Valuing the environment Required reading: Perman et al (2 nd edition) Chapter 14

1. Valuing the environment Required reading: Perman et al (2nd edition) Chapter 14 Markandya, A. “The value of the environment: a state of the art survey” Hanley, N. and Spash, C. (1993): Cost-benefit analysis and the environment

2. Dimensions of environmental value Four categories of service that the natural environment provides for humans and their economic activities: ·  resource inputs to production by firms · sinks for production and consumption wastes · amenity services to households, A ·  life support services for firms and households, L

3. Categories of environmental benefit Use Value (UV): from the actual and/or planned use of the service; Existence Value (EV): from knowledge that the service exists and will continue to exist, independently of any actual or prospective use by the individual; Option Value (OV): relates to willingness to pay to guarantee the availability of the service for future use by the individual; Quasi-option value (QOV): relates to willingness to pay to avoid an irreversible commitment to development now, given the expectation of future growth in relevant knowledge.

4. Total value (TV) is the sum of these four sorts of value across all of the affected individuals: TV = UV + EV + OV + QOV  Other terminology TV = UV + NUV or TV = UV + PUV where NUV stands for Non-Use value and PUV for Passive Use value. What matters is that we count up all relevant things.

5. Environmental valuation techniques Key principles of conventional methods: 1. THE BASIS OF VALUATION OF ENVIRONMENTAL GOODS AND SERVICES IS INDIVIDUAL PREFERNCES: THE IMPACTS THEY HAVE ON INDIVIDUALS UTILITIES, AS MEASURED BY THE INDIVIDUALS THEMSELVES 2. ENVIRONMENTAL “GOODS” ENTER INDIVIDUAL’S UTILITY FUNCTIONS (OR PREFERNCE STRUCTURES) IN SAME WAY AS OTHER GOODS OR SERVICES

6. Environmental valuation techniques (A) INDIRECT METHODS The travel cost method Hedonic pricing (B) DIRECT METHODS Contingent valuation  There are others; we will not consider them.

7. The travel cost method (TCM) First assumption: visits to a “site” are determined by a trip, or visit, generating function Vi = f(Ci, X1i, X2i,.....XNi) where Vi is visits from the ith origin or by the ith individual Ci is the cost of a visit from origin i or by individual i The X’s are other relevant variables.

8. The travel cost method The second assumption is that the cost of a visit comprises both: travel costs Ti, varying with i admission price, P, constant across i and that visitors treat travel costs and the price of admission as equivalent elements of the total cost of a visit (so responding in the same way to increases/decreases in either).

9. THE TCM TECHNIQUE • If we assume that the function f( .) is linear in costs, and suppress the role of other variables, the equation to be estimated is • Vi =  + Ci + i =  + (Ti + P) + i • where i is a random component, assumed to be normally and independently distributed, with zero expectation. • Note that in many cases of interest P is zero. • and  can be estimated from data on Vi and Ti and used to figure the effects on visits of hypothetical changes in P. From this, we can derive a demand function for the site, and from that figuring a monetary measure of the utility of the recreational amenity with free access.

10. Some TCM problems Functional form Estimation Substitute sites Travel cost measurement

11. Contingent valuation (CVM) A direct method that involves asking a sample of the relevant population questions about their WTP or WTA. It is called 'contingent valuation' because the valuation is contingent on the hypothetical scenario put to respondents. Its main use is to provide inputs to analyses of changes in the level of provision of public goods/bads, and especially of environmental 'commodities' which have the characteristics of non-excludability and non-divisibility.

12. Contingent valuation: pros and cons • CVM is seen by many economists as suffering from the problem that it asks hypothetical questions, whereas indirect methods exploit data on observed, actual, behaviour. • On the other hand, the CVM has two advantages over indirect methods: • First, it can deal with both use and non-use values, whereas the indirect methods cover only the former. • Second, and unlike the indirect methods, CVM answers to WTP or WTA questions go directly to the theoretically correct monetary measures of utility changes.

13. WTP and WTP: Which is the correct question? The answer to this question is really a statement about the entitlements assumed. Thus, asking about WTP for an environmental improvement implies that the individual is entitled to the existing level, as does asking about WTA compensation for a deterioration. Asking about WTA compensation for a possible environmental improvement not actually occurring implies an entitlement to the higher level. Asking about WTP to avoid an environmental deterioration implies only an entitlement to the lower level.

14. The steps involved in applying the CVM: (1) Creating a survey instrument for the elicitation of individuals' WTP/WTA. This has three components: (a) designing the hypothetical scenario, (b) deciding whether to ask about WTP or WTA, (c) creating a scenario about the means of payment or compensation. (2) Using the survey instrument with a sample of the population of interest. (3) Analysing the responses to the survey. See next slide.

15. The CVM steps continued … (3) Analysing the responses to the survey. This can be seen as having two components: (a) using the sample data on WTP/WTA to estimate average WTP/WTA for the population, (b) assessing the survey results so as to judge the accuracy of this estimate. (4) Computing total WTP/WTA for the population of interest for use in an ECBA. (5) Conducting sensitivity analysis.

16. PROBLEMS WITH CVM A number of potential 'biases' have been identified in the CVM literature: Two classes of problem are subsumed by the term 'bias‘: Getting respondents to answer the question that would, if they answered honestly, elicit respondents' true WTP in regard to the policy issue that the exercise is intended to inform. Getting respondents to answer honestly.

17. BIAS WITHIN CVM An example of 'bias' of the first class is where the environmental 'commodity' perceived as being of concern by the respondent differs from that intended by the CVM analyst. This is known as 'amenity misspecification bias'. An example of 'bias' of the second class is where the respondent perceives what the analyst intends, but provides a response which is not his or her true WTP but is intended to influence the provision of the environmental 'commodity' and/or his or her level of payment for it. This is called 'strategic bias'.

18. SURVEY DESIGN • Many CVM practitioners argue that with good survey instrument design bias is not a major problem nowadays. • Good survey instrument design is now seen as involving: • extensive pre-testing • the use of focus groups

19. SOME OTHER DIFFICULTIES Averaging responses Use of mean or median (treatment of outliers)? Treatment of ‘no’ responses (to a question asking whether the individual would be WTP a particular sum). Is this a 'protest' or a ‘genuine’ response?. Are protest responses to be included in the average? Clearly, the treatment of outliers and protest responses can have significant implications for estimated median and, especially, mean WTP.

20. Obtaining total WTP Given average WTP, total WTP is just that average times the size of the relevant population. A question which arises is: what is the relevant population? At one level the question is answered by the conduct of the CVM exercise in regard to sample selection. At another level, the question may be open and unresolved. If it is the existence value associated with the Amazon rainforest, say, what is the relevant population (and how does that relate to the sample?)

21. Obtaining total WTP (continued) Another issue which can be numerically important is the question of on whose behalf respondents state WTP. Should respondents be understood to be stating what is strictly their own WTP, or WTP on behalf of the households that they belong to? If the first is true, should arising average WTP be multiplied by the population or by the number of adults in the population?

22. Read yourself: Exxon Valdez case study (Carson et al) Mining at Coronation Hill?

23. Also look at: • Implausibly large estimates of the size of total WTP • Price and scope sensitivity • WTP or WTA: large divergences • and finally • National Oceanic and Atmospheric Administration (NOAA) Panel Guidelines

24. Hedonic pricing An indirect method Widely used in context of environmental pollution Attempts to evaluate attributes of some traded good. Example: Traded good = housing Attribute = Air quality Uses multiple regression analysis to reveal relationship between house “rents” and levels of all relevant attributes … …and in doing so yields implied value of clean air. See example in Box 14.5. Perman et al (Air quality in Los Angeles)

25. Valuing the environment: wider issues See Perman et al, pages 412-420 for details Ethical objections to ECBA Welfare economics is based on a particular form of Utilitarianism, which is 'consequentialist' and 'subjectivist' in nature. There are two classes of ethical objection to this way of proceeding. (1) Agrees that only human individuals have moral standing but rejects consumer sovereignty, arguing that individual preferences are a poor guide to individual human interests.   (2) The scope of ethical concern should not be restricted to humans.

26. Valuing the environment: wider issues (cont.) Sustainable development and environmental valuation A commitment to sustainable development involves an ethical dimension. It involves the assertion that economic activity should observe sustainability constraints. Common and Perrings (1992) show that observing sustainability constraints may involve over-riding the outcomes that are consistent with consumer sovereignty.

27. Valuing the environment: wider issues (cont.) Ethical attitudes and CVM responses 1 Citizen responses 2 Lexicographic preferences 3 Responsibility considerations 4 The purchase of moral satisfaction 5 Expressive benefits and decisiveness discounting 6 WTP and WTA: the citizen and consumer self.

28. 'Best practice' CVM, deliberation and social choice Deliberative polling Citizens' jury