Overview of costs and benefits associated with regulation in Scottish agriculture

1. Introduction

1.1 Background

Given the range of public goods and externalities associated with land management and the level of support payments available to farming, some regulation of agriculture is inevitable to ensure social benefits. However, the farming industry has claimed that the amount of regulation is disproportionate when compared with the level of risks and public expenditure. Whilst claims such as "Red tape may be final straw for Scots farming" (Buglass 2007) are clearly overheated, they do reflect popular concern to put "common sense back at the heart of the government's approach to European regulation" (National Farmers' Union of Scotland 2006).

Yet regulation serves a purpose since it is "the supervision and control of the economic activities of private enterprise by government in the interest of economic efficiency, fairness, health and safety" (Bannock et al; 2003, p329). Hence the magnitude and distribution of regulatory burdens need to be viewed against the social benefits delivered, and against alternative means of overcoming various forms of market failure. It is also important to acknowledge different aspects of regulatory requirements since administrators are charged with meeting a number of operational criteria. These include achieving desired outcomes in a cost effective manner but also managing regulation in an equitable, transparent and accountable manner (e.g. Stigler 1971; Stiglitz 1986; Laffont & Tirole 1993; Gunningham et al., 1998; Conlon, 2005).

Nevertheless, concerns over the potential adverse effect of regulatory burdens on businesses and their competitiveness have prompted increasing attention to achieving "Better Regulation". For example, at the European level, this is typified by the Lisbon agenda in setting the goal for the EU to become the most dynamic and competitive, knowledge-based economy in the world. Equally, at the UK level, the Hampton Review focused on reducing administrative burdens and promoting efficient and effective approaches to regulatory inspection and enforcement. At the Scotland level, Scotland's Environmental and Rural Services ( SEARS) ¹ represents an important contemporary initiative, providing easier access to information as well as co-ordinating and reducing the numbers of separate inspections and reducing the burden of information provision to lower administrative costs to farms and other rural businesses.

This report seeks to contribute further towards understanding of agricultural regulation in Scotland and has the following objectives:

• To describe the regulations associated with Scottish agriculture
• To provide an overview of the methodology for assessing costs and benefits of regulation in agriculture in Scotland, including a critique of the standard cost model
• To assess the costs and benefits associated with key regulations in Scottish agriculture and with specified environmental regulations
• To identify best practice in the implementation of regulations in agriculture in other countries
• To identify areas where there are opportunities to improve the effectiveness of regulation in Scottish agriculture.

1.2 Rationale for policy intervention in agriculture

As a production activity, agriculture represents a small but significant component of the Scottish economy, accounting directly for over £2bn of output and 50k jobs nationally ( SG, 2008). Reflecting linkages between agriculture and other parts of the economy, these direct effects are amplified by indirect and induced multiplier effects - estimated at 1.8 for output and 2.0 for employment - further increasing agriculture's contribution ( SG, 2007).

Beyond these market effects, agriculture also generates non-market effects throughout the economy in the form of externalities and public goods. These include positive benefits such as contributions towards the maintenance or enhancement of aesthetic landscapes, biodiversity and rural cohesion (Slee et al., 2001; Moran et al., 2004). However, agriculture also generates significant negative effects in the form of environmental damage such as air and water pollution and habitat degradation (Pretty et al., 2001 & 2005). Equally, individual (in)action with respect to biosecurity can lead to the spread of infectious animal diseases, imposing external costs on others (Stott, 2003; Sumner et al., 2006).

The existence of externalities and public goods associated with agriculture reflects a divergence between private and social costs and benefits. This may merit public intervention in order to improve outcomes for society, provided that the costs of intervention do not outweigh the benefits gained. In addition, the distribution of gains and losses is typically uneven across different groups within society and political acceptability is also an important determinant of interventions (Gunningham et al., 1998; Goulder & Parry, 2008).

1.3 Instrument choice & design

Whilst a wide range of instruments exist for interventions to correct market failures, they may crudely be characterised as information provision, incentives or classic "command & control" regulations (Stiglitz, 1986; Bemelmans-Videc et al., 1993). That is, farming activities can be guided, rewarded and/or mandated. Some examples are offered in Tables 1.1 and 1.2.

Table 1.1 Examples of policy instruments

	Information and education	Incentive-based structures	Classic regulation and its variants
Types of intervention	-Govt-provided info -Reporting requirements -Technical/quality standards -Naming and shaming	-Creating markets; Tradable permits/quotas -Price caps; targets -Taxes -Rewards: tax credits/subsidies /awards	-This covers a wide range of statutory measures, often backed up with monitoring, enforcement and sanctions, e.g.: prohibiting activities, prior permissions, etc.

Table 1.2 Examples of intervention responses to agricultural problems (MacLeod & Bevan 2007)

Problem	Cause	Response
Poor bathing water quality resulting from farm pollution	Negative externality: the full social cost from farm pollution is not internalised by the polluter.	Bathing Water Directive Nitrates Directive Water Framework Directive
Maintaining high value farmed ecosystems	Positive externality: the value of the biodiversity gain to society due to grazing is not received by the farmer	Payments to farmers in Natura 2000 sites ( EU protected areas) for carrying out agreed actions
Public health problems arising from dietary choices	Informational Failure: the consumer has limited understanding of the nutritional value of foodstuffs	Introduction of "Traffic light labelling" and public awareness campaign

Although official guidance stresses the need for any policy intervention to demonstrate additionality and a positive cost-benefit effect for society ( HMT, 2003), the choice between different classes of instrument depends on a number of factors. These include effectiveness at delivering net gains to society, but also the transaction costs of implementation plus the distribution of impacts across different groups in society (Laffont & Tirole 1993; Gunningham et al., 1998; Hepburn, 2006; Goulder & Parry, 2008; Pannell, 2008).

Information provision can address instances of market failure where individual and collective decisions are poor due to a lack of awareness, and private and social outcomes can be improved jointly in a "win-win" situation. However, relatively few externalities fall into this category and the effectiveness of information provision alone is typically limited. However, it is usually deployed in support of other instruments as part of a policy mix.

In general, incentives offer potential efficiency gains by requiring relatively less information and allowing greater flexibility and innovation than that offered by uniform regulatory controls. However, environmental and animal health outcomes often exhibit threshold effects beyond which damage increases rapidly or becomes irreversible. In such cases, regulatory controls may offer greater assurances that minimum standards will be observed and maintained than under voluntary responses to incentive schemes. Moreover, the administrative costs of monitoring actual outcomes can be significantly higher than simply observing mandatory management practices. Consequently, whilst incentives are typically deployed in pursuit of positive non-market effects, regulation is used more often as a cost effective means of reducing negative effects.

1.4 Compliance costs

The purpose of regulation is to pursue social benefits, to enhance positive externalities and reduce negative ones. In so doing, costs will be incurred as resource usage adjusts to better reflect a socially desirable pattern. Such costs fall into two main classes: administrative costs and policy costs. The policy cost is defined as the cost of changing inputs, outputs or processes in order to comply with a regulation. The administrative cost is the cost of undertaking administrative tasks required to comply (e.g. familiarisation, recording and providing data, cooperating with inspections).

The administrative costs are the "transaction" costs of implementation, and include public administrative costs but also farm administrative costs. For example, on-site inspections to establish baselines and monitor adherence to prescribed practices or achievement of specific outcomes require staff time and record keeping on both sides. Such transaction costs can be significant and are the focus of a number of initiatives, including the Standard Cost Model ( SCM) detailed in Chapter 2 and, in Scotland, SEARS. For the latter, significant effort has already been expended under Phase 1 to identify public and (especially) private administrative costs and ways in which they can be reduced by combining and streamlining a number of information and inspection functions across several public agencies without recourse to legislative change. This has been welcomed by stakeholders, and will continue under a planned Phase 2 that may also consider options requiring legislative change (pers. comm. SEARS team).

Second, whilst there may be administrative costs of complying with regulatory controls, there will also be other compliance costs associated with changes in actual productive activities - these are the policy costs. For example, for regulatory controls couched in terms of environmental or biosecurity performance, farms may respond in one of three ways: by adopting different inputs (e.g. different fertilisers or livestock breeds); and/or using a different technology (e.g. slurry treatment or vaccines); and/or reducing output (e.g. lower yields or stocking densities; ceasing production).

For regulatory controls couched in terms of specific practices or technology standards, the degree of freedom for flexibility in responses will typically be less. In either case, whilst aggregate social gains may be achieved, each of the response options may impose losses at the individual farm-level in the form of additional costs incurred and/or income forgone.

However, the magnitude of these losses is highly context-specific and thus difficult to determine a priori. For example, in some cases, if production and marketing systems were previously inefficient, regulatory standards may potentially improve farm profitability through encouraging better management and opening new market opportunities ( the "Porter hypothesis" - Porter & van de Linde, 1995). Equally, dynamic adjustment may deliver previously unknown efficiency gains through innovation or allow some costs to be passed along the supply-chain. Conversely, whilst scope for improvement may be present in many cases, constraining the production choice of any already relatively efficient farm will necessarily result in a net (private) cost - especially given the price-taking nature of most individual farms leaving little scope for passing additional costs on.

Unsurprisingly, given these different perspectives, empirical evidence for the impact of regulations on business competitiveness is mixed. Yet, notwithstanding some data limitation problems and a relative lack of agricultural-specific studies, a general finding is that ex ante, static estimates often exaggerate the costs to industry. That is, whilst counter examples are possible, dynamic adjustment and innovation often deliver lower compliance costs and, moreover, other factors (e.g. labour costs) are often more important to overall competitiveness (Adams, 1997; Heinzerling, 1998; Sheldon, 2006; Ackerman, 2006; Cole & Elliot, 2007; Pasurka, 2008).

Nevertheless, it is acknowledged that regulatory burdens are an important issue and that attempts should be made to reduce them wherever possible and to establish the benefits of retaining them. Hence a number of high-profile initiatives have focused on improving regulatory quality to better balance effectiveness against the inevitable administrative and compliance costs (e.g. BRTF, 2005; CES, 2005; Hampton, 2005) and official guidance stresses the need for impact assessment to examine the balance of costs and benefits (e.g. HMT, 2003; BRE, 2008). Where regulatory requirements are derived from European or International obligations, whilst valuation of benefits may contribute to attempted renegotiations, short-term analysis may legitimately focus on cost effectiveness - seeking the least costly way of complying with an external standard.

1.5 Scope of report

This report does not estimate specific regulatory burdens nor present comprehensive cost-benefit analyses of individual regulations. Rather it presents an overview of agricultural regulation in Scotland in order to highlight possible areas for improvement in both regulatory design and in deployment of the analytical framework for judging costs and benefits.

Selection of Case Studies

The selection of case studies involved three steps. Firstly, an initial list of regulations associated with Scottish agriculture was generated, based on a literature review and the team's experience. This was reviewed by policy officials in the Scottish Government and a long list of 102 arrived at. Secondly, this was reduced to an interim list of 35 ( see Appendix A) by focusing on regulations that (a) lie within the Scottish Government's ambit, (b) are specific to agriculture and (c) affect on farm operations. The list of 35 was reviewed by the project steering group. Thirdly, a final list of 12 case studies was drawn up using the following criteria:

• a significant proportion (i.e. >50%) of the case studies should be on regulations for which there is potential for inefficiency (i.e. where costs>benefits) or which were perceived to be problematic (see e.g. MacLeod and Bevan (2007); Scottish Parliament (2006a, 2006b; Ambler and Chittenden 2007 p21); Davidson (2006); Pearce (2004).
• the case studies should cover a mixture of agricultural sectors.
• four specific environmental protection regulations are to be included (Water Environment (Controlled Activities) (Scotland) Regulations 2005; SSI 2003 No. 51 The Action Programme for Nitrate Vulnerable Zones (Scotland) Regulations 2003; SSI 2000 No. 323 The Pollution Prevention and Control (Scotland) Regulations 2000; The Control of Pollution (Silage, Slurry & Agricultural Fuel Oil) (Scotland) Regulations 2001, 2003).
• the case studies should be spread across the main policy areas of agricultural regulation.
• the case studies should include a range of different regulatory measures and reasons for intervention.
• the case studies should provide a mixture of regulations where (a) the SG is legally obliged to legislate (i.e. because of EU law) and (b) where the SG is not legally obliged to legislate.

The overall aim was to cover a broad spectrum of regulations, rather than focus on regulations that were all of one type (i.e. all the regulations that were seen as problematic by the industry or the regulations with the highest admin costs). In addition, some of the criteria proved difficult to meet. The range of policy areas covered was constrained by the fact that the SG main remit in terms of farm-specific regulation is in the areas of: (a) farm payments/rural development; (b) environmental protection; (c) animal health and welfare. Employment legislation tends to be outwith the SG remit and not farm specific, while food safety tends to be off-farm. Achieving a range of different measures proved difficult as most of the regulations on the short list were classic regulation. The final list of regulations and the reasons for their selection are outlined in table 1.3.

Table 1.3 Final list of case studies

Policy Area	Regulation	Enabling Legislation	Reasons for selection
Agricultural support/rural dev	1. Scottish Statutory Instruments 2004 No. 518 The Common Agricultural Policy Schemes (Cross-Compliance) (Scotland) Regulations 2004	Regulation ( EC) No. 1782/2003 and Commission Regulation ( EC) No. 796	Significant costs (admin and social), high profile regulation, widespread impact.
	2. Scottish Statutory Instruments 2005 No. 225 The Land Management Contracts (Menu Scheme) (Scotland) Regulations 2005	Council Regulation ( EC) No. 1257/1999(55)	High profile regulation, widespread impact. Potential to identify lessons for LMO's
Pollution control/ habitats and natural heritage/waste	3. SSI 2005 No. 348 Water Environment (Controlled Activities) (Scotland) Regulations 2005	Directive 2000/60/ EC of the European Parliament; Water Environment and Water Services (Scotland) Act 2003	Suggested by SNIFFER/ SEPA
	4. Scottish Statutory Instrument 2003 No. 51 The Action Programme for Nitrate Vulnerable Zones (Scotland) Regulations 2003	EC Directive (91/676/ EEC); Statutory Instrument 1996 No. 1564 (S.137)	Suggested by SNIFFER/ SEPA Cited as problematic, high profile
	5. SSI 2000 No. 323 The Pollution Prevention and Control (Scotland) Regulations 2000	Council Directive 96/61/ EC; Pollution Prevention and Control Act 1999	Suggested by SNIFFER/ SEPA Cited as problematic, significant admin costs; covers intensive farming
	6. The Control of Pollution (Silage, Slurry & Agricultural Fuel Oil) (Scotland) Regulations 2001, 2003	UK Control of Pollution Act 1974	Suggested by SNIFFER/ SEPA
	7. Statutory Instrument 1989 No. 1263 The Sludge (Use in Agriculture) Regulations 1989	Council Directive No. 86/278/ EEC	Evidence of inefficiency, non- EU origin
Animal health and welfare	8. Disposal of fallen livestock under The Animal By-Products (Scotland) Regulations 2003 ( SSI 2003/411)	EU Regulation ( EC) No 1774/2002	Evidence of inefficiency, cited as problematic
	9. Scottish Statutory Instruments 2007 No. 559 The Sheep and Goats (Identification and Traceability) (Scotland) Amendment Regulations 2007	Council Regulation ( EC) No 21/2004	Evidence of inefficiency, cited as problematic, high profile opposition
	10. Scottish Statutory Instrument 2005 No. 434 The Tuberculosis (Scotland) Order 2005	UK Animal Health Act 1981	Example of non- EU origin regulation
	11. Scottish Statutory Instrument 2006 No. 530 The TSE (Scotland) Regulations 2006	Regulation ( EC) No. 999/2001 of the European Parliament	Significant admin costs, cited as problematic
	12. Scottish Statutory Instrument 2006 No. 606 The Welfare of Animals (Transport) (Scotland) Regulations 2006	Council Regulation ( EC) No. 1/2005	Cited as problematic