Environmental Economics

The discussion about ‘entitlements’ – in the sense of social welfare, employment benefits, and industry support – is raging high and wide on the Australian political scene. At the same time we get news from the USA that polluters are gearing towards a legal challenge of US EPAs involvement in cleaning up some of their most important estuaries. Polluters figure that success of clean up actions in the Chesapeake Bay will necessarily imply a need for such actions elsewhere – most notably on the Mississippi Delta – , which will prove enormously costly for the fertiliser, pesticide and other agricultural and non-agricultural related industries.
What is the relevance to the ‘entitlement’ debate in Australia, and to the Australian environmental protection activities? Firstly, it is well known in the economics literature that polluters will behave preemptively in order to protect their ‘entitlement’ to pollute. They would increase pollutant emissions or the rate of natural resource use when they face a prospect of future regulation. I wrote about this some years ago in the Australian Economic Papers (Ancev, 2006). When regulation comes in and forces them to cut back, polluters would still hold to their initial ‘entitlement’ despite the mandated reduction. The US example quoted above is just a case of a flagrant, ‘in your face’ preemptive behaviour of the same sort. Polluters feel that they have an ‘entitlement’ to pollute, and they are going to protect that ‘entitlement’ through legal action.
Secondly, the significance to Australia is in light of the current debate about allowing polluting activities to take place on the Great Barrier Reef. It makes one wonder whether allowing pollution of the reef now might entrust the sense of ‘entitlement’ to pollute within industry. And when we try to clean it up sometime in the future, we might face a legal action motivated by the need to protect those ‘entitlements’! We better get a good lawyer!

The Commonwealth Water Holder has announced that they will be selling annual water allocations to the entitlements that they hold in the Gwydir Valley.
As discussed on this blog (Nov 2012 and Nov 2013) and elsewhere (a conference paper at AARES 2012, and a journal article about to be published) this is a reasonable move. There has been plenty of water in those parts of the country in the last few years, there have been good floods, and ecosystems are up and running. Sitting on the environmental water cannot do much good, so selling some annual allocations makes perfect sense.
Of course, this has to be done in a careful and prudent way, with constant monitoring of the situation on the ground. If done properly, it will be a good thing for the irrigators and their communities, without causing harm to the environment.

Pretty quiet summer time here in Oz. Most of Australia is sizzling with temperatures into high 30’s and 40’s (no relation to climate change). Almost a perfect time to think and write about the recent developments with the Commonwealth Government’s ‘Direct Action Plan’ to deal with greenhouse gas emissions (GHGs).
Details of it have started emerging early in the New Year.
It will have two main components: 1). a funding pool – called the emissions reduction fund – comprising of some $1.55 billion within the first three years; and 2). an emissions baseline for each liable emitter set based on historical emissions: breaching this baseline will involve incurring as of yet undetermined penalty.
It is planned that the funding be distributed using auctions: emitters will bid for funding by offering certain quantity of abatement in exchange for receiving funds, which will mean that those who offer to abate more for less are going to be favorites for funding. Ultimately, this should lead to a desirable outcome that abatement is undertaken by lower abatement cost emitters.
However, this desirable design feature should not distract from the fact that it only ensures how to distribute the subsidy more effectively. That’s right: ‘the subsidy’! Because that’s exactly what the first component of the Government’s Direct Action Plan is: a big, fat subsidy to those who emit carbon dioxide and other GHGs in the atmosphere. This Government has insisted so much on using the term ‘Carbon tax’ for what previous government wanted to call ‘Carbon pricing’, that it is only fair to ask them to call their Direct Action Plan what it is: A Carbon Subsidy.
And anyone who studied a bit of economics would know that subsidies have pretty undesirable characteristics: for starters, they invite more entry into a polluting industry in the long-run, as the subsidy makes it on average less costly to operate. This is in direct contrast to a tax that increases the cost of operation for heavy polluters in the long-run and hence forces their exit from the industry. In addition, the subsidy empties state’s coffers, whereas a tax fills them.
So, no surprises here: the Direct Action Plan is as bad as the very idea of it has always been. But, please call it for what it really is: A Carbon Subsidy.

The Federal Environment Minister recently approved several mining and mining related projects that involve dredging and general industrial development on the Great Barrier Reef (GBR) Coast.
This has rightly upset many environmental groups given the significance of the reef as an iconic and globally recognised environmental asset. One interesting premise on which the decision was made is that the conditions of the approved environmental licences entail offsetting the deterioration of water quality in the reef from these new projects by reducing water pollution attributable to agriculture. Agriculture has been long known to contribute to the water pollution problems in the reef.
While some have cautioned that such offsetting of the effects from mining and mining related projects by reducing pollution from agriculture may be flawed, in principle offsetting could make good sense if there are big differences in marginal ‘benefits’ from pollution between mining and farming.
One could imagine mining operators paying farmers to undertake measures on their farms that will minimise nutrient runoff (e.g. eliminating fertiliser application, putting in large buffer strips, etc.) if the cost of this type of ‘abatement’ is comparably low in relation to the benefits derived from mining operations. Reducing nutrient and sediment runoff is likely to improve water quality in the reef, and perhaps to offset the deterioration caused by new mining activities.
While this can be appealing to both farmers and miners, society needs to ensure that comparisons are being made on like terms. Offsetting might help with reduction of nutrient concentration in the reef, which is beneficial, but dredging and other mining development might create other water quality problems (e.g. heavy metals) that will not be offset, and will cause a long term contamination that is very difficult to rectify.
Offsets are all well and good, but due diligence is called upon, especially when it comes to a place like the GBR.

Recent announcement by the − still fairly new − Federal Government that the planned buy-back of water entitlements will be capped at 1500 GL went largely unnoticed. Not surprisingly, farmers have endorsed this decision, but we have not heard many complaints from the environmentalist groups.
I was more worried with the intention to divert the money planned for buying-back entitlements towards funding infrastructure activities, than with the very fact that buying-back is slowing down and being capped. We know that subsidising irrigation infrastructure is a much less efficient way of securing water for the environment than buying-back entitlements (see the penultimate paragraph of the article in The Australian, link above).
But again, this Government seems to be generally in favour of direct regulation and action, rather than using market-based policy instruments, which is rather inconsistent with its supposed political colours (see a previous post on climate change)
Apart from this, slowing down the buy-back of water entitlements might not be as problematic as it may seem. The Commonwealth Environmental Water Holder already sits on quite a lot of entitlements, and doesn’t seem quite sure what to do with them, especially in times when there is plenty of water around.
So, not biting any further on entitlements might not be such a bad idea, especially if the Government can stand ready to play in the annual water allocation market, if and when adequate opportunities to buy and sell exist. Having a functioning water market will enable compensating for the possible shortfall in entitlements by buying annual allocations at times when the environment needs the water the most. This will be a much better use of the money saved on buy-backs!

OK, let’s get this right. Trying to pinpoint the cause of last week’s bushfires in the Blue Mountains near Sydney to climate change is really barking up the wrong tree.
The main source of the problem is not that it has become marginally hotter, and drier, and earlier in the year. The problem is that too many of us are leaving in places that are prone to natural disasters, including bushfires. Climate change is likely to cause favorable conditions for development of large fires more frequently in the future. But with or without climate change, human societies are more exposed than ever to disasters. We build residences on flood plains, near the coast, and into the bush, which makes us vulnerable to floods, see level rise and hurricanes, as well as to bushfires.
The incentives to do so are all there: these are environmentally appealing areas often away enough from large metropolitan centers to be affordable, yet close enough to allow commuting. In addition, local councils have for many years encouraged development driven by own incentives to increase rate-paying base. Changing climate is going to increase the risk to these communities, but even without climate change, we are already under extraordinarily large risks in these natural-disaster prone areas. These risks pertain to life and wellbeing of an ever-increasing number of people living in such areas. But also, and notably so, there is heightened risk to property whose value seems to be ever-increasing. Both of those have systemic impacts throughout the economy in the form of the cost of disaster relief and sharply increasing insurance premiums across the board.
The solution to this problem is not going to coincide with the solution to the problem of climate change. Society needs to find ways to limit exposure to natural disaster risk. One way is to be very, very careful when approving residential developments in areas that are prone to such risks. For instance, the Blue Mountains Council recognizes this, and has therefore limited the population growth forecast, specifically citing bushfire hazard as a limiting factor. Other councils should follow suit. In addition, measures should be taken to alleviate exposure in the existing communities. Such measures should be wide ranging, and should include physical and engineering works, but also should consider the possibility of ‘buying-back’ or ‘retiring’ residential developments that are most exposed to natural hazards. The cost of these preventive measures will be lower than the cost sustained when natural disasters hit.
It is tempting to link last week’s fires to climate change. While climate change is likely to worsen society’s increased exposure to natural disasters, it is not the original source of the problem. Unless we find ways how to stop the residential sprawl in disaster prone areas, and to alleviate risks in existing residential developments, we will continue to be at high danger from natural disasters, with or without climate change.

A recent article (pre last weekend’s election) about emissions of C02 by Australian motorists caught my attention.
Apparently, our four-wheeled companions are the second worst in the world when it comes to C02 emissions (one can always count on the good old USA to save you the top spot on rankings like this, but it seems even that is not going to last for long in this case). My interest in the article was incited in part by my recent shopping experience for a hybrid vehicle. When I mentioned to my friends that I am after a hybrid, the question was always: ‘Why would you want to do that’? Even the dealers in the car showrooms were surprised that someone is asking for a hybrid. One said: ‘Not too many people are keen on hybrids… You’ve got to remember, this is a country of V8s, and anything below V6 is still seen as a bit of a joke…’
My research in the new car market showed that one can buy a hybrid vehicle that uses about two-thirds the amount of fuel and emits much less C02 emissions for about $1500-$2000 more than the same car with regular petrol engine. I reckoned this is a good deal, and went for it.
I also noticed that most new vehicles are now boasting significantly better fuel economy and better environmental ratings than previous models. This might be partly due to the recent trend of price consciousness by Australian motorists in the face of significant price hikes at the bowser. As colleagues from ANU report in their published research (Burke&Nishitateno, Energy Economics,36(2013): 363-370) new vehicles tend to be more fuel efficient and emit less C02 emissions in countries with comparably higher petrol prices.
I hope that in coming years more Australian motorists will turn to vehicles that emit less C02 and use less petrol. It is good for the environment, and good for the hip pocket.

We are exactly a week away from Federal Elections in Australia. The campaign goes as usual: people hear a lot of debates on the economy, the budget and costings, on illegal immigration, education, disability, parental leave… There doesn’t seem to be much heated discussions on the Environment, perhaps not surprisingly given the questionable salience that the environment carries in elections. There are few environmental issues that are discussed, and few more that surprisingly aren’t. Below is a list that summarises both talked-about issues, and the ones on which we haven’t heard much. Posts on this blog have dealt with many of these in the past.
The list of talked-about issues is dominated by Carbon pricing. There is a stark distinction on this highly sensitive and politicized issue. Labor Party (in government) has recently made a purely politically motivated switch (they desperately needed to get rid of the word: ‘tax’) to speed up a process of transition from a Carbon tax to a tradable permit scheme. The Coalition (in opposition, but leading the polls quite clearly) has been intensively using the Carbon tax against the government, and is itself proposing some sort of subsidy/standard based program towards GHG emissions reduction. This program doesn’t make much sense, and it has been criticised widely by anyone who knows anything about policies towards climate change, but the Coalition has to stick with it to avoid any type of attachment to the notion of ‘pricing’ or ‘Carbon tax’. The third most important political party, The Greens, have quite clearly a typical environmentalist position on GHG emissions, and would like to impose ambitious and very expensive reduction targets.
The next issue on which we hear from time to time is the Coal Seam Gas (CSG), This is particularly salient in rural electorates, where there seems to be an unlikely partnership between farmers and The Greens – who are vehemently opposed to any CSG development. This may hurt The Nationals (a junior partner in the coalition) who are playing along with The Liberals (the senior partner) in courting corporate interests around CSG.
The least divisive rhetoric is probably around the Great Barrier Reef, on which all major parties seem to agree that something needs to be done.
The list of notably absent issues includes the Murray Darling Basin (MDB), Native vegetation and forests, and the fisheries. It is surprising that the government is not making greater noise about the MDB, as they have been successful in striking a deal with all states involved, and creating arrangements where the MDB is federally managed, to the benefit of the environment, and economic efficiency. Native vegetation and forests, and the fisheries, have been in the public focus on few occasions in the past three years since the last elections but it seems that only The Greens are keeping them on their election agenda.
Key political players started this election campaign by saying it is going to be about the Economy. This has shaped the campaign, and on 7th September the environment will not be on the minds of too many people.

I am in Hong Kong, spending some time at CUHK. Being in China, I have started following local newspapers, and stumbled yesterday upon this story in South China Morning Post.
The described situation is typical for societies that take early steps towards environmental remediation. The decisions to clean-up are made based on idealistic views, without considering associated costs and benefits, or possible alternative projects. This was, for instance, evidenced in the US in 1970’s with the Clean Water Act, which cost a lot of money, but whose cost-effectiveness (amount of environmental improvement per monetary unit spent) was disastrous. It seems that China is repeating the same mistakes, as this example from Guangzhou is clearly showing.
While I am not sufficiently familiar with the environmental situation here, I could almost bet that there would be many other clean-up projects that would have brought about much higher environmental benefit than the funded canal remediation in Guangzhou. Indeed some of the most cost-effective projects are rather simple and perhaps not flamboyant enough to attract big political attention, in contrast to the canal project that was visited by many Chinese dignitaries. Certainly, what should matter to politicians is the ultimate environmental and human health benefits attained by funded environmental projects, and not the photo ops and environmental posing. Hopefully, Chinese authorities will quickly learn from this mistake and start making more rational choices about environmental protection.

The Deputy Premier of NSW recently announced planned changes to the Native Vegetation Law and the Threatened Species Act . These pieces of legislation have frustrated farmers for many years, (here is a story from few years back when a farmer went on a hunger strike up on a tree), so there is no wonder that they are happy with this proposal. There is also no wonder that environmentalists are fervently opposing any changes to these laws.
Overly tight native veg and threatened species legislation can impose unnecessary burden and significant costs to farm businesses. On the other hand, relaxing these laws completely would take us back to the dark age of indiscriminate land clearing for farming purposes. So, the question is how to strike the right balance?
Unfortunately, there are no good and ready answers to that question. In theory, we should be able to determine the optimal level of native veg and species protection by looking at the cost to farmers, and benefits to the community at large. The difficulties there exist on both side of the equation: farmers are likely to overstate their costs; and it is notoriously difficult to value community preferences for such things as native veg and threatened species. So, we do not have a good empirical grasp of the size of costs and benefits, which prevents us from setting optimal level of protection.
There are additional problems with the distribution of costs and benefits. Under the existing arrangements, costs are born exclusively by farmers and benefits are supposed to be enjoyed by the wider community, both present and future. It is this distributional inequity that makes farmers so mad.
And so, perhaps the right approach is not to change the level of native veg protection, but to find some way to compensate farmers for the services that they are providing to the community by maintaining native veg on their properties. Otherwise, we are going to go in circles from too stringent to too lax native veg regulation, and back again to too stringent, in accordance to the political cycle. Rather than being close to right most of the time, we will be grossly wrong all of the time.