Creating Markets for Environmental Stewardship:
Potential Benefits and Problems
Creating markets for
environmental services could encourage the adoption
of farming practices that provide cleaner air
and water, and other conservation benefits.
Marc Ribaudo
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Farmers
and other landowners typically under-provide
environmental services such as clean
air and water, carbon sequestration,
and improved wildlife habitat.
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Markets
for environmental services could increase
farmer investments in environmental
stewardship, thereby expanding the
supply of environmental services.
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Impediments
to the formation of fully functioning
markets for agricultural environmental
services may be difficult or costly
to overcome. |
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This
article is drawn from . . . |
The
Use of Markets To Increase Private Investment
in Environmental Stewardship,
by Marc Ribaudo, LeRoy Hansen, Daniel
Hellerstein, and Catherine Greene, ERR-64,
USDA, Economic Research Service, September
2008.
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You
may also be interested in . . . |
"Environmental
Credit Trading: Can Farming Benefit?", by
Marc Ribaudo, Robert Johansson, and Carol
Jones, in Amber Waves, Vol. 4,
Special Issue, USDA, Economic Research
Service, July 2006. |
What does a farm produce? Food
and fiber is the obvious answer, but most farms
have only a portion of their land in crop production.
Farms also contain significant amounts of pasture,
forest, ponds, meadows, grasslands, and wetlands.
In 2002, farms accounted for 41 percent of all
U.S. land, including 395 million acres of pasture
and range, 76 million acres of forest and woodland,
and 16 million acres of wetlands. This natural
capital can provide a host of environmental services,
including cleaner air and water, flood control,
improved wildlife habitat, and carbon sequestration.
When farmers decide how to use their land, they
generally consider only uses that produce goods
and services that can be sold. Products expected
to generate the greatest net returns are the ones
generally selected for production. As a result,
when farmers make their production choices, market
commodities win out. Since environmental services
generally do not have markets, they have little
or no value when the farmer makes land-use or production
decisions. As a result, environmental services
are under-provided by farmers. This is one reason
why billions of dollars are spent each year by
government and nongovernment organizations to pay
farmers to maintain natural areas and improve the
environmental performance of their farms.
If environmental services could be sold like other
commodities, at prices that reflected their true
value to society, farmers would likely invest more
to maintain wildlife habitat, woodlots, and wetlands.
And, those who benefit the most from environmental
services would pay for them. This could mean a
reduced need for taxpayer-funded investments in
environmental services, increased private investments
that are more responsive to changing economic and
environmental conditions, and, perhaps, less costly
service provision. The question remains: If these
services are valued by society, why are there no
markets for environmental services?
Environmental Services Defy Ownership
The biggest reason that markets for environmental
services do not develop naturally is that the services
themselves have characteristics that defy ownership.
With private goods, such as traditional agricultural
commodities, a farmer transfers ownership only
when a buyer pays the desired price. Environmental
services do not have this characteristic. Once
they are produced, people can “consume” them
without paying a price. Improved water quality,
for example, benefits everyone downstream, whether
or not they pay for it. Most consumers are unwilling
to pay for a good that they can obtain for free,
so markets cannot develop. Without a market, there
are no price signals encouraging farmers to produce
environmental services as part of the farms’ output.
Can anything be done other than relying on government
programs to provide publicly funded investments
in environmental stewardship? While government
programs provide incentives to farmers to provide
environmental stewardship, they lack many of the
desirable characteristics of fully functioning
markets. Markets allocate resources efficiently
(at least in theory), those who benefit pay, and
markets are flexible in the face of changing conditions.
Farmers could also benefit from the additional
stream of income earned from their land.
Experiences With Creating Markets for Environmental
Services
Creating markets for environmental services is
not an entirely novel idea. Several markets (water
quality trading, carbon trading, and wetland mitigation)
have been created to reduce compliance costs associated
with environmental regulations. Two other markets
(eco-labeling and fee hunting) have developed on
their own. Experiences with these markets highlight
their promise and pitfalls.
One important characteristic of most markets for
environmental services is that government or some
other authority plays a central role in setting
them up—they do not spontaneously develop
from the interaction of buyers and sellers, as
most markets do. The reason, as noted, is that
environmental services, to varying degrees, defy
ownership—they are public goods. One way
to get around this is to create a good related
to the environmental service that has private-good
characteristics, as has been done for markets in
water quality trading, carbon trading, and wetland
mitigation. These markets would not exist without
government programs that require regulated business
firms (such as industrial plants and land developers)
to meet strict environmental standards. In essence,
legally binding caps on emissions (water and carbon)
or mandatory replacement of lost habitat (wetland
mitigation) create the demand needed to support
a market for environmental services.
In the case of water quality, the U.S. Environmental
Protection Agency (EPA) has established caps on
total pollutant discharges from regulated firms
in some watersheds, and issued discharge allowances
to each firm specifying how much pollution the
firm can legally discharge. A firm can discharge
more pollution than its original allocation by
purchasing allowances from other firms that have
cut their own pollution discharges below EPA allowances
or from unregulated sources of pollution, such
as agriculture. This transaction is known as a
trade. Discharge allowances, therefore, have characteristics
of a private good. So-called cap and trade programs
create a tradable good related to an environmental
service, and use program rules to create demand.
Farmers are likely to be able to provide discharge
reductions at a lower unit cost than industry can,
and to profit from the exchange (see box, “Trading
Can Reduce the Cost of Lowering Emissions”).
In markets for greenhouse gases, carbon credits
are exchanged. Members of the Chicago Climate Exchange
that voluntarily commit to reducing their carbon
emissions by 17 percent can purchase carbon credits
in an offset market. For wetlands, it is mitigation
credits. No-net-loss requirements for new housing
and commercial development require that lost wetland
services be replaced, creating demand for mitigation
credits, which are produced by creating new wetlands.
In all of these cases, the managing or regulatory
entity defines the tradable good and enforces the
transactions.
Eco-labeling uses a different approach. Rather
than creating a new good, labeling establishes
a link between an existing private good (for example,
a food product) and an environmental service (wildlife
viewing, for example). Eco-labels allow consumers
to purchase products, possibly for a higher price,
that are produced in an environmentally friendly
manner. Dolphin-friendly tuna and organic labeling
are examples. The organic label can be used only
by farms that agree to follow a specific set of
environmentally friendly management practices.
Fee
hunting is another example of linking an environmental
service with a private good. Wildlife is a public
good. However, access to private land to hunt is
a private good. Landowners can sell access to their
land for hunting. The fee provides an incentive
for the farmer to maintain wildlife habitat on
the farm (see “Fee Hunting
May Boost Farm Income, Wildlife Habitat”).
Markets Depend on More Than Just the Existence
of a Good
Simply creating demand for an environmental service
does not guarantee that a market for services from
agricultural sources will actually develop and
thrive. For example, trades have occurred in only
4 of the 22 water quality trading programs that
include agriculture as a source of credits. Only
a small percentage of farmers run fee hunting operations,
despite a high demand for access to private land
for hunting. Farmers appear to be able to restore
wetlands at a lower cost than many other landowners,
yet only a handful of the more than 600 current
wetland mitigation banks are operated by farmers.
As it turns out, a number of impediments affect
agricultural producers’ ability to participate
in markets for environmental services. One of the
most important is uncertainty over the environmental
impact of changes in farming practices. In emissions
trading and offset markets, uncertainty about the
quantity of credits supplied by agricultural producers
reduces demand. Purchasers may be unwilling to
enter into a contract with a farmer who cannot
guarantee delivery of the agreed-upon quantity
of pollution abatement, wetlands services, or other
environmental service. This unwillingness is especially
true if the good is being used to meet a regulatory
requirement. Uncertainty can be addressed by regulators’ requiring “factors
of safety” and other coefficients (referred
to as a “trading ratio”) to compensate
for that uncertainty. However, trading ratios increase
the number of credits the buyer must purchase to
replace one unit of pollution abatement, thereby
increasing costs and reducing demand for credits
produced on farms.
Uncertainty about label claims can be a major problem
with eco-labels. Consumers have no way of knowing
if the agricultural goods they purchase are from
producers that actually deliver the environmental
services claimed on the label. Eco-labels can only
deliver environmental services if consumers believe
the label claims are accurate, and producers live
up to their claims.
Uncertainty also affects the potential supply of
environmental services. A farmer who is uncertain
about the economic benefits of investing in environmental
stewardship because the quantity of the resulting
environmental services is uncertain is far less
likely to make the investment. Some markets prevent
uncertain services from being sold. The Chicago
Climate Exchange does not certify credits from
soil types for which scientific evidence is lacking
on the soil’s ability to sequester carbon.
Transaction costs can also undermine the development
of markets for environmental services. Environmental
services from agriculture are produced across a
diverse landscape, and unlike food and fiber, they
cannot be packaged and shipped to a central market.
Just locating trading partners can be costly for
individual market participants, particularly if
a buyer needs to find and negotiate contracts with
multiple farmers in order to accumulate enough
credits to meet permit requirements. In addition,
providing environmental services is likely to be
secondary to a farmer’s primary activity
of producing agricultural commodities. It may be
too costly for farmers to learn about potential
demand for an environmental service, meet participation
requirements, develop a business plan, keep the
necessary records, and integrate the new business
into the traditional farming operation.
Fee hunting faces a unique problem—peer pressure.
Fee hunting is looked upon unfavorably in many
States with a tradition of open access to the land
for hunting. Farmers looking to profit from what
traditionally had been a simple handshake agreement
may be regarded unfavorably by their peers. This
may be a reason that fee hunting is not widespread
in many parts of the country, even though demand
for access is high.
What Can Be Done To Assist Market Development?
If markets are to become important tools for generating
resources for conservation on farms, Government
or other organizations may have to help emerging
markets overcome uncertainty and transaction costs.
One feature of markets is that once they become
established, entities will emerge that provide
cost-reducing services that benefit the market.
For example, private integrators are seeking out
greenhouse gas reduction projects, assembling credits,
and selling them on the Chicago Climate Exchange.
Government can play a major role in reducing uncertainty
by providing research on the level of environmental
services from different conservation practices.
USDA is supporting the development of tools and
methods for quantifying how farming practices affect
environmental services. For example, USDA and EPA
are developing an online Nitrogen Trading Tool
to help farmers determine how many potential nitrogen
credits they can generate on their farms for sale
in a water quality trading program. Other USDA
research programs include Greenhouse Gas Reduction
through Agricultural Carbon Enhancement Network
(GRACENet) and the Conservation Effects Assessment
Project (CEAP).
Government can reduce uncertainty by setting standards
for environmental services. USDA is playing an
important role in establishing standards for organic
agriculture that provide assurance to consumers
that the claims on the label are believable. Standards
also protect producers from dilution of price premiums
due to false claims by those not meeting the organic
standards. USDA also supports “market-based
stewardship” by cooperating with other Federal
agencies and groups to develop accounting practices
and procedures for quantifying environmental goods
and services in other types of markets (see box, “USDA
Activities That Support Environmental Service Markets”).
Information
from Government and other groups can reduce the
costs of market participation. For example, many
State cooperative extension offices provide information
to producers interested in offering fee hunting,
with checklists to help identify business goals,
the type of lease to offer (such as daily, long-term
lease, or lease to a hunt club), other services
to offer (such as bed and breakfast, guides, or
game cleaning), how to advertise, and how to manage
risk.
One way that markets have addressed
the issue of bringing all potential parties together
is through the establishment of clearinghouses
that collect information from buyers and sellers
and provide it at little or no cost to potential
market participants. Clearinghouses are used in
some water quality trading programs. Third-party
brokers and aggregators also bring buyers and sellers
together by purchasing credits from producers and
selling them to buyers. Both government and private
sector entities are playing the aggregator role
in water quality, carbon, and wetland mitigation
markets. Aggregators also reduce uncertainty by
verifying the level of services sold.
Government can help farmers who must meet minimum
practice standards before being eligible to participate
in offset markets by targeting them for assistance
from conservation programs. Government can also
encourage fee hunting by offering liability coverage
to landowners allowing hunters on their land.
Where farmers can participate in more than one
market, stacking credits provides an additional
incentive to adopt practices that provide multiple
benefits. For example, a producer can install a
vegetative buffer at the end of a field to capture
the nutrient and sediment runoff. Within this buffer,
carbon is also sequestered and wildlife habitat
is created. Each of these benefits has value and
can be traded if markets exist.
But There Are Limits to Markets
While markets have many desirable properties, they
are limited in what they can accomplish, even with
government assistance. Public good characteristics
that defy ownership discourage markets for environmental
services from developing—and prevent the
full value of environmental services from being
reflected in prices. Even though some consumers
may be willing to pay a higher price to support
an eco-label, for example, many others who benefit
from the resulting environmental services avoid
paying for them by purchasing unlabeled goods at
lower prices. The prices of credits in water, carbon,
and wetland markets also may not reflect their
full social value, only their value to the regulated
community.
Some markets may eventually become
widespread. A national cap-and-trade program, such
as that proposed by Congress, could establish a
national market for carbon credits and create sufficient
demand to entice many farmers to enter. Others,
such as water quality trading or wetland mitigation,
may be limited to a few specific geographic areas.
For example, of more than 700 watersheds impaired
by nutrients, less than a third have characteristics
that are required to support active markets for
discharge credits from farms. The bottom line is
that markets for environmental services are not
likely to supplant the need for traditional conservation
programs, which will continue to play a major role
in providing environmental services. But where
they can become economically viable, they can provide
an important vehicle for encouraging investment
in environmental stewardship.
Trading Can Reduce
the Cost of Lowering Emissions |
Without trading, the regulated firm reduces
discharges by 500 pounds at a cost of $25,000
(500 lbs at $50 per pound), and the farm does
nothing.
With trading, the firm reduces discharges
by 400 pounds at a cost of $20,000 (400
lbs at $50 per pound). The farm is willing
to reduce discharges for a price of $15
per pound. The firm purchases 100 pounds
of reduction from the farm at a cost of
$1,500 (100 pounds at $15 per pound). The
firm’s costs have
been reduced to $21,500 (a savings of $3,500).
The farm reduces discharges by 100 pounds at
an actual cost of $1,000 (100 pounds at $10
per pound). The farmer receives a payment of
$1,500 from the firm, so actually realizes
a profit of $500 for trading with the firm.
The total cost of reducing pollution (not
considering profit to the farmer) has been
reduced from $25,000 to $21,000. |
USDA Activities That Support
Environmental Service Markets |
In 2006, USDA released a departmental regulation
defining its policy on markets for environmental
services. This policy stated that USDA would:
Cooperate with other Federal, State, and
local governments to establish a role for
agriculture in environmental markets;
Find ways to make USDA policies and programs
support producers wanting to participate
in such markets;
Conduct research and develop tools for quantifying
environmental impacts of farming practices.
The Food, Conservation and Energy Act of
2008 requires the Secretary of Agriculture
to establish technical guidelines for measuring
ecosystem services from conservation and
other land management activities, with priority
given to participation in carbon markets.
Guidelines are also to be established for
a registry to record and maintain information
on measured environmental service benefits,
and a process for verifying that a farmer
has implemented the conservation or land
management activities reported in the registry. |
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