Simple vs. Complex: Implications of Lags in Pollution Delivery for Efficient Load Allocation and Design of Water-Quality Trading Programs

By Shortle, James; Abler, David et al. | Agricultural and Resource Economics Review, August 2016 | Go to article overview

Simple vs. Complex: Implications of Lags in Pollution Delivery for Efficient Load Allocation and Design of Water-Quality Trading Programs


Shortle, James, Abler, David, Kaufman, Zach, Zipp, Katherine Y., Agricultural and Resource Economics Review


(ProQuest: ... denotes formulae omitted.)

Water-quality trading is a mechanism that can improve the economic and environmental performance of measures designed to control water pollution. The case for trading is that markets can allocate emissions of pollution from various sources more efficiently than traditional regulatory instruments and allow regulators to achieve pollution targets with less information (Horan and Shortle 2011). However, water-quality trading also poses a number of challenges related to the design of markets that can achieve their theoretical potential (Fisher-Vanden and Olmstead 2013, Horan and Shortle 2011,Shortle 2013). One of those challenges is lag time inherent to water systems between efforts to alleviate or remediate pollution and changes in the quality of the water.

Following textbook models of pollution trading, water-quality markets are typically designed under the assumption that improvement in the ambient environmental water quality achieved by pollution-abatement efforts is fully realized during the period in which abatement is being implemented. Thus, point sources of water pollution have been allowed, under water-quality trading programs, to immediately substitute credits from implementation of agricultural best management practices (BMPs) for reductions in point-source effluent based on the general premise that the pollution reductions are immediate. This assumption greatly simplifies market design but does not validly represent the often-slow response of ambient water quality to reductions in nonpoint pollution.

Markets designed under the assumption of contemporaneous substitution can adequately perform the economic functions of a market (economic efficiency) but will fail to achieve their ecological functions (reducing pollution to achieve water-quality goals) for some period of time related to the length and structure of any lags present. The market ?fix,? in theory, is to allow for trading across potentially lengthy periods and across space. But futures markets for trading commodities over long periods are extremely complex to implement, are expensive to operate, and do not necessarily perform well economically when the commodity is complex (as is the case with water quality) and/or there is significant uncertainty about economic conditions and regulatory environments in the future (Carlton 1984). Consequently, it can be useful to rely on the simplicity of markets designed under the assumption of contemporaneous substitution (i.e., no lags) if the smaller cost associated with the simpler design is significant and the delay in achieving the environmental targets is acceptable.

This research is motivated by a need to understand the implications of lags in the ambient level of agricultural pollution in waterbodies for the efficiency and design ofwater-qualitymarkets.Weare especially interestedincomparingsimplemarket designs based on the assumption of contemporaneous substitution with complex dynamic market designs that facilitate trading across time and space. For this analysis, we compare the outcomes of pollution-control efforts under simple and complex dynamic allocation rules in the context of nutrient pollution in Chesapeake Bay and identify conditions under which the simple allocation rules perform well. We begin with a conceptual model of efficient pollution-control allocations with lags to develop key concepts and the analytical framework used for this study. We then apply the models to control of nitrogen pollution in Chesapeake Bay.

A Model of E ffi cient Pollution Control with Lags

Market-based approaches to pollution control entail direct or indirect exchanges of property rights related to emitting pollution. Fundamental tasks in the design of such markets are (i) defining the tradable commodity to which the property rights apply, (ii) specifying trading rules governing exchanges of the commodity, and (iii) specifying aggregation rules to limit the aggregate supply of the commodity so that the market's allocations of pollution emissions do not violate the overarching environmental goal of the trading program (Horan and Shortle 2011). …

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