09/04/2014 01:47 pm ET Updated Nov 11, 2014

Put Your Money Where Your Mouth Is

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"In this life, you get what you pay for..." one of the many great insights -- along with the importance of challenging moral norms and rebuking institutional inertia -- contained within the late Kurt Vonnegut's sardonically satirical Cat's Cradle. It's also the sentiment behind the Payments for Ecosystem Services (PES) approach to aligning the interests of people, planet, and profit. PES schemes are an innovative way of incentivizing communities and businesses to reduce pollution and conserve nature. Of course, Vonnegut didn't write about PES, but he did write about ice-nine -- a water pollutant so potent it caused mass extinction. By comparison, the pollution discussed here is less apocalyptic, but much more real.

The problem is simple. Society wants cheap food and safe, affordable drinking water, but run-off from livestock, pesticides and fertilizers pollutes rivers and lakes, raising treatment costs for downstream water providers.

The solution is not simple. While the costs of reducing agricultural pollution fall on farmers, the benefits accrue to water companies, meaning farmers have little financial incentive to invest in downstream water quality. Tighter regulations and fines on farmers might reduce pollution, but are politically contentious, could be costly to enforce, and may conflict with the cheap food paradigm. Meanwhile, subsidizing water treatment simply transfers costs from utility bills to tax bills. What can we do?

A fundamental principle in economics is that people respond to incentives: making polluting behavior more expensive should lead to behavioral change and lower pollution. This 'polluter pays principle' is the logic behind the myriad environmental taxes (think fuel, carbon, landfill) we see today. For many, the practice of making polluters pay also holds a certain moral appeal.

But is this really the best way to address our farmers vs. water companies' challenge? A cynic may point out that levying taxes simply creates an incentive to avoid paying taxes, which is not quite the same as incentivizing pollution abatement. And, as the eminent water scholar (and Laureate of the Stockholm International Water Prize) Tony Allan reminds us, "We don't live in economies, we live in political economies." Agricultural policies take time to develop and are ultimately the result of political, rather than environmental-economic negotiations.

Of course, the 'polluter pays principle' is useful in some contexts, which is why there's so much inertia behind environmental taxes, but it can only take us so far. Some problems need to be approached from a different angle.

The reality is that in most of our economic exchanges, the beneficiary pays. I benefit from food, entertainment and travel, and the idea that I should pay for them is not only morally acceptable, but is a key reason that businesses make these goods and services available.

Does this apply to our problem? Water companies benefit from cleaner water, but should they have to pay farmers not to pollute? There's something discomforting about the idea. Should I also pay criminals not to shoot me? We're certainly challenging moral norms.

Perhaps unsurprisingly, avoiding pollution in the first place is often much cheaper than cleaning it up afterwards. If the costs to farmers of reducing run-off are lower than downstream treatment costs, water companies have a legitimate business case to reduce costs by paying farmers to reduce pollution. And, because farmers would be compensated for their efforts, both the cheap food and affordable water criteria could be satisfied (see New York City and the Catskills Watershed or French mineral water company Vittel).

But setting up a watershed-wide PES scheme introduces it's own set of costs and challenges. The Vittel case, for instance, required 10 years of negotiations. There are questions of enforcement: what happens if one party reneges on the deal? Moreover, how can we be sure that money spent on PES achieves maximum value for money?

These are the questions that inspired a group of environmental economists, led by Professor Brett Day at the University of East Anglia, UK, to team up with a private water company (South West Water), an NGO (the Westcountry Rivers Trust), and farmers along the River Fowey in Cornwall, UK. The group wanted to find a way to minimize the impact of farming on water ecosystems -- a goal that benefits people, planet, and profit -- and decided to use a PES scheme, but with one exciting twist. See the project's excellent video.

What made this scheme especially innovative was the use of a competitive auction. In summer 2012, South West Water made £360,000 ($600,000) available to farmers for capital investment in farm infrastructure to improve water quality as part of its Upstream Thinking Initiative. One hundred fifty farmers upstream of the treatment facility were invited to submit sealed bids requesting up to £50,000 ($83,000) for on-farm capital investments that would improve water quality (e.g. improving manure/slurry storage facilities, new fencing, livestock crossing). The auction was open for 6 weeks and had 3 rounds. After the first and second rounds, farmers were given feedback on how to make their bid more competitive. In total, 42 bids were received, requesting a total of £776,000 ($1.2 million) and 18 were funded.

The auction approach facilitated much faster implementation: the scheme was devised and implemented within 6 months. Moreover, by combining healthy competition with feedback between rounds of the auction, farmers were able to work with advisers to reduce the size of their grant requests, increasing South West Water's value for money.

We should be skeptical though of anything that sounds too much like a 'win-win'. Whereas case studies and in-depth analyses suggest the project will very likely improve water quality and reduce treatment costs, gathering sufficient evidence for impact assessment will take years. More important though is the fact that other beneficiaries, e.g. recreational visitors, don't contribute to the scheme. This means the amount available to farmers, and therefore the incentive to improve water quality, is too small. Society would likely benefit from even further improvements to water quality, which is why ongoing research at UEA is exploring mechanisms to include public funding in similar schemes in the future.

PES is no panacea, but it can be an efficient tool for aligning incentives to benefit people, planet, and profit. But this means challenging moral norms, overcoming institutional inertia, and that perhaps, in this life, you get what you pay for.

This blog post is part of the Plan B for Business series produced by The Huffington Post and The B Team community to help articulate a Plan B for Business. To see other posts in the series, click here. For more information about The B Team, click here.