Finding the "Best of the Best" in Water Quality BMP's: The Economists' Viewpoint

Prepared by:
Michele Marra and Kelly Zering, Department of Agricultural and Resource Economics.

Why do we have a problem with water pollution? Sometimes when economic activity occurs, not all of the costs of the activity are borne by those engaged in and receiving the benefits of it. In other words, some external costs are not taken into account. This causes more of the economic activity and less investment in pollution prevention to take place than is socially optimal. Because those engaged in the activity that results in water pollution receive no incentive to change their behavior from market signals, some sort of intervention may be called for to reduce the economic activity to the socially desirable level. One example of this type of intervention has come to be called watershed management.1

The purpose of this report is to describe important economic criteria to consider when making agricultural watershed management policy. We hope it is helpful to policy makers at all levels of government and also to concerned citizens.

Watershed Management Policy-making

The goal of watershed management is to improve or maintain water quality within the watershed to achieve the socially optimal level of water quality. Many tools are available to watershed managers to help achieve this goal. Some can be described as "carrots" and others as "sticks." Sticks consist of rules which, if violated, result in a penalty for the violator, such as a fine or loss of privileges. Conversely, carrots are incentives offered for changes in behavior, such as USDA cost-sharing programs. Before an analysis of which policy instruments will be most effective in achieving the water quality improvement goal in a particular watershed or region, attention must be given to the set of alternatives available to those who must change behavior to achieve the goal.

The most effective method of water quality improvement from an environmental standpoint would be to ban economic activity. This method generally is not considered because of its excessive cost (in terms of goods and services foregone). This option may make sense in some sensitive environmental areas if the cost of water quality degradation includes loss of a unique environmental asset, but in general this is not a serious option. This option does serve to illustrate the simple principle that the set of options should be the "best" (most efficient) set according to economic, as well as environmental, criteria. The cost of achieving water quality goals must be balanced with the benefits. That is, the "best" option should be expected to achieve the greatest environmental benefit per dollar spent or achieve a target level of benefit at least cost.

From the policy maker's viewpoint, total cost should be the sum of private and public costs associated with the option. This concept is often forgotten when public resources are spent to promote a particular mechanism for changing behavior. Moreover, an option must be considered feasible and reasonable from the standpoint of the person whose behavior is being modified.

To allow efficient utilization of public resources, economic analysis is also needed to rule out options that have little chance of success. In addition, economic evaluation of possible options will give policy makers some idea of the level of subsidy required for effective implementation of those options likely to improve water quality.

The ideal from an economic viewpoint would be to present all the relevant cost and benefit information to each contributor to the pollution and, given a watershed-wide pollution reduction goal, shares of the reduction could be allocated to each. Allowing flexibility in the choice of pollution control methods and/or trading of shares insures that the reduction can be achieved at the least total cost (i.e. that the "best" methods will be employed to achieve the goal). This approach has been adopted in some areas, most notably in the case of industrial air pollution abatement. One drawback to this strategy in the case of non point source pollution is that monitoring and enforcement are costly.

BEST MANAGEMENT PRACTICES

A series of land and water controls, "best management practices" (BMPs) are being used to address non point source runoff. The concept of promoting and/or requiring "Best Management Practices" has been applied so widely probably because identification of adopters (and non-adopters) and, thus, enforcement of the rules, is not so costly. For example, it is easy to spot whether a farmer practices conservation tillage or has a large enough spray field so that animal waste can be field applied with minimal nutrient loss to ground and surface waters (although, as we've seen recently in North Carolina, the cost of inspecting every farm in a short time period can be significant). BMPs have been developed for most non point sources of pollution, including farms, forestry enterprises and residential property. The following sections focus on agricultural BMPs, although the principles suggested would apply to the other BMPs, as well.

Farmer Incentives

Voluntary farmer adoption of a particular BMP depends on whether or not its use will maintain farm profitability or, at the very least, will not decrease profitability by a significant amount. If BMP adoption is too costly in terms of forgone profit, farmers will not change their behavior without some additional incentive to do so.

A potential adopter often may not have all the relevant information to assess whether or not a BMP will be profitable. In the absence of information, they may be reluctant to change behavior. Economic analyses can provide a basis for BMP selection and implementation.

Measuring the Benefits

The cost of measuring environmental improvement due to BMP implementation can be quite high; field edge monitoring and test wells are often required. However, BMP effects on water quality can differ substantially depending on site-specific factors such as soil type, slope, operator experience or crop planted. Where BMP effects are site- specific, accurate measurement may be quite costly. In other cases, however, benefits can be estimated experimentally and applied to a wide area. An example would be the benefits of a lagoon expansion that would lower the probability of an accidental spill. Some effects can be estimated with the aid of a model of the relevant physical and biological processes. Again, there must be a weighing of the benefits of accuracy against the costs of monitoring.

Measuring the Costs

In many instances, the farm level costs of BMP implementation are easier to measure than the benefits. For example, the costs of purchasing or leasing more land for spray fields and installing the irrigation equipment can be obtained by surveying realtors and equipment dealers.

Some BMPs require more management time than others. For managers with high opportunity costs of their time (i.e., the return to time spent in other activities is large), management-intensive BMPs will hold a relative disadvantage. This cost is important to include, but is often ignored in the estimation of BMP costs because it is more difficult to measure than other input costs. Imposing management-intensive BMPs on these managers may result in a misallocation of resources. Conversely, BMPs that require a certain level of management skill, may result in a misallocation or failure when imposed on poor managers.

Estimates of implementation costs will allow improved decision making both at the regulatory level and the farm level. If a BMP is not feasible for a certain group or a certain area, then it will not pay to direct public resources into promoting it there. If cost sharing incentives are contemplated to entice adoption, they should be sufficient to result in enough adoption to achieve the water quality goal without "over spending" on the program. Adoption costs are, therefore, valuable tools to use in tailoring the level of cost sharing to the situation. At the farm level, BMP cost and benefit estimates will aid the producer in making better adoption decisions.

THE BEST OF THE BEST

Finding the "Best of the Best": The Big Picture

The search for the "best of the best" can be characterized as an optimization process. The purpose of this characterization is to define specific criteria for identifying the "best of the best". First, a state or regional social optimization process determines how much pollution is acceptable and how much private and public cost should be incurred to prevent additional pollution. The optimization process also determines agriculture's share of pollution reduction/prevention. In this context, the optimization facing the agricultural community is to maximize private and public wealth subject to achieving the desired pollution reduction and a host of other constraints.

Finding the "Best of the Best": The Challenge to Agriculture

Maximization of private and public wealth implies maximizing farm profits, income of the non-farm community, property values, and investment in the community. Many constraints or external conditions limit the optimization process. The acceptable level of pollution or the degree of pollution reduction is one constraint. The external funds available for cost-share, enforcement, government overhead, and education are another constraint. The current technology in agricultural production and in pollution prevention are limiting factors. Another external factor is the resource base of farms in the region, including soil types, topography, condition of riparian areas, and proximity to sensitive waters. A socioeconomic constraint is the current farm structure including the distribution of farms by size, by geographic dispersion, by enterprise mix, and by financial status. An important external factor may be the human resource base of farmers and supporting businesses in the region (knowledge, skill, education). A deceptively simple condition of the optimization facing the agricultural community is that the marginal benefit of each Best Management Practice implemented must equal or exceed the marginal cost of that practice.

Finding the "Best of the Best": Selection Criteria

Criteria for identifying the "Best of the Best" can be derived from the marginal condition for optimization stated above. Researchers, educators, policy makers, and individuals strive to specify the costs and benefits of each practice taking into account the many external factors listed above. Several specific criteria are listed below.

• a) No other feasible practice would allow a farmer to achieve greater profits over time while achieving the same degree of environmental protection.
• b) No other allocation of the budgeted public funds across cost share, enforcement, and education would achieve greater environmental benefits.
• c) No other allocation of budgeted public funds across regions (e.g., sub basins, highly sensitive waterways) would achieve greater environmental benefits.
• d) No other allocation of funds across farm sizes, enterprises (e.g., dairy, row crops, hogs, poultry), or farms by financial status would achieve greater environmental benefits.
• e) No other allocation of funds or set of practices would provide greater community wealth /income over time while maintaining the same degree of environmental protection.

If we assume diminishing marginal benefits to spending (for example, the marginal benefit of eliminating the last few ppm of nitrogen from a waterway is less than the marginal benefit of eliminating the first few ppm), then the above allocations will be achieved when the marginal benefit per dollar is equal across all choices.

This is true whether the allocation is across different uses of public funds or farmer choices of pollution abatement strategies. The list of criteria above is just an example and may be expanded. Even this short list illustrates the need for a great deal of specific information.

Finding the "Best of the Best": Information Needs

In order to apply the criteria listed above, very specific information is required.

• Criterion a) requires knowledge of the cost of each BMP in a farm specific setting. Research and educational efforts can provide reasonable estimates of the range of direct investment and typical operating costs for many BMPs. The farmer and consulting experts will have to determine actual farm specific costs. Indirect costs and benefits of each BMP may be more difficult to estimate. For example, the change in field operations costs due to buffer strips depends heavily on the size and shape of the field, the size of the field machinery, and the location of the buffered areas. When costs and benefits are difficult to estimate, educators can provide a list of factors to consider and methods of calculation. Criterion a) also requires that educators and researchers provide a clear estimate of the expected environmental benefits of each BMP. Environmental benefits should be listed for each potential pollutant affected. Environmental benefits should also be listed in terms of both expected values and risk reduction, where appropriate. For example, enlarging a dairy waste lagoon may not provide much benefit in average years, but can prevent a catastrophic event that occurs rarely.
  
• Criterion b) requires information on the expected expenditures of public funds on cost share, education, enforcement, and government overhead for each BMP. The effectiveness of each BMP may depend on the level of expenditure in one or more of these categories. Information on the number of cost share projects and the level of cost share proposed is also required.
  
• Criterion c) requires specific information on which waterways would benefit most from pollution reduction. The word "benefit" implies not only a physical measurement but also a social valuation. For example, cleanup of a waterway that is "used" by or affects a large number of people may yield greater social benefits than a similarly polluted waterway that is not "used" by many people. Criterion c) also requires information on the effectiveness of each BMP in correcting pollution problems along specific waterways.
  
• Criterion d) requires information on the source of pollution affecting specific waterways and on the ability of specific types of farms to adopt BMPs. For example, which enterprises (row crops, hogs, poultry, . . .) are causing most of the pollution along a specific waterway? Are there specific sizes of farms with that enterprise that create most of the problem? Does the financial condition of some of those farms make cost share more effective when targeted to those farms. Again, specific information on the effectiveness of BMPs for the type of farms being targeted is required.
  
• Criterion e) requires information about the effects of BMPs on community income and wealth. Where BMPs address a local problem as well as a regional water quality problem, community wealth may be increased. Where BMPs reduce economic activity, they may decrease community income. Alternatively, where BMPs create need for a new service or create a new product, they may enhance community income and wealth.

Implications of the Search for the "Best of the Best"

The criteria and information needs identified above have implications for the selection and implementation of BMPs.

1. Flexibility is important. The site specific nature of much of the information required makes it highly unlikely that the "best" BMP (or set of BMPs) can be identified by anyone unfamiliar with the site. A research, education, cost share and regulatory program that emphasizes a menu of BMPs and a flexible process for local identification of the "best" seems most likely to be effective.
   
2. A major effort to prioritize geographic locations in terms of where installation of BMPs is most likely to have the greatest water quality benefit is recommended.
   
3. A major effort to prioritize farm sizes, enter- prises, and practices in terms of likely efficacy of BMPs for optimal allocation of public funds is also recommended.
   
4. More work is needed to identify the farm specific determinants of cost, feasibility, and effectiveness of each BMP. Much of the work to date seems limited to estimates of the direct investment and operating cost of BMPs with limited consideration of indirect costs or benefits.
   
5. New efforts are required to assess the implications of each BMP for community wealth and income. Community costs and benefits should be included in any new evaluation of BMPs.
   
6. The same criteria used to evaluate existing BMPs can be used to prioritize research into new pollution prevention technology. While funds for pollution prevention research are increasing, they remain limited. The "best of the best" criteria can be used to determine the potential value of proposed technologies. High cost technologies or technologies that address only a small portion of the potential for pollution reduction may receive a lower priority. Easily managed technologies that control potential pollutants effectively at low cost (or even at a profit) on the types of farms being targeted may receive a high priority.
7. 
   The "best of the best" criteria can be used in designing educational programs and regulatory/ monitoring/enforcement programs as well.

Summary

Economists' perspective on Best Management Practices can be summarized as the search for maxi- mum social benefit at minimum social cost. Collaboration between economists, other scientists, and policy makers, coupled with regulatory flexibility, holds promise for finding the "best of the best".

Regardless of whether the search is being conducted by policy makers or farmers, finding the "best of the best" involves weighing the costs and benefits of each option from their viewpoint. The information provided through economic analysis of available options will allow more efficient decisions to be made and increase the likelihood that the chosen option is the "best of the best."

Acknowledgements

Thanks is expressed to Jennifer Platte, Department of Agricultural and Resource Economics, NC, who reviewed an earlier draft.

AREP96-1 October 1996