Markets and sewerage

EXECUTIVE SUMMARY

The sewerage industry in Australia employs assets with a written down replacement value of around $18 billion (1987-88), which compares with $13 billion for Telecom and $L5 billion for Australia Post (Industry Commission, 1990).  Its task is to transport domestic and industrial liquid wastes away from cities and towns to sites where the environmental impacts of waste discharges can be managed.  As a part of this task, the industry may treat the sewage, both to reduce its disposal costs and to reclaim valuable constituents for sale.

Once liquid wastes are securely enclosed in pipes and access to the sewer is controlled, sewer disposal of liquid waste is exclusive to the purchaser, and can be bought and sold like any other marketed service.

Liquid wastes, as by-products of both domestic and industrial activities, are collective "bads" once they enter the environment, in the sense that many people are affected by the same waste discharge.  Due to large numbers of people affected, and a lack of defined individual property rights to a clean environment, market bargaining will not signal damage costs back to sewer operators and the generators of domestic and industrial wastes.  In practice, environmental damages are assessed, and permitted levels of discharges of liquid wastes from sewers and other sources determined, by state environmental protection agencies.

Where waste discharges are restricted, rights to dispose of environmentally damaging liquid wastes via the sewers or otherwise are scarce goods.  In the absence of market signals to indicate the value of scarce liquid waste disposal rights, different parties along the sewer pipe will make decisions in ignorance of the benefits and costs of their choices for others.

As Australian sewerage is currently organised, individuals and firms have little incentive to consider the effects of their liquid waste production and disposal on others.  There are few market price signals to indicate the value of rights to sewer disposal of liquid wastes.  The managers of publicly owned and operated water and sewerage enterprises have not been encouraged to price according to the costs of providing services.  Sewage and its constituent wastes are rarely measured, and quantity-based charges for sewerage services and for discharge into the environment are the exception rather than the rule.  Without such market signalling and incentives, Australians do not get the best possible mix of waste production, transport and treatment for permitted discharges into the environment.

Market-based approaches to liquid waste disposal and sewerage have been adopted in several countries overseas.  Privatisation of sewerage enterprises, recently undertaken in the UK, and franchising of sewerage operations, practised in France, improve the operational efficiency of sewerage enterprises, but create little new information or incentives for waste producers and processors to coordinate their activities.  Effluent charges, as adopted in Germany, do provide information and incentives for parties to recognise and respond to their impacts on others.  However, since effluent charges set prices and not quantities of discharges, they are unattractive to control agencies who prefer control over quantities when they cannot accurately measure pollution damages.

Marketable liquid waste discharge rights, although yet to be adopted anywhere for sewage discharges, appear the most promising of the new institutional innovations.  Marketable rights equal to the present permitted levels of discharges accomodate the present quantity standards approach to pollution control.  New rights could be created when sewage disposal facilities are expanded.  The prospect of pro fits from market trading in rights provides both the incentive to reveal information about benefits and costs of waste disposal and the incentive for parties to respond to information provided by others.  The values of rights will also provide information about the need to expand the system.  Discharge rights will end up with those who value them most, and thus the overall cost of achieving permitted discharge standards will be minimised.  The fact that marketable rights would be considered private property will be a desirable constraint on ill-informed or politically biased alterations to environmental standards.

The present high costs of accurate and reliable liquid waste measuring apparatus are a major barrier to the prompt introduction of marketable rights for liquid wastes, since the value of rights is dependent on careful policing of all discharges, to ensure that individual contributions do not exceed entitlements.  Effective marketable rights to sewer disposal of wastes will require accurate measurement of the particular waste at all sewer intake and exit points.  The same accuracy of measurement will also be required for implementation of effluent charges, if they are to achieve a similar degree of efficiency in liquid waste disposal.  Both of these market-based approaches to environmental protection bring the high costs of effective and efficient environmental protection out into the open, mainly in the form of high measurement and policing costs.  The current "command and control" approach, involving modest scientific research budgets, little accurate measurement, and little incentive to honestly reveal individual costs and benefits, tends to conceal the high costs borne by individuals and industries under current quantity standards.

Creating markets in sewage wastes will be costly and will take time to implement, but, over time, the institutional change will itself help to solve the technical problems.  The past organisation of sewerage and environmental protection has discouraged research and development in the areas of liquid waste treatment and measurement;  the prospect of markets in liquid waste discharge rights would stimulate efficient research, investment and innovation in all these areas.

INTRODUCTION

An important and valued achievement of modern industrial society has been the divorce of household and industrial liquid waste production from the need to worry about its disposal.  We not only create liquid wastes directly;  we also cause industry to produce wastes in the process of satisfying our needs.  By purchasing commoditities and services we require someone to dispose of the residual wastes from the productive process.  Similarly, we pay fees or local taxes for the disnosal of our own oersonal wastes.  We pay little or no attention to the processes involved in these activities, legitimately insofar as our payments for the products and services are assumed to acquit our personal reponsibilities for the costs of liquid waste disposal.  Thus it comes as rather a shock if disposal is unsuccessful, as when we encounter sewage effluent in the waves at Bondi (Beder, 1990).

There is nothing wrong with people not understanding all the implications of their day-to-day decisions for liquid waste production and disposal.  The economy and the environment are complex, and time is precious.  A great advantage of markets is in allowing economies in the search for information.  Those with specialist knowledge, skills and capital are contracted implicitly or explicitly to provide the necessary information about the costs and benefits of waste production and disposal.  What is required is the correct signalling of costs, so that when individuals or firms make decisions which lead to liquid wastes and waste disposal, they consider the costs imposed on others as well as themselves.  If they do, the community should get about the right amounts of liquid waste generation and disposal -- the amounts which correctly balance the benefits of waste-generating domestic and industrial activities against the costs of waste transport and treatment and the unpleasantness and harms due to waste discharge into the environment.

As sewerage is organised in Australia, do individuals and firms in fact have the necessary incentives to consider the effects of their liquid waste production and disposal on others?  We conclude that the present publicly-owned and operated sewerage systems blunt such incentives, and outline alternative methods of organising sewerage which would provide more market signals to prompt people to change their behaviour in the interests of others.  Problems involved in implementing market-based organisation of sewerage are also examined.  But first we briefly consider the nature of sewage and the general relationships between discharges and impacts on the environment.

WASTES IN SEWAGE AND ENVIRONMENTAL IMPACTS

Sewage includes human wastes which are in effect liquid, plus wastes which can be conveniently transported in water in solution or suspension, such as soil particles, food particles and grease.  Sewage is thus a complex mixture of mineral and organic matter, in suspension or dissolved, comprising 99.9% or more of water (Bolton and Klein, 1971).

The flow of water in a sewer system provides both waste transport and dilution, a role which people have assigned to rivers throughout history.  Sewers are artificial, enclosed rivers specifically created for waste transport;  they cannot function without a continuous and substantial water supply to waste-producing households and firms.

The common constituents of sewage include:

• suspended inorganic solids, such as sand and clay;
• oxygen-demanding organic wastes, normally measured by their biochemical oxygen demand (BOD);
• nutrients, such as nitrogen and phosphorus;
• pathogens, such as bacteria and viruses;
• oil and grease;
• inorganic synthetic chemicals, such as detergents, and
• heavy metals, such as lead and mercury.

Each of these and many other sewage constituents has an impact on the environment where it is discharged, and particular constituents may interact in the sewerage pipe or in the receiving environment.  Thus monitoring of sewage discharges aimed at avoiding environmental impacts harmful to people may require many separate measurements, and estimates of environmental impacts are subject to considerable uncertainty.

When treated or untreated sewage is discharged into the environment, the wastes it contains impose costs in the form of unpleasantness or harm on people who use that environment.  To understand the relationship between discharges and costs to people, recall that the natural environment has a capacity to absorb most wastes, either by transforming them into harmless substances, or by diluting or dispersing them so that the resulting concentrations are harmless (Tietenberg, 1988).  The relationship between the rate of waste discharge and the rate of environmental absorption is critical in determining the nature of changes in the natural environment and consequent costs to people.  This relationship is illustrated in Chart 7.1.

Chart 7.1

Chart 7.1 suggests three main types of relationships between discharges and environmental change.  The rate of discharge of a waste may be less than the rate of absorption.  Second, the rate of discharge may exceed the rate of absorption, so that the waste accumulates, but the environment can recover, that is, environmental absorption of the waste can reduce the accumulated stock if discharges are reduced or cease.  Finally, absorption may be non-existent or negligible, so discharges accumulate over time, and environmental change is permanent.

For example, consider sewage containing organic matter and heavy metals discharged into a stream.  So long as discharges of organic matter are less than absorption, there will be a temporary but not drastic change in the environment, in the form of a lowering of the dissolved oxygen content of the stream.  If organic discharges exceed absorption, organic wastes accumulate in the stream, which becomes putrid when all its dissolved oxygen is used up.  The stream will begin to recover once discharges fall below absorption.  In the case of the heavy metals, the wastes accumulate continuously, and effects on the environment and consequent harm to people increase for as long as the discharges continue.

The natural rate of absorption of biodegradable wastes will vary enormously depending on the volume, temperature, chemical composition, mobility, rate of oxygenation, and so on, of receiving waters.  Rates of absorption in confined, immobile inland waters will generally be low;  on the other hand, scientific studies commonly record very little environmental impact more than 100 metres or so from ocean outfalls releasing large volumes of partially treated sewage (Holmes, 1987).

The implications for environmental protection measures are clear.  Where absorption is substantial, rates of waste discharge must be the object of control, with the aim normally being one of keeping discharges below the absorption capacity.  Short-term surges in discharges, causing temporary waste accumulations, will have to be monitored separately, in order to compare incremental benefits and costs.  Where absorption is negligible, the accumulated stock of the waste in the environment must be monitored, and the resulting permanent costs assessed, as a basis for comparing the incremental benefits versus (continuing) incremental costs of adding to the stock.

SOME ECONOMICS OF LIQUID WASTES

LIQUID WASTES AS COLLECTIVE BADS

Due to their unpleasant or harmful nature, liquid wastes are "bads" to the people who produce them as by-products of domestic or commercial activities, that is, the producers are willing to make sacrifices to be rid of the wastes.  The cheapest form of disposal for settled individuals, generally practised by people until late last century, is to dump the wastes just far enough away to avoid the nastiness (Butlin, 1976: 9-11;  Fogarty, this volume).  This does no harm in the absence of neighbours, but others are harmed when people congregate in villages or towns or cities.  Such costs, imposed on others without their consent, are termed externalities or spillovers.

Spillovers between neighbours can be overcome if the waste disposers can be forced to bear the full costs of the smells, health problems, damage to plants and animals, etc., that they impose on others.  However it will not always pay to do so;  sometimes the costs of private contracting or court action or government enforcement of pollution controls will exceed the costs of the spillovers.  The community will be better off if no formal action is taken.  An individual may protest to his neighbour if the neighbour's dog relieves itself on the first person's lawn;  taking the neighbour to court would involve disproportionate costs for all concerned.  As in many other aspects of human interaction, informal restaints resulting from common courtesies and mutual sensibilities are often more effective than formal legal constraints.

Dispersal of liquid wastes in the environment, via water or air movements, and the mobility of people, mean that liquid waste discharges commonly affect substantial numbers of people.  The wastes are collective or public bads, in the sense that many people are harmed by the same waste discharge.  In these circumstances, dischargers are unlikely to bear the full costs they impose on those harmed by waste discharges.  There are two main reasons for this.  One is that it is often difficult to identity who discharged the offending waste, so that market deals or legal action to correct the problem are impossibly expensive (The Sunday Herald, August 12, 1990).

The second reason, why dischargers are unlikely to bear the full costs they impose on others, is that individuals harmed by discharges often have little incentive to act to signal their costs back to dischargers.  To see why, consider the case of an individual fisherman or riverbank resident downstream from an unregulated pulp mill.  Knowing that he is one of many, the individual who is harmed by discharges from the mill may prefer to free-ride -- to leave it to his fellow fishermen and residents to pay and/or lobby to have discharges reduced.  After all, his contribution will make little or no difference, and he will reap the full benefit of any reductions.  Thus, quite rationally, he may decide to make no contribution at all.  If many or most affected parties downstream think likewise, little of the total costs of liquid waste disposal is imposed on dischargers, and the community suffers from excessive disposal of liquid wastes.

SEWERAGE -- SHEETING HOME THE COSTS

The collective bad nature of liquid wastes, and the consequent failure adequately to control private waste disposal, caused major public health problems in urban areas up until the late nineteenth century.  Publicly-funded and -operated sewers were created to segregate liquid wastes from the urban environment and to provide water transport of wastes to sites where their impact on the environment would be less costly and harmful.

Once liquid wastes are securely enclosed in pipes, access to the sewer system may be controlled and other methods of waste disposal strictly policed and penalised, the waste-producing household or firm cannot shift the costs of waste disposal onto others.  The sewer is the least-cost method of disposal, and the waste producer can be forced to pay the cost of sewerage by the threat of exclusion, which would expose the household or firm to even higher anticipated costs of on-site treatment or storage, illegal dumping penalties or shutdown.

Strict policing of sewer access and illegal dumping of liquid wastes creates a willingness to pay for sewerage disposal of wastes, stimulating the provision of sewerage services.  At the same time, sewerage charges may encourage households and industries to reduce their production of liquid wastes, and may create incentives for treatment of wastes to render them suitable for disposal on-site.

Households and firms are legally liable for the disposition of the wastes they produce while the wastes remain at the production site.  Once in the sewer, the wastes from separate sites are rarely identifiable.  Legal responsibility for the disposition of wastes in the pipe resides with the sewer operator, who should be subject to penalties for unauthorised discharges which harm others.

At the sewer outlet, large volumes of sewage are dispersed into coastal or enclosed waters, imposing costs on large numbers of users of that environment.  As in the case of local disposal by waste producers, private action will not accurately reflect affected parties' costs back to the sewer operator, even if the collective costs to those parties are large.  Individuals who are harmed -- fishermen, bathers, birdwatchers, coastal residents -- don't each own a piece of the receiving waters, and thereby have the right to charge the sewer operator for disposal, or sue for damage to their property.  Knowledge that the number of parties harmed is large inclines each individual to leave it to others to take action.  Also any negotiations between individuals and the sewer operator over damage compensation or payments for reduced discharges would be complicated by the difficulty of assessing affected parties' true costs.

In practice, environmental damage around sewer outlets is assessed, and constraints on sewage discharges determined, by government agencies.  Normally a state government environment protection or pollution control agency determines allowable discharges of particular wastes from all sources, and public and private sewer operators are issued with permits which authorise discharges up to those limits.

To get discharge standards right, an environmental protection agency needs to know how the costs of sewage discharges to all those harmed, and the benefits of discharges to households and firms, vary as the level of discharges varies.  Ideally, the agency would permit that level of discharge at which the total cost to affected parties of the last unit of sewage discharged just equalled the benefit (profit) to households (firms) of being able to discharge that unit of sewage (see Chart 4.1 above, with levels of sewage discharges replacing levels of land degradation).  But because sewage discharges are collective bads, there is still a problem in identifying the true costs of those who lose due to discharges.  Individuals who are harmed have little incentive to reveal their true costs to the agency;  on the contrary, they have incentives to exaggerate costs, to persuade the agency to set tight standards, so long as they do not have to pay for the standards.  So the introduction of a government agency, with the power to set discharge standards and to force compliance by the sewer operator, does not guarantee the "right" amount of sewage discharge, even if we ignore the complex constitution of sewage and changing conditions in the receiving environment.

THE DEMAND AND SUPPLY OF SEWER WASTE DISPOSAL

Where disposals of wastes are restricted, rights to dispose of environmentally damaging liquid wastes via the sewer are scarce goods.  The rights are valuable to households and firms because the legal alternatives to sewer disposal of wastes, on-site treatment and cessation of waste-producing activities, are all costly.  The value of such rights depends on the supply of and demand for sewer disposal of particular types of liquid wastes.

The supply of sewer disposal of particular wastes is determined by:

• permitted discharge levels for each type of waste in the receiving environment;
• the costs of constructing and operating the sewer system, and
• the costs of constructing and operating any sewage treat ment plants which remove wastes from the system.

The demand for sewer disposal of particular wastes is determined by:

• households' willingness to pay for liquid waste disposal;
• the willingness of commercial and industrial firms to pay for different levels of waste disposal, which is bounded by the profits made by firms at different levels of waste discharges, corresponding to different levels of output and resource use, and often to different production technologies, and
• the costs of alternative methods of liquid waste disposal, in particular, of processing to reduce liquid wastes, net of the values of valuable materials recovered.

These separate determinants of supply and demand are mostly under the control of separate actors -- environment protection agencies, sewer system operators, treatment plant operators, households, commercial and industrial firms, liquid waste processors and potential entrants to the industries involved.  For efficient provision of liquid waste disposal, it is essential to have accurate communication between these parties about waste producers' disposal needs and willingness to pay, permitted discharge levels, and the disposal alternatives available and their costs.

MONOPOLY IN SEWERAGE

Sewerage providers are rarely subject to competition or the threat of competition in the transport of sewage, due to the very high costs of duplicating pipe networks.  Since households' and firms' alternative means of liquid waste disposal are usually much more costly, the sewer system operator is able to raise charges above the true costs of providing the service.  Hence sewerage is invariably subject to price regulation, either via public operation of sewer systems, or direct regulation of firms' prices.

The existence of co-tenancy contracts for co-ownership of large indivisible facilities, such as generators and transmission lines, in the Unites States' electricity industry suggests a possible avenue of escape from the pipeline monopoly problem (Smith, 1988).  This would involve joint ownership of pipes, with capacity rights being proportional to shares of total asset values.  Capacity rights in pipes would be marketable, and each co-owner would pay usage charges for measured use of the pipes.  A pipeline would be managed by a separate operating company created by the co-owners.  Thus it maybe possible to introduce competition between water and sewerage providers who use the same pipes.

The market power of sewer operators will be much less where waste producers have low cost alternatives to sewer disposal of wastes.  This will often be true for the producers of small volume industrial wastes, where road transport and other forms of disposal such as incineration are available, and for large firms and industries able to arrange their own disposal outside the sewer system.  For example, Victoria's State Electricity Commission has constructed a separate pipeline to transport saline wastewater from its Latrobe Valley power stations to Bass Strait.

POLICING AND MEASUREMENT OF LIQUID WASTES

Policing makes waste producers liable for the costs of the wastes they create;  they can't shift the costs onto others.  Policing plus penalties create incentive to reduce waste production and willingness to pay for waste disposal and treatment.  With the prospect of reward for their services, individuals and firms have incentives to establish liquid waste transport and processing businesses.

The need for policing is unaffected by the mechanism employed to reflect costs back to waste producers.  In principle, this might be achieved either by creating private property rights in an unchanged environment, allowing individual victims to impose costs on waste dischargers, or by government charges or penalties imposed on behalf of victims.

Unless the object of policing is to eliminate waste discharges into the environment, policing must involve measurement of liquid wastes.  Measurement of the contributions of individual liquid waste dischargers is necessary to establish their liability for costs imposed on others.  For example, an environmental protection agency needs accurate discharge data to impose penalties on firms violating their discharge permits, and the court will require the same in a compensation case brought by victims of discharges.

Measurement of the amounts of liquid wastes transported and processed is also desirable to establish the true costs of disposal to waste producers, and the appropriate rewards due to parties who perform these valuable activities.  Sewage is commonly un-metered, with disposal charged on a lump-sum basis.  This may be justified by high costs of measurement of sewage volumes and constituents.  However, as a result, the sewer operator has no means of setting quantity-based charges which encourage lower discharge levels.  It is unable to communicate information about the costs which extra quantities of wastes from households and firms impose on itself and on the environment at the sewer outlet.

The fact that sewerage is for the most part a monopoly service reduces the pressure for accurate measurement of liquid wastes.  With no alternative suppliers of sewage disposal breathing down its neck, a sewer operator is in a strong position to unilaterally revise contractual terms.  On the other hand, liquid waste disposal firms operating in a competitive environment will want to measure the quantities of various wastes to ensure that the costs of their services are covered.  Waste producers contracting with commercial waste disposal firms will also require measurement to ensure that they receive the services they contracted for.  Thus striking a deal will involve measuring the quantities of the particular wastes involved.

Since victims of liquid waste disposal may suffer damages based on either the rate of discharge or the accumulated stock of particular wastes in the environment, it is necessary to identify the correct damage measure for each type of liquid waste.

ORGANISATION OF SEWERAGE IN AUSTRALIA

INDUSTRY ORGANISATION

In Australia, sewerage is everywhere publicly provided.  Where both water and sewerage are provided, they are almost always combined in a single enterprise.  In the major cities, sewerage is provided by statutory authorities or city councils.  Elsewhere, services are provided by local councils or regional boards.  Historically the operations of sewerage enterprises in Australia have always been open to political influence;  appointments to water and sewerage boards have typically reflected political jurisdictions and other interest groups as well as technical and business expertise.

Water and sewerage enterprises in Australia are currently responsible for the provision of a variety of commercial and noncommercial services, ranging from water supply, sewerage and drainage control, to regulation of industrial waste discharges and land development and management of parks and wildlife.  Almost all of their income is derived from the provision of water and sewerage.  They are not explicitly required to earn a competitive rate of return on assets.  Consequently there has been inadequate incentive for management to upset traditional modes of operation by moving to reduce costs or to set prices on the basis of the costs of providing services.  For example, water and sewerage enterprises generally undertake a high proportion of construction and operating activities in-house, rather than contracting jobs out to specialist enterprises.  Moreover, because the charges for the different services provided are typically unrelated to costs, cross-subsidies between different services, and between different customer groups, are common.  Thus in 1987-88, the Sydney Water Board's domestic customers were subsidised in their usage of water and sewerage services by 67,000 industrial users to the tune of $140 million (Australian Financial Review, February 16, 1990).

Discharges of liquid waste are typically not metered, and sewerage charges are generally based on property values and unrelated to quantities of wastes removed.  Volume and concentration-based charges for industrial wastes are progressively being introduced.  Charges are commonly based on several broad categories of pollutants including suspended solids, biochemical oxygen demand, nitrogen, sulphur, and phosphorous (for example, see Melbourne and Metropolitan Board of Works, 1990).  Quantities of these and other pollutants discharged into the sewers are limited by trade waste agreements which are established between industries and the sewerage authority in question.  Where liquid waste produced by industries is not suitable for discharge into the sewer, private firms provide liquid waste collection, treatment, recycling and disposal services for industrial wastes.

State environmental protection agencies issue licences specifying maximum allowable quantities and concentrations of discharges of liquid wastes.  Liquid waste producers can negotiate with the agencies about direct discharges into the environment.  Sewerage enterprises are similarly required to obtain licences for their discharges.  Monitoring of compliance is the responsibility of the agencies, which have the power to prosecute dischargers which fail to meet their licence conditions.

The effectiveness of the policing of these standards is unclear, as resources available for monitoring illegal discharge are limited, and the ability to trace pollutants to their source is constrained by the current state of technology.  Furthermore, the determination of environmental standards is not transparent;  it involves a mix of scientific evidence, the current use of the receiving environment, environmental standards elsewhere, advisory bodies of experts and interest group representatives and political lobbying (see Bates, 1983: 157-164).

EFFICIENCY CONSEQUENCES OF THE PRESENT ORGANISATION

The organisation of sewerage affects the efficiency of resource use at two levels:  within sewerage enterprises, where efficiency depends on managers having appropriate incentives and on signalling and incentives within the enterprise, and in allocation of resources along the length of the sewer pipe, where the separate actors require appropriate signals and incentives to communicate information about their waste disposal needs and alternative disposal options.

The average real rate of return for Australian water and sewerage enterprises was approximately 2% in 1987-88;  the rate for metropolitan sewerage was 3.2% (Industry Commission, 1990).  This low level of return is a reflection of the organisational structure and accountability arrangements for these enterprises.  Board appointments are made for political as well as commercial reasons.  Water and sewerage enterprises are commonly required to achieve environmental and public interest objectives, some of which are very difficult to assess, as well as commercial objectives.  Boards are subject to Ministerial direction.  As a result, managements produce services in an inefficient manner (for example, by allowing overmanning which satisfies management preferences for a "quiet life"), and may fail to produce services desired by people (for example, slow response to service complaints).

A correct allocation of resources along the sewer pipe depends partly on setting the correct discharge standards at the sewer outlet.  However, in responding to a mix of scientific evidence, expert opinion and political pressures, Australian environmental protection agencies are unlikely to get discharge standards right.  As explained above, what they really need to know are the costs of particular waste discharges to victims and the benefits of the same discharges to households and firms.  The costs to victims are obscure due to the "collective bad" problem.  On the other side, if households and firms are not charged for their waste discharges, the environmental protection agency has no direct information about the benefits they receive.  This is the situation for most sewerage users, as distinct from industries producing certain liquid wastes.

In the absence of measurement and market-based charges for sewer disposal of liquid wastes, there is little accurate communication along the sewer pipe about what current and potential waste producers -- households, firms, liquid waste processors -- are willing to pay for sewer disposal, and what those who supply disposal facilities -- sewer system operators, treatment plant operators, environmental protection agencies who control access to the environment -- are willing to accept in compensation.  Yet when a household or firm considers increasing its output of liquid wastes -- installing a dishwasher or an additional killing chain at an abattoir -- it should have information about, and the incentive to allow for, the costs of liquid waste transport and treatment and any resulting environmental damage which its decision imposes on others.  Similarly, a sewer or treatment plant operator considering a sewer extension or additional treatment capacity requires information about the consequent benefits to waste producers, and revenue derived from service charges will normally provide the incentive to undertake the project.

MARKET-BASED ORGANISATION OF SEWERAGE

Governments in a number of OECD countries have moved from traditional "command and control" mechanisms of regulation of liquid waste disposal to more market-oriented arrangements designed to improve information signalling and incentives.  Some of these organisational reforms, such as the recent privatisation of water and sewerage authorities in the UK and franchising of water and sewerage operations in France, have been designed to improve the operational efficiency of sewerage enterprises.  Others, such as the imposition of liquid effluent charges or taxes in some European countries, and proposals for the creation of marketable liquid waste discharge rights or permits, so far only implemented in isolated cases (OECD, 1989: 95-97), are designed to improve the allocation of resources between parties along the sewer pipe.

PRIVATISATION/FRANCHISING OF SEWERAGE

In the face of budgetary constraints, aging facilities, and internal and external pressures to upgrade treatment requirements, some countries have divested the management and, in some cases, the ownership, of sewerage facilities from the public sector, relying more heavily on private provision of sewerage services.  In the UK, the responsibilities of ten water and sewerage authorities were transferred into private hands in December, 1989, when the authorities were transformed into public limited companies CPLC's") (Kinnersley, 1988).  Privatisation has been coupled with a strict regulatory regime.  Regulation of prices and service quality is seen as a necessary constraint on the exploitation of monopoly power by the PLC's, which are the sole providers of sewerage services in their respective areas of operation.

The UK privatisations have improved sewerage managers' incentives to minimise costs and to provide services desired by sewerage customers.  However, since there is only limited measurement of liquid wastes, the system does little to improve signalling of the costs and benefits of waste discharges.

Privatisation of the management of sewerage facilities has also been occurring in France and the US.  In the US, where the burden of constructing and maintaining sewerage facilities falls on local councils, augmenting and replacing the present infrastructure is proving a substantial drain on government budgets.  Local councils are seeking out savings by contracting with private firms to operate sewerage facilities (Stump, 1986).  Many French municipalities contract the management of water and sewerage facilities to one of five private water and sewerage companies which operate nationwide.  About 40% of sewage disposal in France is managed by the private companies (Deschamps, 1986).  Typically, the municipalities maintain ownership of the basic infrastructure, and franchise management of the facilities to private companies (Kinnersley, 1988).  Competitive bidding for franchises encourages the firms to provide acceptable quality services at low cost.  Municipalities retain the right to resume management of facilities at any stage.  The major problem with the franchise contracts is specification of the terms of maintenance of water and sewerage assets which outlast the term of the franchise.

LIQUID EFFLUENT CHARGES

Governments are also increasing their use of effluent charges in pollution control, including charges for sewer disposal of wastes (OECD, 1989).  Most OECD countries impose some charges on liquid wastes discharged via sewer systems.  Some OECD countries, including Australia, also allow direct industrial discharge into the environment.  Firms are required to comply with licences issued by the relevant government agencies, and pay a volume- or concentration-based charge for the right to dispose of their effluent in this manner.

OECD countries have been reluctant to rely solely on effluent charges to control the discharge of liquid waste into the environment (Hahn, 1989).  Since the 1970s, combined systems of regulation plus charges have been adopted in a number of countries, including Germany, France, Italy and the Netherlands.  Effluent charges based on the estimated value of environmental damage caused by liquid waste discharges would signal the costs of liquid wastes to producers, thereby creating incentives for waste treatment and the reduction of discharges by waste producers.  Most actual effluent charges understate the costs imposed on the environment by liquid waste discharges;  the charges typically function as revenue-raising rather than cost-signalling devices (Hahn, 1989).

The effluent charge system in the Federal Republic of Germany has an explicit incentive objective, designed to encourage firms to meet licence specifications.  The important feature of the German charge system is variable charges, based on the degree of compliance with environmental standards.  If federal minimum effluent standards are met, as specified in industrial permits, a discount of 50% is applied.  Where industrial discharges fall below 75% of minimum standards, firms are charged according to the actual volume of liquid waste discharged.  Payment of the charge may be delayed for three years where firms adopt waste treatment technology capable of reducing industrial discharge by 20% (OECD, 1989: 39).

MARKETABLE LIQUID WASTE DISCHARGE RIGHTS

Marketable rights (also commonly termed marketable permits) fit neatly with the almost invariable preference of environmental protection agencies to set quantities rather than prices of liquid waste discharges (OECD, 1989: 111-112).  If discharge rights are, like any other private property, exclusive to their owner and transferable in the market, they will eventually end up with those who value them most.  The market will reallocate rights over time so that the community gets the greatest possible returns net of costs of transport and treatment of wastes from the permitted maximum level of pollution.

Marketable rights for liquid waste discharges have only been implemented in a handful of cases worldwide (OECD, 1989).  They have not been introduced for sewage waste discharges.  Yet they are straightforward enough in concept.  Liquid waste discharge rights could be created for each category of discharge into the environment from a given sewer outlet.  Rights would entitle the owner to discharge specified quantities of wastes into a specified sewer system.  Rights equal to the total permitted discharges from each sewer outlet would be allocated initially on some basis for each category of waste.  The rights would be tenable for a long period and tradeable free of controls.  In principle, rights to discharge domestic and service industry wastes could be issued to individual households and small businesses;  in practice, as explained below, waste measurement costs and other costs of issuing and trading rights will make this prohibitively expensive for such small liquid waste producers.

For each liquid waste category, parties with an interest in trading in rights will include the original waste producers, waste treatment firms which use the sewers, sewage treatment plants and the sewer system operator.  Individuals and groups harmed by pollution, and the government, could enter the market to buy permits and retire them, thus reducing total permitted discharges.

Implementation of market trading in rights creates incentives for would-be buyers and sellers of rights to reveal the values they attach to rights to discharge liquid wastes.  It thereby encourages communication of benefits and costs of liquid waste production, transport and treatment between parties along the sewer pipe.  This will promote efficiency in production, transport, and treatment of liquid wastes.  Compared with the current non-tradeable discharge licenses, highly-profitable firms with no cheap way of reducing liquid waste production have the additional option of purchasing discharge permits from other firms.  Less profitable firms, and firms that can reduce their discharges cheaply, have the extra option of selling permits at the same time as they change products or production methods.  As a result, over time the overall cost of achieving permitted discharge standards will be minimised.

The industrial chemical complexes around Altona in Melbourne and Botany in Sydney typify situations where ability to trade liquid waste discharge rights might be mutually beneficial to participating firms.  Where two firms produce the same liquid waste, but face different costs of waste reduction or treatment or different market prospects for their products, trading may increase the expected profits of both firms.  Trading in discharge rights may also provide a "golden handshake" for firms in declining industries;  for example, the closure of textile processing firms which are major polluters and only marginally profitable may be facilitated by sales of such rights.

CHARGES VERSUS MARKETABLE RIGHTS

Economists have debated extensively the theoretical and practical merits of effluent charges versus marketable rights.  By most accounts, the correct choice depends on circumstances (Baumol and Gates, 1988).  Charges set the price of liquid waste disposal;  rights set allowed quantities.  Each put a price on scarce rights to sewer disposal of environmentally damaging liquid wastes;  charges directly, by government decision, and marketable rights indirectly, by forcing would-be dischargers to compete in the market for the limited supply of rights.  Each thus prompt interested parties along the sewer pipe to reveal information about willingness to pay for waste disposal and the costs of alternative methods of disposal.

Charges and marketable rights generally have different effects on the incomes of waste producers, dischargers and the wider community.  Charges automatically embody the polluter-pays principle, and cause a redistribution of income away from liquid waste producers and dischargers to government and thence to the wider community.  Government auctions of marketable rights can in principle achieve similar distributional outcomes to charges;  in practice the rights are invariably given to the holders of current discharge licenses.  The effluent charges actually imposed in European countries are generally well below estimated environmental damage costs, and charge revenues are commonly used to subsidise private investment by industry in pollution control.  These facts suggest that a high weight is given to the status quo distribution of income in political decisions about the environment (Hahn, 1989).

Another important difference between charges and marketable rights is the ongoing role of government.  Charges remain under government control, and are able to be changed in response to new scientific, economic or political information.  Once established, rights will become jealously-guarded private property, a basis for longer-term decision making, and correspondingly more difficult to change.  As knowledge of the environment and desired discharge standards change, those with a benign view of government will see charges as facilitating desirable flexibility in environmental policy.  Marketable rights, probably requiring government purchase of rights or compensation when standards are tightened, will be seen by others as a desirable constraint on poorly-informed or self-seeking governments.

MARKETS IN LIQUID WASTE DISCHARGE RIGHTS

Since Australia's environmental protection agencies rely on quantity standards, rather than charges, market signalling of the costs and benefits of liquid wastes would be most conveniently introduced by creating marketable rights to sewer disposal of liquid wastes.

ADVANTAGES OF MARKETABLE RIGHTS

As previously explained, marketable rights create the incentive to reveal information about the costs and benefits of waste production, transport and treatment, and thereby help the community to achieve effluent discharge standards at least cost.  So long as there are no restrictions on who can buy rights, the incentive extends beyond current players;  if existing companies (in particular, international waste treatment companies) or new companies using Australian scientific and technical expertise wish to enter waste-producing industries or waste treatment, they can do so by purchasing rights.  This will encourage the adoption of new technologies in both the waste producing and waste treatment industries.

MEASUREMENT PROBLEMS

If the creation of marketable rights to the sewer disposal of liquid wastes would save a lot of community resources, why has no market economy implemented it?  First and foremost because of the complex composition of sewage and the high costs of accurate measurement of most liquid wastes.  Recall that sewage commonly contains a large number of wastes with distinct effects on the environment which impose costs on people.  Separate marketable rights are required for each type of harmful waste.  In some cases rights should be defined in terms of short-term rates of discharge, in others in terms of accumulated discharges, so continuous or at least frequent periodic measurement is required.  We need liquid waste measuring devices equivalent to the common water meter -- on-site, rugged and precise.  For most important water pollutants, such equipment was either unavailable or costly in the early 1980s, with apparatus costs per installation ranging from a few hundred to several thousand US dollars (Russell, Harrington and Vaughan, 1986: 76-86).

No one will pay anything for a right which cannot be enforced, and this requires policing of illegal discharges and measurement of the discharges of all right holders, to ensure that individual contributions do not exceed entitlements.  Thus effective marketable rights involve accurate measurement of the particular liquid waste at all sewer intake and exit points.

If the measurement costs involved in policing marketable rights are too high, it will not be worthwhile to create them.  The introduction of marketable rights is more likely to be cost-effective for large-volume sources of liquid wastes, such as industrial plants, sewage treatment plants, and major commercial developments.  While measurement costs remain high, it will be too costly to introduce marketable rights for households and small businesses.  This is the pattern we observe in the progressive introduction of charges for liquid wastes by sewerage enterprises in Australia and overseas, and by European environmental agencies which impose liquid effluent charges;  volume- and concentration-based charges for industry and sewage treatment plants, and small-customer charges based on flat fees, or water usage, or a combination of the two.

OTHER PROBLEMS OF IMPLEMENTING MARKETABLE RIGHTS

There are further technical complications.  The waste assimilation capacity of the environment will vary with seasonal and climatic conditions;  to maximise efficiency of waste disposal, discharge rights should vary seasonally, for example.  Where individual pollutants interact in the pipe or the environment, setting upper limits to discharges of individual wastes maybe less important than ensuring appropriate mixes through time.  In some cases the need for control of a sewage constituent may be unclear due to scientific uncertainty.  So a once-and-for-all allocation of rights based on imperfect information about the impact of sewage on the natural environment may lead to inefficient use of the environment.

All the above problems apply in any pollution control regime involving quantitative limits on discharges, whether or not the rights so created are formally recognised and tradeable.  The only difference with tradeable rights is that if the environment protection agency gets the limits wrong the government may have to purchase rights from owners.  Under the present "command and control" regime it is less likely that government decision makers bear any of the costs of incorrect decisions.  This raises the question of whether, in a situation of uncertainty, the agency will act too conservatively in setting discharge limits, which will in turn influence the market values of waste disposal rights.

Markets work best, in the sense of signalling true costs and benefits and transferring property to those who can use it most productively, if there are lots of potential buyers and sellers.  If we create marketable rights to sewer disposal of particular liquid wastes, will the rights be traded?  Hahn (1989) reports little trading in most water and air pollution permit programs in the US.  He attributes this to small numbers of potential traders, to actions of rights holders to restrict competitors, and to difficulties in monitoring environmental impacts, leading to agency restrictions on trading of rights.  Thus, when contemplating the creation of marketable rights for a particular liquid waste in a particular sewer system, we must consider the likely number of traders, and the possibility of strategic behaviour towards commercial rivals, for example, one food processing company not selling rights to another to prevent its establishment in the same farming area.

Productive trading may occur between only two interested parties;  a rural industry producing organic wastes and a neighbouring town could trade BOD disposal rights so that the job of BOD reduction would be undertaken by whichever could do the job most cheaply.

CONCLUSIONS

Market prices for liquid wastes provide information about the costs and benefits of wastes to other people, and the incentive to respond to others' needs.  Decisions about liquid waste production and disposal in Australia make little use of prices, and thus the decisions of different individuals along the sewer pipe are not well coordinated, in the sense that individuals are making decisions in ignorance of the benefits and costs of their choices for others.  As a result, we do not get the correct mix of liquid waste production, transport, and treatment for permitted discharges into the environment.

Creating markets in sewage wastes will be costly and will take time to implement, but, over time, the costs of failure to communicate costs and benefits along the sewer pipe will almost certainly be much greater.  At present, the environmental protection agencies setting sewer discharge limits have no clear idea of the costs that an incremental tightening of standards will impose on industry and treatment plant operators.  Individual liquid waste producers and processors have little idea of others' willingness to pay for waste disposal, and costs of providing disposal.  Thus, at present, opportunities for desirable adjustments and profitable deals are being missed.  And due to a lack of bottom-line rewards for innovations in waste production and treatment, firms are less likely to be using least-cost technologies.  Nor is there much domestic reward for Australian firms which design waste treatment and monitoring equipment;  their best markets are overseas, where more market-oriented approaches to sewerage have found favour.

Government liquid effluent charges would be a partial solution to the signalling and incentive problems.  Corporatisation or privatisation of sewerage, so that sewerage enterprises become net wealth maximising businesses concerned to increase revenues by offering more valued services and to minimise operating costs, would also improve signalling and incentives.  These measures would not solve the longer-term problem of uncertainty about politically and bureaucratically determined waste disposal rights and charges.  Incentives for long-term research and development and investment in liquid waste reduction, treatment and measurement technologies and installations depend substantially on a clear definition of the future rules of the game in liquid waste disposal.

Marketable liquid waste discharge rights would provide the security and incentive required for greater private innovation and investment in liquid waste disposal.  Marketable rights equal to the present permitted levels of discharges accomodate the present quantity standards approach to pollution control.  Discharge rights will end up with those who value them most, and thus the overall cost of achieving permitted discharge standards will be minimised.

The high costs of accurate measurement of liquid wastes at all sewer inlet and outlet points are a major impediment to the introduction of marketable rights.  As with existing effluent charge systems, implementation of marketable rights would be piecemeal, starting with those sewer systems and types of waste which offer the greatest net payoff, based on unit costs of installed measuring equipment, numbers of waste producing and treatment firms and of potential traders, potential for innovations in waste production and treatment and the state of knowledge about environmental impacts at the sewer outlet.  High costs of measurement would rule out the early allocation of marketable rights to households and small commercial businesses.  Industrial waste producers, waste treatment firms, sewerage system operators, large commercial establishments and developers who are able to design waste reduction technology or contract out waste treatment, are, however, potential owners and traders of rights, since the quantities involved could justify the installation of expensive measuring equipment.

A measurable industrial waste produced by a substantial number of firms in a large metropolitan area would be a suitable candidate for the initial creation of marketable rights.  Providing that all wastes go to the same sewer outlet, and sewer capacity is adequate, trading and the consequent shifts in the location of discharge rights will not alter the environmental impact of waste discharges at the outlet.  In the absence of practical experience of marketable rights with sewerage, such institutional innovation is required to demonstrate the advantages and problems involved.

Since marketable rights are proposed on the basis of existing imperfect quantitative discharge standards, environmentalists may complain that the creation of rights to discharge pollutants confirms the existing situation, and contributes nothing to the solution of our pollution problems.  This ignores the fact that marketable rights and effluent charges create incentives for market participants to reveal additional information about the "costs and benefits of pollution.  Providing the measurement problems can be overcome (and this too requires deliberate creation of incentives), the establishment of private rights to sewer disposal of wastes will increase the information base for future environmental decision making, and this has to be good for Australians.

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