- 4.1 Theory and Practice of Pollution Abatement
- 4.2 The Legal Framework for Optimal Control
- 4.3 Using Economic Instruments for Water Management
- 4.4 Conclusion
4.0 THE ECONOMICS OF WATER QUALITY
In economic jargon, pollution is a negative externality which leads to misallocation of resources because those causing pollution do not bear its full costs. If polluters were required to fully compensate all those affected by pollution, however, them would still be some pollution. In other words, full application of the "polluter pays" principle will not result in the elimination of pollution, nor is it intended to.
Given full opportunity to implement its collective will, society would probably not choose to abolish all pollution. This result stems from the fact that, at least in some cases, small levels of pollution cause little harm and can be quite expensive to eliminate. The question for policy makers, then, is what is the optimal level of pollution control? This question is relevant for agricultural as for other sources of water pollution.
After a brief discussion of economic theory in section 4.1, section 4.2 examines whether this theory is compatible with the Resource Management Act.
4.1 Theory and Practice of Pollution Abatement
In economic terms, the problem is to determine the level of pollution control which maximises net benefits to society, where net benefits (NB) equal total benefits of pollution control (TB) minus total costs of control (TC), or
maximise NB = TB - TC
This problem is usually solved by choosing a level of pollution control where marginal cost (MC) equals marginal benefit (MB)8. In this context, MC is the additional cost to the producer of one more unit of pollution control. MB is the additional benefit to society of one more unit of pollution control, and includes cultural, social (including the needs of future generations), and intrinsic values as well as financial concerns. Most of these are difficult to quantify.
Economic analysis generally assumes the costs of controlling pollution increase as control increases. For example, to reduce pollution from 100 tonnes to 90 tonnes is assumed to be relatively cheap compared with the cost of reducing pollution from 10 tonnes to zero, which may be prohibitively expensive. This assumption is reflected in the MC curve in Figure 1, which shows that costs rise as the level of pollution control increases. Pollution control is not just "end-of-the-pipe" treatment; it also includes using less raw material, more efficient processing, and recycling and re-use of "wastes".
Similarly, it is generally assumed the marginal benefit of pollution control decreases as pollution control increases. That is, society derives more benefit from reducing pollution from 100 tonnes to 90 tonnes than from a reduction from 10 tonnes to zero. Thus, in Figure 1 the MB curve declines as the level of pollution control increases. Neither of these assumptions about increasing costs or decreasing benefits necessarily holds in the real world, as will be explained below.
Figure 1: Marginal 1 benefits and marginal costs of water quality
Regardless of the shape of these curves, the optimal situation for society is typically where marginal benefit equals marginal cost. If MB is greater than MC, as at pollution control level PC,, the benefits of pollution control exceed the costs, and the total welfare of society can be improved by increasing pollution control to PC*.
At control level PC2, however, the cost of pollution control exceeds what it is worth to society, indicating more resources are being expended on pollution control technology than can be justified by the benefits. Only at PC* is there an optimal level of control, ie the marginal cost is equal to the marginal benefit of control, and net benefits are maximised.
In order to determine the optimal level of pollution control using this model, one needs to know the shape of the MC and MB curves, that is, how costs and benefits vary with the level of pollution control and the level of control at which costs and benefits are in balance. In practice, it is usually not possible to chart these curves precisely. Nonetheless, describing these curves in general terms should be of assistance in setting resource use policies.
As has been said, the marginal cost curve shows the additional cost to the producer of one more unit of pollution control. In other words, the curve shows the cost of applying pollution control technologies, that is, alternative management practices. Since the practices will vary depending on the nature of the problem, and sometimes with location as well, there will be a different marginal cost curve for each water quality problem and the associated alternative practices.
Typically, the MC curve will not be a simple smooth curve like that shown in Figure 1. Likewise, the marginal benefit curve, which reflects the value of clean water, and therefore pollution control, for other uses, is often not a smooth declining curve as shown in the figure. There are likely to be some instances where marginal benefits increase with more pollution control, and where the optimal level of pollution is zero. Nonetheless, the same principle applies: optimal resource use is achieved by maximising benefits to society, that is, setting marginal costs equal to marginal benefits.
A paper by Sinner (1991) provides further discussion of optimal water quality decisions, including how marginal costs and benefits are calculated and why the typical assumptions are often invalid. The paper also briefly discusses the use of economic instruments and regulation to achieve policy goals, and how intangible benefits can be incorporated into policy decisions. A study by O'Neil and Scrimgeour (1991) applies some of these concepts to the problem of dairy shed effluent.
4.2 The Legal Framework for Optimal Control
Section 3 of this paper describes the provisions of the Resource Management Act 1991 relating to water quality. According to officials at the Ministry for the Environment, the Act is not intended to direct regional authorities to calculate how to achieve maximum public welfare. Instead, it is argued, these authorities should ensure certain outcomes are met and then allow private parties to pursue their own interests. Under this view, there would be no need for authorities to determine where marginal costs equal marginal benefits, ie the point of optimal pollution control.
Section 32 of the Act requires that both central and local government use the most efficient and effective means of achieving a given policy or objective. While section 32 does not require the policy or objective itself to be optimal in the sense described above, it does require that authorities shall be satisfied that any objective, policy, or rule is necessary to achieve the purposes of the Act. Regional council officials have also questioned the balancing of costs and benefits under the RMA, suggesting this is an outdated approach based on the Water and Soil Conservation Act 1967.
Yet because of the very nature of water quality problems, the balancing of costs and benefits cannot be avoided. By attempting to ensure certain outcomes, councils win typically constrain the actions of private parties. In other words, private benefits will be constrained to protect public benefits. This is as it should be, because water is a public resource, but the decision on how far to protect the public benefits should also take account of private costs and benefits. That is, councils should decide how much pollution control is optimal, i.e. what level would maximise total welfare.
This point can be demonstrated with an example using Figure 1, where the diagram represents a water quality problem to be addressed by a regional council.9 The outcomes which the council must ensure, "the environmental bottom line," will require some level of pollution control. Consider the case where these outcomes require control only at PC1, i.e. allowing more pollution than the optimal amount. Leaving private parties to pursue their own interests beyond this point will not result in the optimal level of control because the costs and benefits typically fall on different parties.
In this case, there are two ways to increase pollution control to the optimal result. One is for councils to use economic instruments to require private parties to bear the costs and benefits of their actions. For example, pollution above the bottom line could be taxed to encourage control at PC*, or polluters could be required to negotiate with affected community groups and compensate them for any agreement to allow pollution above the bottom line. The second approach to move toward PC* is for councils to estimate the optimal level of control and set standards requiring that outcome to be achieved. Without active involvement by the council, however, either by setting higher standards or by establishing mechanisms for economic instruments, the optimal result will not be obtained.
Consider now the opposite case, where the outcomes the council must ensure, the "bottom line," require control greater than PC*, say at PC2. In this situation, the point of optimal control will have been exceeded. Recall that the benefits include social, cultural and intrinsic values, though implicitly all these are based on human values. On the other hand, if very high or infinite benefits are attached to cultural and intrinsic values, the outcome at PC, may be desirable. This implies that the marginal benefit curve has been drawn incorrectly, and is higher, e.g. at MB' or MB'' in Figure 2, when all factors are taken into account. Sinner (1991) presented a methodology for incorporating intangible values into a decision framework based on benefits and costs.
Figure 2: Optimal water quality with higher marginal benefits
Policy makers would need to consider the probable shape of the MB curve based on community values. In the example in Figure 2, if the original curve MB is considered the more likely shape, total public welfare could be increased by reducing the amount of pollution control from PC2 to PC* and putting the extra resources to a more beneficial use. This might include spending more on environmental protection in another area of greater public concern, or it might mean assessing lower rates.
Although water allocation is a different issue than water quality, the same principle applies: in-stream flow should be at the level where the marginal costs of not taking an extra unit of water for abstractive uses are equal to the marginal benefits of the extra unit for in-stream uses. In terms of Figure 2, increasing pollution control is equivalent to increasing the in-stream flow.
It must be acknowledged that, in practice, this methodology will be difficult and expensive to apply. Ibis is especially true if it were attempted on a site-specific basis, as it would be in an ideal world, since costs and benefits vary from one point on a stream to another. Nonetheless, as a framework, the principles of optimal control remain valid and should be applied in resource decisions. This means that in setting standards, officials should adopt the principle of balancing costs and benefits, even if these are not actually estimated, rather than only trying to set a "bottom line."
Any balancing of costs and benefits must be done within the context of the RMA and the definition of sustainable management. The needs of future generations, the life-supporting capacity of the natural environment, and the avoidance, remedying, or mitigation of adverse effects are all deemed to be of very high benefit to New Zealand by virtue of their establishment in statute.
With respect to water quality, the allowance for "reasonable mixing" may provide regional councils with sufficient flexibility to achieve optimal water quality as described above. In a situation where impacts on other uses of water are small, a longer mixing zone could be allowed as long as the purpose of the Act is not compromised. Conversely, where demand for clean water is high, a short mixing zone would be appropriate, i.e. the high marginal benefits would justify a higher degree of pollution control. Councils could use regional plans to indicate the degree of protection desired for different water bodies and the associated mixing zones that would be allowed.
4.3 Using Economic Instruments for Water Management
Apart from the usual approach of setting standards and enforcing compliance, the use of ,,economic instruments" has also been advocated as a means of managing water quality. Such instruments, which can include pollution taxes, tradeable discharge permits, or tradeable extraction rights, can create powerful incentives for better environmental performance. In most cases, these instruments would be used in conjunction with regulations to achieve the best results. For instance, a council could set the minimum flow for a river, and then allow trading of water rights up to that level.
In a situation where pollution imposes costs before the "bottom line" is reached, a pollution tax can discourage the polluter from pushing up against the absolute standard. 'Me tax forces the polluter to recognise that, although the standard has not been violated, the pollution does impose costs on society. Faced with paying a tax for every ton of contaminants, polluters will search for technologies which allow them to reduce the discharge, and will implement them if the cost is less than paying the tax.
Revenues generated can be used for other activities, such as monitoring and enforcement which will further enhance water quality. It is not clear whether the RMA will allow councils to impose charges which exceed administrative costs. 'me Ministry for the Environment is considering providing some guidance to councils on this issue.
Tradeable permits can help lower the total cost of achieving environmental objectives. Again, this approach must be used in conjunction with regulatory standards. Once a local authority decides how much pollution in a water body is acceptable, it can allow polluters to negotiate among themselves how best to achieve the overall standard. However, tradeable discharge permits will only work where the location of the adverse effect is not important. It would not be appropriate, for instance, to allow a discharge on one stream to be doubled in exchange for eliminating another discharge on another stream in the same river catchment, if the impacts of the two discharges are not physically related. Probably for this reason, the Resource Management Act (section 137) does not allow discharge permits to be transferred from one site to another.
There are circumstances, however, where an authority may wish to encourage or allow holders of discharge permits, or those seeking permits, to negotiate about how much each will discharge. For instance, if there are two or more discharges close to each other, causing cumulative impacts, it would be appropriate to regulate the total effects, grant each polluter a consent to discharge an equal portion of the total, and then allow them to trade discharge rights among themselves.
There may be ways to facilitate some degree of negotiation within the parameters of the Resource Management Act, with regional councils playing a key role in approving any outcome. One possible mechanism would be for councils to buy back a discharge permit from a current consent holder and issue a consent for an equivalent discharge to another person on the condition that the council be reimbursed for the cost of compensating the original holder. Councils would not allow such transactions unless there were no adverse effects, and could choose to notify the proposed new consent application. Since original holders would only relinquish their permit if they agreed to the compensation, the new applicant could be required to negotiate this prior to applying for the new consent.
Under such a regime, polluters who find it costly to reduce emissions could purchase rights from others who can reduce emissions beyond what is required, as long as the overall goal is met. More importantly, all polluters will have a financial incentive to find ways to reduce emissions. This will drive innovation and generate better pollution control technologies, while achieving established environmental goals at the least cost to society.
Tradeable rights for taking water have been used in parts of central Otago, where they developed in conjunction with mining practices. Allison (1988) reviewed these rights and Brash (1991) and Currie (1992) have commented on some of the factors which led to these perpetual rights being reduced to 30-year permits by the Resource Management Act 1991.
MAF Policy is currently funding a study, in co-operation with the Marlborough District Council, of how instruments such as tradeable abstraction permits and discharge fees could be used to manage water use and water quality issues. This will include an analysis of the ability of tradeable permits to resolve water use conflicts, and whether they can be adapted to accommodate in-stream values. For instance, in addition to allowing in-stream users to purchase higher flows, those discharging contaminants may want to purchase higher flows at critical periods to maintain their normal dilution factors. Consideration must also be given to the principles of the Treaty of Waitangi and the fact that the Crown and local authorities cannot sell water they do not own. Permits would probably need to be limited to a fixed time period.
In many cases, using pollution taxes or tradeable permits will not be feasible, especially where discharges are difficult to measure. In other cases, however, they might usefully be combined with regulatory standards to achieve effective management of the water resource. More work will need to be done to examine the practical applications of these policy instruments.
4.4 Conclusion
Setting the "bottom line," and then leaving private parties to pursue their own interests, will not usually result in the optimal level of water quality. The ability of regional councils to determine "reasonable mixing" will perhaps provide the flexibility needed to realise the maximum net social benefit for society. In addition to setting and enforcing standards, there are other mechanisms which can be used to allow interested parties to negotiate between themselves to determine water quality parameters once the basic requirements of the Resource Management Act are met.
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