Trends in economic analysis and the costs and benefits of environment protection
Introduction
Section 10 of the Protection of the Environment Administration Act 1991 requires the State of the Environment report to include an examination of trends in economic analysis and of costs and benefits of environment protection. In New South Wales, agencies are required by legislation to take economic considerations into account when assessing measures to protect the environment and promote ecologically sustainable development.
In the past, environment protection was often seen as conflicting with the goals of economic development. Consistent with this view was the belief – and commonly the practice – that environmental matters should be considered separately from wider economic issues. However, there is now a much better understanding of the linkages between environmental quality and economic activity, and an appreciation that policies need to take explicit account of these linkages to achieve optimal outcomes for current and future generations.
At the same time, economists have come to recognise that some of the tools of mainstream economics can be adapted to provide practical guidance for managing environment protection. Fundamental to these developments is the concept of the environment as a resource, both in its own right and as an input into the production of marketed goods.
There are practical and methodological difficulties in applying economic tools to decisions about the environment. Nevertheless, substantial progress has been made in this area and the Department of Environment and Conservation (DEC) is continuing to develop these tools so they can be increasingly used for improved environmental and economic decision-making in NSW.
Economic tools are used to:
- assess the costs and benefits of proposed environmental standards, policies or investments in order to achieve overall net gains for society
- identify least-cost options for achieving specific environmental outcomes
- assess the economic impacts of environmental pressures
- provide advice on, and assessment of, regulations, market-based instruments and economic incentives
- support efficient and effective land management
- provide advice on the efficient and effective conservation and use of natural resources.
Trends in economic analysis of environment protection
Environmental regulation
In the 1960s and 1970s, it was self-evident that problems such as urban smog and water quality needed to be addressed. Regulations in the form of command-and-control directives were applied to deal with these problems, often without appropriate assessment of the costs and benefits of these measures. However, as the cost of achieving further gains rose, calls grew for a more formal assessment of costs and benefits. As a result, by the 1990s governments had prescribed the need for economic analysis prior to the introduction of new regulations.
Regulations and environmental standards are now generally required to have well-defined objectives based on robust evidence of the costs of compliance and the benefits that will be generated (or the costs avoided).
At the same time, there has also been increasing interest in Australia in improving regulatory practice, as seen in the launch of the National Reform Agenda by the Council of Australian Governments (COAG). As part of this Agenda, the Productivity Commission and the NSW Independent Pricing and Regulatory Tribunal (IPART) have been investigating regulatory compliance costs for business and ways to benchmark business regulation. Areas with environmental implications, such as freight transport and urban congestion, and chemicals and plastics, have been specifically targeted by these reforms.
In NSW, economic assessment of proposed regulations is required under three statutory instruments: the Subordinate Legislation Act 1989, the Protection of the Environment Operations Act 1997 and the Protection of the Environment Administration Act 1991. Schedules 1–3 of the Subordinate Legislation Act set out the statutory requirements for evaluating the costs and benefits of regulations as part of regulatory impact statements.
Environmental regulations in NSW undergo cost-benefit analysis (CBA) to ensure that key principles of good regulation are met. The benefits generated from proposed new requirements must outweigh the costs or deliver statutory goals at the least cost before new or revised regulations are adopted.
CBA identifies all the costs and benefits of a given program, quantifies them in monetary terms as far as possible, and then compares them in order to arrive at a net benefit. Without valuations of environmental benefits or costs, environmental goods and services are usually undervalued. Where costs or benefits are unable to be quantified, they can be presented in qualitative terms and considered when the analyst interprets the measured net benefit (or cost) of the program. CBA can also help in choosing between alternative programs by selecting the program with the highest net benefit after considering any unmeasurable outcomes.
In 2005, DEC developed a Reference Manual for Cost-Benefit Analysis (DEC 2005a) which outlines the steps involved in conducting a CBA. The manual documents generic procedures for the economic analyses necessary in preparing a regulatory impact statement and provides a ready reference for the economic issues commonly addressed in CBA. The manual codifies the application of economic analysis when regulations are made or amended, leading to a more consistent and efficient analysis of the impacts of environmental regulations.
CBA may be supplemented by tools such as the Australian Government's Business Cost Calculator, a computer program that compares business compliance costs associated with different regulatory options.
Environmental management
In addition to the increasing use of economic analysis in environmental regulation, there is also a growing recognition of the value of economic tools and techniques in environmental management, particularly in supporting decision-making and achieving environmental management objectives.
These tools and techniques include the use of economic instruments, economic impact assessments and economic valuation studies, as discussed below.
Economic instruments
Economic instruments include taxes and charges, subsidies, deposit-refund schemes, tradeable permits and financial enforcement incentives. Their flexibility offers the potential to meet environmental quality objectives at substantially reduced costs by allocating the 'work' of environmental improvement to wherever it can be done at least cost. Economic instruments can also stimulate the development of more efficient pollution prevention and control technology, and ensure resources are allocated efficiently.
Market-based approaches such as economic instruments are not an alternative to a regulatory framework. Rather they rely on, and operate within, a regulatory framework that defines property rights, minimum acceptable performance, and compliance.
Both IPART and the Productivity Commission have investigated the role of economic instruments, such as pricing, entitlements and trading, in improving resource allocation in relation to management of rural water use (for example see IPART 2006; Productivity Commission 2006).
DEC is using economic instruments to address specific environmental problems and achieve better environmental outcomes in NSW at least cost. Extensive education and consultation programs with industry and environment and community groups are also carried out during the development and design of these instruments to ensure their success. The costs and benefits section below provides examples of some of the economic instruments used in NSW for environment protection.
Economic impact assessments
Economic assessments have a valuable role to play in providing information to support decision-making in environmental management.
Regional Economic Impact Assessment
As well as conserving natural and cultural heritage, the management and operation of national parks and reserves is an economic activity in its own right that contributes to the wellbeing of local communities. Both DEC expenditure on park management and capital works, and spending by park visitors associated with their visits, generate economic activity and employment. In addition, over 80% of DEC park management staff live and work in rural and regional NSW and therefore contribute to economic activity by purchasing goods from their local economies.
DEC uses input-output analysis to estimate the direct and flow-on effects of park management and visitor expenditure on local economies in rural and regional NSW. This information is used by park managers to assist in park planning and management.
To support these assessments, DEC surveys visitors to national parks and reserves (including marine parks) to collect data on visitors, including their expenditure in the park's local economy.
Integrated ecological–economic impact assessment
DEC has worked with the NSW Department of Natural Resources and the Australian National University in the development of decision-support tools for the management of NSW coastal lakes. An important component of this process has been the development of the Coastal Lakes Assessment and Management tool which contains integrative models that can be used to explore potential ecological, economic and social impacts associated with the management of the NSW coastal lakes system.
Economic valuation studies
Travel-cost method
In addition to the economic impact of parks and reserves on local economies, protected areas also provide a wide range of other values which can be assessed through the use of economic techniques. Information on these values is used by park managers in park planning and management.
For example, the economic value that visitors attach to their trip to a national park can be estimated through use of the travel-cost method (TCM). This method uses the costs visitors incur in travelling to a particular location (such as a national park) as a proxy for the amount they are willing to pay to obtain the recreational experience from the location they are visiting. The net economic benefit enjoyed by a visitor to a site is expressed as consumer surplus, which is the difference between the maximum an individual is willing to pay for goods or services (in this case the recreational experience obtained from visiting a national park) and the amount they actually pay (the travel costs).
Primary data for TCM studies is obtained from surveys of visitors to national parks and reserves and marine parks.
Valuation of the health costs of air pollution
Air pollution affects people's health and the environment, and imposes a real cost on the community. In 2006, DEC released Air Pollution Economics: Health Costs of Air Pollution in the Greater Sydney Metropolitan Region (DEC 2006a). The study estimated the health costs of ambient air pollution in the region by evaluating mortality from long-term exposure to air pollution, admissions to hospital for respiratory and cardiovascular complaints, and the incidence of chronic bronchitis. Particulate matter served as an indicator pollutant for estimating the health impacts of common ambient air pollutants, such as carbon monoxide, lead and nitrogen dioxide.
The DEC study found that the health costs of ambient air pollution in the greater Sydney metropolitan region are between $1 billion and $8.4 billion per annum. These costs are equivalent to between 0.4% and 3.4% of gross state product and are chiefly based on the estimated costs of premature mortality (from long-term exposure) and chronic bronchitis. These findings are being used to guide strategies to reduce air pollution and its significant health impacts.
Environmental Valuation Reference Inventory
Environmental valuation techniques are used globally to support research, develop policy and evaluate regulation. DEC is funding, on behalf of Australia, a two-year pilot membership of the Environmental Valuation Reference Inventory (EVRI), an international environmental database managed by Environment Canada which is accessible free of charge to all Australians. EVRI contains over 1700 international studies providing values, methodologies, techniques and theories on environmental valuation (DEC 2006b).
EVRI has increased the practicality of using the benefits transfer approach, which is a time-saving and cost-effective method where economic values from previous studies are applied to current policy challenges. Benefits transfer can provide estimates for cost-benefit analyses and regulatory impact assessments, which encourages the internalisation of pollution costs and appreciation of natural capital tradeoffs.
The EVRI database supplements ENVALUE, a valuation database created by DEC's predecessor, the Environment Protection Authority.
Costs and benefits of environment protection
Spending by the NSW Government on environment protection aims to reduce environmental degradation and pollution; conserve the State's natural and cultural heritage; foster sustainable consumption, resource use and waste management; and improve the management of land, water and the coastal environment. This expenditure has increased from approximately $1 billion in nominal terms in 2003–04 (without any adjustment for the effects of inflation) to over $1.2 billion in 2005–06, and represents 2–3% of total budget spending (NSW Budget Statement Papers 2004–05 to 2006–07).
Generally, the best approach to environment protection is a mix of policy tools which links regulation with economic instruments and voluntary approaches. Flexible approaches and complementary policy measures assist in ensuring efficient and effective outcomes. Such outcomes will be enhanced when environmental objectives are clearly specified, regulatory redundancy is avoided, and the costs and benefits are clearly articulated and evaluated (Productivity Commission 2004). Self-regulation and voluntary measures, based on consensus-building among stakeholders, have at times been promoted on the basis that they can address environmental problems in a flexible manner at a low cost. However, while voluntary programs may be successful in raising awareness and rewarding best practice, experience with such measures in Australia and overseas shows that they are limited in achieving enduring environmental outcomes. When firms do not face appropriate incentives to abate pollution, these measures generally fail to stimulate a reduction in negative externalities.
In a major review of voluntary approaches, OECD 2003 concluded that their environmental effectiveness is questionable and the economic efficiency of voluntary approaches is generally low.
In the case of environmental regulation, a recent report to DEC noted that available information on current regulation in NSW suggests significant environmental gains are being achieved, while negative economic effects on development and business are rare (BDA Group 2005). Environmental regulations do not impose excessive costs; they do not reduce economic growth; and they neither hurt international competitiveness nor cause widespread job losses and plant closures. Rather, an effective environmental regulatory regime has promoted significant environmental improvements against a background of substantial population and economic growth.
Examples of environmental regulation and other environmental management activities which provide economic benefits to individuals, businesses and the community follow.
Human settlements
Waste issues
The Waste and Environment Levy has been in operation since 1971 and is a key economic tool for reducing waste in NSW. The levy is simple to apply, readily understood and broad in its coverage. It provides an ongoing price incentive for the diversion of materials from disposal to other economically viable uses. The levy also acts as a funding mechanism for a range of programs that overcome barriers to reducing waste disposal and improve the environment more widely.
To date, the levy has been particularly effective in reducing the disposal of high-volume materials and heavy wastes, such as construction and demolition waste. It has also been effective in building capacity in areas such as the recycling of organics. In 1990, NSW had no organics recycling services. However, by 2004, there were 61 licensed composting facilities and over 70 councils providing regular organics recycling services. Recovery rates increased from no recycling of waste in 1990, to recycling of 40% of waste in 1998, and over 50% in 2002–03.
In late 2005, the NSW Premier announced the waste levy would increase by $6 per tonne each year for five years. This increase will encourage waste generators to reassess options for waste reduction, while providing a greater number and range of alternative waste technologies and additional recycling capacity able to compete with landfill.
BioBanking and urban development
The Biodiversity Banking and Offset Scheme (BioBanking) will provide a framework for offsetting the impacts on biodiversity from development at one site through positive management actions at another biobank site, with the requirement that overall biodiversity values are improved or maintained. Establishment of biobank sites under a BioBanking agreement by individuals will enable the generation of 'credits' which can be sold and used to offset the impact of developments elsewhere. BioBanking will also recognise that biodiversity loss should be avoided and/or minimised before the use of offsets is considered.
Overall, the scheme generates economic value by guiding conservation activities onto suitable lands away from highly priced, serviced urban land to larger areas which are lower priced and less subject to degradation from incompatible land uses.
BioBanking is under development and is expected to commence in mid-2007.
Atmosphere
NSW leadership on climate change
The NSW Government recognises the importance of addressing climate change. It is continuing to develop a range of effective policy responses that ensure flexibility in achieving greenhouse gas abatement in the transition to a reduced reliance on non-renewable carbon fuels in the future. Australian state and territory governments have established a National Emissions Trading Taskforce to develop a multi-jurisdictional emissions trading scheme. Creating a market for greenhouse gas emissions and emission reductions has the potential to provide flexible and low-cost abatement options and accelerate the adoption of existing and new technologies.
The European Union has recently established its own emissions trading scheme, and other regions and nations are also actively considering emissions trading approaches. For example, nine north-east and mid-Atlantic states in the USA are cooperating in the design of a regional cap-and-trade program to cover carbon dioxide emissions from power plants (RGGI 2006).
Greenhouse Gas Abatement Scheme
The NSW Greenhouse Gas Abatement Scheme commenced on 1 January 2003, one of the first mandatory greenhouse gas emissions trading schemes in the world. The scheme aims to reduce greenhouse gas emissions associated with the production and use of electricity. It achieves this by using project-based activities to offset the production of greenhouse gas emissions. These activities earn abatement certificates which can be created through low-emission generation of electricity; activities that result in reduced consumption of electricity; reduction of on-site emissions not directly related to electricity consumption; and the capture of carbon from the atmosphere by forests.
The scheme establishes annual statewide greenhouse gas reduction targets, and then requires individual electricity retailers and certain other parties who buy or sell electricity in NSW to meet mandatory benchmarks based on the size of their share of the electricity market. More than 10 million abatement certificates had been created by June 2005.
Climate Action grants
The Climate Action grants program is an incentive-based program to support projects that develop and adopt technologies, processes and practices which reduce greenhouse gas emissions or help the NSW community adapt to the impacts of climate change.
A total of $5.7 million is available for technology action grants under Round 2 of the program over the next 2½ years.
Industry energy and resource use
The DEC Industry Partnership Program provides opportunities for companies to improve their bottom line by reducing their use of resources, such as energy, water and raw materials, and lowering the volume and toxicity of their waste. Companies involved in the program have achieved financial savings of over $9 million and delivered major environmental benefits (DEC 2006c). Annual environmental savings from the program include:
- 31,000 kilowatt-hours of electricity and 4600 gigajoules of gas
- 32,000 tonnes of CO2 (equivalent to 7000 cars removed from roads each year)
- 3500 tonnes of raw materials
- 200 megalitres of water
- 7000 tonnes less waste sent to landfill.
At a project level, the economic and environmental outcomes of the program are highlighted by the 'Cleaner production in metals manufacturing' project. An investment of $81,000 in matched funding has delivered annual savings of almost $3 million to a cluster of 10 Sydney-based metal manufacturers. The most successful of the companies involved in the project has been Hawker de Havilland (Boeing), which is recycling 250,000 litres of cutting fluid and 500 tonnes of aluminium off-cuts per year. The company is diverting over 31 tonnes of cardboard from landfill per annum and has reduced its energy consumption by 5000 kilowatt-hours a year (equivalent to 50 tonnes of CO2). These initiatives are saving the company at least $1.8 million a year (DEC 2006d).
A key feature of these programs is that they demonstrate that companies, without prompting, often do not take all the measures that they could to allow them to generate profit as well as protect the environment. Relatively inexpensive government-funded advisory programs have worked well for mutual benefit in most such cases.
Water
Hunter River Salinity Trading Scheme
The NSW Government's Hunter River Salinity Trading Scheme is a tradeable emissions scheme that manages discharges to the Hunter River of saline water from coal mines and electricity generators (DEC 2006e). It is recognised internationally as a leading-edge approach for dealing with an environmental problem.
By using real time data and trading, the scheme has enabled a dramatic improvement in salt levels in the Hunter River. Under the scheme, total allowable emissions are set for companies which are then able to trade their emission entitlements. Management costs are minimised with participants able to trade their salt credits online or implement abatement options. The costs of administering the scheme are fully recovered from participants.
The scheme has enabled multiple uses of the river to co-exist without compromising river water quality. Water quality has improved dramatically while self-generating economic activities have also grown so that:
- four new mines have opened
- coal mining has expanded by 46%
- 800 new jobs have been created
- production has risen $1.4 billion per year
- the NSW Government is receiving additional royalties of about $90 million a year.
Prior to the scheme's introduction, salinity impacts were becoming a constraint on further growth.
RiverBank
NSW RiverBank is an economic instrument that will create incentives that strike a better balance between environmental and economic outcomes. RiverBank aims to restore some of the State's wetlands and river systems. DEC is coordinating the program in cooperation with NSW catchment management authorities. Funded under the City and Country Environment Restoration Program, RiverBank will use $105 million over five years to enter the water market and buy water entitlements for the environment from willing sellers.
The program will focus initially on the Macquarie Marshes, the Lowbidgee and Gwydir wetlands, and Narran Lakes. Water may also be purchased for other areas of high conservation value if favourable market and other opportunities arise. The water will help increase environmental flows, reduce extraction to sustainable levels, and return threatened environments to acceptable health over time.
Licence holders will have the choice of selling their entitlements and investing in water efficiency equipment, reducing their operations, or moving out of the irrigation sector entirely.
RiverBank will facilitate an efficient and fair recovery of water from irrigators to benefit the environment.
Rainwater tank and washing machine rebates
The NSW Government has extended and increased two successful water saving rebates offered in the greater Sydney area. The $150 rebate for the purchase of water-efficient front-loading washing machines has been extended to 31 July 2008. The rebate for buying rainwater tanks has been increased to a maximum of $800 when customers connect the tanks to their home's internal fittings, such as toilets or washing machines.
The rebates provide a strong economic incentive to purchase a water-efficient washing machine or rainwater tank by offsetting the purchase cost and lowering the pay-off period. Sydney Water has already issued more than 16,000 rebates which are expected to save more than 347 million litres of water each year.
South Creek nutrient offset scheme
The nutrient offset scheme for South Creek is a two-year pilot project designed to bring together developers, landholders and the community to improve water quality in western Sydney. The pilot allows landholders to undertake practical nutrient reduction trials that can provide credits to offset emissions from other projects which have considerably higher marginal costs of emission reduction.
For instance, upgrading a modern sewage treatment plant to further reduce nutrient pollution entering a waterway such as South Creek can cost more than $10,000 for every kilogram of nitrogen or phosphorus saved. However, reducing the same amount of pollution by trapping runoff from neighbouring market gardens can cost as little as $500, or 20 times more pollution reduced for the same investment.
A number of landholders have already signed agreements under the scheme, and by June 2005 they had delivered cumulative reductions of 360 kg of nitrogen and 40 kg of phosphorus. Total reductions of 1930 kg of nitrogen and 570 kg of phosphorus are expected by June 2009.
National parks and other protected areas
Economic impact of national parks and reserves on local economies
DEC has carried out a series of studies into the contribution that national parks and other protected areas make to rural and regional economies in NSW.
A recently released study of the impacts of protected areas on the regional economy of north-east NSW estimated that expenditure by DEC on park management contributed $17 million a year to the regional economy, including $13 million paid to households as wages and salaries (DEC 2006f). This expenditure generated the equivalent of 265 local jobs.
Expenditure in the region by park visitors added around $107 million to the economy each year, including $59 million paid to households as wages and salaries, and generated over 1650 local jobs.
Marine parks
Socio-economic impact assessments of the Port Stephens–Great Lakes and Batemans Marine Parks were prepared by DEC and the Department of Primary Industries on behalf of the Marine Parks Authority to provide information on the economic impact of the park (MPA 2006a; MPA 2006b). The assessment found that negative impacts on the regional economies from reduced commercial fishing were likely to be offset by increased expenditure by the authority, other benefits and economic trends based on population growth.
Future directions
DEC continues to assess the costs and benefits of proposed and existing environmental management regulations and the impact of other environmental management activities. DEC is also developing economic assessment and valuation work in a number of new fields, including the following.
Future strategies for adopting an environmental accounting framework
Governments worldwide are incorporating economic analysis into State of the Environment (SoE) reporting. DEC and the Australian Bureau of Statistics (ABS) are investigating the application of environmental accounting to SoE reporting in NSW. This activity builds on work that the ABS is undertaking on the long-term development of a System of Environmental and Economic Accounting in Australia.
Environmental accounting helps to establish formal links between the environment and the economy. It attempts to provide measures of the environment as a source of natural capital as well as a receiver and storer of the waste products of the total human social and industrial environment. Such formal links are needed to integrate sustainability objectives with economic management.
Current national accounts systems fail to provide measures of environmentally sustainable development. Three major features in particular are inadequate:
- The systems neglect the use and depletion of natural resources, which means that factors that threaten the sustained productivity of the economy may not be fully captured. Changes in stocks of natural capital are not recorded.
- The systems fail to account for the degradation of environmental quality and the resulting effects on human health and welfare.
- The systems account for environmental expenditures as contributors to national product when these may instead be considered social costs for the maintenance of environmental quality, such as the clean-up of chemical spills (UNCED 1991).
Environmental accounting frameworks, such as the United Nations System of Environmental and Economic Accounting (SEEA), are increasing in significance in this context. SEEA enables governments to incorporate environmental impacts through elaborating on environmental flows and stocks, expanding assets accounts to include environmental assets, and detailing how production and consumption affect natural resources (Harris & Fraser 2002).
There are three main environmental accounting approaches that attempt to systematically describe interaction between the environment and the economy (Mohamed 1993):
- adjustment of national accounts to reflect environmental concerns, such as resource depletion and environmental degradation
- development of a set of satellite accounts which combine physical information from environmental statistics and natural resource accounts with economic information from national accounts: this approach complements the information from the national accounts rather than modifying it, thus allowing decision-makers to choose among different information systems
- development of natural resource accounts which describe, in physical terms, stocks and flows of resources between the environment and the economy, and within the economy: material resource accounts record actual and estimated stocks, reserves and flows of non-renewable natural resources such as energy and materials.
The Victorian Government is using the SEEA framework in its SoE reporting to show how much water, energy and materials are used to produce Victoria's goods and services. In recent years, several European jurisdictions have successfully adopted the SEEA as a framework for their national accounts.
Ecosystem services
A recent survey of coastal councils found that the primary issues they face relate to water supply and water quality (ALGA 2005).
DEC recently managed a pilot project to assess the economic contribution of water-related ecosystem services to water resource management in the Manning region of NSW. Preliminary findings are that high quality native vegetation provides economic benefits in terms of regulation of water yield, retention of sediment, and reduction of nutrients and pathogens. Beneficiaries include commercial fishers, oyster producers, urban and rural water users, and businesses, farms and residences affected by flooding in the catchment.
Protection and rehabilitation of native vegetation in catchments may provide a useful component of the integrated water cycle management strategies being developed by several local government authorities in coastal NSW.
Sustainability programs: Product Stewardship Agreement for Televisions
DEC is developing a Product Stewardship Agreement for Televisions, supported by the Environment Protection and Heritage Council and the television industry. The need to divert televisions from landfill and establish a national collection and recycling scheme stems from environmental concerns about the toxic and hazardous substances the appliances contain and the economically inefficient level of resource use represented by televisions going to landfill.
The NSW Extended Producer Responsibility Priority Statement 2005–06 sets out priority waste streams, including electrical and electronic products such as televisions (DEC 2005b). Product stewardship, or extended producer responsibility (EPR), extends a producer's responsibility for a product to the post-consumer stage of the product's life cycle (OECD 2001).
This NSW initiative is reflected in overseas developments, such as in Europe where EPR is implemented through a suite of European Union policies, including the Directive on Waste Electrical and Electronics Equipment.
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