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Paper presented to a forum on 'Economic and budgetary risks of environmental degradation', organised by the Victorian Department of Treasury and Finance, \n10 September 2003



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Forum on ‘Economic and Budgetary Risks of Environmental Degradation’ organised by the Victorian Department of Treasury and Finance September10, 2003.

(Talk prepared by Alistair Watson, Freelance Economist, Melbourne - aswatson@bigpond.net.au)

Introduction

Environmental issues have several characteristics that make for subtle problems in public administration. These characteristics are an amalgam of technical and economic features of environmental goods and services and the Australian agricultural system.

Four points that have to be considered are as follows:

• The roles of the public and private sector in environmental policy are ambiguous. The ‘market’ has problems handling problems like degradation caused by salinity and loss of biodiversity. Some role for Government is necessary. An additional complication for Australia is that different tiers of Government and agencies are involved. Many people choose not to engage with these administrative difficulties but arguably there is a mismatch in environmental policy between financial capacity, technical capacity and the ability of various agencies to respond to local problems and needs. • Obviously at least to economists and Treasury officials, not all degradation should be

repaired by Government (or the private sector for that matter) because in some cases the damage is irreversible on any reasonable time scale and cost of remediation. • There are underlying philosophical questions concerning the objectives of environmental policy. What should be the base line or reference point in the analysis?

Are we trying to restore ‘nature’ as such? What is or was nature to begin with? • Considerable uncertainty surrounds the scientific facts of the more controversial environmental issues. That is why they are controversial. The most unambiguous role for Government is investing in the pure and applied science necessary to increase

knowledge about environmental phenomena. Investment in R&D increases the number of options that are available as economic circumstances change. Another manifestation of uncertainty is with respect to the economic effect of biophysical processes, some of which are so long-term as to make any economic analysis highly speculative. Not so much for Victoria but many of the agricultural industries and land uses we are now concerned with in Australia may not be around in fifty years time, irrespective of anything to do with environmental phenomena.

The last point is really another way of saying that thinking through the reference point and objectives of environmental policy is important. Otherwise, open-ended financial commitments could be incurred for no good result on the ground. A useful distinction can be drawn between loss of recreational amenity and aesthetic aspects of the environment and the more instrumental loss of productivity in agriculture that can occur with severe deterioration of the environment. For a high-income country like Australia, the former will become more important over time rather than the latter.

The Environment and the Budget

Government is interested in a productive economy and equity, including inter-generational equity. The social costs and benefits of investment in the environment are important not the fiscal consequences of environmental issues like salinity and biodiversity per se. That was a major conclusion of the work done for the Department of Treasury and Finance by the Allen Consulting Group who noted that ‘the direct fiscal impact of the unmitigated environmental outlooks is minor’ (p.iii). And, at p.viii ‘environmental degradation is not comparable to demographic change…as a budget threat, for example.’

Serious environmental effects would show up in the State budget mainly through effects on Commonwealth income tax collections. Farmers are not much affected by State taxes. Farm businesses are almost invariably below thresholds for payroll tax and farmers have generous exemptions from land taxes. This is not to diminish the importance of environmental policy. Much the same observations could be made about any small component of the budget taken on its own.

But it does mean that impacts on the State budget are only part of the story for environmental policy making. And arguably, much of the necessary environmental expenditure should be off budget and funded by user charges and local government rates. For example, charges for irrigation water should be sufficient to operate and maintain the irrigation system and, where technically and administratively possible, include charges for any damage caused by irrigation.

Although it is forgotten from time to time, Constitutional responsibility for management of land and water resources rests with the Australian States. Victoria has the most intensively modified landscape and the greatest population pressure on its land and water resources. The demand for environmental amenity is hence relatively greater in Victoria. Victoria is unlikely to be well served by excessive reliance on Commonwealth programs that are based on average needs and experience across Australia.

The Commonwealth Government does not have access to the same scientific expertise as the States. Victoria should be wary of centralist proposals for environmental management because of its own distinctive features. There is a high proportion of recreational farms within 150 km of Melbourne. Almost by definition, these sub-commercial farms are owned by wealthy individuals. There is not much justification on equity grounds for environmental programs funded by taxpayers for these fortunate landowners.

Some Policy Implications

Environmental issues have diverse features. It is therefore inappropriate to have ‘a one shoe fits all’ approach. Cases like point-source pollution of waterways often need regulatory solutions. In other cases, no Government action may be justified at all because environmental damage is contained on private land or no practical solution is available.

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In environmental policy, we should be interested in comparisons of the marginal benefits and marginal costs of specific proposals for environmental remediation not the quest for some illusory environmental Nirvana, whereby the agricultural landscape is restored to pristine condition. We should also be interested in using low-cost policy instruments. In this regard, it is arguable that the emphasis on consultation of the last couple of decades may have run its course. ‘Burn-out’ is a common complaint of farmers and others involved in existing consultative arrangements.

R&D programs on the environment should therefore involve research on institutional arrangements to develop new policy instruments. Government has to be careful to distinguish genuine environmental concerns substantiated by scientific evidence and economic analysis from populist and exaggerated claims of actual or potential environmental damage.

Care also has to be taken that reasonable caution in environmental management is not swamped by invalid application of a ‘precautionary principle’ that in some versions is no more than an unreasonable veto on all development proposals. Slogans and catchphrases are the bane of environmental policy - the ‘precautionary principle’, the ‘triple bottom line’, ‘sustainability’ and the ‘environmental footprint’, to mention just a few.

Environmental policy is often compromised by well-intentioned concerns for the welfare of farmers and other rural people. In many cases, this is misguided and has often exacerbated environmental problems. Drought policy is an obvious case.

The size distribution of farms in agricultural industries is pertinent when considering the capacity of farms to undertake environmental remediation on their own account. Like the precautionary principle mentioned above, the so-called ‘triple bottom line’ is an inadequate criterion in actual cases of environmental degradation. Social concerns that often are interpreted as requiring Government support of small farms may be inimical to the resolution of environmental problems.

Dryland salinity provides the best-known example in Australian agriculture. Only large crop-livestock farms are capable of maintaining rotations including lucerne and other deep-rooted pasture plants that are useful in salinity mitigation. More intensive cropping is necessary on smaller farms.

Existing assistance arrangements for agriculture and the social security system are the best ways of dealing with adverse consequences of environmental degradation, and other risks, on individuals.

In considering policy for the environment, it is necessary to consider environmental risks along with other contingencies including:

• Developments in commodity markets and market access. • Productivity change in agriculture.

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• The relative decline of the agricultural sector.

With respect to the last point, because agriculture is in relative decline, optimising the time path of returns from agriculture on a purely technical interpretation would favour a more exploitative stance to agriculture now because returns to the agricultural sector are higher than they will be in the future.

Cost sharing remains a contentious issue in environmental management. Again, it is necessary to think carefully about the reasons for Government intervention and the source of the environmental problem in question. In general, ‘amenity’ related intervention should be a charge on the community at large and ‘productivity’ related intervention a charge on farmers. But there are difficult cases such as land clearing where both effects are present.

Especially because Australia has an export-dependent agriculture, care has to be taken that political compromises over cost sharing do not open the door to large-scale public support of farmers for dubious environmental benefits. ‘Stewardship’ is a much-abused

concept in European agriculture and in large measure has become yet another excuse for subsidising the farm sector. It should be recognised that subsidising repair of past environmental degradation will inevitably lead to further environmental damage.

Put slightly differently, imposing a ‘duty of care’ on farmers for the environment could impose a duty of care on the community for farmers. What is the logic of subsidising agriculture for environmental reasons when the bulk of agricultural output is exported?

Concluding comments

Perhaps the most import concept of cost in environmental management is the idea of sunk costs. The appropriate stance for Government policy is forward-looking.

From the notion of sunk costs follow two essential ingredients of environmental policy:

• The starting point should be the world as it is not what we might like it to be. • Not all environmental damage is repairable nor is it all worth repairing.

For environmental policy to be effective, a rigorous approach is required that gives primacy to generation and dissemination of credible scientific information.

It is also important to recognise the difference between reversible and irreversible environmental damage because the community may wish to pay for some environmental benefits in the future that cannot be afforded at present.

Environmental policy has to separate on-site and off-site effects of farming because this is a major determinant of public and private responsibilities for the environment. Finally, environmental policymaking has to consider the appropriate division of public responsibilities between Commonwealth, State and local governments.