1 Introduction
Economic instruments have been receiving a lot of attention as the way forward for environmental management and have been described as promising tools for advancing sustainable development in New Zealand (Sinner and Salmon, 2003). Sometimes described as "market-based instruments", these instruments seek to bring market opportunities and processes into areas that have been traditionally controlled by direct regulation, information and motivational processes. In the area of water quality, economic instruments hold potential but the tools are not without cost to government. Economic instruments can be described as levers for natural resource managers to use to change behaviour of polluters (point source and non-point source) so that they are aligned with the government's goals and objectives for resource management. Economic instruments are basically market mechanisms that are designed to address context specific problems of environmental quality.
This report was commissioned by the New Zealand government to summarise the current state of knowledge concerning the use of economic instruments for managing diffuse source contamination of water quality. The terms of reference specified that the report should cover:
- Identification of economic instruments applicable to non-point sources of water pollution. These will include fees/charges/resource rentals, taxes and differential rating, subsidies, tradable permits, land leasing and compensated covenants to restrict land use activities.
- Pros and cons of the identified economic instruments with regard to the New Zealand context.
- Description of national (if available) and international examples of the uses of economic instruments specifically to address diffuse sources of water pollution.
- How the use of non-market valuation can inform the use of economic instruments in addressing diffuse sources of water pollution.
- Using examples of a range of pollutants (including nitrate, phosphate, pesticides and other toxic contaminants, BoD and suspendable solids) identify the most appropriate economic instrument in each case.
- Recommendations regarding the feasibility of the use of economic instruments in relation to diffuse sources of water pollution in New Zealand.
The project team and the steering committee worked to address these points through the use of examples and specific case studies. The report outlines the ways that markets and the overall institutional relationships between producers, consumers and governments can be aligned to address water quality issues in New Zealand including:
- The opportunities that exist immediately and the opportunities that may be possible over the longer term with economic instruments and markets more generally in New Zealand;
- What has come to be understood from international experience about how instrument performance is determined by biophysical processes, institutions and the nature of the economic agents; and
- The characteristics of biophysical and institutional characteristics that are likely to be critical for the design of economic instruments for diffuse source water quality issues in New Zealand.
There is no single instrument for solving water quality issues for New Zealand or any other jurisdiction. The effectiveness of any given instrument will depend on the problem faced, the context of the problem, the details of instrument design and existence of complementary or competing policies and incentives. The appeal of well-designed economic instruments is the potential for providing flexibility for individuals and firms as well as enhancing the ability of institutions to contend with change.
The innovative contribution of this report is the development of a practical framework for evaluating potential instruments that takes account of the instruments, the biophysical processes, people and communities and the characteristics of the institutional setting. Selecting among potential economic instruments requires natural resource managers to draw on their knowledge and this report offers a framework for sorting through the choices.
1.1 Background
New Zealand has an extensive network of high-quality fresh water systems. Water quality in New Zealand, although generally high by world standards, is variable. Land-use intensification poses a threat for the multiple uses of freshwater supplies including water for the environment, drinking water supplies, recreational users and stock water drinking supplies.
The New Zealand government is embarking on a Programme of Action to ensure that principles of sustainable development underpin all government activity and that government decisions take account of the well-being of current and future generations. The Programme of Action establishes a set of operating principles for policy development that require government to take account of the economic, social, environmental, and cultural consequences of its decisions. The focus is on the practical application of the sustainable development approach to certain key issues including the quality and allocation of freshwater.
The Ministry for the Environment and the Ministry of Agriculture and Forestry are leading work on water quality, water allocation and waterbody protection in association with other government departments. The focus for the water quality project is rural land use impacts on waterways and water quality; the economics component of this project focuses on the use of economic instruments to manage the cumulative effects of diffuse sources of pollution from intensified rural land use. This report was commissioned as part of the water quality project.
1.2 The role of economic instruments
Traditionally, the main tools of natural resource and environmental managers were thought to be regulation, monitoring and enforcement of penalties. This approach has been called command and control and the terminology suggests an approach that asserts more control than often occurs in reality. For instance, international experience suggests that agencies are often under-resourced, and hence do not have the capacity to undertake the extensive monitoring required to implement command and control environmental regulation (Randall, 2003). Considerable resources are required to prove non-compliance that will stand up to court challenges. There is also the general problem of obtaining information from polluters (known as the asymmetric information problem) or there may be a lack of political will to impose penalties at levels that will induce firms to alter their behaviour.
Regulatory agencies may take the more pragmatic approach of setting out regulations and negotiating with firms to find suitable paths to compliance. This more pragmatic approach has been dubbed responsive regulation (Ayres and Braithwaite, 1992) and by its nature is an adaptive form of governance. It is worthwhile highlighting that this form of environmental governance is gaining credence and offers another tool for environmental management.
The development of many economic instruments and the more adaptive forms of governance, has resulted from the recognition that strict prescriptive regulation may impose too many costs on both government agencies and the firms being regulated. Theoretically, economic instruments potentially offer a way to introduce more flexibility and thereby reduce the costs associated with achieving environmental outcomes.
However, economic instruments are not without their own hazards and are not substitutes for regulation and standards. In fact, economic instruments often rely on regulation and standards. Certainly, there are no one-size-fits-all solutions to ensure environmental quality, as markets, on their own, are unlikely to produce uniformly socially optimal outcomes. Moreover, many environmental problems may not be suited to the use of economic instruments. Often a mixture of regulation and economic instruments is required to achieve appropriate levels of environmental quality at minimum cost.
1.3 Outline of the report
One of the main purposes of this report is to describe the potential role for economic instruments and provide decision makers with a framework that enables them to select the most appropriate instruments to use in a specific circumstance. Moving from theory to practice requires being able to describe the prerequisites for implementing a particular economic instrument. To facilitate this process, a particular set of instruments was selected by the Steering Committee for consideration in this report. A short description of each of these instruments is provided in the second section of the report. The emphasis is on instruments which are currently not widely used in New Zealand as this is where the additional gains in social welfare are likely to occur. New Zealand has developed some innovative approaches with compensated covenants and has a few lessons to extend to other countries.
The report then describes an evaluative framework for sorting through the potential options in terms of instruments that are available in the short term and which instruments will require institutional change and therefore could only be implemented over time. Within this framework, the relative cost-effectiveness of the instruments can be determined. This is done by considering the attributes of the environmental process, the technology for monitoring and the nature of the market. In addition, the nature of the groups that are potentially being targeted is also an important factor to consider. These groups can potentially represent different segments of the market with different risk profiles, for instance, that need to be taken into account.
The terms of reference for this report also required a review of the role of non-market valuation. Non-market valuation is an important issue in the determination of optimal strategies for environmental management, including the setting of standards and estimating damage costs for environmental charges.
Finally to place these instruments in a New Zealand context, two case studies are presented where:
- Diffuse source agricultural drainage rich in nutrients enters groundwater and then discharges to freshwater lakes; and
- Sedimentation occurs in streams and estuaries as a result of surface runoff from urban development and forestry.
