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The Link Between Agricultural Subsidies and Water Quality Outcomes

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Journal

Authors: Palm-Forster, L.; Suter, J. and Messer, K

Journal: Experimental Evidence on Policy Approaches That Link Agricultural Subsidies to Water Quality Outcomes

Reviewers

Dr. Carson Reeling, Assistant Professor, and Natalie Loduca, Graduate Student

Summary

Financial incentives and conservation compliance policies are widely used to provide agricultural producers with incentives to reduce agricultural nonpoint source (NPS) water pollution—or the nutrient, sediment and chemical pollution that runs off farmland into surface waters. For example, conservation programs like EQIP and the Conservation Reserve Program offer cost-shares or rental payments for farmers who employ certain conservation practices on their lands.

A challenge for managing NPS pollution is that many producers contribute simultaneously to runoff, and reducing pollution from a single farm may not have a large effect on overall water quality. For this reason, academic economists have long been interested in so-called “ambient” pollution control strategies that tie individual farmers’ conservation incentives—like cost-share payments—to watershed-scale NPS pollution levels. This article uses economic experiments to explore farmer incentives for adopting conservation practices under different ambient policy instruments including (i) an ambient tax on pollution, (ii) an ambient subsidy for conservation practice implementation that gets smaller the greater the watershed-wide pollution and (iii) a subsidy that pays farmers who adopt a threshold level of conservation practices a constant amount regardless of watershed-wide pollution levels.

The experimental results show that the first two policy instruments result in similar conservation levels among farmers. However, farmers are most likely to conserve under the third policy instrument. This instrument is financially “safer” for farmers since their subsidy payments depend only on their own conservation behavior.

What this means for Food and Agricultural Business

Reducing nutrient runoff is an important issue facing agricultural producers and their suppliers, especially in the Midwest. Concerns about water quality in Lake Erie, the Gulf of Mexico and elsewhere have already led to controversial regulatory crackdowns on farmers in Ohio and have increased policy-makers’ interest in alternative strategies for managing runoff from agricultural lands. Indiana recently instituted its own Nutrient Reduction Strategy following the U.S. EPA Hypoxia Task Force’s recommendations to decrease nutrient runoff from agricultural lands to the Gulf of Mexico by 20 percent by 2025. The effects of environmental regulations will not only affect farmers, but have the potential to impact firms all along the supply chain by, for example, reducing demand for farm inputs like synthetic fertilizers or driving up farm output costs. Understanding farmers’ conservation decisions may generate insights that spur environmental improvement, helping agribusinesses avoid the worst consequences of regulation.

To this end, one implication arising immediately from the paper’s findings is that straightforward, guaranteed financial incentives may induce greater conservation. The ambient subsidies the authors examine lead to uncertainties: farmers’ payoffs under these subsidies depend on watershed-wide pollution levels and, as a result, on their neighboring farmers’ conservation choices. This creates a “monkey see, monkey do” situation for participants in the study. Those who expect their neighbors to conserve—generating lower pollution levels—could anticipate receiving a larger subsidy for conservation and therefore are more likely to conserve themselves. Those who do not expect their neighbors to conserve could anticipate receiving a smaller subsidy and are less likely to conserve themselves. In either case, participants’ expectations about their neighbors’ choices drive their behavior. In contrast, the subsidy that pays conservationist farmers a fixed subsidy regardless of ambient pollution levels—and hence independent of their neighbors’ conservation choices—severs as the link between participants’ expectations of their neighbors’ behavior and their payoff. When participants have greater financial control over their conservation, their incentives to conserve go up as well. To the extent that agribusinesses can underwrite farmers’ conservation choices by offering conservation incentives that do not depend on group-level outcomes, then conservation levels should rise.

There are many ways agribusiness can support and benefit from farm-level conservation behavior. Price premiums for sustainably-produced food products provides one obvious example. But new pollution control strategies currently being discussed by federal regulators present unique opportunities for influencing conservation outcomes. In particular, a February 2019 memo from the U.S. EPA reaffirmed support and relaxed standards for implementing so-called “water quality trading markets.” Under these markets, allowable emissions of nutrient pollution at the watershed level would be capped at some amount. Pollution permits would be issued to regulated pollution sources—mostly wastewater treatment plants and large industrial sources—in accordance with this cap, with each permit giving the permit holder the right to emit a given quantity of pollution. Regulated polluters must reduce any amount of pollution not covered by their permit holdings or buy additional permits from other polluters. Agricultural sources of nutrient pollution are not usually regulated and hence are not bound by the pollution cap. However, these producers may participate in water quality markets voluntarily. By adopting conservation practices that reduce nutrient pollution, farmers can generate and sell “offsets” to regulated polluters to help them comply with the cap. Therefore, water quality markets may provide revenues to incentivize farm-level conservation, reducing the need for expensive and questionably-effective government conservation subsidy programs.

Water quality trading markets have been implemented in several places throughout the U.S. over the past three decades. Few have been successful in managing nutrient pollution, largely due to a lack of participation by farmers. Many academics blame the high costs of quantifying and verifying farm-level pollution reductions. Selling offsets usually means regulated polluters have to go out and find farmers with which to trade, leading to expensive search and contracting costs. The U.S. EPA’s memo on water quality trading addresses these obstacles to trading by supporting more flexible approaches for quantifying farmers’ pollution abatement from conservation practices, making it easier and cheaper to calculate and verify it. These approaches include the use of computer-based models for predicting the effects of farm-level conservation activities on pollution levels.

This increased flexibility presents a unique opportunity for agribusinesses. Some firms like Land O’Lakes’ SUSTAIN enterprise have developed sophisticated tools for quantifying the environmental effects of agricultural production practices at large scale. These firms are already well-positioned to offer offset calculation and verification services to farmers. However, the explosion in farm-level data means other firms can, and likely will, be able to offer competing services in the near future.

Agribusinesses can also serve as a source of support and guidance for conservation compliance and can help coordinate trades, further reducing the information and transaction costs from trading. A recent study by researchers at Purdue and elsewhere finds that ag retailers are a highly trusted source of information about conservation for farmers. These retailers are likely to also have vast customer networks that can be exploited to match offset buyers with offset sellers—for a cut of the gains from offset sales, of course.

Understanding farmer conservation behavior under various policy incentives is important to agribusinesses given the current regulatory environment. Underwriting farmers’ conservation activities through incentives allows them to take greater control of their own financial outcomes and can lead to greater conservation. The ability to offer services to support conservation activities and take advantage of sustainably-produced outputs presents a unique opportunity to agribusinesses to help farmers comply with environmental regulation and exploit market opportunities for sustainable products.