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Trading Efficiency in Water Quality Trading Markets: An Assessment of Trade-Offs

Author

Listed:
  • Hugh McDonald

    () (Motu Economic and Public Policy Research)

  • Suzi Kerr

    () (Motu Economic and Public Policy Research)

Abstract

Declining water quality as a result of increased nutrient leaching is a serious and growing concern, both internationally and in New Zealand. Water pollution issues have traditionally been addressed with command-and-control type regulation, but market-based nutrient trading schemes are becoming more widespread. In New Zealand, a cap-and-trade system has been implemented in Lake Taupo and another has been designed for Lake Rotorua. Despite the importance placed on avoiding transaction costs in water quality trading markets, there has been little discussion in the literature of practical policies to decrease these transaction costs, or any real assessment of when it is and is not optimal to decrease transaction costs. This paper begins to address these issues. We find that strong efforts to control time-of-trade transaction costs are most likely to be worthwhile in schemes with heterogeneous participants and large expected values and volumes of trading. The trading inefficiency that results from search and bargaining, and trade registration costs can be minimised at some cost. Regulators can reduce trade approval costs if they establish baseline leaching levels for all participants and design standardised leaching monitoring systems as part of the set-up of the system, and monitor all sources equally regardless of whether participants trade instead of estimating and approving changes in traders’ leaching at the time of each trade (as occurs in a baseline-and-credit system). Finally we find that while regulators may be tempted to restrict trading or increase measuring and monitoring requirements to increase the environmental certainty of a scheme’s outcome, environmental risk may be better addressed through a less certain but more stringent environmental target.

Suggested Citation

  • Hugh McDonald & Suzi Kerr, 2011. "Trading Efficiency in Water Quality Trading Markets: An Assessment of Trade-Offs," Working Papers 11_15, Motu Economic and Public Policy Research.
  • Handle: RePEc:mtu:wpaper:11_15
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    File URL: http://motu-www.motu.org.nz/wpapers/11_15.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    water quality markets; transaction costs; nutrient trading markets; trading ratios;

    JEL classification:

    • Q53 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Air Pollution; Water Pollution; Noise; Hazardous Waste; Solid Waste; Recycling
    • Q15 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Land Ownership and Tenure; Land Reform; Land Use; Irrigation; Agriculture and Environment
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights

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