefits from these decisions (see text for explanation).

Source: Reproduced with permission from Clem Tisdell.

Although in the case illustrated in Quadrant I of Figure 14.6, aquaculture is socially beneficial for a range of production levels, it is also important to recognise that in some cases, the adverse spillovers generated by the aquaculture of a particular species can be so great that its culture should not be tolerated. For example, in Figure 14.6, although curve OAB may represent the private benefit to producers from farming a species, the net social benefit (i.e., private benefit less social costs) from doing so may be negative as shown by curve OFG because environmental spillover costs exceed private benefits for all levels of aquaculture of a species. For example, the introduction of a new species to a region can pose significant risks to wild species in the region. Escaped farmed species may compete with other wild species or become predators of them. The risks and potential costs to natural ecosystems of introduction of new species and attendant economic losses may be so great as to make it desirable from a social economic point of view to ban their introduction. Escapees from aquaculture potentially pose several types of environmental risk.

Different methods or techniques of aquaculture can give rise to different magnitudes of external costs. It may, therefore, be desirable to introduce public policies that limit the use of some techniques or ban these altogether. The regular feeding, for example, of antibiotics to farmed fish can give rise to a number of serious environmental consequences. These include the growing resistance of disease‐creating organisms to antibiotics and the reduced natural resistance among the farmed stock, and possibly where there are escapees, reduced resistance of wild stock to diseases. Therefore, some governments may consider it to be desirable to ban the use of environmentally ‘dangerous’ antibiotics in aquaculture or to restrict their use.

Different methods of husbandry in aquaculture can have significantly different environmental consequences. Nevertheless, it is frequently the case that technological progress reduces the magnitude of environmental effects. For instance, between 1980 and 1997 the average feed conversion ratio in Norwegian salmon aquaculture fell from just under 3 to just over 1 (Asche et al., 1999). This means that less waste per kilogram of fish produced goes into the surrounding environment. The food used nowadays, for example, sinks more slowly through the water, and improved techniques are available to monitor feeding so that the quantity of food supplied to the fish can be adjusted more accurately to consumption (Asche et al., 1999). In addition, innovations have resulted in a substantial reduction in use of antibiotics by the Norwegian salmon industry (Asche et al., 1999).

Adverse environmental spillovers are often the source of lack of sustainability in aquaculture production and can result in this activity eventually becoming uneconomic (Tisdell, 2003). Although they are not the only source of lack of sustainability in economic production, they should not be overlooked as a potentially important source. Significant sustainability problems can arise when water for aquaculture is shared by several users, including several aquaculture farmers (Tisdell, 2003; Tisdell et al., 2012).

Again, some forms of aquaculture raise income distribution questions. Large‐scale aquaculture, which displaces small farmers or adversely impacts on the incomes of poor fishing and subsistence communities, has an adverse income distribution effect. This has happened for shrimp aquaculture in some less‐developed countries, for example in Bangladesh. On the other hand, seaweed farming in Indonesia appears to have reduced rural income inequality, at least in some villages (Firdausy and Tisdell, 1993).

Some forms of crustacean culture raise additional sustainability issues and in essence pose an inter‐generational income equity problem. The practice has arisen in some parts of monsoonal Asia of alternating rice and shrimp/prawn production in low‐lying estuarine areas, e.g., in the Sunder barns of Bangladesh. Rice is planted just before the wet season. After the rice is harvested in the dry season, the fields may be flooded with brackish water to create ponds for rearing shrimp or freshwater prawns (Macrobrachium species). These ponds are drained before the start of the next wet season and the animals are harvested. The land is then prepared for rice and replanted. So, the cycle continues. This, however, does not appear to be a sustainable practice. It results in falling rice yields in some areas due to rising soil salinity and mineralisation of the soil.

Different forms of aquaculture can result in a variety of environmental issues (Tisdell, 2015) including environmental health risks and biodiversity loss. If, however, aquaculture has adverse environmental impacts, this does not mean that it should be banned from a socioeconomic perspective. Instead, policy measures, such as taxes on effluent, could be adopted to ensure that aquaculture businesses take their external costs into account in their decision‐making. (A tax, for example, can result in the firm’s private costs of production after tax being brought into line with its social cost.) Optimal economic policies to control environmental spillovers need to be given more attention, specifically in relation to aquaculture. Economic theory indicates that it is not optimal, as a rule, to eliminate all environmental effects, but that government intervention to control these is sometimes justified. This can be seen by considering the example illustrated in Quadrant I of Figure 14.6 because, when the socially optimal (economic) level of aquaculture output, X₁, is achieved, environmental spill over costs equivalent to the distance GC are present.

14.7 Summary

• The survival and development (in a market economy) of any type of aquaculture depend on its economic viability. One way of assessing the profitability of an aquaculture enterprise is to compute the present value of its stream of net profits less the discounted realisable value of the enterprise should it be sold at some specified time in the future. The choice of discount rates is discussed. From an economics point of view, the discounted present value of an aquaculture enterprise should be positive for it to yield a positive level of profit, or its benefit‐cost ratio should exceed unity. An alternative way of assessing the profitability of an aquaculture project or business is to estimate its internal rate of return. The advantages of doing so were outlined.
• Market supply and demand conditions determine the prices and sales prospects for aquaculture commodities and are significant influences on the economic fortunes of an aquaculture business. Important economic influences on these conditions and their consequences are identified.
• Economies of scale in production (as well as in product distribution and sales) can have important implications for the economic viability of aquaculture enterprises. For example, businesses may have to reach a minimum critical size in order to be profitable and to survive. In some cases also, cost economies may be obtained from product diversification and this diversification may reduce business risk.
• Most aquaculture procedures have to cope with a considerable amount of risk and uncertainty; both production‐ and market‐related. Ways of allowing for and coping with this are identified.
• In evaluating the economics of aquaculture, its diverse social or aggregative economic effects ought to be taken into account; especially when the market mechanism fails to allow for these. The economic consequences of adverse environmental spillovers from aquaculture production are singled out for particular consideration. Possible implications for the sustainability of aquaculture production are noted. Potential public policies to address these shortcomings are outlined and assessed.

References

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