An experimental approach to assessment of trading and allocation mechanisms for nutrient trading

Regional councils throughout New Zealand are in the process of drawing up plans to enable them to meet the requirements of the Resource Management Act and the National Policy Statement on freshwater. Some councils are working on targets for nutrient leaching at the catchment level and are considering alternative approaches to ensuring these targets are achieved. In this paper we investigate the farm level effects of agricultural policies by employing the methods of experimental economics to investigate alternative mechanisms for farm and catchment level regulations aimed at improving water quality. Results are presented for four cap and trade system designs in order to assess the effect of alternative approaches to allocation of nutrient discharge allowances and rules governing trade or exchange of these allowances. The objective of this study is to assess the utility of cap and trade systems through experimental economics, with a focus on the efficiency and equity of these mechanisms. Cap and trade systems are promoted as one of the major achievements of environmental economics. However, the move from theory to field implementation is a difficult transition, particularly due to the prevalence of uncertainty and the bounded cognitive ability of real agents. Data from the experiments enables comparison of the results of nutrient trading with the outcomes that would be expected based on economic theory. This assessment of the relative performance of cap and trade systems highlights important findings for environmental regulation. First, catchment profit is around 10% lower than predicted by theory. Second, the distribution of profit among farmers has little in common with that predicted by theory. Third, the trading behaviour of farmers bears little resemblance to theoretical predictions. Overall, these findings highlight the need to carefully assess the efficiency, equity and overall benefits of cap and trade systems for environmental regulation