Economic Valuation of Environmental of Impacts Session 5 Nathalie Olsen

1. Economic Valuation of Environmental of Impacts Session 5 Nathalie Olsen

2. Where are we?

3. Aim of the Session • To introduce economic valuation and to place it into context in the IAP process

4. Overview of topics for this session • What is economic valuation? • Why is economic valuation important? • Techniques for economic valuation • Market-based techniques • Travel Cost Method • Hedonic Methods • Contingent Valuation • Benefit transfer • Limitations of economic valuation

5. What is economic valuation? • Attempts to quantify and express in monetary terms the full value of environmental resources • For private goods, prices reflect relative scarcity and people’s willingness to pay • Prices for environmental goods do not exist or do not reflect full value of resource • Nature of environmental goods and services • Not well-defined (ecological functions) • Unclear property rights (fish stocks, groundwater) • Public goods (clean air) • Economic values need to be derived

6. Why is monetary valuation important? • Planning process is influenced by economic analysis (CBA) • Goods and services which have quantities and prices can be taken into account in decision-making process • Economic valuation helps to bring the environment into decision-making process

7. Total Economic Value • Use values • Direct use (timber, other forest products) • Indirect use (ecological functions) • Option value (WTP to conserve for future use) • Non-use values • Existence value (WTP to know an asset exists) • Bequest value (WTP to pass on asset to next generation) • TEV = Direct Use Value + Indirect Use Value + Option Value + Existence Value

8. Some basic concepts for cost-benefit analysis • Economic versus financial analysis • Shadow pricing (including externalities) • Discounting • Time horizon • With and without project/policy scenarios

9. Based on an environmental assessment - physical indicators List all environmental issues to be examined in the planning process Set priorities based on which issues are most important for most stakeholders Quantify in physical terms the impact/damage Identify which impacts/damages could be valued in monetary terms Steps to link environmental impacts with their valuation

10. Techniques to place monetary values on environmental impacts • Market based methods • Production function approach • Cost of illness approach • Cost-based approaches

11. Production function approach • The environment is an input into the production of a marketed good • Based on damage function which relates cause (soil erosion) to effect/damage (reduced soil fertility) • Applicability: deforestation, wetland and reef destruction, water pollution in agricultural and fisheries • Measures ‘use’ value of resources

12. Cost of conservation project Present values, million CFA (1989 prices) Costs and Benefits of Rainforest Conservation in Cameroon Resource costs -4,475 Foregone forest benefits – Timber -353 Foregone forest benefits – forest products -223 Total costs -5,051 Benefits of conservation project Direct use Use of forest products +354 Tourism +680 Indirect use Protection of fisheries +1,770 Flood control +265 Soil productivity +130 Total benefits +3,199 Net benefits to Cameroon at 8% discount rate -1,852 Economic rate of return 6.2% Net benefits to Cameroon at 6% discount rate +319

13. Cost of Illness Approach (1) Costs of air/water pollution estimated by looking at costs of human health impact Dose-response function identifies relationship between level of pollutant and degree of health effect (water quality and diarrhoea) Value health effect based on cost of illness, including cost of medicine, doctors visits, hospital stays, other incidental expenses Loss of earnings due to illness

14. Cost of Illness Approach (2) • Applicability: • Value health costs of water and air pollution • Limitations • Dose-response functions not available locally • Does not measure WTP to avoid illness

15. Cost-based approaches • Opportunity cost approach • Cost effectiveness analysis • Replacement cost approach • Defensive expenditure approach • Limitations: • Costs significantly underestimates benefits • Use when not possible to quantify benefits • Applicability • When benefits are very difficult to value

16. Opportunity Cost Approach • Uses CBA and market prices to estimate benefits of alternative use of resource • Cost of conservation = foregone income from alternative use of land • Application: resources for which difficult to quantify benefits such as • Tropical forests, wildlife sanctuaries, cultural/historical sites

17. Replacement Cost Approach • Estimates the costs required to replace damaged resource or to restore damaged resource to original state • Applicability: • When remedial action must be taken to meet a standard (air or water quality) • When environmental effect requires expenditure to replace natural asset (roads, dams, soil, water) • Limitations: • Assumes complete replacement or restoration is possible

18. Cost-effectiveness analysis • Choose the most cost-effective means of reaching a pre-set target • Applicability: • Social programmes (health and population) • Examples: • maximum level of exposure to a waterborne disease agent • emission standard for industrial facilities • Limitations: • Compares alternative means of reaching target, but can not identify whether alternative are all too costly

19. Defensive/Preventative Expenditure • People act to pre-empt damage • Expenditures provide estimate of minimum valuation of potential damage to health or environment • Applicability: • Assess demand for public services (water supply, electricity, rubbish collection) • Example: • to assess demand for urban water supply project, look at how much people pay for water from other sources to avoid exposure to water-borne pathogens • Provides lower-bound estimate of social benefits of public services • Limitations: • There must be no secondary benefits to expenditure

20. Travel Cost Method • Uses expenditures (transport costs and time) to reach a site to estimate willingness to pay • Application: • recreational areas, national parks, historic/cultural sites • time spent collecting fuel wood and water • Limitations: • Requires survey, skills • Measures only use value

21. Travel cost method – Viewing Value of Elephants, Kenya • Survey of tourists and expenditures at national park • Results: • tourists were willing to pay an extra $20-24 million per year to ensure that they saw elephants • Information used to set park admission prices • Revenue from parks could be far greater than revenues from ivory trade and other uses of land

22. Hedonic Methods Approach • Uses market price of a good to estimate the value of an environmental attribute which is embedded in the price of the marketed good • Example: house (size, construction, location, environmental and aesthetic attributes, e.g. clean air) • Application • property prices and air pollution/aesthetic traits and access to water supply and rubbish collection • Job markets and risks to life • Limitations: • requires survey, lots of data, economic theory/econometrics • Relies on existence of properly functioning land/property and labour market

23. Contingent valuation • Ask individuals what they are WTP for a change in environmental attribute • Based on hypothetical market • Requires that respondents understand well the good they are being offered and that they answer truthfully • Application: • Changes in the provision of public services • Only method to measure existence value • Limitations • Requires rigorous survey, economic skills • Due to hypothetical nature, subject to many biases

24. Benefit transfer • A valuation estimate for the same/similar environmental good from another location is used as a rough approximation locally • Application: • Value of recreational and protected areas • Dose-response functions for impact of air and water pollution on health • Damage functions for agriculture (soil erosion) • Limitations: studies must exist, differences must be adjusted for

25. Limitations of valuation • Income distribution • Intergenerational equity • Risk and uncertainty (unknown thresholds) • Irreversibility (unknown future uses) • Large margin of error

26. Choosing Valuation Techniques