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

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

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

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

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

Introduction: motivation for change 1. Tend to be inflexible: regulation is commonly viewed as lacking in flexibility 2. Extremely costly (government, community) if poorly designed and administered 3. Sub-optimal: environmental and economic efficiency Why?

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 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

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

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)

Features of market-based instruments Instrument Base Instrument Examples Practical Australian Examples Price (  behaviour by  P) AuctionRebatesSubsidiesTaxes Bush Tender, North-East and North- Central Catchments Victoria Beverage container deposit system, SA EnviroFund – NHT, Australia Quantity (  behaviour by Q Cap and trade Offsets Bubbles Hunter River salinity trading scheme – to curb saline water discharge from 20 mines and 2 electricity generators Tradable water entitlements in MDB Market Friction (  Friction) Risk Management Leverage funds Product differentiation Conservation insurance, SA (MBI Pilot 1) Greenbank – leverage NRM objectives (MBI Pilot 1) Eco-labelling, QLD (MBI Pilot 1)

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

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

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

Problems of market-based instruments 1. Market/Monopoly power in the output market – achieve supernormal profit by reducing output below market competitive level e.g. environmental tax 2. 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

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???

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

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

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

Salinity: applicability of MBIs  Some criteria for consideration: 1. 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)

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.

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?

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

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’

‘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

‘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

‘Mixed’ market instrument?  Possible mix of instruments: 1. A percentage tax on a tradable permits 2. 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

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

The next step  …model salinity as: 1. An undesirable output – minimisation? 2. …and/or desirable output? Possibility to sell this ‘output’ in the market place? Natural salt from the ground – valuable?

Thank you.