Environmental Economics

Early last week a newspaper article reported that logging of native forests in NSW are loss making operations. This revelation comes in the face of calls by some political parties in the NSW Parliament to expand logging of native forests based on the argument that this will keep people in the logging industry on the job. Representatives of other parties in the parliament have quite rightly pointed out how ludicrous this proposition is.
This can be seen by looking at the very basic principles of resource economics. Natural assets (forests, fish, water, minerals, etc.) have values that are quite obvious, and can be very, very large, but do not have prices because they are given by the Nature. But, once these natural assets are transformed into marketable commodities (logs, fish fillets, saleable ore) they command a price. The difference between the revenue obtained for these marketable commodities and the costs – inclusive of all factors of production, and particularly inclusive of some ‘normal’ return on invested capital – , of putting them on the market is sometimes called a ‘shadow’ value, and reflects the value of these assets as represented by the Natural Resource Rent.
Now, what is the report of losses from native forest logging telling us? The implied Natural Resource Rent is negative, which translates into saying that these forests are not valuable at all, and in fact we, as society, should be paying for someone to cut them down! This clearly defies logic, as we all know that native forests are valuable not only for the timber and pulp that we get from them, but also for the numerous eco-system services that they provide: land and water protection, biodiversity conservation, and recreational and aesthetic services. So, if society does not get anything for something that it is so clearly valuable, we should immediately stop using the asset in the way we do. This means that logging of native forest in NSW should not proceed at all until that time when society can capture a positive and significant rent from this activity.
What’s more, the rent should be high enough to more than offset the loss of values of eco-system services that will eventuate as a result of the logging. Given the likely magnitude of those values, logging native forests should be very profitable to justify its existence. Stopping it when it is not profitable should be a no-brainer!

Key interest of the week in Australia is the 2013 Federal Budget. There are many aspects of life affected by the annual budgeting ritual: health, education, employment, and … the environment. It is interesting how the Environment gets so little attention on the Budget night. The same is also true on the Election Day, a phenomenon known as ‘lack of saliency’. People seem to talk a lot about the Environment and seem to genuinely care, but when it comes to ‘serious’ things in life, like the Budget or the Election, the Environment does not get very high priority.
So, what is the verdict for the Environment in the 2013 Budget? The news is actually not bad at all. A nice summary of the Budget items relevant to environmental issues is provided by EnviroInfo.
The main points are that many of the subsidies and compensations to C02 emitters are scrapped. This is a welcome development, given that those subsidies and compensations were in their own right a distorting element in the whole concept of Carbon price. So, not only will scrapping those fill in few gaps in the Budget, it will also remove perverse incentives that subsidies carry along. All good there.
Further, there is a mention of what seems to be a very marginal adjustment to the Biodiversity fund, which will not change substantially the operation of this program.
On the agriculture side of things, there seem to be an enhancement of the Carbon Farming Futures Program. This is good news in its own right, but the success of this program is somewhat in doubt if judged by some of the interesting stories around funding decisions under the Filling the Research Gap initiative of the program.
Finally, funding to the tune of $1.8 billion over 10 years from 2014-2015 is committed to environmental water requirements in the Murray Darling basin. It seems that majority of this funding is going to be devoted to technical projects aimed at improving irrigation efficiency, which is really a form of a subsidy to the irrigation industry. It would have been better to devote more funding to the Commonwealth Environmental Water Holder for the purpose of buying-back entitlements. The announced additional $10 million that are going to be devoted to research about how to best use environmental water holdings just strengthens the case for more buy-backs.
Overall, the 2013 Budget is not bad when it comes to the Environment. Most of the announced changes make good sense, and will eliminate some unjustified subsidies to polluters. There are no new big environmental initiatives, so after all it is perhaps not overly surprising that the Environment has not featured prominently in the media coverage of the Budget.

I recently attended the 3rd International Water Association’s Conference on Water Economics, Statistics and Finance in Marbella, Spain.
It was a great event, with participants from all over the world. At the conference I gave a keynote talk titled: Evaluating Tradeoffs between Economic and Environmental Efficiency in Water Industries.
The main thrust of the talk was on the conceptual and empirical possibilities for environmentally adjusted efficiency measurements, and their application to the water industries (irrigation, municipal, and wastewater). In a nutshell, this is about how to introduce environmental effects in the traditional methods for productivity and efficiency measurement, and how to use them to evaluate tradeoffs between the economic and environmental performance of production units. If this is done properly, it will enable us to identify such units (e.g. irrigation enterprises) that have mediocre or poor economic performance (do not create much economic benefits) and at the same time create significant environmental impacts (e.g. take a lot of water out of the rivers, which affects water dependent ecosystems). In other words, these type of units damage the environment but do not make a commensurate economic contribution.
In the course of preparing the presentation, I undertook an extensive survey of the literature, which showed that several research groups around the world have very recently grappled with these ideas, and have published work that paves the way for a prolific line of research. This indicates that a widespread application of these methods to quantify environmentally adjusted economic efficiency in all sorts of industries, including the water industries is impending. Watch this space!

Biggest international news (sad, or otherwise, depending on who you ask) this week has been the passing away of Margaret Thatcher, the British PM from the 80’s (I personally subscribe to de mortius nil nisi bonum view) . She was known for many things, but not many people would have guessed that she was an early advocate of the need to do something about climate change.
Combine that with her widely known neo-liberal capitalist approach and free-market philosophy, and one could almost trace the notion of ‘carbon pricing’ back to Thatcher’s 1980’s. Fast-forward about 25 years to the present time, and you see the natural ideological offspring of Thatcherism that can be found on the right of the political spectrum to be much less enthusiastic about climate change, and about carbon pricing. The latter is particularly evident in current Australian politics.
What irony that the staunch followers of Iron Lady’s views and philosophy are staunchly opposed to one of the things that she was apparently very passionate about, and for which she would have probably proposed a typical Thatcherist policy: put a price on it!

Yesterday, I attended the Australia-China Climate Change Forum held at the UNSW.
The keynotes were Greg Combet, the Federal Minister for Climate Change and Xie Zhenhua, Vice-Chairman of the National Reform and Development Commission, PRC. Many of the key people surrounding climate change science, economics and policy both in Australia and in China were there.
It was reassuring to hear that China is thinking very seriously about implementing policies to reduce carbon intensity of their industry, and reduce GHG emissions. In fact, they have moved beyond thinking, and are introducing pilot emission trading scheme programs in seven provinces including Beijing, Shanghai, and Shenzhen. These will start running from 2013, and are envisaged to transform into a national ETS by 2020. There are many things around these pilots and a future national scheme that need to be further worked out and implemented, but this a start. It seems that some form of carbon pricing will find its way in the Chinese economy in the next 7-8 years or so. This will inevitably mean that the associated costs will be transmitted throughout the economy, and are likely to affect consumers in several key areas including electricity and transportation. So, prices of certain goods and services are going to rise, and there are still many, many people in China who need affordable access to these goods and services.
The key question that follows from this is what is the public support in China for implementation of stringent carbon emission reduction policies? Even though a different political system, the importance of public support is no less significant in China than it is in Australia. If many people, especially within the rapidly growing Chinese middle class see climate change policies as threatening the continuing rise of their economic prosperity, the Chinese government is going to have a very hard sell on these policies. We are likely to see caps on emissions that are too high, generous allocations of grandfathered permits, and consequently minimal actual carbon prices. The Chinese government will have to be very careful in how they progress with climate change policies so as to avoid the public backlash that the current Labor government in Australia has experienced.

Yesterday I was at the official opening of my Faculty’s new Centre for Carbon, Water and Food. It was a marvelous occasion, with the Prime Minister of Australia doing the honors, accompanied by couple of ministers and MPs, the Chinese Ambassador to Australia, and delegations from our Faculty’s partner institutions in China, as well as the full suite of University’s leadership .
The Centre itself is an excellent, state of the art facility, where world class research on many scientific aspects of carbon and water cycles and their essential linkages to the agricultural production will be investigated. This will no doubt lead to greater understanding of the complex environmental questions that we are facing today.
However, better knowledge of water and carbon cycles, their bio-physical and chemical characteristics, their spatial and temporal dynamics will not, in its own right be sufficient to lead to better long term environmental and natural resource management and improved environmental quality. To achieve this, we also need improved understanding of how people and their economic system interact with these important natural cycles, and how are they likely to respond when circumstances change. Perhaps most of all we need to understand how to facilitate change in the way people govern the environment and natural resources, i.e. how to foster timely institutional innovation in this area. This is very complex (perhaps more complex than the science of water and carbon cycles), and cannot be answered in the usual simple way: ‘government needs to do something about it’. We only need to look at the Minerals Resource Rent Tax to see that even when government does something, nothing much changes if the understanding of how the economic system will respond is missing.
Only a sustained, significant and substantial research effort in understating economic drivers and human institutions that shape carbon and water cycles would enable the translation of scientific advances in understanding these complex natural cycles to better environmental and natural resource management outcomes. Unfortunately, I could not see evidence of commitment to this type of research in the new Centre. Even less fortunately, I couldn’t even say that I am really surprised!

Just few years ago, politicians talked about drought proofing this country. Not only did they talk, but they delivered: NSW Government went on and built a desalination plant at a cost of $3 billion to the public. Month or two after the plant opened, the skies opened up too, and the Warragamba Dam started to fill again. So much so, that the desal plant was never really needed to operate. The Dam is currently spilling.
Did we learn anything from this? Apparently not. We are now hearing calls to flood proof Australia.
After a long drought (and long forgotten by know) we had several very wet years, with severe and repeated flooding events, especially in South-East Queensland and Northern NSW: some of the very same regions that were severely affected by drought only few years ago.
Now that we drought proofed Australia, it is time to flood proof. We will again spend billions from the public coffers to build expensive infrastructure. Surely enough, once we are done flood proofing, a new drought will come in and we will be looking at more white elephants. We must be able to do better than that!

I have been less active on the blog in the last 3 weeks or so mainly due to two reasons: 1). The AARES Conference that was held in the Sydney Convention Centre, 5-8 February
and 2) My department has moved to new offices in the Biomedical Building at the Australian Technology Park (ATP), and I was busy moving office.
On with the deliberations on Environmental Economics. It was reported just yesterday in the papers that the NSW Government will impose a mandatory separation distance, or buffer or exclusion zones, between Coals Seam Gas (CSG) development and residential areas broadly defined, including specific businesses, such as horse studs. The proposed separation distance is 2 km, which has been in use in Queensland for some time.
Of course, miners immediately started to cry foul saying they are set to loose billions as a result of the buffer zones. On the other hand, many environmentalists are likely to tell you that 2 km exclusion zones for CSG are not nearly enough. So, what is the right separation distance?
The short answer is: nobody knows. How did we come up with 2 km? The same answer: nobody knows. It is all a result of bargaining based on rather murky politics! And the outcome is a rather arbitrary number that does not necessarily make much environmental or economic sense.
And this is not unique to CSG. We see environmental standards, or environmental policy targets, being set in this manner all the time: how do we know that we should reduce our CO2 emissions by 5% by 2020? Why not by 8%, or by 3%? How do we know that we need 2,750 GL as a baseline target to be recovered for environmental purposes in the Murray Darling Basin? Why not 3,000 GL or 2,000 GL? Nobody knows.
Getting back to CSG, it seems very unlikely that a uniform magnitude of a buffer will work in a diverse landscape, underlined by diverse mineralogy and hydrology. One could easily imagine that in some cases we might need a buffer of 5-6 kilometers, and in other perhaps only 500 meters will do. One thing is certain: such a uniform, arbitrary number as 2 km, is not going to bring the most overall benefit to society. We surely can do better, and the knowledge of how to do it is there. All it remains is to convince the politicians to give it a serious thought rather then to react only to day-to-day politicking.

The NSW Environmental Protection Agency (EPA) has recently released the 2012 edition of the State of the Environment (SoE). This report is published every three years (the last was in 2009), and its purpose is to take stock of the available information on the state of the environment in NSW.
The news is generally good! The environment in NSW has been improving over the last three years. This is a broad trend across environmental themes surveyed (corresponding to the chapters in the report): people and the environment, atmosphere, land, water and biodiversity. However, not all news delivered in the report is good, and this was noticed by environmental activists. They picked on declines in biodiversity, and on stubborn persistence of number of days where concentrations of two air pollutants: coarse particulate matter (PM10) and tropospheric photochemical ozone, exceed the nationally set air quality standards.
I was particularly intrigued by the air pollutants, as together with colleagues we have recently completed a study on the effects of environmental taxation policies (Load Based Licensing) on emissions of major air pollutants in NSW, including PM10; and NOx and VOCs (volatile organic compounds), both of which are precursors in formation of photochemical ozone.
Figures 2.10 and 2.11 in the SoE 2012 report show that emissions of PM10, NOx and VOCs have declined in the Sydney region over the last 20 years. However, when the Lower Hunter (Newcastle) and Illawara (Wollongong) are added to Sydney (all three together referred in the report as the Greater Metro Region – GMR) emissions of both PM10 and NOx have increased, and substantially so. This is consistent with the findings from our own study, which showed that emissions have not declined in spite of environmental taxation. In particular, some specific features of the environmental taxation policy can offer explanation of why emission trends in Sydney are so different to the emissions trends in the overall GMR. This is mainly due to the so-called spatial weighting where emissions from industries in densely populated areas (Sydney) are taxed at a significantly higher rate than emissions in less densely populated areas (Lower Hunter and Illawara).
All this just reiterates that environmental taxation is as good as the match between the rate at which emissions are taxed and the cost structure of the emitters. If the rate is set at a correct level relative to the costs of reducing emissions, we will see emissions dropping and air quality improving. If the rate is set too low, emissions are going to keep rising, and there will be many days when national ambient air quality standards are exceeded.

This was published in the SMH in the last few days. Good to see that people think about it.