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Environmental Economics Research Paper No.5
Consultancy report prepared by: Dr David James, Ecoservices Pty Ltd
Commissioned by Environment Australia
© Commonwealth of Australia, 1997
ISBN 0 642 26850 9
This report reveals that Australia has made considerable progress in applying economic instruments for environmental protection and natural resource management. Government agencies appreciate some of the advantages of economic instruments and have taken steps to adopt them in many of their regulatory regimes.
Innovative systems have been introduced in water resources management, fisheries, forestry and mining. The introduction of load-based licence fees and tradeable permits for pollution control provides positive evidence of the political will to achieve cost-effective solutions to environmental management problems.
It is encouraging also to note that governments are beginning to realise that many core economic instruments, such as the taxation system and pricing regimes for the use of natural resources, can have significant, and often detrimental, effects on the natural environment. Closer scrutiny of potential impacts will hopefully lead to more rationally based economic policies that address external environmental effects.
Protection of biodiversity is an emerging area in environmental policy, with work on the identification and valuation of the benefits of biodiversity conservation only just beginning. Australia is rich in biodiversity, yet has one of the worst records of extinction on a global scale. The formulation and implementation of appropriate conservation policies can be expected to present formidable challenges to government and the wider community.
The relative strengths and weaknesses of the instruments surveyed can be assessed in terms of the evaluation criteria listed in the introduction to this report.
In terms of effectiveness in reaching environmental objectives, it is evident that the most successful instruments are those that specify quantity or quality constraints or standards as one of their operating characteristics. Tradeable permits generally do this. In the market for trades, overall quantities are specified within the permit system, and adjustments take place mainly in prices of trades. This may have detrimental effects from an equity viewpoint, and could affect the competitive position of economic activities obliged to manage any significant price increases. The Industry Commission (1992) has noted such effects in markets for transferable water entitlements.
Performance bonds also appear to have been effective in meeting environmental objectives. The incentive for companies to cooperate is strong, as the penalty for non-compliance (refusal of permission to continue mining operations) is high. The Queensland scheme contains an innovative system of economic incentives, with concessions for improved performance in environmental management. Because mining companies can furnish the bond by way of insurance premiums or other asset-backed guarantees, the strains on cash flows should be minimised. It would seem that performance bonds could be applied in many other situations. The survey revealed that they are in fact used in Australia as a component of environmental protection programs.
There may be some uncertainty about the effectiveness of instruments that operate through pricing controls based on the user pays/polluter pays principles in protecting the environment. Price rises may not always effectively promote conservation of resources because users may not change their behaviour when faced with an incremental change in their costs. There is evidence, for example from the Hunter Water Corporation, that pricing policies can lead to more conservative use of reticulated water supply, but these regimes require community acceptance and provisions to protect adverse economic effects on low-income groups. User pays charges applied in trade waste programs have been reported as having incentive effects, but these are only in the beginning phases and the full impact has yet to be observed.
As regards deposit refunds, the South Australian scheme for beverage containers indicates that these schemes can be successful in reducing litter and encouraging product and materials recovery.
In terms of efficiency gains, there is a general problem of determining how such gains may be assessed, for example, relative to a previous resource use pattern or to a projected resource use pattern under different types of environmental management regimes. Usually, the gains from economic instruments are claimed relative to poorly designed command-and-control systems. They typically consist of lower compliance costs and/or of improved efficiency (including productivity) benefits in resource management.
In the case of tradeable resource use rights, there is evidence of improved economic viability in several kinds of industry. The Industry Commission (1992) noted economic benefits of $40 million accruing in the agricultural sector of New South Wales over seven years, and efficiency gains in other States. Rationalisation of fleets in fisheries using individual transferable quotas has led to higher economic returns to operators and the industry as a whole.
Water supply authorities servicing urban areas have reported efficiency gains. The Hunter Water Corporation has managed to reduce the demand for water by 30 per cent and postpone costly increased reservoir capacity. The treatment and sale of sludge and effluent are positive signs of improved resource use efficiency and implementation of the principle of sustainable development.
There is some evidence that trade waste programs are resulting in greater efficiencies in industry, including reduced generation of waste and greater reclamation of materials.
Tradeable permits and user charges provide ongoing incentives for improved efficiency and environmental performance. With tradeable permits, the ultimate gains will depend on market structure and adjustments. With user charges, the largest gains can be expected where increasing rates of charge over time have been announced. This approach to a charging system gives industry and the community time to adjust, but at the same time provides an ongoing incentive for improved resource use and environmental protection. It will be instructive to monitor the future environmental performance of dischargers subject to the newer systems of tradeable permits and load-based licence fees in States that are introducing these management systems.
The Queensland mining bond system provides effective ongoing incentives for sound environmental management. Self-regulation by industry is an important component of the Kwinana sulphur dioxide control scheme. In both cases there are strong incentives for industry to work in a collaborative partnership with the environmental authorities to achieve flexible and cost-effective emission controls.
Equity aspects vary according to the type of instrument and the way it is designed and implemented. The objectives of efficiency gains and of social equity may at times be in conflict and equity problems are probably the main obstacle to introducing user pays pricing to encourage better resource use. Proposed price increases may be strongly opposed through the political process, regardless of the fact that high costs (of inefficient resource use) may be imposed on the community.
These considerations partly explain the reluctance of water service authorities to apply full cost recovery pricing. Corporatisation and privatisation of such authorities may be the only politically and publicly acceptable means of achieving improved resource management. Whether equity objectives may be handled effectively, and in what way, through community service obligations is a matter that has not been resolved.
Equity effects appear to be an important obstacle to introducing product charges for environmental protection purposes. Charges that have been introduced, such as charges on ozone depleting substances, have been designed to raise modest amounts of revenue to cover administrative costs, rather than have an incentive effect.
Adverse price effects may be cushioned by incorporating direct regulations and other policy measures to back up economic instruments. For example, in pollution control programs, economic charges may be supplemented by product, equipment or performance requirements as well as education, information exchange and training.
Cost impacts in industry are also important from an equity viewpoint. The reluctance of governments to charge full cost for irrigation water for political reasons is well known, despite inefficiencies in the use of infrastructure and adverse environmental effects such as waterlogging and salinity. By establishing systems of tradeable rights for water, government agencies can be placed at arm's length from the operations of markets. Nevertheless, it has been apparent that supervising agencies should have the power to monitor and veto trades if the socioeconomic consequences are deemed to be unacceptable. These functions are provided for in most schemes for transferable water rights that have been introduced in Australia.
Community acceptance is essential to the success of any system of resource management or environmental protection. Before introducing any instrument, extensive public consultation should be carried out. Further efforts may be needed to inform the public of proposed schemes and invite feedback so that backlash can be avoided.
The community has generally been somewhat suspicious of economic instruments, but there is now greater understanding and acceptance of their use. Public awareness and information programs can help to overcome some of the difficulties. Conservation groups are more strongly advocating economic instruments as a means of protecting the environment. Industry has taken a keen interest and is actively participating in the design of management regimes. It appreciates the advantages of being able to make flexible commercial decisions regarding environmental protection, and is more amenable to operating under market conditions rather than under rigid controls of government regulators.
Strong community support can be expected where government agencies are seen to be meeting community goals, values and aspirations. In South Australia, the refund deposit system for beverage containers has received strong public support because of a community desire to prevent littering and promote recycling. The Special Environmental Levy introduced by the Sydney Water Board was also initially strongly supported by the community. Experience suggests that public support for economic instruments and financing mechanisms will be most favourable where it can be demonstrated that funds are being allocated to environmental programs and projects. Local councils and other water authorities have generally been successful in using environmental levies.
Industry acceptance is an essential aspect of implementation. The important message to convey is not whether economic instruments will result in any cost, but whether economic instruments are likely to enable industry to comply with the environmental objectives of government at a lower cost than under alternative systems of instruments. Where capital assets are handed to the industry sector, as under systems of tradeable rights, industry may actually gain from the introduction of such instruments, especially when compared with command-and-control systems or with effluent/user fees.
Administrative feasibility depends on existing and proposed institutional structures, legislation and administrative procedures. Jurisdictional constraints may create particular problems of policy coordination.
Specific legislation may be required to introduce new systems of economic instruments. This is likely to be the case for new taxes or charges and systems of tradeable rights. In other contexts, government agencies may have regulatory powers that encompass economic instruments. Alterations to charging systems may be introduced fairly easily, for example, to achieve incentive effects.
Administrative costs of economic instruments are difficult to determine, especially when compared with other regulatory regimes. Economic instruments in principle should not cost more in administrative resources than command-and-control regulations, and there may be good reason to expect lower costs, depending on the design of any particular system. Provisions for cost coverage can be incorporated in the design and operation of instruments. Environmental and user charges of many kinds are imposed by governments to raise revenue to cover costs. Revenue can also be raised through licence fees or by auctioning user rights.