Studies in Cost Benefit Analysis

Prepared by Michael Jarrett

Eynesbury College

Man for the Snowy adds life to river fight

Reporter: Steve Letts first Published: 27/02/00

For more than 30 years the Snowy River has been slowly dying. The proud and iconic river of
Banjo Patterson's mountain horseman has been rendered into a sad trickle for what policy makers
saw as the nation's good. Its water was sent west, over the mountain to the Murray and
Murrumbidgee Rivers to generate power and water in the arid
interior as part of the Snowy River Hydro-Electric
Note : A megalitre is a million
Scheme.
litres. A gigalitre is a billion litres.
One kilolitre of water is contained
But on Victorian Election day in September last year this in a cubic metre in dimension
sad trickle wrought its revenge on a generation of policy ( 1 metre x 1 metre x 1 metre)
makers, sweeping from office one of the most firmly and weighs one tonne. You can
calculate the volume of water being
entrenched governments: Jeff Kennett and his
discussed here. It is huge!
Liberal/National Party Coalition.

It was largely the work of

Independent Craig Ingram, The Snowy Alliance is angry
a member of the Snowy that the Snowy River now receives
Alliance, who was elected 1% of the flow it previously did.
There are environmental impacts
on his platform to save the
associated with this greatly reduced
Snowy River. With the flow.
balance of power in his The "spring melt" from the
hands he welcomed in a new Australian Alps sand from the holes
government, one that promised to listen to his concerns. "I in the Snowy River that were the
homes to native fish species. Now,
think there's probably an equity thing," he said. "We've had
these holes have simply
imposed on us a decision that's buggered up our river and and fish stocks are almost gone
we've found no financial benefit from it." from the river. A flow of 28%,
Mr Ingram recognises that the Snowy is not the only sick concentrated around spring-time
river in the country. "People of the Murray say their river is would bring the river back to life,
in a bad state but they've had a financial benefit from it in and improve the ecology of the
river.
terms of irrigation and development, and they've got
prosperous towns," he said. "Unfortunately we've had to sit
back and watch our river be buggered up without any benefit Mr. Ingram is arguing that East
from it." Gippsland has experienced private
costs and negative
Fight for the Snowy externalities, and the irrigators in
the Murray-Murrumbidgee
irrigation areas have gained a
positive externality: more water,
for which they have not
paid enough.

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George Collis works in the small but efficient back room of the Snowy Alliance, and he is
determined to win more seats for the cause. "The Snowy River alliance is a political
organisation and we've had success in East Gippsland," he said. "We're looking to the federal
seat of Gippsland and the state seat of Benalla, which is up for a by-election shortly," Mr
Collis said.
The political platform of the Snowy Alliance is basic:
Mr. Collis is arguing that
increase the current flow of 9 gigalitres a year to 330 the opportunity cost of
gigalitres a year - that's 28 per cent of its original flow. diverting some of the Snowy
River flow is effectively zero,
"The Alliance wants the environmental decline of the river if the Murray-Murrumbidgee
and see it become a river that can sustain itself," Mr Collis irrigation system was repaired.
said. "Science tell us the minimum amount of water is 28 per
cent - it's not an ambit1 claim, it's backed up by science.
With that amount of water the Snowy will stop declining," Mr. Collis argues that the
he said. issue of water to the Snowy is
complicated by the Federal
Government's desire to
Beneath the surface privatise the Snowy River
Hydroelectric Commission -
At first glance the Snowy Valley doesn't seem to be doing that is to sell the Commission
too badly, particularly when compared to other isolated to private sector investors.
communities. The valley is still green well into summer. The Government would give
the new owners a 75 year water
Below Orbost, the river looks flush with water but that's
licence on the flow from the
mainly due to a back up of brine2 from the estuary. At Snowy River - if the Snowy
Marlo, the river has not so much a mouth, as pursed lips. Alliance does not act now, it
The tide is now inexorably driving a salt wedge up the 15 will be too late.
kilometres to Orbost and beyond. Upstream the flood
markers are largely ceremonial, serving as much use as
could be expected in a river missing 99 per cent of its flow. New South Wales
Government Treasury reports
Elsewhere, the key industries of the valley – pastoral
have estimated that 154
farming and forestry - have seen better days. Shops are gigalitres of water pumped to
closing up and the population is slowly drifting away to New South Wales farmers is
bigger regional centres. wasted due to poor quality
distribution systems and
Community Impact evaporation. Irrigation channels
are open to the air, and many
concrete channels are often
Out of 28 licenses along the floodplain, only five are still cracked, leading to seepage.
active. The salt intrusion from the sea has poisoned the Many irrigation channels are
opportunities of farmers in the lower reaches. With 800mm simply bare earth ditches,
of rain a year, the irrigation is used to top up summer crops. created by tractors digging a
The total irrigation on the Snowy is far less than held by trench in the soil.
many individual operators on the Murray and
Murrumbidgee.

ABARE (Australian Bureau of Agricultural and Resource Economics) has estimated that if
25 per cent of the flow was returned to the Snowy simply by opening a valve at Jindabyne,
water to irrigators would be cut by 3 per cent and power generating capacity by 7.5 per cent.

1
An “ambit’ claim is an “ambitious” claim – when you ask for more than you reasonably expect.
Having made the “ambit” claim, you then moderate your demands, hopefully ending up with what you
wanted in the first place.
2
“brine” is heavily salted water – more salty than normal sea water.

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But that does not take into account water gained by efficiency savings. Mr Collis said 330
gigalitres was not much water when compared with the volume set aside for irrigation. "Up
to 12,000 gigalitres is diverted for irrigation (and) 25 per cent of that is waste," he said. "So
in effect we have 3,000 gigs of water. We only want 330 gigalitres, so there's plenty of water
around."

Mr Collis' view is not necessarily accepted in Canberra.

Environment Minister and South Australian Senator
Federal Government reports
Robert Hill has famously described the Snowy campaign have calculated that in the ten
as a romantic notion. "What we know is without change years to 1997, on average 677
two days out of five, water in Adelaide will be above the gigalitres or 28% of all water
World Health Organisations standard," Senator Hill said. delivered to farms in the Murray-
"That's obviously intolerable and change has to be made in Murrumbidgee basin is lost before
it reaches the farm gate.
the next 20 years to ensure that doesn't occur - that's what
In some years, 40% of all water
this debate is all about. "If you make a decision now to was lost before it reached the
divert more water to the Snowy you reduce some of your farm gate.
options for the Murray in the future which you may wish
to take up."

But the Senator's argument doesn't sit well with Craig The reason for this is the poor
Ingram. "If you look at Robert Hill's comments - it's okay state of the irrigation
infrastructure, which has not been
for the Snowy to provide environmental flow for the properly maintained or improved.
Murray, but not the Snowy to provide environmental flow In the Sunraysia Irrigation System
for itself. That's one of the reasons why people down here (Mildura) area, losses are 17% on
voted for an independent rather than a party politician," Mr average. This is due to reliance on
Ingram said. simple channel irrigation. What is
needed is proper concrete pipes,
but in the Mildura-Robinvale area
The Australian Conservation Foundation's Tim Fisher isn't this would cost $300 million to
partisan3 in his support for the Snowy. He has campaigned complete.
for years for more water for both the Murray and Who is going to pay? The
Murrumbidgee Rivers. "The Snowy Scheme was irrigators? The Victorian and New
South Wales governments, or
constructed before an environmental scheme. It probably should the Federal Government
wouldn't get off the drawing board these days in terms of contribute as well?
environmental or economic benefits," he said. "There's Many irrigators are putting in drip
plenty of water, the water the Snowy needs is perhaps 10 irrigation systems on their farms,
or 15 per cent of inefficiency. "Just in delivery there is and can save 30% of their water
usage on farm. However, simply
considerable potential to improve irrigation farm practice relying on farmers to be more
and efficiency. Just those two alone means there is enough. efficient once the water reaches
The question is how much is it going to cost and who is their farms misses the point.
going to pay." There are huge losses of water
before the water reaches the farms
in question.
With the cost expected to be in the hundred of millions of
dollars, that's a good question.
Ingram and Fisher believe it should be split equally between the Victorian, New South Wales
and Federal governments, but to date the latter is not coming to the party. Senator Hill has
commissioned another inquiry and report. However, the issue has finally gained momentum.

The Snowy River is firmly on the national agenda, and it won't be easily brushed aside.

3
“partisan” means being a strong supporter of one side of an argument

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This whole sorry issue highlights the poor measurement of externalities, and poor
pricing of the water resource in Australia.

There has been too much focus on private costs and private benefits, and not enough
attention to the crucial importance of factoring into costs the costs of public infrastructure.

There has been little analysis of the distribution of costs and benefits, and the time frame of
costs and benefits.
Commissioning a report is a
good way for a politician to
appear to do something and do
nothing. There have been many
reports done already on the
Murray Darling basin.
What the Government is doing is
hoping the private sector will
economise water usage, through
market forces. Irrigators can
buy water licences - these give
you the right to pump water out of
the Murray / Murrumbidgee.
These licences can be bought and
sold, and many small irrigators
are selling their licences. Water
licences are being sold by farmers
who engaged in beef cattle
production (and who made profits
of $200 per megalitre of water
pumped) to horticultural /
viticultural farmers (grape
growers especially) who can
make profits of $1,200 per
megalitre pumped on their
production.
The Snowy Alliance points
Now there are major out that the Snowy River
issues with water Hydroelectric System is $1 billion
quality and salinity, in debt. Over the past twenty
which can now be years the Victorian and New
accurately measured. South Wales governments have
received $5 billion in dividends
from the System. The system has
But will South Australia not been improved - both
get a fair go? governments have taken more in
dividends than they should have,
one could argue.
The Federal government is not
interested in financially
supporting improvements in the
system - maybe they think the
Victorian and New South Wales
governments are responsible for
this mess, and they should pay,
not Canberra!

The new Deakin project in

Mildura wants to double the
irrigated land area around
Mildura. The local M.P. Russell
Savage is concerned. He notes
that irrigators' licence fees only
cover the cost of maintenance to
the new system, using current
methods of water distribution
(“furrows”, or open channels) and
that licence fees are not set at a
high enough level to pay for
improvements to the irrigation
system.
This is clearly unsustainable
agriculture.
Furrow irrigation raises the water
table and brings salt to the surface
of the land.
What is needed is dripper
irrigation and concrete pipes.

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Advanced Readings on Cost Benefit Analysis
Public and Private Goods

Private goods are rivalrous and excludable. A good is said to be ''rivalrous'' if the use
of it by one person prevents another person from using it. An apple is a ''rivalrous''
good; if I eat it, you cannot also eat it!

If people can somehow be prevented from consuming a good, then the good is
''excludable''. In a market economy, you can be excluded from consuming many
goods and services if you cannot pay for it. The price system is very effective in
excluding people from consumption.
However, you cannot be excluded from consuming a range of goods and services. For
example, if you live in one city and go on holiday interstate, you will enjoy the street
lighting provided by the government of that state. You have not paid for the electricity
that lights your way at night, but you cannot be stopped from using it. Street lighting is
a public good; it is non-rivalrous and non-exclusive. If we are both driving down a

5
road in Melbourne, the fact that I am enjoying the street lights to help me find my way
does not exclude you from using the same lighting at the same time.
The market system does not provide public goods, because it is difficult to make
consumers pay for them. Market failure occurs, as a result. Governments must provide
public goods; no one else will. The armed forces and the provision of defence are
examples of public goods. We all benefit from national security, regardless of whether
we are taxpayers or not.
Markets often fail: they do not produce the socially desirable level of production of
many goods and services. Governments attempt to correct market failure in a range of
different ways.
Why Modern Buildings Are Boring To Look At
One of the joys of travelling through Europe is to view and appreciate the beauty of the
buildings in cities like Paris. The architectural beauty of Paris provides a positive
externality for many firms operating in Paris, because the attractions of the city bring
in many tourists each year. These tourists spend money on accommodation, food and
transportation, amongst other things. Without the beauty of the city, these firms would
not gain as much revenue as they currently do.
A merit good is a private good with positive externalities; that is, a merit good
provides social benefits to other people. The architecture of Paris is a merit good.
A modern property developer undertakes the construction of new building because he
or she sees the potential for a private benefit: profit to the developer. Accordingly, the
developer incurs private costs to build the building. We may enjoy looking at beautiful
buildings, but a property developer cannot make us pay for looking at their building.
The developer may agree with you that a little extra money could have been spent, to
make the building look much more aesthetically pleasing, but who is going to pay for
it?
Markets provide goods at the optimal private level. They often under-provide at a
socially optimal level.

Governments can influence

the supply of buildings by
offering developers a
subsidy so that new
buildings are designed to
complement the styles of the
existing stock of buildings.
A subsidy lowers the price
of the building, and
increases the supply of them
in the market.
The government is assisting
society in gaining a positive
externality.

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In Adelaide and in many other cities, local councils are encouraging owners of
"heritage" listed buildings to keep using these buildings, and not to demolish them.
Subsidising the cost of repairs and maintenance of these buildings does this.

For example, if the owner of a "heritage" listed building decides it needs to be

repainted, the local council may provide him or her with free paint. (Usually the owner
must agree to repaint using the original colours first used on the building.)
In this way, the stock of old buildings is maintained.
We can show this effect in the diagram above. Instead of having qe heritage houses left
in a suburb, qs are maintained. The price of buying and maintaining a house has fallen,
because other people are assisting the owner in managing the house financially. This
fall in price is shown in the reduction in price from ps to pe.

Family Planning in the Developing World

The world currently has a

population of six billion.
One in every five people
alive today lives in the
People's Republic of China,
and one in every six people
lives in India. Both these
countries promote family
planning, and the benefits of
smaller numbers of children
per family.

Reducing the rate of

population growth, and, in
China's case, actually reducing the size of the total national population, reduces
adverse environmental impacts. In rural areas, the poor turn to marginal land for
farming. Often, poor villagers cultivate the slopes of hills, and erosion and
deforestation occur. Rivers become silted up, and other farmers are affected.

The Indian and Chinese governments promote family planning through mass
advertising. In this way, the demand for family planning services and contraception is
increased. The societies of both these nations can benefit from the positive externality
created by family planning promotion. Instead of qe of family planning services being
utilised by people in India or China, qs is demanded.

Leaded and Unleaded

Petrol

A demerit good is one that

has negative externalities.

The use of leaded petrol in

cars creates pollution.

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Lead can accumulate in the human body, and high levels of lead can lead to mental
retardation in children, and illness (such as liver failure) in later life. However, leaded
petrol is cheaper to make than unleaded petrol. Unleaded petrol is more expensive than
leaded governments encourage consumers to buy new cars, which use unleaded petrol?

By placing a tax on leaded petrol. This will decrease the negative externality created by
the use of leaded petrol. The quantity of leaded petrol demanded will fall from qe to qs,
and the price of a unit of leaded petrol will rise from pe to ps.

Smoking

Cigarette smoking is well known to contribute to cancer. Governments attempt to

reduce cigarette smoking by using taxation, and by educating people on the dangers of
smoking. In theory, the tax collected on cigarettes should cover the cost of the
additional health care
required by smokers and
cover the cost of the
education programs.

The effect of the tax will

shift the supply curve to
the left; and shift the
demand curve to the left as
well. Instead of qe
cigarettes being
consumed, now only qs2
will now be consumed.

Controlling Negative Externalities

There are three main ways of controlling negative externalities.

The first is to alter the market by taxing the good or service that is creating the
externality.

The second is to internalise the externality. This is done through a process called
extending property rights.

Everyone knows about the problem of green house gas emissions and the threat of
global warming. The use of ''fossil'' fuels like coal have significantly added to the
levels of carbon dioxide in our atmosphere. However, no one ''owns'' the atmosphere; it
is a public good. The developed nations of the world are the most industrialised, and
create most of the green house gas emissions.
Some developing countries, particularly in the Pacific, are facing rising sea levels that
will seriously damage their environment. Some small Pacific island nations are in
danger of being submerged!

One proposal that has been put forward is to create a system of carbon credits. Nations
would be allocated tradable ''certificates'', allowing them to generate a given amount of

8
carbon dioxide per certificate. The total number of certificates would be set at the level
of carbon dioxide emissions that would not cause carbon dioxide levels to rise any
further. The number of certificates would be allocated on the basis of national
population.

The United States of America has a population of 270 million, or about 4.5% of the
world's total population. The USA generates about 25% of all green house gases. India,
with 15% of the world’s population only generates 6% of total green house gas
emissions. (Six nations in the world generate just over half of all green house gases:
the USA, UK, the Russian Federation, Germany, Japan and Poland).

Many developing nations have small populations, and even smaller levels of
industrialisation. These nations would have more ''right to pollute certificates''
allocated to them than they would actually need. Other nations would not have enough.
An international market in carbon credits could be created; and these developing
countries could sell their carbon credits.

The money gained from the sale of carbon credits could be used to fund development
programs in these, poorer, nations.

''Right to pollute certificates'' would be sold on an annual basis, and the number of
certificates issued each year would decrease, thus increasing the cost of using polluting
technology. Industries in the USA, for example, would thus face higher costs each
year, increasing the incentive to adopt less polluting technology.

The system could be managed by the United Nations, supporters of the proposal have
argued. The scheme clearly puts the cost of pollution back on the polluters; the
externality has been internalised as part of the costs of production of the polluter.

Do you think it would be likely for this proposal to be adopted on a global basis?