2022, Volume 25, Paper 5
ISSN: 2209-6612

Nitrogen for Better or Worse: Issues in Estimating the Benefits and Costs of using Nitrogen Fertilisers

Bill Malcolm, Garry Griffith, Alex Sinnett, Paul Deane and Chinthani Rathnayake
School of Agriculture and Food, Faculty of Veterinary and Agricultural Sciences, University of Melbourne, Parkville.

EXTENDED ABSTRACT/ OVERVIEW

The private benefits of using nitrogen fertiliser for agricultural and horticultural production are large; so too are the social costs from the losses of nitrogen in various forms to the surrounding environment. Emissions from nitrogen fertiliser contribute to global warming and adversely affect air quality and human health and pollute groundwater and surface water. If less of the nitrogen fertilizer used in agricultural and horticultural production went into creating negative externalities for society, and more of it went into creating output with positive private value, further net benefits would result for producers, consumers and society. Nitrogen fertilisers that are less prone to leakage from their agricultural purpose would assist in making this change for the good. Fewer agricultural policies such as subsidies that encourage increased use of nitrogen in agriculture and horticulture and more policy designed to ensure beneficiaries of the use of nitrogen in agriculture and horticulture pay the true social cost the emissions from nitrogen fertilizer are causing, would help too.

The primary purpose of this paper is to review fundamental economic ways of thinking about estimating the private and social benefits and costs of using nitrogen to produce agricultural and horticultural crops. Such a review will identify the types of information required to design and implement policy to promote the socially optimum use of nitrogen fertilisers and to reduce the social costs caused by current farm practices. This review is partitioned into five main parts. Depending on their interests, readers may choose to focus on just one or a few of the parts, rather than the complete document.

In Part 1, The ARC Research Hub for Innovative Nitrogen Fertilisers and Inhibitors is introduced. This Hub has the objective of enhancing the efficiency of nitrogen fertilizers in production processes and assessing the prospective improvements that might flow from innovative nitrogen fertilisers with less negative externalities than traditional nitrogen fertilisers. The agricultural economists associated with the project have the task of analysing the social costs of using traditional nitrogen fertilisers and the social benefits and costs that might be achievable with innovative nitrogen fertilizers for agricultural and horticultural production. As is often the case, the project economists and the scientists working together on these questions bring different disciplinary expertise and knowledge to bear on the issues. Science and economics have different ways of seeing the issues and the possible solutions. Elements of these differences in approach are introduced in the background section of Part 1. This is followed by a short introduction to the use of nitrogen in agricultural and horticultural production, and a high-level overview of the different methods available to tackle the task of estimating the social costs and benefits of nitrogen use.

In Part 2, a snapshot of some estimates of social costs of using nitrogen fertilizer in agricultural and horticultural production is provided. The conclusion of this part is that a considerable literature exists in which can be found key technical data about pollution from nitrogen used in agriculture that could inform and guide benefit cost analyses of pollution from nitrogen used in agriculture and horticulture in Australia. To answer questions involving economics, empirical technical data needs to be analysed in a framework built on a solid foundation of economic theory, as alluded to in the discussion in Part 1.

This leads to Parts 3 and 4, which outline accepted economic principles and methods of analysis for estimating costs and benefits of activities on the farm, and beyond the farm gate, respectively. The conclusion from Part 3 is that when considering a change to an input to a farm system such as nitrogen applied to crops or pastures, it is necessary to consider the changed response functions and the changed costs of the different inputs, along with associated ‘whole system’ changes. The concept of the ‘rotation-hectare’ is introduced. If a crop is grown in a rotation, then the whole of rotation emissions with and without that crop component of the rotation is the relevant measure. Then, even assuming the product quality and price remained unchanged, the new optimum use of the new input has to be estimated to draw conclusions about the implications of the change for the farm system and the wider economy and environment. What else might farmers change? If the price of an input increases or its productivity declines relative to alternative inputs, farmers substitute relatively cheaper or more productive inputs for the relatively more expensive and less productive inputs. A whole-of-system understanding is needed, as well as a clear understanding of the concept of the ‘counterfactual’.

In Part 4, the method for a social benefit cost analysis is outlined and discussed. A key point is that a social benefit cost analysis includes all benefits and costs, whether or not they have a market price. The estimate of net social benefit includes all the marginal (or additional) private benefits and costs resulting from the proposed change, as well as all the marginal (or additional) social benefits and costs. This includes social benefits and costs that do not have market values, as often is the case with negative externalities. In the context of applying nitrogen fertilizers, social costs derive from the emissions contributing to global warming and adversely affecting air quality and human health and pollution of groundwater and surface water. Methods for estimating these costs and benefits are set out. The dynamic systems nature of costs and benefits over time is crucial in such analyses, involving concepts of the farm system in which nitrogen fertilizer is used, counterfactuals, discount rates, opportunity costs, time preferences, risk and uncertainty to estimate probable net present values and benefit cost ratios of potential changes to the status quo over a planning period. For complicated markets and value chains, system modelling frameworks encompassing science and economics are often required. These methods are also discussed.

In Part 5, the discussion moves to possible policy interventions to assist in reducing the social costs of the mostly negative externalities from nitrogen in their many forms. A range of policy options are set out and discussed, including a direct tax on nitrogen use, a tax on one or more of the agricultural or horticultural outputs derived from the nitrogen application, quantitative restrictions on emissions, permit systems which allow a specified volume of emissions, or subsidies for alternative less pollution-intensive inputs such as enhanced efficiency nitrogen inputs or outputs. Evaluating these policy options involves using the methods outlined in Part 4. A key point is that the incidence of a policy instrument such as a tax is often shared, the final burden being paid ultimately by different parties, not borne where the initial burden is laid. For most agricultural and horticultural products, final demand tends to be own-price inelastic in the medium term, so it is consumers who eventually pay through higher prices for the social cost caused in meeting their needs.
The paper finishes with a brief conclusion and a list of the references cited.

Key words: nitrogen, fertilisers, negative externalities, economics, social benefit cost analysis, social cost

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