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Purpose of this talk. To illustrate the use of economic tools in natural resources damage assessmentTo introduce briefly economic valuation methods, in particular the contingent valuation method. Part I: Natural resources damages. . Externality. Pigou defined (1918) the concept of an externality as
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1. Environmental economics and valuation - Afternoon IA Summer School
25-31 July, 2004
Philippe Polomé
2. Purpose of this talk To illustrate the use of economic tools in natural resources damage assessment
To introduce briefly economic valuation methods, in particular the contingent valuation method
3. Part I: Natural resources damages
4. Externality Pigou defined (1918) the concept of an externality as the effect of someones action on someone else
In the absence of corrective action, a negative externality will lead to a socially unsatisfactory outcome. Markets will fail to produce an efficient outcome.
The remedy that Pigou identified was what we now call the polluter pays principle: the polluter should pay for the damage he causes to others.
5. Non-market valuation Placing a monetary value on the damages caused by pollution is an exercise in non-market valuation
It seeks to measure in monetary terms the value that people place on items that they care about.
It has been used in the context of
Cost-benefit analysis
Setting effluent taxes
Calculating natural resource damages
6. Natural resource damages Monetary measure of the damage from specific acts of pollution.
Some key questions:
What acts trigger payment?
Who is required to pay?
Who is entitled to receive payment?/ What is done with the money that is paid?
How does one calculate the amount to be paid?
7. Purpose of the payment Three possibilities:
Compensation for the damage that has been caused.
Punishment for negligence.
Incentive to others: influence potential future polluters to make them more careful.
Our interest is in the compensation
Payment could be different if we had other purposes
8. What damages are covered? Given the goal of compensation, what damages are covered?
Legal systems have traditional concepts of damages, such as:
damage to goods and property
loss of income
personal injury, loss of life
loss of use and enjoyment (of property...)
pain and suffering (loss of wellbeing)
But these concepts do not adequately account for damage to the environment caused by pollution because:
There is no owner ? no-one has standing to sue for damages.
The damages fall outside the (above) conventional categories. They are typically non-pecuniary, and involve non-human victims.
9. Natural resources damages The law creates the concept of a public claim for damages, separate from the private claims.
CERCLA (1980) and OPA (1990) in the US
The current Council regulation in the EU (postponed!) may play the same role (proposal 2003/0209 AVC)
Both legislations create a maximum liability of about 1 billion (instead of 200 M at the time of the Prestige accident) through the creation of a fund for compensation.
Each fund is financed by oil receivers worldwide which are established in the EU or in the US
Incentives
Clarifies the responsibilities
10. Natural resources damages II The US law makes the government a trustee for the natural resources that are harmed, and gives it standing to sue for damages.
The proposed EU legislation may also act in this way
The consequence is that the government can (and should) claim any damages not covered by private claims, with or without the consent of the affected landowners (if any)
What damages can be claimed?
Damages for injury, destruction or loss of natural resources resulting from the release (including lost non-use and lost recreational)
Costs of cleanup, removal, remediation
Any other necessary response costs, including the costs of the damage assessment
11. Calculation of the damages Replacement cost
Based on conventional (private) damage: if you break my car, you have to replace it
Flawed approach: it is not possible to replace lost wildlife on a scale such as caused by an oil spill
Value of injuries
Based on economic valuation methods such as contingent valuation, travel cost, hedonic pricing, ...
The focus is on compensating
Restoration cost
Based on an explicit plan (case-by-case basis)
Includes at least clean-up + possibly specific actions for recovery of ecological services to an equivalent level or create an equivalent to the lost ecosystem
Currently the preferred approach both in the EU and the US
12. The lesser of rule Principle of law: The correct compensation for a private loss is the lesser of
what the lost item was worth to its owner
what it would cost the owner to replace the item
Economic efficiency prescribes the same: Inasmuch as the restoration cost is less than the value of injuries, it is the proper economic value
However, both the EU and US experiences indicate a preference for restoration
13. The role of non-market valuation Compensation for interim loss
Restoration takes time
In the meantime (which can be decades), the patrimony is not available
Justifying the cost of the restoration plan
Calculate compensation for recreational losses and other human uses
The restored area may not be quite the same regarding human uses (restoration is not replacement)
Yet human uses have substitutes so this is a tricky subject
32. Part II: economic valuation
33. Economic notions of value: WTP WTA Basic assumptions:
Individual preferences can be represented by a utility function U(z, y), z = environmental quality, y = income
The proper basis for social preferences is aggregation of individual preferences
Let ?z+ > 0 and ?z- < 0 an environmental improvement/deterioration
U(z, y) = U(z+?z+, y-WTP) max amount to secure an improvement
U(z +?z-, y) = U(z, y-WTP) max amount to avoid a deterioration
U(z+?z+, y) = U(z, y+WTA) min amount to forfeit an improvement
U(z, y) = U(z+?z-, y+WTA) min amount to compensate a deterioration
34. Differences between WTP and WTA Different property rights
More difficult to elicit WTA than WTP
In damage assessment, we often seek compensation (=WTA): a loop is needed, for example
Value of restoration = value of interim loss
WTP to prevent any further release until restoration complete (Exxon-Valdez)
35. Traditional structuration of value
Economic value (WTP, WTA) is the total value
Decomposition is arduous
Natural resources damages refers only to non-private damages
36. Valuation methods Revealed preferences methods
Market pricing
Under certain condition the price can be considered the marginal WTP for an item
Travel cost method
Travel is complementary to the environmental quality of the destimation site
Hedonic pricing
Amenities influence the price of certain market goods, e.g. houses
Other less common techniques
Stated preferences techniques
Contigent valuation
Stated choice methods
Group valuation
37. Revealed vs. stated preferences methods Both types are based on surveys!
Revealed preferences
Are often considered more reliable
Demand cut-off point is hypothetical
What about those who do not participate
Can become complex as substitution relations are taken into account
Sometimes may allow to pin-point specific damages, e.g. lost recreational fishing trips
Stated preferences
Are sensitive to survey design
Very flexible/versatile
Only techniques capable of eliciting the total value
38. Contingent valuation Probably the most commonly used valuation method (>2000 papers in 2000)
In the US, can be used to present estimation of damages in court. In the EU, the proposed legislation may follow that way.
Principle: ask a sample of people how much they value an item ? tricky question for natural damages
Why should people answer such an unusual question in a meaningful way? Valuation scenario
Phrasing/format
Payment vehicle
Sample
Biases
39. Contingent valuation: Valuation scenario In a CV survey, the respondents are asked to choose their preferred scenario regarding some future government course of action.
Example: Exxon Valdez spill (1989), choose betweena tanker escort ship program + some extra tax, orno escort ships but a new spill like the Exxon Valdez
Choose between the baseline (do-nothing) scenario and the alternative (do-something)
Each alternative must be carefully described
The scenario must be credible
Need not exist in reality but as a possibility
Must be understandable and described in details (visual aids...)
Must have some cost
40. Contingent valuation: Phrasing/format Posted price principle
Simpler cognitively (as in for market goods)
Dichotomous (or binary) choice
Answer can be Yes/No/Dont know/Abstain
Referendum situation
Place respondents in a situation in which it seems natural to interact with government policy
The respondent should feel his vote matters!
Should the referendum be explicit?
41. Dichotomous choice CV: Bid design Consequence of the referendum format
Need several bids over the sample
Bids must be informative
How do we know what bids to use beforehand?
Focus groups
Sequential design
42. Contingent valuation: Payment vehicle The justification of the respondents payment is the cost of the programme, but there is no need that it bears a resemblance to the actual cost
How is the respondent going to pay?
Tax (preferably local to be credible)
Combination of increased prices of some market goods
e.g. if oil receivers are obliged to use double hull tankers to deliver oil in the EU, the price of oil in the EU may increase
Should payment be one-time or continuing for a period of time?
43. Contingent valuation: Sample What is the population of interest?
The value of the damages will depend very much who is considered to be affected
Exxon Valdez
Trial between Exxon and the governor of Alaska
The sample used for CV on non-use value refered to the whole US population
This is a consequence of the notion of natural patrimony and non-use value: Alaskan environment belongs to all the US citizens and the states government is a trustee to the general public
Prestige: should the lost value of Finnish citizens be accounted for?
Sample must be simple (all the members of the affected community must have the same probability to be interviewed, no on-site sample)
44. Contingent valuation: Potential biases The survey must be consequential
Inconsequential surveys produce random answers
The respondents must answer with their own preferences (symbolic response bias)
The focus of a valuation survey is on individual preferences
Avoid placing the respondent in hte skin of someone else e.g. what I would do if I was in the government
45. Contingent valuation: Tests Compliance with the NOAA Panel Guidelines
In-person interviews (although mail surveys couls be acceptable)
Dichotomous choice format with no-vote option
Careful description of the good and its substitutes (face validity)
Price sensitivity (the higher the bid the lower the proportion of Yes answers)
Scope: does the WTP increase when the amount of the good increases?
Usually difficult to test
Debriefing: why did the respondent answer the way he did?
Interviewers effect and protests should be examined
Sample size must be several hundreds at least
Probability of Yes equation should have several significant explanatory variables
46. Dichotomous choice CV: Estimation issues Dichotomous choice CV ? Dichotomous choice models
Usually parametric: Prob{Yes} = F(xb + bidg)
F probability distribution function
Should accomodate for a spike at zero
Care with distributions with fat tails (e.g. logistic)
Distribution of WTP is F, often asymmetric
Mean
Median
Reference: Haab and McConnell. Valuing Environmental and Natural Resources Edward Elgar, 2002
47. Working session: The trial of the Prestige spill We simulate a trial of spill: You have to convince the jury (Dolf and I) of your claims! The goal is for the claimants to obtain the highest possible compensations.
Group 1: the defendant (Insurance company), your job is to discredit the other groups evidence
Group 2: private claimants/stakeholders (mostly fisheries)
Public claimant divided in two groups, the quality of their evidence is the quality of their CV (see below)
Group 3: Deep sea natural resources (lot of uncertainty, possible irreversibility, very high cost)
Group 4: Coastal and surface natural resources (likely complete recovery in 2 to 12 years)
Design a CV for natural resource damages
Based on the morning sessions, what are the damages? Differentiate from private claims
Frame the valuation question
Choose a payment vehicle
What is the sample you would like?
Write out the important questions explicitly
... any good idea you may come up with