Valuing the Environment

1. Valuing the Environment We don’t see the virtue of possession while it is ours.

2. Must learn the value of things that we use. • Need special techniques • How to calculate the damage? – special techniques – monetization of C & B – difficult -environmental goods not traded in the market • ∴ difficult to calculate non-use value • Want to see how benefit / cost can be implemented in an environmental context – to find various valuation techniques • Identify & discuss various techniques -used to value envt resources in both ex ante & ex post settings • Followed by discussion of strategies – exist for using economics to protect environmnet when valuation can’t reliably be obtained • Techniques of valuation –– not valuing leaves with ‘o’ value

3. Valuing benefits • Techniques to cover both, damage caused & services provided by the environment. • To asses damage - estimates – useful even in courts • US – Comprehensive Environmental Response, Compensation & Liability Act: seeks monetary compensation from responsible parties for oil spills, release of waste in river ….. • Pollution affects health - diseases, outdoors not enjoyable, damage to animals, materials, vegetation………

4. To asses damage • Identify affected areas • Estimating physical relationship between pollutant emissions & damage caused • Estimating responses by affected parties • Placing monetary value Each step is difficult to accomplish. Difficult to experiment on many (therefore controlled experiment)– pollution: some fall ill, some die – not ethical • (i) Controlled laboratory experiments on animals • (ii) Collect data on mortality rate

5. Find correlation Animal experiments: expensive & extrapolation from animal - effects to human - effects is tenuous - some seen only in LR – right doses?  right effects? once correlation identified – how strong is it? • Once Damage identified – place monetary value on it – difficult – assigning value to extending life by many years – is it worth it?

6. Types of values • We may need to place the value of stock (forest) or of flow (timber) value of the stock = present value of services flowing from the stock – If present value of the services is maximized  resource is used efficiently • Economic value in 3 components: a) use value – direct use of resources b) option value – future ability to use environment c) non-use value – existence value - controversial • These 3 categories are combined to find total willingness to pay (TWP) • TWP = UV + OV + N-UV

7. Classifying valuing methods Several methods are available to estimate value. We try to find the range of possibilities and how they are related.

8. Direct method • Market price: actual observable choices • Simulated markets: hypothetical calculation – on-use value – through survey • Contingent valuation: derive values that cannot be obtained by traditional methods – people’s opinion Limitation: could be biased / casual replies Potential bias of 4 types: strategic, information, starting point, hypothetical – Policy designed by poorly designed surveys can result in costly policy mistakes

9. Indirect observable methods • (i) infer a value (ii) actual behaviour • Through travel-cost method: create a demand curve for ‘ready to pay’ for a visit – Freeman identifies 2 variants (i) no. of trips visitors make – travel cost (ii) Random Utility Models – to value quality changes • Hedonic property & wage-use multiple regression analysis – to find environment component of the value of property – hedonic wages approach: higher compensation for taking risky bottles • occupations • Averting expenditure – not to find cause but spend to reduce damage- buy water

10. Indirect hypothetical methods • Attribute-based methods: People will generally make a familiar choice • Contingent ranking: given a set of different hypothetical situations to make choice & give ranks – compared to see trade-off – expressed in monetary value • Sometimes for valuation more than one method is used: (i) to capture total economic value (ii) to provide independent estimates

11. Value of human life • How to allocate the resources among programmes / schemes depends on value of human life – How is life valued? • Priceless ! – Not very useful as resources used to prevent loss of life are scarce ∴ make choices • Calculate the probability of death after reduction in environmental risk & place the value on the change – ‘implied value of life’ • Viscusi 1996: value of human life between $ 3 million to $ 7 million • In the B/C analysis analyst faces many decision points that require judgement. Nature of these judgement must be clear in our mind.

12. Effect on services provided to the ↑ users ↑ in recreational uses • Primary Vs secondary effectsof cleaning a lake: • Secondary effects be counted if this ↑ in demand  employmentof previously unused resources viz. labour – count the value of the increased employment – could be a rearrangement of employment • Tangible Vs intangible benefits Can assign monetary value Cannot assign value but shouldn’t be ignored

13. Approaches to cost estimation • Easier than estimating benefits – looking into future – requires good estimation skills - a firm with ‘interest’ can control the outcome by controlling information i) Survey approach – collects information ii) Engineering approach – use technologies that minimize cost – may not approximate the actual cost of a firm iii) Combined approach – attempts to balance information supplied by the source with the one derived independently.

14. The treatment of risk Scientific uncertainty: • Difficult to judge the consequences of any policy – estimates are not precise - using high doses & extrapolating to low & from animals to humans – to calculate correlation bet indicators of human health & pollution levels • Climate change problem – global warming – rise in temperature has serious implications – based on computer model with certain assumptions

15. Risk treatment has 2 dimensions • Identifying & quantifying risks – scientific & descriptive • Deciding how much risk is acceptable – evaluative & normative C-B analysis grapples with evaluation of risk in many ways i. e. If we have policy options A, B, C, D range of outcomes X, Y, Z - result depends on how the future evolves - depends on whether demand for the resource is low/medium/high in future – if choice is ‘A’  outcomes AX, AY, AZ – if ‘B’  BX, BY, BZ ∴ 12 outcomes

16. Conduct C-B for all 12 outcomes - select the policy that maximizes net the benefits – problem is that we don’t know the future outcome – choose the policy that is best with outcome X may be disastrous if Y results. • ∴ choose a dominant policy – ‘is one that confers higher net benefits for every outcome’ • When no dominant solution – other options – probability of outcomes – X= 0.5, Y= 0.3, Z=0.2 – we can estimate present value of net benefits

17. Expected Present Value of Net Benefits(EPVNB) for a particular policy is defined as ‘the sum over outcomes of the present value of net benefits for that policy where each outcome by its probability of occurrence’. • Symbolically, EPVNBj = ∑ Pi PVNBij j=1, ….. Ƒ I i=0 Ƒ = number of policies being considered I = number of outcomes being considered Where, EPVNBj = EPVNB for policy j P1 = probability of the ith outcome occurring PVNBij = PVNB for policy j if outcome i prevails

18. Finally, select the policy that has the highest EPVNB. • In every society some risk-lovers & some risk-averse . ∴ the society as a whole is risk-neutral. Valid assumption? Some gamble: risk-lovers – some buy insurance: risk-averse – some do both • Arrow & Lind argue that R-neutrality is appropriate since “when the risks of public investment are publicly borne, the total cost of risk bearing is insignificant and therefore, the govt. should ignore uncertainty in evaluating public investments.” • As the number of risk bearers increases the amount borne by any individual diminishes to zero. • If the decision is irreversible = more caution – option to change lost

19. Choosing discount rate • Discount rate: defined conceptually as the social opportunity cost of capital • This cost of capital can be divided in 2 components (1) risk less cost of capital (2) the risk premium • DR is a major determinant of allocation of resources – lower the DR in PuS than in PrS, PuS will find more projects with longer payoff periods – variety of DR to justify programs / projects supported by political parties • Historical dispute between Jimmy Carter & Congress – the choice of DR is crucial – lower DR weights future operating costs relatively more heavily • Americans: net benefit = +ve & Canadians: net benefit = -ve – for Tidal Power Project

20. Critical Approach • C-B analysis takes, sometimes, a long waiting period – not the only technique – should be used with other available information – shouldn’t be the only determinant for decision • ‘Who gets B and who pays C’ is not clear by the analysis and it is important to know who pays & who reaps • Even when the data is not so reliable the outcome may not be sensitive to that unreliability - If done correctly, can clarify what choices yield net benefits to the society – can influence political process • C-B promises more than it can deliver, especially in absence of solid benefit information

21. When benefits are difficult/impossible to quantify, economic analysis helps. Policy makers should know, how much a policy action will cost and what is its impact on the society, even when the efficient policy choice cannot be identified with certainty. • Cost effective analysis & impact analysis help in this need.

22. Cost – effectiveness analysis • When C-B analysis is not available or not sufficiently reliable  making effective choice is difficult • Use some other basis to set policy target • say, pollution control: What is acceptable level of carbon-monoxide? Many countries study its effect on human health & based on that researchers find a threshold level below which no damage seems to occur – further lower it for safety margin & accept it as ‘target’.

23. Approaches can be based on expert opinion – ecologists can tell: how much wet-land to be preserved? • Once the policy target is specified choose the means to achieve it - cost consequences imp - can trigger a political backlash - several means: expensive / inexpensive – complicated: identifying cheapest manner of achieving an objective - ∴ detailed analysis of choices • all efficient policies are cost-effective but all cost-effective policies are not efficient • Cost effective analysis involves an optimization procedure, which is a systematic model for finding the lowest cost means of accomplishing the objective – but this may not lead to efficient allocation as predetermined objectives may not be efficient

24. Efficiency equi-marginal principal • Net benefits are maximised when marginal B = marginal C • Cost effective equi-marginal principal: The least cost means of achieving an environmental target will have been achieved when the marginal cost of all possible means are equal. • e.g. target: specific emission reduction - techniques: many – How much each technique should achieve? – allocation for different techniques should be adjusted to equalise MC.

25. Impact analysis • When the information to do C-B analysis or cost effectiveness analysis is not available? • Use ‘analytical technique’:impact analysis – it is an attempt to quantify the consequences of different actions - Impact analysis doesn’t attempt to convert all consequences into money – not necessarily an attempt to optimize – put all information in front of the policy maker – he asses the importance of all consequences and acts accordingly – doesn’t guarantee efficient outcome

26. To conclude, • All techniques useful - none is the best - it is the nature of available info & it’s reliability that makes the difference. • C-B analysis is very powerful & controversial – plays very important role in legislative and regulatory policy debates. • Provides useful framework in organising disparate information • Cannot answer whether pre-determined goals are efficient.