Emissions policy clouded by the hot air of self-interest

Once again we hear Federated Farmers bleating about thepotential burden placed on them by an Emissions Trading Scheme (ETS),proclaiming that farmers are doing all they can to reduce greenhouse gas emissions.  Hence any carbon charge on agriculture would be pointless.   Rubbish.

A price on carbon has two main effects on an industry.Firstly It provides an incentive for producers to change the way they dobusiness – using less carbon intensive inputs, adopting new productionprocesses and so on. Secondly, and to the extent that the aforementionedactions do not negate the costs of the carbon charge, it eventually leads to anincrease in output prices.   This price change is what prompts consumers to changethe mix of goods and services that they buy   – again away from carbon intensivegoods.

The claim by Federated Farmers seems to deal with only thefirst effect.   Is it plausible?   Farmers, like the rest of us, behave inaccordance with personal preferences and market prices.   If prices change, sodoes behaviour, even if it takes some time to see measurable impacts. One ofthe reasons that New Zealand agriculture is efficient is that it responds tomarket prices.   To argue that farmers can’t or won’t react to a carbon price isan insult to most farmers.

The second effect, that of higher prices causing a reductionin demand, is of course precisely what a carbon charge is intended to do.   Arguingthat agriculture should not be part of this mechanism has as much merit asarguing that it should not pay ACC premiums linked to its accident rate, orthat it should not face fines for polluting waterways.

In agriculture there is actually a third, probably dominantway that a carbon charge has an effect: namely the effect on the price of land.  The price of land equals the discounted value of expected farm profits afterall other costs have been paid.   So, to the extent that higher costs cannot bepassed on in the form of higher output prices, agricultural land values willfall.   Seem familiar?   The same thing happened when Supplementary MinimumPrices were abolished in the mid 1980s.   Did agricultural production collapse?Certainly not.

Faced with lower land prices some farmers may be forced tosell. Arguably there might be a case for compensation in those cases, but a newpurchaser will buy the land at a lower price and in most cases continue to farmit as profitably as before.   There will be some instances where land use willchange, for example from agriculture to forestry, but again this is preciselythe desired effect of a carbon charge; to move resources (in this case land)from more carbon intensive activities to less carbon intensive activities   –  even better if the new use is carbon absorptive activities such as forestry.

So even if individual farmers are doing all they can toreduce greenhouse gas emissions and won’t be persuaded by a carbon charge to doother things (which seems a dubious claim), given New Zealand’s Kyotocommitment, the agriculture sector as a whole is probably somewhat too large inthe following sense: Reducing the country’s carbon emissions involves somecost, but in the long run our standard of living will be less negativelyaffected if agriculture is fully included in the ETS and land use is allowed torespond to relative price signals, than if agriculture is exempt from the ETS.

Having made that general point, our own research shows that thereis merit in provisional assistance to various industries, includingagriculture, in order to allow time for new technologies that reduce emissionsto be developed.   However, this is not an argument for exemption from an ETS, noreven for delayed entry.   It is an argument for some temporary allocation offree emission rights.   Agriculture, like other industries, should face thecorrect price incentives to reduce emissions.    

It is pleasing to see therefore that the changes to the ETSannounced by the government earlier in the week don’t exempt agriculture, althoughthe entry date on January 2015 seems on the generous side. More puzzling is thevery slow phase out of industry support – all the way to 2050.   This is such along horizon that, quite apart from the fact that it can hardly be consideredtransitional, has almost no credibility.   No one in industry or agriculture isgoing to believe that future governments will be tied to such a policy for sucha long time.   I cannot think of an analogous situation.   It would have beenmuch better to plan for a phase out over a decade or so, with a broader base ofpolitical support.   The self-interested myopic hot air from some in theagricultural sector has fortunately been given little credence.   Let’s hopethat those advocating a phase out of assistance to 2050 ultimately receive thesame reaction.

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