Mixed Market Instruments for Salinity Mitigation

1. Mixed Market Instruments for Salinity Mitigation Amy Cheung School of Economics - UNSW Policy Choices for Salinity Mitigation: Bridging the Disciplinary Divides – Workshop 1-2 December 2005

2. Content • Introduction: motivation for change • Market-based instruments: features • Problems with market-based instruments • Salinity: applicability of MBIs • A case for “mixed” market instruments for salinity mitigation • The next step

3. Introduction • Quality of natural resources  a public good that regulatory authorities must protect by preventing private agents from its overutilisation • Standards, regulations, legislations: basic mechanism for regulatory authorities to conduct environmental policy throughout industrialised countries

4. Introduction • Compliance  mandatory with penalty for non-compliance • Amount of pollutants set either on: - scientific opinion of the adverse health or ecological effects of the pollution - social or political judgment of the public’s value to the environmental good

5. Introduction: motivation for change • Traditional command-and-control regulatory measures fails to efficiently manage natural resources because:

6. Introduction: motivation for change • Tend to be inflexible: regulation is commonly viewed as lacking in flexibility • Extremely costly (government, community) if poorly designed and administered • Sub-optimal: environmental and economic efficiency Why?

7. Introduction: motivation for change • Only produce an economically efficient (i.e. least cost) solution to meeting a given environmental standard by: good judgment + good information • May discourage new economic and technological abatement initiatives because polluters do not incur a financial penalty for their emissions provided they remain below the standard

8. Introduction: motivation for change • Uniform standards: do not fully take into account differences in abatement costs between producers  sub-optimal distribution of abatement devices • Salinity is a non-uniformly distributed ‘pollutant’, so a standard may not be cost-effective

9. Features of market-based instruments • Increased interest in market-based instruments (MBI) in past 20+ years to address environmental problems • Mainly through the price mechanism  creates positive incentive to alter attitudes of private agents toward the environment • A more flexible approach to facilitate natural resource management in market economies • Idea dated from earlier seminal works by Pigou (1920) and Dales (1968)

10. Features of market-based instruments

11. Features of market-based instruments • The market  encouraged overutilisation of natural resources (a ‘free’ good) now the approach where environmental objectives could be met at least cost! • Improve on or creates previously non-existent market to provide incentives for the greatest reductions in pollution by those agents that can achieve these reductions most cheaply

12. Features of market-based instruments • Achieve static and dynamic efficiency Arise when polluters face different marginal abatement cost – able to work out efficient level of resource use depending on cost of abatement Polluters want to continuously seek new ways to reduce cost of abatement – incentive to develop new and cheaper technology now and future

13. Features of market-based instruments • Efficient solution: equating marginal damage costs with marginal costs of environmental protection • Difficult to determine, especially marginal damage costs – encompasses many “costs” and often very long time frame – e.g. time lag for pollution-related illnesses to take effect

14. Problems of market-based instruments • Market/Monopoly power in the output market – achieve supernormal profit by reducing output below market competitive level e.g. environmental tax • Uncertainty on outcome and costs: resource use efficiency depends on individual agents’ decisions in response to the incentive provided by the tax – outcome to be greater or less than envisaged

15. Problems of market-based instruments 3. Tax ‘burden’: concerns about level of financial burden may place on some natural resource users – both at household and industry level 4. Cost: Poorly designed MBIs may cost as much as pure regulation; administrative cost; some producers will face higher cost/consumer pay higher price post-tax - economic slow down???

16. Salinity • Salinity: one of Australia’s most costly environmental problems • Damages to built infrastructure, agricultural production, wetlands, rivers, water supplies and hence welfare of rural communities

17. Salinity • Vital knowledge: where the salt lies in the landscape, how it moves, how quickly it is moving, and where it is most likely to cause damage in the future • It has been demonstrated that salt is localised and moves along well defined underground pathway

18. Salinity • Land use changes- tree clearance, irrigation: more rainfall soaks into the ground, raising the water tables, and bringing natural salt deposits to the surface • Non-uniform pollutant – different characteristics of each region – climate and topography

19. Salinity: applicability of MBIs • Some criteria for consideration: • Environmental effectiveness: assessing relative costs and benefits of measures such as salinity taxes/charges Price: irrigators’ response to market signals Quantity: deliver env. effect with greater certainty with compulsory compliance (e.g. strictly no irrigation ≤xML)

20. Salinity: applicability of MBIs 2. Economic efficiency: need to assess which MBIs have achieved a cost-min pattern of resource use efficiency – use to evaluate the relative cost and benefits of these env. policy instruments 3. Acceptable cost burden: administrative cost Vs compliance cost.

21. Salinity: applicability of MBIs 4. Revenues: what happens to the revenue generated from taxes? Usually allocated to public budget, could be reserved for an env. fund (e.g. funding for a tree-planting credit scheme), return to tax payers (e.g. in the form of tax reduction n other areas) Potential source of administrative inefficiency?

22. Salinity: applicability of MBIs 5. Flow-on wider economic effects: need to consider possible effect on the local economy: • Price level, competitiveness, trade patterns, production patterns, local employment, income distribution, growth of local economy, rate of innovation in salinity mitigation • Different time horizons

23. Salinity: applicability of MBIs 6. Compatibility: the instrument should be compatible with existing or proposed laws, institutional framework and administrative structure. Coordination may be difficult at different levels of government (e.g. Federal and State) – existing Constitution 7. Community acceptance: industry, environmental groups, regional community Need to address different perception of ‘fairness’

24. ‘Mixed’ market instrument? • Application of pure price or quantity instruments may be problematic in practice - due to asymmetric information • Salinity: a case for a mixed market instrument? • Mixed market instrument refers to using both price and quantity instruments to solve an environmental issue • Combines political appeals of quantity instruments and efficiency of prices

25. ‘Mixed’ market instrument? • Mixed instrument: due to the degree and types of uncertainty present in salinity • Covers shortcomings inherent to pure price-based and quantity-based instruments In a saline region: • if transaction costs are high • number of parties involved in a dispute is large • common property  Use quantity instruments, otherwise, use price instruments and vice-versa

26. ‘Mixed’ market instrument? • Possible mix of instruments: • A percentage tax on a tradable permits • A policy where polluters will have a choice of adhering to a standard, or purchase more permits to cover excess, or being taxed for excess pollution • Polluters are able to choose the cheapest option – individual polluter knows own cost function • May be complicated, but not impossible

27. The next step • Salt are localised, so we need a local solution • Question: • When we model a potential policy for salinity mitigation, do we…

28. The next step • …model salinity as: • An undesirable output – minimisation? • …and/or desirable output? Possibility to sell this ‘output’ in the market place? Natural salt from the ground – valuable?

29. Thank you.