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Market friction is anything preventing markets from developing and working properly. In some instances, badly operating markets can create poor natural resource management (NRM) outcomes, such as land degradation, increased salinity and reducing water quality.
Market friction approaches aim to improve the way existing markets work, primarily by:
- enhancing information available within the market so consumers, investors or producers are able to make better informed decisions about the environmental consequences of their purchases, investments or production, or
- reducing the transaction costs associated with participating in markets that produce NRM outcomes, leading to more efficient environmental outcomes.
There are a range of approaches to enhance information flows or reduce transaction costs. These approaches may not deliver immediate or direct benefits, so it is often difficult to predict or assess their impact.
Poorly informed markets are less likely to result in the efficient allocation and use of natural resources. Good information is vital to bring market forces and NRM together and leads to trade that better reflects the NRM attributes of goods and services. There are many ways in which information blockages and bottlenecks prevent the operation, or emergence, of markets in ways that benefit the environment.
- land managers may perceive better land management practices as a high risk, impeding the adoption of more sustainable practices. Where improved knowledge and information reduces this perception of risk, barriers to adoption are reduced.
- Information required to accelerate the adoption of sustainable land and water management practices is often not available. For example, commercial investment in carbon sequestration can be constrained by lack of robust carbon modelling to support carbon accounting and verification.
Inadequate information increases risk and uncertainty. For example, better communication of research findings about new and more sustainable cropping practices can enhance land manager uptake and improve their access to finance. Providing information on the benefits and costs of sustainable NRM practices can:
- enhance the uptake of more sustainable practices
- influence traded prices for natural resources (e.g. water entitlements)
- change land managers’ risk preferences
- improve the confidence of direct or institutional investors.
Land managers who use sustainable production practices may not have a credible or practical way to show the market their practices are sustainable—they cannot differentiate their product and establish a market niche. This can be the case even where there are consumers with preferences for these goods.
Product differentiation is not a new concept and is generally linked to information. However, there have been difficulties gaining traction for product differentiation and price premiums for agricultural products that use sustainable practices. There are a number of impediments along the supply chain that make this difficult, particularly for homogenous products where producers are essentially ‘price takers’ (e.g. sugar producers).
The major exception to this is the emerging market for fresh organic produce that can attract significant price premiums in retail outlets. However, the extent to which those premiums translate to farm-gate prices is not well known.
The increased interest in carbon emissions has resulted in differentiated product development for a number of carbon-intensive services including:
- carbon-neutral flights, where the emissions from flights are neutralised via offsets and the cost is recovered through product differentiation and price, and
- green electricity where consumers elect to have a proportion of their electricity sourced from low-or zero-emission generation, and pay a premium for the service.
Under both of these examples, the services are specifically differentiated as ‘green’ products and a premium is charged.
Actions that reduce the transaction costs or risks associated with participating in existing and emerging markets for natural resource use and management can provide significant NRM benefits.
There is an increasing interest in market-based approaches for allocating and using natural resources. However, the transaction costs associated with many market approaches can be high, constraining good NRM outcomes. For example, a water-quality offset may require a great deal of time and effort by land managers and scheme administrators, but using a well-researched decision-support tool may cut transaction costs considerably.
Markets will always operate more efficiently if the transaction costs of participating in those markets can be reduced. Generally, transaction costs in any market will reduce as the market expands and becomes more mature. Examples of approaches that deliver lower transaction costs include the following.
- SunWater in Queensland operates an internet-based exchange for water entitlement holders to exchange water entitlements within many SunWater schemes. The exchange enables buyers and sellers to place bids or asking prices for water entitlements similar to the stock exchange. The exchange effectively brings willing buyers and sellers into contact at virtually no search costs.
- To date, biodiversity offsets in New South Wales (NSW) have been developed and assessed via a complex, case-by-case procedure. However, the BioBanking initiative being piloted in NSW provides a more rigorous, transparent and repeatable process to underpin evaluations for offsets and allows for the creation of ‘biodiversity credits’. In addition to providing greater certainty of desirable environmental outcomes from using biodiversity offsets, the scheme is also likely to provide a significant reduction in transaction costs.
There are opportunities for regional NRM groups to use market friction and associated approaches to enhance NRM outcomes, particularly where these approaches are used in conjunction with other regional NRM groups policies and programs.
These approaches are often best delivered in conjunction with partner organisations, for example:
- where scientific knowledge and information can help to inform market development, establishing partnerships with research and development agents or providers can be beneficial
- product differentiation is best delivered in conjunction with producer groups and retailers, and
- actions to reduce transaction costs associated with other regulatory mechanisms (e.g. environmental offsets) are best developed in conjunction with the appropriate regulatory agency.
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