AnalysisDesigning watershed programs to pay farmers for water quality services: Case studies of Munich and New York City☆
Highlights
► We compare approaches for nonpoint source water pollution in New York and Munich. ► We identify factors affecting transaction costs of contracting for ecosystem services. ► Using existing institutions, such as organic certification, reduces transaction costs. ► Homogeneous agents and a monopsony structure can decrease transaction costs.
Introduction
Preserving and restoring water quality is a major concern in numerous countries. The success of regulations in reducing pollution from point sources1 has led to an increased focus on nonpoint, unregulated, sources of pollution such as agriculture, which may have lower abatement costs. Point–nonpoint source trading has been enabled by legislation in several places in the U.S. as a way to reduce abatement costs but there has been less trading than expected due to issues such as transaction costs (Fang et al., 2005). Contractual arrangements and payments for water quality services from municipal water organizations to nonpoint sources represent a similar policy instrument. The current study uses a transaction cost framework in conjunction with detailed case studies of two water quality payment schemes (i.e., Munich and New York City) to examine the factors that increase and decrease transaction costs in order to improve policy choice as well as policy design and implementation. Rather than just admitting that high transaction costs can prevent contractual arrangements as emphasized by Coase (1960), we devote attention to factors explaining the level of transaction costs and strategies employed to shape them (Anderson and Libecap, 2005, Déprés et al., 2008, Libecap, 1989).
The water supply of Munich, Germany, with a population of 1.2 million, is mainly from the Mangfall Valley. The water supply for New York City, with a population of over 9 million people, comes from the Catskill Mountains and the headwaters of the Delaware River. In both cities, decreasing water quality in the 1980s meant that expensive water filtration systems would need to be installed ($6 billion in the case of New York City), or that land management changes would need to occur in the watersheds. In both cases, agreements with farmers to change land management practices resolved the water quality problems, however the two cases differed in a number of ways. Using these two detailed cases, we examine the factors that influenced the level of transaction costs, the nature of the transaction costs that are likely to affect the potential for exchange, and the opportunities for greater reliance on voluntary contractual solutions.2 Transaction costs arise throughout the process of an exchange transaction, even if it ultimately does not occur. From an operational viewpoint, these costs notably include the costs of defining, enforcing and exchanging property rights (Dahlman, 1979, McCann et al., 2005). Under some circumstances, they may be high enough to prevent voluntary exchanges (Coase, 1960).
The contributions of this paper are at least threefold. First, it adds empirical content to basic transaction cost concepts by analyzing the design and implementation of real contractual arrangements for nonpoint source pollution in a multi-player setting. Second, our comparative analysis of Munich and New York indicates how specific transaction costs were modified to enable efficiency gains and successful arrangements. Third, it uses the case studies to develop recommendations regarding the design of similar contractual solutions to water quality issues. While our analysis is focused on water quality, it has applicability to other complex environmental and natural resource issues where both physical location and the specific institutional environment are important.
The remainder of the paper is organized as follows. 2 Transaction Cost Issues in Munich, 3 Transaction Cost Issues in New York City provide historical background and context, analyze the transaction cost issues in each city, and show how various issues were overcome leading to satisfactory arrangements.3 The final section provides an overall assessment of arrangements, draws some generalizable lessons and policy implications, and then concludes.
Section snippets
Transaction Cost Issues in Munich
Munich is the third largest city in Germany with about 1.2 million inhabitants. For more than 125 years, Munich drinking water was extracted mainly from springs in the foothills of the Bavarian Alps, namely the Mangfall Valley. This valley, located 40 km from the city of Munich, supplies around 80% of the tap water consumed in Munich, that is, about 90 million m3 per year (SVM, 2008). The land in the catchment areas is mainly used for farming or forestry. Interestingly, since the end of the
Transaction Cost Issues in New York City
New York City is the largest city in the United States, with about 9 million inhabitants, and consumes almost 5 million m3 of water per day.6 The New York City watershed consists of 518,000 ha in the Catskill Mountains and Hudson Valley regions. The portion west of the Hudson River is located 120–200 km north of New York City (
Some Lessons from the Munich and New York City Strategies to Cope with Non-point Source Pollution
The previous two sections on the historical background of water supplies in Munich and New York City show that the two cities were benefiting for free from natural filtration services for many years. They eventually noticed a deterioration in their water quality and made the connection to watershed activities, notably intensive farming, and were forced to act. Previously, these two groups of agents, farmers and water suppliers, were using the same environmental assets for different purposes
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Acknowledgements: We are particularly grateful to Naoufel Mzoughi, Christophe Déprés and participants at the workshop ‘A Primer in Economic Analysis of Soil-Related Ecosystem Services (Montpellier, November, 18, 2010) for many helpful comments and suggestions. We also benefited from comments at the World Congress of Social Economics meetings (Montreal, June 28–July 1, 2010). We are particularly indebted to two anonymous referees and the editor of Ecological Economics for suggestions that greatly improved the paper. We are also grateful to the French research program GESSOL sponsored by the Ministère de l'Ecologie, du Développement durable, des Transports et du Logement, the Agency for the Environment and Energy Management (ADEME), the EU Fellows Program at the University of Missouri, and the Missouri Agricultural Experiment Station for financial support. The usual disclaimer applies.