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1.1 Definition of Economic Valuation
1.2 Importance of Valuation of Natural and Environmental Resources
2 Driving Factors in Economic Valuation of Natural and Environmental resource
2.1 Market Economy: Demand, Supply, Price and Quantity
2.2 External Effects
2.3 Benefits Transfer
3 Method for Valuing The Environment
3.1 Market-Based Techniques (Stated Preference)
3.1.1 Market price proxies
3.1.2 Production Function Approach
3.1.3 Appraisal Method
3.2 Nonmarket Valuation: Indirect Techniques (Revealed Preference Methods)
3.2.1 Hedonic property pricing
3.2.2 Travel Most Method
3.2.3 Random Utility Model
3.2.4 Factor Income Method
3.2.5 Contingent Valuation
3.2.6 Choice Modeling
4 Short Time Horizons and Risk
5 Technology and Technological Change
6 Reconsidering Aspect
6.1 Making Better use of Existing Value Evidence
6.2 Future Valuation Research
7 Transaction Cost and Social Capital
7.1 Transaction Cost
7.2 Social Capital
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Monetary valuation of environmental goods has by now become the subject of numerous economic books and articles. Interest in the topic seems to be increasing in the economics profession, and theoretical insight, methodological improvements and the numbers of empirical findings are expanding rapidly. The aim of such valuation is usually to incorporate environmental concerns into a cost-benefit analysis. Another purpose is to construct environmentally adjusted national income measures Environmental value estimates have also been combined with macroeconomic models, e.g. to estimate welfare effects of a climate treaty Further, estimated willingness to pay is now accepted in the USA as a basis for legal compensation claims for damages to natural resources caused by spill of hazardous substances (Nyborg, 1996)
Valuation can simply be defined “as an attempt to put monetary values or to environmental goods and services or natural resources”. It is a key exercise in economic analysis and its results provide important information about values of environmental goods and services. This information can be used to influence decisions about wise use and conservation of forests and other ecosystems. The basic aim of valuation is to determine people’s preferences by gauging how much they are willing to pay (WTP) for given benefits or certain environmental attributes e.g. keep a forest ecosystem intact. In other words, valuation also tries to gauge how much worse off they would consider themselves to be as a result of changes in the state of the environment such as degradation of a forest.
Economic valuation never refers to a stock, but only the change in a stock. If one speaks of the economic value of biodiversity, then one always means the economic value of a change of biodiversity. It is not a question of determining the ‘true’ value of biodiversity or ecosystems but valuing changes and comparing them with their alternatives, e.g. with a golf course vs without a golf course. Thus it is non-sense to ask “how much are the African National Parks worth?” A plausible question in this case would be: ‘WWF has proposed a new policy to prevent the huge losses of wildlife species from African National Parks. What is the monetary value of the benefits of this policy (i.e., the economic damages avoided)? Economists thus stress that the valuation should focus on changes rather than levels of biodiversity or ecosystem. Non-economists have frequently tried to value biodiversity levels, for instance, the recent example of value assessment of ecosystem services and natural capital for the entire biosphere level However, economic-theoretical support for such a valuation approach is weak. The reasons are that willingness to pay (WTP), or willingness to accept, are based on compensation or equivalence variations of a change, and that change should be relatively small in comparison with income levels (John Mburu, 2005)
Environmental and natural resource economists have developed methods to estimate the benefits of preserving environmental goods and services (and, conversely, the damages when such resources are destroyed or depleted). If the benefits of environmental protection can be measured, they can be compared with costs. Decision makers can then implement environmental policies that maximize the net benefits of such choices to society what economists refer to as maximizing social welfare. A policy that maximizes social welfare is economically efficient, and most economists consider movements toward efficiency, measured through benefit-cost analysis, a critical criterion in environmental policy design.
The economic benefit provided by an environmental good or service is the sum of what all members of society would be willing to pay for it. For resources traded in markets such as oil, land, timber, and crops, the value of small quantities of market goods can be measured by their observed price. In competitive markets, prices reflect both the marginal cost of producing the good to suppliers and the marginal value to consumers. Prices are readily observed and constantly updated.
Economic valuation is anthropocentric. Amenities are beneficial only to the extent that human beings value them. This does not suggest improvements in ecosystem function or other nonhuman effects of a policy have no value. Many people value open space, endangered species, and biodiversity and have shown through their memberships in environmental advocacy groups, votes in local referenda, and donations that they are willing to sacrifice much for these causes. However, the value of an environmental amenity remains what people are willing to sacrifice for that amenity.
Economic value has use and nonuse components. Use values involve an observable interaction between the individual and the environment, including consumptive uses, such as hunting, and non-consumptive uses, such as hiking. Nonuse value involves no actual interaction between people and the environment. For example, people may value simply knowing that an endangered species (e.g., the panda bear) survives or that a pristine area (e.g., the Arctic National Wildlife Refuge) exists, even if they never plan to see or use such resources (1). Option value is a willingness to pay to have the choice of using a service in the future. Society may have some willingness to pay to preserve a pristine wilderness area, a biodiversity hot spot, or an endangered species, in anticipation of possible future use of such resources. In practice, however, option value has often been confused with expected use and has led to the double counting of values (Olmstead, 2009)
The economic concept of value is supported by centuries of rigorous thought, has been applied by legislative and executive mandates to do benefit-cost analyses, and is accepted as a legal basis for natural resource management and damage assessment. What can economics value and what can it not? Economics is good at valuing adjustments on the margin and advising decision makers about trade-offs. Most natural resource policy decisions are marginal, and economic tools are appropriate for measuring such trade-offs. Economics is weaker at valuing all-or-nothing comparisons, such as the existence or disappearance of whole ecosystems. Some analysts have incorrectly attempted to use valuation to measure the all-or-nothing value of ecosystems (2). The elimination of Earth’s vital ecosystem services would be catastrophic. Economic valuation is not well suited to assessing the value of the complete destruction of global ecosystems. Such efforts produce a “serious underestimate of infinity”
Economic values also depend on who is valuing them. For goods traded in world markets, everyone buys or sells at the world price, and marginal values are consistent across people.
However, for goods that are not traded, values depend on the people affected. For example, the damage from air pollution in one country versus another will depend on the income of the country. People in a poor country have many critical pressures on their scarce resources and so may be unwilling to expend too many resources fighting this single risk. They may place a lower value on air pollution abatement than people in richer countries.
Economics also places a value on time. The choice to save or consume and the choice to invest or not around the planet creates a market interest rate. This interest rate is a value on time. Obtaining services today is worth more than anticipating those same services in the distant future. Policies that delay benefits are worth less than policies that provide benefits more quickly. However, the fact that we all value the present slightly more than the future does not imply we should destroy the planet for immediate gratification. There is every reason to expect that rising productivity will allow future generations to be wealthier than current ones. Prudent decision makers will preserve environmental resources for the future because they will have great value in the future (Olmstead, 2009)
The policy relevance of valuation information is extensive, but might include
demonstrating the value of biodiversity: awareness raising;
land use decisions: for conservation or other uses;
setting priorities for biodiversity conservation (within a limited budget);
limiting biodiversity invasions;
assessing biodiversity impacts of non-biodiversity investments;
determining damages for loss of biodiversity: liability regimes;
limiting or banning trade in endangered species;
revising the national economic accounts;
Choosing economic instruments for saving biodiversity (e.g. taxes, subsidies).
Why should we bother about the value of nature? Isn’t the fact that nature is deteriorating, the climate is changing; resources are getting depleted, etc. enough reason to protect environment and nature to the limit?
Of course this is a legitimate argument, but in many cases this will not be sufficient to convince people with other ethical values (for example “making money)
Reasons to bother about monetary valuation of environmental and natural resources are:
Environmental valuation techniques can provide useful evidence to support habitat conservation policies by quantifying the economic value associated with the protection of biological resources.
Pearce 2001 argues that the measurement of the economic value of biodiversity is a fundamental step in conserving this resource, since “the pressures to reduce biodiversity are so large that the chances that we will introduce incentives [for the protection of biodiversity] without demonstrating the economic value of biodiversity are much less than if we do engage in valuation.
By assigning monetary values to biodiversity, the benefits associated with biodiversity can directly be compared with the economic value of alternative resource use options it thus can and should be applied in Cost Benefit Analyses of (larger) public and private projects (Jochem Jantzen, 2006)
To understand the role of economics in environmental nature protection, some background knowledge of market economy is needed.
In a market economy the so-called “invisible hand” of the market (Adam Smith, founder of classical economic theory) arranges the prices and quantities of products.
In “day-to-day” market economics, markets determine prices and quantities of products and services, as shown in the last paragraph. Theory says that due to demand and supply, an optimal mix of products and services is demanded and supplied, leading to the highest possible welfare (given the physical production and consumption limitations).
However, for products and services that are not sold on the market, no direct market price information is available, making it difficult to optimize the supply and demand of such services But although no prices exist for “a forest”, “biodiversity”, “pollution”, it is clear that many individuals attach a certain value to such non-priced goods and services.
Even before environmental problems became visible and well understood, economic theory had to deal with the problem of non-priced goods and services and the optimal supply and demand thereof. This leaded to the concept of “externalities” (or external effects). This also became a key concept in valuation of natural and environmental resources. Externalities can be described as follows (Wikipedia):
In economics, an externality is a side effect from one activity which has consequences for another activity but is not reflected in market prices. Externalities can be either positive, when an external benefit is generated, or negative, when an external cost is generated from a market transaction An externality occurs when a decision causes costs or benefits to stakeholders other than the person making the decision, often, though not necessarily, from the use of common goods (for example, a decision which results in pollution of the atmosphere would involve an externality). In other words, the decision-maker does not bear all of the costs or reap all of the gains from his or her action. As a result, in a competitive market, too much or too little of the good will be consumed from the point of view of society. If the world around the person making the decision benefits more than he does, such as in areas of education, or safety, then the good will be underprovided; if the costs to the world exceed the costs to the individual making the choice in areas such as pollution or crime then the good will be overprovided from society's point of view (Jochem Jantzen, 2006)
So the valuation of natural and environmental resources should be seen as a part of the economic theory on externalities:
positive externalities occur in case natural habitats create an economic benefit for certain consumers (that don’t pay directly for it): the vicinity of a forest, lake, etc. will create additional value to the ones that benefit from the vicinity of the natural habitat;
Negative externalities occur in case pollution or noise is emitted in the environment changing the physical environment for consumers in a negative way.
As externalities, by definition, are not traded on markets, the value of the externality needs to be estimated making use of a variety of methods that have been developed and applied the last 30– 40 years.
Due to time and research funding constraints, it is unlikely that all of these resources will be subject to individual and explicit valuation. It is therefore necessary to consider the opportunities that are available for the use of environmental value transfer, more commonly referred to as benefit transfer.
Benefit transfer is defined as transferring values that have been estimated for one environmental attribute or group of attributes from one site or location (termed the study site) to assess the benefits of a similar site or location (termed the policy site (Robinson, 2001)
The objective of benefit transfer can be expressed as estimating the value of an environmental resource for a policy site such that the mean square errors (MSE) are minimized subject to time and research funding constraints. Devousges et al. express this objective as:
Minimize MSE = var ( + (Bias
Subject to AF = AF0 and AT = AT0
Where is the estimated benefit
AF is the available funds
AT is the available time
The total economic value of environmental resources is built up of use and non-use values. Use values are often easier to assess than non-use values. In general it can be said, that the more to the right in the schedule for calculating the total economic value of environmental resources, the more difficult it will be to assess the value
Two broad classes of methods can assess the economic value of environmental amenities and disamenities in the absence of explicit markets: behavioral (revealed preference) methods and attitudinal (stated preference) methods. Revealed preference methods seek natural experiments to estimate the demand function for an environmental good. Researchers look for cases where people face exogenous differences in environmental prices and the available quantity of goods; the relationship between price and quantity can be estimated by observing consumers’ choices in these situations. However, because the experiments are usually not randomized, the methodologies must control undesired variation using a combination of carefully choosing experiments and controlling for remaining problems with statistical techniques. Some revealed preference techniques lean more heavily on structural statistical models, and their attendant assumptions, to estimate values. Other techniques, often called quasi-experimental methods, lean more heavily on the assumption that policy interventions are truly exogenous and have created something close to a randomized experiment in a natural setting Both approaches have strengths and weaknesses Stated preference, or attitudinal, methods ask consumers how much they value environmental goods and services in carefully structured surveys. The approach has the appealing virtue that it can be used to value any environmental good or service as long as the good can be described. Because the approach is not tied to behavior, it can be used to value some goods and services that revealed preference methods cannot value. However, in practice, the survey methods are more difficult than they appear.
Economists have a professional bias toward revealed preference approaches because economic science has developed around observing choices agents make in markets. The social sciences, in general, do not have this prejudice as sociologists, psychologists, and political scientists often apply attitudinal methods. However, as observed in social psychology, what people say they would do and what they actually do may differ. This raises several problems with stated preference methods, discussed below.
Thus, economists generally rely primarily on revealed preference approaches to estimate use value and reserve stated preference methods for nonuse value and to assess peoples’ value for states of the world that do not exist (Olmstead, 2009)
The pioneers of natural and environmental resource valuation relied on the “law of demand” as a way to measure the market values for natural resources and environmental amenities. While the same is true today, the degree of sophistication in the measurement of these values has increased considerably. Three market-based techniques that have recorded a significant history of natural and environmental resource valuations are described here: the market price approach, the appraisal method, and resource replacement costing (Wellman, 1997)
Market price approaches consider the costs that arise in relation to the provision of environmental goods and services which may be observed directly from actual markets. These costs can take the form of opportunity costs or the cost of alternative provision as well as mitigation costs or the costs of aversive behavior and shadow project costs
Market price approaches can be proxies for direct and indirect use value but not non-use values. This is because the price a consumer pays for a good or service is a minimum expression of their willingness to pay for it they may in fact be willing to pay much more than the market price, i.e. consumer surplus is not accounted for.
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