Agri-environmental externalities: a framework for designing targeted policies

Abstract

The optimal provision of agri‐environmental externalities is studied in a model of endogenous input use and land allocation augmented by their effects on biodiversity, landscape diversity and nutrient runoffs. Whereas biodiversity and landscape diversity are public good aspects of agriculture, nutrient runoffs are negative externalities. We show that fertiliser use is higher and the size of buffer strips lower at the private optimum than at the social optimum. The socially optimal land allocation differs from the private solution as a result of the valuation of diversity benefits and runoff damages. The socially optimal policy under heterogeneous land quality involves a differentiated fertiliser tax and a differentiated buffer strip subsidy. We use Finnish data to characterise empirically the socially optimal design of policy instruments.