Nitrogen emissions are a significant source of water pollution, contributing to eutrophication and oxygen depletion in marine sediments. Multiple sectors, including aquaculture and agriculture, contribute to the problem, but regulations and policy instruments are typically sector-specific, leading to inefficient outcomes. This paper investigates the potential of an innovative auction-based mechanism to enhance the regulation of nitrogen emissions within the aquaculture sector, while accounting for costly emission reductions in the agricultural sector. We utilize detailed panel datasets from the Danish aquaculture and agriculture sectors to empirically simulate and evaluate the cost-effectiveness and potential welfare benefits of the auction mechanism. The abatement cost and damage functions for the aquaculture sector are estimated using farm-level economic data and aggregated to the catchment level. For the agricultural sector, catchment level costs and benefits from abatement are derived from the Danish TargetEcon model. The findings reveal that the auction mechanism leads to a higher overall welfare compared to existing regulatory frameworks, as the benefits from avoided environmental damage and revenue generated by the auction exceed the losses in farm profits.
Our findings demonstrate that the auction mechanism can achieve lower abatement costs than traditional sector-specific regulations while generating revenue that could be reinvested in sustainability measures—such as support for recirculating aquaculture systems (RAS). By incorporating sectoral cost asymmetries and the nonlinear nature of nitrogen damages, the mechanism provides a flexible, incentive-compatible tool that reduces information asymmetry, particularly within the aquaculture sector.
Keywords: Auction, Environmental regulation, Externality, Information asymmetry; Mechanism design, Nitrogen emission