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Opinion article written by Dr Eric Crampton, republished from The NZ Initiative

Freshwater management is a tough political problem. 

Any substantive reduction in the nutrient load in too many of our rivers will require significant land use changes – and changes in wastewater practices in some towns. 

Substantive land use change is costly. If those making the changes have to bear all of the costs, there will be bankruptcies. 

The threat of the both the real and the political costs of those bankruptcies make for a hard problem. Thursday's announcement from Minister David Parker hits some of the low-hanging fruit around wetland protection and restrictions on winter grazing methods. But more comprehensive work is yet required through regional freshwater management plans.

Any substantive reduction in nutrient load through those plans will not be tough enough for what may be required for environmental sustainability, or they will be sufficiently costly that they will be abandoned with a change in government.

There is a way through the morass. It involves sharing the burden of getting to a more sustainable environment, so that the institutions that get us there can be durable over the longer term. 

Let's step back and consider why strict targets without compensation are likely to cause a lot of bankruptcies. 

Farm purchases and dairy conversions are often heavily leveraged. Farmers will have borrowed to purchase the land and to put in the infrastructure improvements for irrigation and dairying. The selling price of the land, and the amounts that banks have been willing to lend, reflect the expected return that comes from the business. 

That return builds in certain expectations of the regulatory environment. 

Farmers have never had to pay for water directly. The value of water instead is reflected in the value of an irrigation consent tied to a piece of land. Research done earlier this decade suggested that land with an irrigation consent traded for up to fifty per cent more than comparable land without a consent. In other words, the value of the water was already incorporated into the selling price of the land. And that value will not have gone down over the intervening years.

A big change in the regulatory environment around water abstraction, or around allowable nutrient runoff or on-farm practices, would substantially change the cost calculus for already heavily leveraged farms. Costs go up, returns go down, and net cash flow is insufficient to pay the mortgage. Hello, bankruptcy. 

Perhaps those who took the wrong side of a bet by buying land at prices that left no room for regulatory changes should also bear the burden of having gotten that wrong. In that view, there is no injustice in farms going bankrupt as a consequence of stringent nutrient guidelines. 

But that is a rather hard line to take considering family farms have played straight by all the rules, fenced off streams, and done their best to reduce nutrient load with the tools they had. 

And it would be politically risky. Those bankruptcies will put political pressure to unwind the new measures. It also would be inconsistent with the coalition government's emphasis on just transitions. So the more likely outcome is guidelines that try to find a line between what is necessary for the environment, and what farmers can bear. 

The Government has another option – one that can help the environment at a much lower overall cost and without bankrupting our farmers. 

Cap-and-trade systems have proven effective in reducing pollution and environmental burdens in areas ranging from sulphur dioxide emissions, to commercial fishing, and greenhouse gas emissions. 

Rather than setting regulations mandating particular on-farm practices, the Government could cap the total nutrient load in different water catchments. Advances in soil mapping and our understanding of the underlying geology, combined with smart-market systems, provide the opportunity for building smart-markets in nutrient loading, and in water abstraction. 

Hard environmental bottom-lines can be built into the trading system to ensure caps are respected. 

The simplicity of the trading mechanism, as compared to the current extensive compliance costs for trading in water in Canterbury, or for trading in nutrients in Taupo, means the system would be far more effective. 

Free allocations of tradeable permits reflecting current activities, with the allocated permits declining over time, would completely change the dynamics of achieving environmental improvement.

Rather than bankrupting farms into submission, the system would encourage farms to sell their water or nutrient rights back into the trading scheme when it made sense for them to do so – and, in so doing, help them fund their own transition to other land uses. 

Crown buy-back of rights through cap-and-trade would share the burden of reaching sustainable outcomes. And users' stake in the system, reflected in their rights ownership, would not only build support for the system among those subject to it, but also make the system more durable across changes in government. 

If the minister wants improvements in environmental quality that can stand over the longer term, cap-and-trade systems deserve a second look. 




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