Negative Externality in Australia - Term Paper Example

NEGATIVE EXTERNALITY IN AUSTRALIA Introduction Externalities occur when the decisions arrived at by a party fail to factor the costs and benefits likely to be imposed on other parties and the environment. From society’s viewpoint, the presence of externalities can make people undertake too much or too little of a given activity. On the basis of recognized policy principles, research indicates that the presence of negative externalities often warrants government intervention in order to safeguard the welfare of the society by creating a succinct alignment of marginal social benefits and costs. This paper analyzes some common negative externalities, as well as possible ways through which government intervention may control and regulate these externalities. The study conducted in this paper is based upon a case study of the wastewater management system in Australia. The analysis of negative externalities in this case study is better approached by tackling the following three questions: 1. Explain what negative externalities are, and why there may be the case for government intervention to address them. Describe some of the ways to correct the negative externalities and the pros and cons of each method. Provide real life examples. An externality occurs when some activities by consumers or producers result in unintended direct or indirect effects over other unintended players in the market. Externalities may be negative or positive (Laffont 2008). In this case, negative externalities arise when the action of a party results in damage to other people without any form of compensation being awarded for that damage. Within the context of a business environment, a negative externality refers to a spill-over of an economic transaction that result in negative effects on a party that has no any direct involvement in the activity that causes the externality. Thus, the first party does not incur any costs for the repercussions on society while the second party gets no benefits from the effects inflicted upon them. Reasons for Government Intervention Externalities constitute one of the many reasons that lead to government intervention within the economic sphere. Thus, it is because the production, consumption, as well as investment decisions made by households, individuals, and organizations or firms usually affect people who are not directly involved in the transactionsMost externalities fall into the technical externalities category. In this context, the indirect effects impact on the production and consumption opportunities of other people, though the cost of the product or service does not consider those externalities. Consequently, there exist some differences between the returns or costs to the society and the private returns. Regarding the assertion that technical externalities require government intervention and taxation with an aim of preventing less-than-optimal results has led to an argument by economists that market mechanisms should be allowed to correct for any externalities and offer efficient outcomes. Against this proposition, optimal government regulation might be the implementation of institutional mechanisms that enable proper bargaining between the parties involved in the externalities. Types of Negative Externalities There are two types of negative externalities: I. Negative Production Externality These occur when a company’s production degrades the well-being of people who are not entitled to any form of compensation from the polluting firm. Examples of this type of externality include the emission of smoke from factories leading to clean-up expenses in efforts to reduce air pollution by the surrounding communities. Another example is the construction of a water reservoir such as a dam. The result is the destruction of the fishing industry in the river’s upstream. The externality here arises because the fishermen who relied on fishing are not compensated by the company that is now bound to benefit from the activities that it carries out on the dam. II. Negative Consumption Externality These arise when the consumption by one individual lowers the well-being of other people who do not receive any compensation from the individual. Examples of these kinds of externalities include an individual smoking a cigarette in a public place thus affecting the well-being of other people within that public place, and who happen to be non-smokers (Holcombe & Sobel 2007). Ways of Correcting Negative Externalities a. Taxation Government has many ways of addressing negative externalities such as legislation of policies that prohibit the consumption of a particular good or service or introduction of a pigouvian tax to discourage consumption. For example in the case of cigarette smoking, such a tax can be implemented by the government with the aim of discouraging smokers from acquiring more of this product. One of the demerits of such a government measure is that even with the additional costs; some people may still prefer to consume the product by adjusting their spending. In such cases, taxation earns revenue to the government minimizing the damages that are caused by negative externalities. The government use the revenue collected to mitigate the problem of externalities. Furthermore, companies still retain the option to comply with the new tax or allocate more resources to curb the pollution. In this case, companies might decide to continue causing the externality if the expenses are less than the cost of abating pollution. Companies might also decide to layoff their workers in order to recover the new taxation costs (Ben-David 2010). Figure 2. How Negative Externalities Decrease Through Tax Disadvantages Pigouvian tax is applied as a flat sales tax, not unlike other taxes that are progressive in nature. Thus, the taxation measure does not take into consideration the producers’ or consumers’ willingness and ability to pay. Therefore, the tax could be applied in a manner that makes even the least well-off individuals to pay most of the cost. For instance, the carbon taxes aimed at raising the cost of gasoline and other fossil fuels have become very controversial. The critics of these taxes argue that the least well-off people may not have any choice in their habits of consumption. Thus, they still have to pay for the gasoline for their daily activities. On the other hand, the financially well-off people can cut back rather easily. b. Environmental Protection Regulations A tax can make firms fault to pay up; however, when the tax is made cheaper than another alternative method of production, the problem of pollution cannot be solved. In such a case, the government can give emission permits that regulate the amount of pollution that a company can produce within legal standards. c. Tort Law (Tort System) The system involves a clear definition by the government on the rights of every individual. For example, one has the right to own property without anybody pouring any form of toxic wastes near the premises. In the war between environmental and commercial interests, it is often easier to support the seemingly defenceless party. Disadvantages This perception fuels the notion that most legislation passed against negative externalities, usually is exaggerated to play within the emotions of the audience observing images of pollution on the media domains. In most of the times, people harbour the notion that large companies are closely connected to pollution (dumping, smog and oil spills) due to incidences resulting from incompetence and gross negligence, but fail to take into account simple human error. d. Internalizing Costs The method of internalizing the costs of particular products is an effective way of addressing the issue of externalities. Through internalization, the higher social price and cost is achieved, consequently leading to an effective method of allocating resources. The fundamental assumption in this context is that the internalization of costs can quantify external costs. 2. Choose a case study from your home country (Australia) where an externality exists in the current market. Using the key characteristic of four market structures identify the type of market structure in your case study (i.e., monopoly, oligopoly, perfect competition or monopolistic competition). Illustrate the situation with externalities in your case study and the resulting deadweight loss in a diagram and discuss ways that your government has addressed the presence of negative externalities in the market.  This discussion examines the negative externalities caused by the discharge of effluents into sewerage systems by water users in Australia. There are numerous externalities that relate to the harmful external effects of commercial and residential clients disposing of wastewater into the sewerage line before subsequent treatment and disposal. Some particular pollutants are extremely corrosive and cause extensive damage to sewerage and treatment facilities. Additionally, the discharge of non-hazardous substances into sewers (such as nitrogen, salts, and phosphorus) raises the cost of water treatment before its discharge into the environment. Hazardous substances such as corrosive materials and metals often pose substantial health risks to water businesses’ workers and exacerbate the costs of infrastructure maintenance. It is important to note that some pollutants only become hazardous to human beings at a certain level. Whereas end-of-system treatment to a certain level happens before discharge to the environment, environmental impacts, public health, and amenity could still occur before this happens (Institute of Sustainable Futures 2007). For instance, after a heavy downpour, sewerage systems often overflow and pipes crack, resulting in the pollutant substances getting into the environment, such as urban waterways. This result in external costs similar to those encountered during storm water and wastewater disposal. It is plausible that the issue of wastewater management in Australia presents a wide range of negative externalities that have justified government intervention. Wastewater management is a very critical undertaking that touches on every corner of the country Due to the magnitude of the task; waste management is usually conducted by state corporations and line ministries in a rather monopolistic approach. To reduce the dead weight loss government and another regulatory authority utilises the market mechanism to force the market work at socially efficient point. Therefore, taxations and policies would shift the MPC to the right thus reducing the effect of negative externalities.  In the past few years, the government rely in infrastructural works such as connection of clients to sewerage systems as well as mitigation efforts to meet regulatory standards pertaining to the management of wastewater discharges. Evidence suggests that infrastructure investment and regulation has yielded significant results in addressing the negative externalities arising from wastewater pollution. Due to the increased government efforts in wastewater regulation, there have been drastic reductions in the amounts of nitrogen loads discharged from the Western Treatment Plant located in Melbourne (Van Bueren & Hatton MacDonald 2009). The reduction in nitrogen loads has coincided with stringent regulation and assessment of wastewater clients and the ongoing upgrades of water treatment facilities across Melbourne. It is worth noting that the prevailing arrangements for wastewater management poses a potential shortcoming that comes with the over-dependence on regulation as a way of managing pollutant substances that pose minimal risk to the environment, infrastructure and public health and safety. It is notable that the principles of the wastewater hierarchy that governs waste management in some states in Australia do not consider the range of benefits and costs that accompany various waste management alternatives (Productivity Commission 2008). Thus, the wastewater hierarchy favours some management activities, such as avoidance over others, such as treatment, without any regard to the relative costs. On the contrary, cost-reflective costs for treatment offer an incentive for the waste dischargers to look for the least-cost waste management alternative despite what that might pertain. Particularly hazardous substances that present significant risks to public safety, environment or the infrastructure are either closely regulated or prohibited. Other forms of external effects such as those that emanate from sewerage overflows after heavy rainfalls are managed through system operation procedures, as well as through direct management (Brennan, Tapsuwan & Ingram 2007). For instance, Sydney Water has the power to term certain substances in the sewerage systems or sub-systems as critical, and henceforth, restrict their disposal. Many experts hail these approaches as appropriate in addressing waste management issues, as well as the limited role for price control in the management of these issues (apart from recovering management expenses or imposing fines for breaches). As environmental regulation focuses on water discharges from sewerage treatment plants, some key issues that the government is trying to include the following: Whether the current regulations take into account the socially acceptable level of public health and environmental externalities and, if so, Whether wastewater clients are facing prices that correlate with the marginal cost of water treatment to the required environmental standards. For instance, it can happen that specific pollutants are the crucial factor governing treatment costs as opposed to the overall volume of the wastewater. Other issues regard the protection of public health and safety, as well as the maintenance of infrastructure along the sewerage transport and distribution system. Presently, many residential clients are faced with fixed wastewater charges, or costs that are based on the total volume of water used, mainly due to the costs of monitoring sewerage and metering. Therefore, this explains why the government has come up with subtle approaches for wastewater pricing in order effectively to reflect the cost of attaining the anticipated discharge standards. These approaches include the following: Differentiated wastewater charges These charges are arrived at on the basis of the content of the wastewater, such as concentration, the overall load, or both. In Melbourne, for instance, trade waste tariffs incorporate a variable component aimed at reflecting the marginal effects that pollutant discharges have on treatment costs. The major disadvantage of this system is that the application of measured volumetric charges for wastewater in residential places has proven to consume massive investment in monitoring and measuring exercises, with very little benefits. It appears that charges that are based on wastewater content rather than volume are less likely to be effective for domestic wastewater clients or places with low trade waste customers (Grafton & Ward 2010). In order to realize the full benefits of load-base charging, the government may need to conduct a review of some conflicting regulations and policies concerning waste management, especially the water hierarchy approach. Nodal Charging system The model encapsulates the setting up of wastewater charges in proportion to pollutant loads at each node along the sewerage distribution system. The idea here is that a collection of clients that are subject to a given levy would be financially motivated to collectively devise ways of lowering treatment expenses, as well as the pollutant loads delivered into their environment. Water consumption in Australia can be categorised into six sectors which include agriculture, household, water supply, and manufacturing & mining sectors. Of all these sectors that consume water in Australia agricultural sector use the highest percentage of 65% while households, water supply and manufacturing taking 11%, 11% and &% consecutively(Productivity Commission 2008). However, the consumption of water in the urban centre from 2000 to 2005 shows a different statistics. Domestic consumption lead other sectors of the economy with 62% followed by industrial 23%, system losses 8%, local government 5% while other sector take the remaining take 2% of water consumption(Productivity Commission 2008). The urban water consumption lead to externalities. Existing Valuations for Water-Related Externalities –Sorted by Externality Type. Externality Type Monetary Value Estimate $AUD 2010 (unless stated) Location and Year Total Economic Values (TEV) Covered Valuation Technique(s) Used 1. Environmental Pressure or State Change Indicators WATER QUALITY Water Quality (Appearance) Blamey et al (1999) 24.64 (/yr./hh Australia, 1999 Indirect Use Values, Option Values, Bequest Values, Contingent valuation (CV) Michael et al (1996) in Taylor (2005) A) Sydney B) Residents of the Darling River region A)27.6 –162.84 B)144.9 –211.14 (/yr./hh/as a tax) Australia, 1993 Indirect Use Values, Option Values and Bequest Values CV Reducing Interruptions to Water Services (WTP) A) Reduce the frequency of interruptions when they face one interruption in ten years, B) Face monthly interruptions D) Reduce length of interruptions of 24hr Hensher et al. (2004) and Birol et al (2006) A) 120.13, B) 58.13, C) 4.69 Australia, 2004 Direct Use Values, Option Values Choice Experiment Method GREENHOUSE GAS EMISSIONS (CO2 only, $/t CO2) Brown and Milne (2010) 20 Australia, 2010 Indirect Use Values, Option Values and Bequest Values Proposed Carbon Price Australian Government (2008) 24.15 –33.6 –42 Australia, 2008 Indirect Use Values, Option Values and Bequest Values Carbon Pollution Reduction Scheme, 2008 Garnaut (2008) 21 –42 Australia, 2008 Indirect Use Values, Option Values and Bequest Values Cost of Reaching Carbon Reduction Targets Existing Permits/ Credit Schemes Marsden Jacob Associates (2007) 40.44 Australia Indirect Use Values, Option Values and Bequest Values Sydney Water (Existing Permits/ Credit Scheme) NUTRIENTS NITROGEN (N) -Current Charges Marsden Jacobs Associates (2007) 872 (/kg) Australia, 2007 Direct Use Values, Indirect Use Values Direct Use Values, Indirect Use Values Market Data ECOSYSTEM WTP to protect the Nadgee Nature Reserve (Aust.). Bennett (1984) in Nunes and van den Bergh (2001) 67.12 Australia, 1984 Use Values, Direct Use Values, Bequest Values, Vicarious Values, Existence Values and Intrinsic Values CV Source: Urban Water Security Research Alliance Technical Report No. 42. According to Daniels, et al., 2012 the above data represent the different type of externalities in Australia for different years as indicated in the table. The data shows the value of each externality and has been collected from different studies around the world (Daniels, et al., 2012). 3. Suggest “other” options for dealing with negative externalities in your case study. Outline the economic reasons for your suggested options.         Another way of addressing the management of wastewater discharge would be the reduction of prescriptive regulations for pollutant substances that are non-hazardous. Thus, this is a very effective way as it allows clients to decide on the least-cost way of managing wastewater, whether through avoidance, treatment or abatement. In addition, will in return lower the total cost of waste management. Clients with a low-cost opportunity to conduct on-site waste treatment will get an incentive as a result of introducing a cost-reflective price for wastewater treatment. On the contrary, clients with less on-site opportunities for abatement will be able to more wastewater for effective treatment downstream (Water Services Association of Australia 2008). It is worth noting that one fundamental issue in the determination of load-based pricing feasibility for wastewater is the cost of monitoring and measuring the quality of wastewater. At present, Australian water businesses only conduct a monitoring of the quality of discharges arising from large business waste clients. Thus, the cost of monitoring waste discharges from medium and small-scale wastewater customers is often regarded prohibitive, and this poses a major barrier to further pricing alternatives. The contribution of business waste clients to overall costs of treatment will be effective in evaluating the feasibility of load-based pricing model. For instance, trade waste comprises of a significant percentage of the overall waste collected in places such as Sydney, Adelaide and Melbourne. However, the waste accounts for a little percentage of the overall wastewater collected in the ACT. Further implementation of load-based charging system for wastewater is likely to become feasible in places where trade waste is significant and effective mechanisms for measuring and monitoring water quality can be implemented. It is not surprising that water businesses in areas such as Sydney have started to adopt this pricing technique in some form (National Water Commission 2013). Conclusion Despite government intervention in managing negative externalities in the wastewater management systems in Australia, questions still abound as to whether the current regulation mechanisms are optimal. In most cases, management of externalities is not merely about the choice of policy framework, such as pricing versus regulation; rather, the debate should be about the optimum level of intervention. A demonstration that the intervention measures highlighted above are optimal may be hard due to technical and economic challenges in analyzing and valuing the effect of the above activities on the environment, infrastructure, and third parties. However, one notable thing is that a lot of care is needed in the future selection and implementation of policy frameworks for the management of negative externalities in the wastewater management systems in Australia. It is imperative for government to anchor pricing to negative externalities on an existing regulatory policy that addresses the same problem. It has been noted in the discussion above that duplication of policy instruments has led to efficiency losses in the past and the present regulatory mechanisms. References Ben-David, R 2010, Governance and the water industry. Presented at VicWater 2010 Annual Conference 2 September. Melbourne: Essential Services Commission Brennan, D, Tapsuwan, S & Ingram, G 2007, The welfare costs of outdoor water restrictions. Australian Journal of Agricultural and Resource Economics, 50 (3), 244-260. Daniels, P., Porter, M., Bodsworth, P. & Coleman, S., 2012. Externalities in Sustainable Regional Water Strategies: A Compendium of Externality Impacts and Valuations, Queensland: Griffith University. Grafton, Q & Ward, M 2010, Dynamically efficient urban water policy. Research Papers, Centre for Water Economics, Environment and Policy, ANU Holcombe, R & Sobel, R 2011, Public policy toward pecuniary externalities. Public Finance Review, vol. 29 no. 4, 302-326. Institute of Sustainable Futures 2007, The full spectrum urban water externalities. For the Victorian Smart Water Fund 2007 National Water Commission 2013, Australian water reform 2009: second biennial assessment of the progress on implementation of the National Water Initiative. Canberra: NWC. Laffont, Jean-Jacques, 2008, “Externalities,” in The New Palgrave Dictionary of Economics. London: Palgrave Macmillan). Productivity Commission, 2008. Towards urban water reform: a discussion paper. Melbourne: Productivity Commission. Van Bueren, M & Hatton MacDonald, D 2004. Addressing water-related externalities: issues for consideration. Paper presented at the Water Policy Workshop convened by the Australian Agricultural and Resource Economics Society. Water Services Association of Australia 2008. National wastewater source management guideline. Melbourne: WSSA Read More