The environmental effects of expanded trade: a firm-level simulation analysis o investment in Texas grapefruit

Abstract

This research is about the future of the Texas citrus industry and, in particular, whether rapid growth and development associated with expanded trade are likely to be significant factors affecting future investment in the industry. The Dixit-Pindyck model employed in this research is an investment analysis technique building on orthodox investment analysis (based on net present value calculations) to account for uncertainty and irreversibility by incorporating the value of the option to wait to invest into a modified investment decision rule. The Dixit-Pindyck model applies because an investment in a citrus grove involves a large, irreversible (sunk cost) component. The research was conducted in four stages. First, based on a historical review of the Texas citrus industry, prices and freezes were modeled as key sources of uncertainty. Second, the environmental effects from growth associated with expanded trade-specifically, water scarcity, congestion, and the opportunity cost of land--were identified as factors likely to affect future investments in Texas citrus. Third, information and data pertaining to these variables were obtained through interviews with experts to develop a profile of a prototypical citrus investment opportunity. Finally, an ex ante analysis of a prototypical Texas grapefruit investment decision was developed, and decision rules for prospective future investments were devised using the Dixit-Pindyck model. The research results support the appropriateness of the Dixit-Pindyck model for modeling future investments in Texas citrus. The modified investment decision rule, which accounts for uncertainty and irreversibility, is significantly different from a decision rule derived from an orthodox investment analysis. This of uncertainty for a prototypical investment in a Texas grapefruit grove. Sensitivity analysis was conducted to estimate the extent to which three trade and environment factors affect investment behavior. As modeled, these trade and environment factors were not an important additional source of uncertainty likely to influence future investment in grapefruit, relative to prices and freezes. Declines in investment in citrus in the LRGV in the recent past are well explained by a model which accounts for risk due to freezes and price volatility.