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2021 | OriginalPaper | Chapter

6. Water Quality Trading

Authors : James Shortle, Markku Ollikainen, Antti Iho

Published in: Water Quality and Agriculture

Publisher: Springer International Publishing

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Abstract

Chapters 6, 7, and 8 examine three specific policy approaches that are drawing substantial interest as innovations for agricultural nonpoint pollution control. These are water quality trading (Chap. 6), water quality auctions (Chap. 7), and credit stacking (Chap. 8). Both have potentials for addressing many of the limitations of conventional approaches including consideration local conditions.
Water quality trading refers to emissions trading in water pollution. The mechanism has not had wide application but is an interesting candidate for water pollution policy innovation. It is a performance based economic incentive and can be implemented to integrated management of point and nonpoint sources. Water quality trading is receiving considerable interest as a mechanism to improve the effectiveness and cost-efficiency of water quality protection. This chapter presents the theory of trading, significant challenges that must be addressed when using trading to manage agricultural nonpoint pollution, and a review and assessment of the practice of water quality trading, and lessons for future application. The overall conclusion is that trading has significant merit provided policy makers have the technical capacity and resources to implement performance-based trading programs.

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previous chapter Environmental Policy Instruments for Agriculture
next chapter Water Quality Auctions
Footnotes
1
When issued free of charge one approach to the initial allocation, referred as “grandparenting,” is based on historical emissions. Another approach used in the European Union Emissions Trading System, referred to as benchmarking, distributes allowances that cover the emissions of sources with emissions well below the industry average (the lowest 10% in any sector). Sources that do not meet the benchmark receive smaller initial allocations.
 
2
The price would be expressed in monetary units such as USD or EUR per allowance. For the hypothetical example, the reader may select their preferred currency.
 
3
Several factors can affect the relative performance of taxes and trading in application that may qualify this conclusion, including differences in transaction costs between the mechanisms (Stavins 1995). Furthermore, if the regulator is not committed to achieving a specific target but will instead allow some variability in the emissions, then there are circumstances under which taxes may be economically preferred to markets (Weitzman 1974). The cap in cap-and-trade places an upper limit on emissions. Changes in the demand to pollute will cause variations in the price of allowances but the pollutions do not vary. An emissions tax fixes the price of emissions but allows emissions to fluctuate with changes in the demand to pollute. Depending on the characteristics of the benefits and costs of pollution, there are circumstances in which the cap is economically preferred to the tax and vice versa (Horan and Shortle 2021).
 
4
The damage-denominated trade ratio label is due to Konishi et al. (2015).
 
6
Heterogeneity in marginal damage costs can provide another rationale for point-nonpoint trade (Lankoski et al. 2008).
 
7
US Soil and Water Conservation Districts are independent subdivisions of state governments organized typically by county. They were originally developed in the 1930s to address soil and water conservation problems.
 
8
A fair criticism of the ex ante empirical simulation research is that studies do not embrace the full physical and economic complexity of the problem, which may result in overly optimistic expectations of the potential benefits. For instance, it is common to dispense with explicit modeling of participant behaviors in markets and simply assume that trading will result in the least-cost allocation for the set of trading rules. The trading equilibrium is then computed as the cost-minimizing allocation. This approach excludes explicit consideration of how participant behavior within markets affects outcomes. In one study addressing this issue Nguyen et al. (2013) use an agent-based model to simulate boundedly rational agents operating in bilateral and clearinghouse markets. They find that market-based trading in either the bilateral or clearinghouse form provides a better outcome than traditional regulations, but they also find that cost minimization within a set of market rules is not a good prediction of the trading outcome.
 
9
Figures on trades and prices are from personal communication with Jacqui Bolton, Resource Officer, Waikato Regional Council, 10/26/2020.
 
10
The South Nation River program in Ontario is the hybrid baseline-and-credit type. The success of the program is the result of an economic, regulatory, and institutional environment that delivered the requisite point source demand and facilitated trading, albeit on a very small scale.
 
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Metadata
Title
Water Quality Trading
Authors
James Shortle
Markku Ollikainen
Antti Iho
Copyright Year
2021
Book
Water Quality and Agriculture

Print ISBN: 978-3-030-47086-9

Electronic ISBN: 978-3-030-47087-6

Copyright Year: 2021

DOI
https://doi.org/10.1007/978-3-030-47087-6_6