The scientific revolution in the biological sciences with its rapid advances in molecular genetics offers great potentials for productivity gains in agriculture. Food crops with higher yields and better nutrition content, plants that are resistant to drought and pests, livestock that are immune to disease, and fisheries that are sustainable, are possible developments which can result from the application of biotechnology.
However, opposing the expected gains, there are risks related to the widespread use of transgenic crops. Gene flow in plants can enable domesticated plants to become pernicious weeds, or enhance the fitness of wild plants which might be serious weeds, thus shifting the ecological balance in a natural plant community. New viruses could develop from virus-containing transgenic crops. Plant-produced insecticides might have harmful effects on unintended targets. While some of these scenarios are highly unlikely, little is known about the overall impact that transgenic crops can have on biodiversity, ecosystem balance and the environment.
Therefore, most developed countries have established regulating agencies which approve the release of transgenic crops. The decision- making rule of these agencies can be described as comparing - explicitly or implicitly - the expected costs of the release with the expected benefits. They will approve the release of the transgenic crop if they expect that the discounted sum of benefits exceeds the sum of the expected discounted costs. Generally, the decision can be seen as one under temporal uncertainty and irreversibility. Real option pricing theory has shown that under such circumstances, the benefits have to exceed the costs by a factor significantly greater than one to account for the option to delay the decision. This factor is commonly called the hurdle rate.
The hurdle rate for the release of transgenic crops is derived for two different scenarios which represent an optimistic and a pessimistic view on the effects of transgenic crops.
The optimist assumes that transgenic crops will generate continuously but stochastic benefits. This view about transgenic crops was modeled assuming the additional benefits follow a geometric brownian motion. Using conservative guesstimates for the parameters of the hurdle rate, it can be shown that the hurdle rate has at least a factor of two. Under an optimistic view additional benefits from transgenic crops should be at least two times the expected loss in biodiversity.
The pessimist assumes that benefits, if at all, will be only available for a short period of time. This view about transgenic crops is modeled by assuming the additional benefits follow a mean-reverting process where additional benefits decrease to zero over a specific period. Surprisingly, this model results in lower hurdle rates compared to the optimistic one, which could be explained by the higher value of the option to delay the decision due to the positive trend in additional benefits in the optimists model.
The results further suggest that a tax on transgenic crops or mandatory refuge areas decrease the hurdle rate and therefore support an earlier release.
Fortunately, an empirical application of the model seems to be easy as most parameters like prices and yields can be estimated from information provided by the market. There are also several on-going and completed studies on the economic measurement of biodiversity that can provide information on irreversible costs.