In general, green payments programmes can be designed in a number of ways, with each differing along several important dimensions. Programmes may have different environmental and income objectives, different degrees of cost-effectiveness, and may imply different economic trade-offs between and among consumers, producers and the environment. Under a traditional welfare economics approach, environmental goals could be achieved cost- effectively using traditional environmental policy instruments (Chapter 2).
Equity objectives would then be efficiently addressed using non-distortionary policies (i.e. lump-sum transfers) to adjust the income distribution. However, contemporary welfare economics rejects the feasibility of lump-sum transfers to achieve equity objectives, and suggests considering both efficiency and equity in optimal policy design (e.g. Gardner, 1987).
Given that non-distortionary transfers are impossible, efficiency and equity objectives can be usefully modelled by a social objective function, U (Gardner, 1987). Following Horan et al. (1999a), we define U over the economic welfare of relevant groups: consumers, producers, owners of factors of production, those damaged by non-point pollution, and taxpayers.
The associated welfare measures are consumer’s surplus (CS), producer quasi-rents (PSi, i = 1, …,n, where i indexes farms), factor surplus (FS), pollution damages (Dk, k = 1,…,K, where k indexes damage sites) and net government transfers (G). Thus, U = U(CS, PS1, …,PSn, FS, –D1, …, DK, G), with Uincreasing in all its arguments. Uis random because stochastic variations in weather, particularly precipitation, cause environmental damages to vary for any given set of management choices by producers. (Other sources of randomness could also be modelled.) How efficiency and equity objectives are satisfied depends on the choice of instruments, how the instru- ments are designed and implemented, and market and information structures.
For instance, green payments are optimally chosen, designed and implemented to maximize expected utility, E{U}, subject to producer responses.
To illustrate the trade-offs involved with choosing instruments to maximize E{U}, consider an input subsidy scheme with subsidies of the form sij(xi0j xij) for all iand j,where xijis the jth input used on the ith farm, sij is the corresponding subsidy rate and xi0j is the baseline input level from which the subsidy is evaluated. No payments are made when xij > xi0j for pollution-increasing inputs or when xij<xi0jfor pollution-decreasing inputs. We have sij>0 for pollution-increasing inputs and sij<0 for pollution-decreasing inputs.
An efficient subsidy rate equals an input’s expected marginal contribu- tion to damages from a particular farm (Chapter 2). With equity concerns, however, optimal subsidy rates reflect all economic trade-offs among groups defined by U. If Uweights a particular group more heavily at the margin, then optimal input subsidy rates are designed to induce two impacts with respect to that group, other things being equal: an increase in expected welfare and a decrease in risk. There may also be trade-offs at the margin between these two impacts. For example, the larger the marginal disutility of
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environmental damages relative to the marginal utility of producer surplus, the more the subsidies provide incentives to reduce the use of pollution- increasing inputs and increase the use of pollution-reducing inputs.
There may or may not be trade-offs between expected environmental damages and expected farm income. Depending on the trade-offs among groups as defined by U, one could envisage scenarios in which green pay- ments reduce expected environmental damages and simultaneously increase expected farm income. The costs of green payments in this scenario would be borne by other groups, such as consumers, factor suppliers or taxpayers.
Theoretically, optimal green payments would be farm-specific, reflecting the contribution of a specific farm to environmental damages and the weight assigned to a specific farm in the social objective function U. Theoretically, opti- mal green payments would also be applied to all inputs, because in general every input has some impact at the margin (either positive or negative) on pollution.
However, both of these conditions are impractical. Budget limitations and trans- actions costs would limit who was paid under a green payments scheme, what actions would be monitored for compliance and payment, how programmes would address producer heterogeneity, and how much information would be obtained and utilized for policy design and implementation. Optimal site-specific input subsidies might also provide arbitrage incentives that could undermine the system (Shortle et al., 1998).
This raises important issues in the design of second-best green payment schemes that have yet to be addressed. For example, cost-effectiveness may be highly sensitive to how payments are targeted to induce pollution control efforts across critical watersheds and land uses. Cost-effectiveness will be poor if producers who have limited impacts on expected damages are given more weight in the social objective function than those with larger impacts on expected damages. Alternatively, subsidy rates could be applied uniformly across producers in a region to reduce transactions costs and to limit arbitrage opportunities. Uniformity reduces cost-effectiveness because it eliminates opportunities to reduce costs further by targeting producers according to their relative impacts on ambient pollution.
There are also international trade issues to consider. The Uruguay Round Agreement on Agriculture (URAA) calls on participating nations to reduce agricultural programmes and policies that support domestic agricultural produc- tion or distort agricultural trade. Agri-environmental policies fall into the permit- ted set of ‘green box’ policies in so far as they have minimal distorting impacts on production and trade (Vasavada and Warmerdam, 1998). Strictly speaking, the only green payments that would not alter production are subsidies on ‘pure abatement’ activities. Such a programme would probably not be very cost- effective and might or might not produce significant environmental gains. A cost-effective plan would alter production practices and land use choices, inevitably impacting production and trade. This would pass muster under the URAA only to the extent that these changes did not negatively impact other countries to the point where they would have legitimate cause for complaint to
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the World Trade Organization. Green payments outside the terms of the URAA might be possible as part of an internationally negotiated package of agricultural policy reforms involving reductions in other agricultural price and income supports.