Externalities and Canadian policy: would you pay for something others benefit from?

Driving through Canada’s countryside at this time of the year, it is not hard to miss farmers finishing up fall harvesting before the snow flies. We don’t usually think much about the risks and uncertainties they face as they work to produce high quality, safe food for Canadians and the world.?

Clearly, Canadian farmers and ranchers face risks that most of us would shrink at- from extreme weather events, hail and drought that can make or break a season’s bottom line, to volatile commodity markets and exchange rates and interest payments on debt, the impact of war and trade disputes, labour shortages, as well as the million-dollar investments on farm machinery and land required to remain competitive. It makes one wonder how they can sleep at night! Recent focus on programs that address farmers’ mental health issues by? Farm Management Canada and other organizations are testimony to the difficulties they face.????

On top of all this, farmers and ranchers are constantly reminded of how detrimental their production decisions are for the environment. Social media headlines tout how harmful methane emissions are from their cattle, how nitrogen from manure and fertilizer is leaching into waterways and the air, and how much soil is being degraded through their tillage practices and cropping decisions.?

However, many farmers would argue they are already committed to being stewards of the land, understanding more than many the impact bad agricultural practices have on the future sustainability of their farmland. They naturally want to ensure there will be a future for their children and grandchildren.??

To some degree, Canadian farmers have already made significant progress toward addressing the impact of agriculture on the environment, from improving soil health, storing carbon, reducing GHG emissions from livestock, protecting water bodies from nitrogen run-off and preserving wildlife habitat. CAPI analysis in a recent Quick Think report (Poirier 2022) based on data from the 2021 Census of Agriculture, confirmed some progress.? However, we know there is still work to be done.???

But to what extent are we measuring these impacts accurately? And once measured, how do we ensure they are valued or priced correctly so they will be taken account in farmers’ decision-making, or rewarded in markets through price premiums from consumers???

This is where “externalities” come in, understanding what they are, how to value them and how to ensure they are “internalized” in farmers’ production decisions, with sufficient rewards from consumers and markets willing to pay for them???

To help investigate these issues, CAPI held workshops and produced a series of reports touching on “externalities” that were summarized in a recently published Quick Think report. This was followed by an insightful discussion in CAPI’s recent webinar with sector experts.????

But what are “externalities”? “Externalities” occur when societal costs or benefits arising from an individual farmer’s production decisions are not priced through the normal market mechanism and hence are not factored into their decision making. Impacts of agriculture on air or water pollution are perfect examples of “externalities”. Because there is no explicit price or cost to the farmer associated with them - and it is hard to nail down which farm actually produced that pollution- externalities will be over produced unless they are “internalized”. This requires price discovery so they will be taken into account in decisions.??

Similarly, non-market benefits from agricultural production, such as rural landscape aesthetics or wildlife habitat, (also known as ecological goods and services” (EG&S)), are not priced through markets either and hence tend to be under produced.? It only makes sense that farmers, who are concerned about their bottom line, will only take account of the costs they see when making decisions. After all, would you pay for something that others benefit from??

Without being able to value those impacts which markets are extremely efficient at doing, this becomes a “market failure”. In the economic literature, this is justification for government intervention, especially if the benefits from that intervention exceed their costs.?

CAPI research by Skolrud et. al (2020) estimated the value of these net externalities (both negative and positive) at -$4.3 billion in 2011. This was a slight improvement over the – $5 B in 2006 and -$4.7 in 1996. This resulted from negative externalities valued at -$8 B and positive externalities of $4 B in 2011.??

However, it is not easy to estimate the value of externalities, given the complexity of agricultural ecosystems, uncertainty, and missing data and research that accurately measures the physical and monetary value associated with agri-environmental impacts. Luckily more resources have been put into improving data and research on agri-environmental issues over the past twenty years, with increasing science analyzing the value of EG&S from agriculture.? We have come a long way baby.??

Clearly, this improvement over time is the result of efforts made by Canadian farmers and ranchers to improve their environmental record through the adoption of new technologies (e.g. GPS, remote sensing) and more sustainable beneficial management practices (BMPs) that had positive impacts on soil health, carbon sequestration and GHG emissions. If these practices helped them reduce costs, this was a even better (e.g. no-till)!?

But Canadian farmers have had some help along the way with federal and provincial government programs and private sector initiatives focused on addressing the impact of agriculture on the environment. Government spending on public science research, information, extension and subsidies in addition to regulations, taxes and zoning have motivated farmers and ranchers to change production practices to improve environmental outcomes.? Provincial nutrient management legislation, Environmental Farm Plans, carbon offset programs as well as private sector voluntary initiatives, such as soil and water conservation societies, Ducks Unlimited (DUC) and local Alternative Land Use (ALUS) programs. These have all worked to help farmers “internalize” externalities. Clearly, if farmers are involved providing input into these initiatives, the extent to which externalities are “internalized” will be even greater!?

Other ways to “internalize” externalities is to develop markets for such things as carbon offsets, something still in the early stages in Canada. Also, when companies require input suppliers to meet sustainability standards to respond to consumer and buyer demands and for ESG purposes, this helps reward farmers for their sustainable production practices, thereby internalizing externalities.??

Recent programs such as the On farm Climate Action have boosted funding to help reward farmers who adopt sustainable BMPS with what is considered a “carrot” rather than a “stick” approach. The signing by FPT Ministers of the five-year (2023-2028) Sustainable Canadian Agricultural Partnership (SCAP) agreement last July and prospects for a Green Agricultural Plan, signal a new era of government commitment to enhancing the sustainability, resilience and competitiveness of the Canadian agriculture and agri-food sector- a sign of optimism.??

The path will not be easy however. There will have to be some difficult choices and trade-offs made. So for example, governments may need to consider how the full suite of agricultural programs? are working? together to deliver the environmental outcomes desired to improve policy coherence. However, this will require programs that are designed and delivered effectively and efficiently with good value for money. By valuing externalities with good science, data, and analysis is one way we can ensure that governments? have the means to do this.??