quasi-markets and the provision of nature conservation in agri-environmental policy

European Environment, Vol. 6,95-101 (1996)

QUASI-MARKETS AND THE PROVISION OF NATURE

ENVIRONMENTAL POLICY CONSERVATION IN AGRI-

Iain Fraser, Department of Economics and Economic History, Manchester Metropolitan University, Manchester, UK

The development and introduction of the quasi-market approach for the provision of nature conservation is an important moment for agri-environmental policy. The previously inalienable right of farmers to receive financial support has been removed. An example of this approach to policy in the UK is described and analysed, highlighting strengths and weaknesses. The relevance of these findings within the broader EU context for the looming Common Agricultural Policy reforms is discussed.

CCC 0961-0405 / 96 / 030095-07 0 1996 by John Wiley & Sons, Ltd and ERE' Environment.

INTRODUCTION

hroughout the 1980s and 1990s there has been an evolution of UK agri-environmental T policy. There is now a sharper distinction

between policies protecting the rural environment and those which actively encourage additional provision and enhancement. The environmental focus of the latest policy developments is now more to do with the product and not the process. Some of the policies which encourage extra environmental provision can be viewed as applications of the quasi-market principles more generally associated with social policy in the UK (Le Grand, 1991). Employing the terminology used in the context of social policy, we have a purchaser and a provider. For agri-environmental policy we can think of the farmer as the provider and the government or its associated agencies as the purchaser. Via a bidding process the purchaser selects from the potential providers. Contracts are then negotiated and entered into for the provision of the environment. Thus selection means discretion, which gives rise to competition between farmers for the limited available funds. Examples of this type of policy are the Countryside Stewardship Scheme (CSS) and the Hedgerow Incentive Scheme (HIS).

This paper analyses the quasi-market approach to agri-environmental policy with special reference to the CSS. We begin with a brief review of agri- environmental policy in the UK. This is followed by a description of the CSS and economic analyse of the quasi-market approach. Finally, a discussion of these findings within the broader EU context is provided. The relevance of this analysis for the EU arises from the need to reform the Common

EUROPEAN ENVIRONMENT

NATURE CONSERVATION IN AGRI-ENVIRONMENTAL POLICY

Agricultural Policy (CAP) and the rising signifi- cance of environmentally friendly farming as an explicit policy objective.

AGRI-ENVIRONMENTAL POLICY IN THE UK

Since 1945 there has been growing pressure on agriculture to increase productivity by intensification via the adoption of new production technology. This ethos has led to many examples of negative externalities being generated by agriculture (Shoard, 1980). The agricultural sector has resisted attempts to introduce legislation which is restric- tive. Instead it has fostered the idea of voluntary co-operation on the part of farmers, who are characterized as being the custodians of the countryside. This fundamental principle has been re-emphasized in the UK Government’s 1995 White Paper on the countryside, Rural England: a Nation Committed to a Living Countryside (HMSO, 1995). Voluntary co-operation has meant that many policies aimed at environmental protection and enhancement have needed to offer compensation to farmers for altering existing agricultural practices. Thus voluntarism is crucial to the implementation UK agri-environmental policy.

However, even when agri-environmental policy is not voluntary, as is the case with the UK Nitrate Sensitive Areas scheme, it is still necessary to compensate farmers for profit foregone when complying with the specified standards (Frederik- sen, 1994). Unlike the UK, however, other Member States, such as Belgium and the Netherlands, implement the EU Directive relating to nitrate pollution from farms by using taxes to induce compliance under this scheme. Thus as Hodge (1989) explains, the reference point for agricultural externalities in the UK has always emphasized the positive. The polluter pays principle has not been used, which means that the application of taxes on agricultural pollution, for example, has not been feasible.

The evolution of agri-environmental policy in the UK has been gradual. First policy aimed at protecting existing features or ecologically important sites was introduced. It attempted to maintain a sustainable baseline level of environmental quality, preventing the destruction of environmental features brought about by the intensification of agriculture. The most important piece of legislation in this context is the 1981 Wildlife and Countryside Act and the 1985 Amendment Act. This legislation extended the role of Management Agreements to help protect Sites of Special Scientific Interest (SSSIs). Management Agreements are reactive in

nature, protecting SSSIs from threatened agricultural intensification. A negotiated level of compensation for profit foregone is paid to farmers for not intensifying production on the SSSI, but this process has come in for much criticism (Fraser, 1995a).

The next step in the evolution of policy was the maintenance of less intensive, traditional forms of agricultural practice to deter farmers from intensi- fymg production. Policy focused on the agricultural process as opposed to explicit environmental output, but it was now proactive in nature. The most important example of this type of policy is Environmentally Sensitive Areas (ESAs). Environ- mentally Sensitive Areas were launched in 1985 and are operated by MAFF. The authorization for this scheme came from the EC’s New Structures Directive, which was passed by the Council of Ministers to become Article 19 of Council Regu- lation 797/85 on Improving the Efficiency of Agricultural Structures (EC, 1985). This was the first environmental scheme to be financed out of the agricultural budget. In designated ESAs, farmers can chose whether or not to enter the scheme, thus maintaining the voluntary principle. Farmers receive predetermined standard payments in return for agreeing to continue with existing farming practices. This approach to policy simplified the allocation of compensation to farmers, but the potential for over-compensation was large. Since their initial introduction in the UK, ESAs have become the Cornerstone of agri-environmental policy (Whitby, 1994).

Finally, because of the changing nature of farm level support with the widespread introduction of quotas (milk, sheep and cattle), the reduction in support prices and the general acceptance by farmers of environmental objectives, it has become feasible to introduce policies which are environmentally positive and discretionary. The quasi- market approach is a significant development in the operational approach to agri-environmental policy because of its use of discretion. Farmers can no longer expect environmental payments without proving their suitability. Importantly, however, this approach to policy still retains the voluntary principle. Examples of this approach in the UK are the CSS and the HIS.

THE COUNTRYSIDE STEWARDSHIP SCHEME

This CSS was launched in 1991 by the Countryside Commission given their experience at operating the Countryside Premium Scheme (CPS). The CPS was a discretionary bidding scheme introduced to extend the limited environmental aspects of

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Set-Aside policy. As this scheme was deemed to be successful, the discretionary bidding mechanism was employed with the CSS.

The CSS aims to combine landscape, wildlife, historical and access objectives. It was designed to be a comprehensive scheme, to achieve environmental and recreational benefits as an integral part of agricultural support. Anyone managing suitable agricultural land can apply by entering the bidding process by submitting a farm management plan. The scheme is discretionary because the Country- side Commission does not have to accept bids. For example, in 1991 there were 1200 bids made, but only 868 agreements. Thus the fear of rejection should mean that farmers compete more vigorously to enter the scheme. Farmers who are accepted can enter into a ten year management agreement.

Initially the CSS was targeted at five distinct agricultural landscapes, but this has now been increased to seven. It is not confined to specially designated geographical areas as is the case with ESAs. Each landscape type has several tiers of environmental management objectives. The focus is on explicit environmental output produced, as opposed to the production process. This means that it is easier to differentiate between bids. All farmers design their management plan from the menu detailed in the application pack (Countryside Commission, 1991) of options with payments specified. Table 1 gives details of the number of bids accepted into the scheme and the total land area covered to date.

The expenditure on the scheme has risen sub- stantially from €5 million in 1992-3 to nearly €11 million in 199&5 (Countryside Commission, 1995). At the moment the CSS is only a pilot scheme, but recent announcements by MAFF have indicated that this scheme will become fully operational in 1996. Indeed, the government’s recent White Paper (HMSO, 1995) promises to expand the CSS so that it becomes the main land management tool outside ESAs. The funding of the vastly extended role for the CSS is only vague, but expected savings from the CAP reforms are identified as a possible source of finance.

There is an associated scheme in Wales called Tir Cymen. It is similar to the CSS, but there are differences. Most importantly, Tir Cymen is a whole farm scheme. It takes a holistic view of conservation to avoid the possibility of slippage. This is where a

Table 1:

I. FRASER

farm extensifies on a fraction of its land, but over- compensates for loss of production by intensification elsewhere, with the overall effect being a reduction in aggregate environmental quality.

Another agri-environmental scheme which is voluntary and employs discretion, thus encapsulat- ing the quasi-market principles, is the HIS. This scheme began in 1992 and it is also operated by the Countryside Commission in collaboration with other government bodies. The HIS only operates in England. A similar scheme operates in Wales called the Hedgerow Renovation Scheme, but participants of Tir Cymen are not eligible if their farm plan already includes provision and work relating to hedgerows. The HIS offers financial incentives for activities which restore hedgerows and their associated features. Funds in this scheme are targeted at applicants judged in terms of four main criteria. An interesting feature of the HIS is that it includes a degree of cross-compliance in that all hedges on the farm, including those identified, need to be managed correctly. The Countryside Commission accept bids that offer potential for environmental improvement and public benefit. The length of agreements is ten years, with restor- ation to be achieved in the first five years to allow healthy growth thereafter. In 1992 there were 403 agreements under this scheme, covering 672,346 m, and in 1993 471 agreements covering 773,652 m.

Although the quasi-market approach has not been operating very long in the UK, the US Conservation Reserve Programme (CRP) can offer some information about actual operating potential. This CRP was set up and mandated by the US Congress to be an auction which is equivalent to the CSS. Farmers had to submit bids to the government specifying the number of acres and the price per acre desired to remove land from production. If the farmer was successful he or she was then notified. Congress viewed the auction mechanism as a way to give farmers incentives to bid competitively for the right to participate in the scheme. However, the CRP was difficult to implement due to the evalua- tion of bids, so the system became an offer system. The CRP now requires farmers to tender a single price and they can retire as much land as they wish (Smith, 1995). This suggests that the CSS approach to bidding over potential management plans where environmental output is tangible and payments fixed via the menu is superior.

Year Number of agreements Total area (ha) ~

1991 868 31,689 1992 1197 35,079 1993 867 20,700 1994* 1113 14,992

‘Provisional (source: Countryside Commission).

THE COUNTRYSIDE STEWARDSHIP SCHEME: ECONOMIC THEORY AND IMPLEMENTATION

The idea of a market and exchange presupposes the

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existence of property rights and contract law. The institution called a market is any formal or informal construction which enables a meeting of minds and negotiation of the terms of a contract and hence the exchange of property right. In the past this has not been the case for agricultural externalities because of their public good nature, problems of free riding and the existing property right allocation. However, the quasi-market approach has been able to introduce an operating environment which aims to derive the benefits of a conventional market.

The agri-environmental quasi-market mechanism is an explicit set of rules determining resource allocation and costs on the basis of bids from the market participants. It is a non-standard market mechanism used to induce the production and allocation of environmental resources. On the demand side consumer purchasing power is not expressed in money terms; there is a purchasing agency, the Countryside Commission, which has an allocated budget from central government. On the supply side there is competition between the farmers supplying environmental output over quality, not price.

Ideally, like a conventional market, the quasi- market should have many providers and purcha- sers. If there is an insufficient number of providers it is possible that an individual might be able to yield some market control. If this is the case then the quasi-market should allow new providers to enter the market without much relative cost. This also implies that the market allows for ease of exiting. In the case of the CSS there are a large number of farmers who can enter the scheme. These farmers can enter the quasi-market relatively cheaply and it is easy to exit if required. However, there is only one purchaser, the Countryside Commission, but this is not such a problem. Although the Country- side Commission is a monopolist, this position cannot be exploited because it would endanger its working relationship with the farming community, which is important given the voluntary nature of policy.

It is normally the case that the interaction of supply and demand establishes prices which act as a signal for the efficient allocation of scarce resources. However, in the quasi-market the signal which induces co-operation is derived by a process of bidding and contractual negotiation. It is thus not the forma1 interplay of supply and demand. To enter into negotiation the farmer needs to submit a bid. It is possible to view the bidding mechanism either as a tendering process or as an English sealed bid auction. If tendering, then the farmer is effectively offering environmental output which some agency or body will purchase. This is an auction organized by a buyer, who in this

case is the Countryside Commission, with the lowest bid winning in conventional theory. If a sealed bid auction, then the farmer can be viewed as attempting to gain the property right to receive financial reward for producing environmental output. In this case farmers effectively compete via their management plans to obtain the property right to financial support. Under either interpreta- tion the Countryside Commission aims to select those farm plans which offer the highest level of environmental quality. Competition in bidding should stimulate farmers to offer their most environmentally beneficial farm plan to be more certain of winning.

A possible economic justification for employing a quasi-market mechanism is efficiency. A simple way of gauging efficiency is the total cost of provision. Efficiency could simply be the minimization of total costs. This is a crude and simplistic approach. A more sophisticated approach would be to explicitly relate costs to the quality and quantity of management plans bid. Thus value for money should determine efficiency. If this is the case, then the effectiveness of this type of policy mechanism relative to other approaches can be assessed. With the CSS the number of accepted bids has been used as a measure of effectiveness. This measure need not be a good proxy to the successfulness of the scheme. To guarantee an efficient outcome it necessary that the optimum number of bids accepted is when the marginal environmental value of bids entered is equal to zero (Fraser, 199513). However, once the initial round of contracts has been awarded, a locking-in effect can happen - that is, once a farmer is accepted into the scheme the Countryside Commission in the next round of bidding has less good farm plans to select from. This can negate the potential efficiency gains which might be obtained because of the weaker competition in subsequent rounds of bidding.

For the quasi-market to operate efficiently it is necessary that cheap and accurate information is available about the costs and quality of environmental service being provided. The farmer needs to be able to accurately assess the costs of provision. The Countryside Commission needs to be able to select the best management plans and then monitor the quality of output. However, the Countryside Commission faces the problem of asymmetrical information. This asymmetry of information can manifest itself in several ways: intent of the bid; feasibility of the bid (can the farmer actually provide the farm plan offered); and quality of service offered. With regard to the intent of the bid, competition between farmers should minimize this problem. Once a bid has been accepted and a management plan introduced, it is then necessary


that the Countryside Commission introduces a monitoring/auditing process, but this is costly. However, without compliance monitoring the farmer will be able to engage in behaviour which will yield an economic rent because of asymmetrical information.

An example could be where the farmer, in an attempt to save on the costs of provision, provides a level of quality below that agreed in the negotiated contract. There are two types of opportunistic behaviour resulting from asymmetrical information which need to be considered: moral hazard and adverse selection. With moral hazard, the farmer might provide a level of output less than that contracted for. Under adverse selection the farmer has private information about his or her true capabilities of provision, which might relate to costs being inflated. In a truly competitive market the opportunities for this type of behaviour are limited, but in a situation in which negotiation is central to the operation of the quasi-market mechanism this is not so. To be able to control these problems requires a dual approach: care during the bid selection and contractual negotiation process; and clear enforcement procedures thereafter. Another reason for employing monitoring stems from the possibility that in the bidding process ex-post costs of production can be uncer- tain. In this context, if the farmer is risk-averse, then the level of environmental quality offered in the management plan might be overstated. This implies that those farmers who can offer the highest level of environmental quality might not win the bid. Also, if there is no careful monitoring of the scheme there will be incentives for the farmer to ‘quality pad his or her bid, i.e. bid a level of environmental quality in terms of his or her plan and not actually deliver that level in practice.

The quasi-market might not operate efficiently because of the costs incurred by farmers when planning and submitting a bid. Costs are incurred when paid advice is sought for management plan preparation. If these costs are prohibitively high, then this might act as a disincentive to the farmer to bid, even if the potential level of environmental quality is high. With competitive bidding it is assumed that the cost per unit of provision can be lowered by increasing the number of bidders. It can therefore be argued that in the case where output is easily verifiable, the franchising process (which includes the choice of what services should be put out to contract) should be designed to maximize the number of bidders. The minimization of bid preparation costs should assist in this process. It is in the interest of the Countryside Commission to keep the participation costs of bidding to a minimum. By focusing on output not process, and

I. FRASER

by employing a menu approach, the Countryside Commission has produced such a scheme.

The CSS does have eligibility conditions which are effectively a form of discrimination. This can be interpreted as introducing a reservation quality level of environmental output. The problem with employing any form of discrimination is that there is no guarantee that the highest potential bidder will win. However, an open policy of discrimination can be justified if it aims to force the bidders to actually increase their bid in an attempt to win. Positive discrimination as practised by the Country- side Commission in terms of the CSS does allow it to target its limited funds more effectively.

A criticism of many of the existing agri- environmental policies has been that they produce a fragmented environmental landscape. However, joint bids have been openly accepted into the CSS. Such bids can link spatially isolated parcels of land, thus promoting the idea of connectivity, which, via wildlife corridors, provides enhanced environmental benefits. In addition, joint bids might mean that farmers who have been reticent in the past about joining agri-environmental schemes do so now. However, despite the benefits of the quasi-market

approach we should not overlook the problems which exist with the implementation and operation of this type of policy. Indeed, the claimed success by the Countryside Commission of the CSS can be doubted to a certain extent by contradictory evidence from the Ramblers Association (Kempe, 1993). It was found that many of the claims made about access were exaggerated and problems varied from difficulty in identifymg sites entered into the CSS to obstructed footpaths. This raises an interesting point about monitoring policy implementation. If it is known that a farmer is participating in a scheme and that output such as hedges, trees or footpaths are part of the management plan, there could be a role for the general public in helping to monitor the scheme.

Furthermore, the combining of environmental output and rural amenity use could give rise to a theme park mentality and a lack of sound ecological reasoning behind agri-environmental policy moti- vation. To avoid this there is a need to be careful not to confuse the objectives of sustainability and ecological diversity with recreation and amenity value. With the CSS much is made of the access to agricultural land, but there is nothing inherently environmentally beneficial about this requirement. Interestingly, there is also an implicit recognition in this policy for paying farmers for access to their land, a contentious issue, which has been at the heart of the environmental/ farming dispute for years.



DISCUSSION

The term quasi-market has been used to describe discretionary agri-environmental policy because the resource allocation mechanism employs market principles. The introduction of discretionary based bidding schemes as a means to employ competition in the allocation of scarce resources is an important development in the evolution of agri-environmental policy. It marks a clear change in policy: farmers are no longer guaranteed financial support. The previously inalienable right to unquestioned financial support for environmental provision has been removed. Furthermore, the use of a bidding mechanism to implement discretion goes some way towards overcoming the problem of asymmetrical information, which has been a problem for agri- environmental policy.

The type of environmental provision required does determine to a certain extent the type of resource allocation mechanism which can be employed. In this context, defined and identifiable environmental output, as opposed to the farming process, ensures that the application of a bidding scheme is feasible. Thus although the introduction of a bidding scheme might seem attractive on the grounds of efficiency, this will only be true for correctly identified policy objectives. Therefore it is envisaged that this type of mechanism remains only one of several which will be employed in agri- environmental policy.

Finally, within the broader EU context, it is interesting to consider the findings of our analysis. These might be important if this type of mechanism was to be implemented by individual Member States or at the EU level in the near future. At present there are growing pressures in the EU to reassess agricultural policy and, in particular, agri- environmental policy. This situation arises because of the unrelenting pressures which the CAP faces and the likely reforms which are going to be necessary within the next 10-15 years. The need to adapt the CAP relates to new objectives, such as enlargement to the east, international trading requirements brought about by the GATT agreement and the increasing pressure from the urban majority for more environmentally friendly agriculture. Within this context new and alternative approaches to policy will be sought. In general, it is assumed that there will be a withdrawal of direct support for farmers and that agri-environmental policies will continue to grow in importance. The need to reduce direct support payments emanates from international trade and the objective of reducing distortion to the system. However, it is accepted that without the necessary incentives for farmers it will not be feasible to sustain acceptable

countryside management practices. Therefore there will be a need to devise a system of environmental payments that is decoupled from agricultural production and which satisfies international trade agreements.

A CSS type discretionary bidding mechanism could be part of the potential solution in this context. With the payment to farmers explicitly defined for agri-environmental output, Member States or the EU would be able to argue that there is a clear decoupling of environmental from agricultural objectives. The simplest and most trans- parent way in which to achieve decoupling would be to focus policy on environmental output and not simply process restrictions. The use of discretion in policy implementation would make it clear to the external monitors of international trade practices, such as GATT, that payments only go to those farmers who provide a satisfactory level of environmental quality. Finally, if policy relied on voluntary participation only, those farmers who could satisfy the environmental criteria would apply. These key characteristics of discretion, product and voluntary participation would help to ensure that this type of policy would be cost- effective.

This approach to policy design might appeal to Denmark and the Netherlands, for example. Both countries have always been keen to encourage sustainable land management, but without necessarily viewing agricultural policy as a means to supplement the income of farmers. Alter- natively, France and Germany have always employed the CAP to support existing rural populations and the use of discretion might not be compatible with their objectives of agricultural policy. Therefore it is likely that those Member States who pursue a more free market approach to agriculture production might be attracted to the potential of an agri-environmental discretionary bidding system.

REFERENCES

Countryside Commission (1991) Application Pack for the Countryside Stewardship, CCP 345, Countryside Com- mission, Cheltenham.

Countryside Commission (1995) Quality of Countryside: Quality of Lqe, CCP 470, Countryside Commission, Cheltenham.

EC (1985) EC Regulation 797/85 (Structures Regulation), OfficiaZJournal of the European Communities, L93/10-193/ 11.

Fraser, I.M. (1995a) An analysis of management agreement bargaining under asymmetric information, Jour- nal of Agricultural Economics, 46, 20-32.

Fraser, I.M. (1995b) The Countryside Stewardship Scheme and Auction Theory, Mimeo, Manchester Metropolitan Uni- versity, Manchester.


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Frederiksen, B.S. (1994) National responses to the EC nitrate policy, Journal of Environmental Planning and Management, 38,253-263.

HMSO (1995) Rural England: a Nation Committed to a Living Countryside, Command Paper 3016.

Hodge, I. (1989) Compensation for nature conservation, Environment and Planning A, 21,1027-1036.

Kempe, P. (1993) Countryside Stewardship Scheme: Survey by the Rambler's Association of Public Access Sites, Ramblers Association, London.

Le Grand, J. (1991) Quasi-markets and social policy, Economic Journal, 101,1256-1267.

Shoard, M. (1980) The Theft of the Countryside, Temple/ Smith, London.

Smith, R.B.W. (1995) The conservation reserve program as a least-cost land retirement mechanism, American Journal ofAgricultura1 Economics, 77, 93-105.

Whitby, M. (Ed.) (1994) Incentives for Count yside Manage- ment: the Case of Environmentally Sensitive Areas, CAB International, Wallingford.


quasi-markets and the provision of nature conservation in agri-environmental policy

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