A Brief Introduction To Environmental Economics What Is Environmental

a brief introduction to environmental economics what is environmental economics? economics is a body of knowledge (a science) that has ce

A Brief Introduction to Environmental Economics
What is environmental economics?
Economics is a body of knowledge (a science) that has certain
theories, values, methods, and assumptions. One goal of economists is
to understand how to produce goods for society in the most efficient
manner. This is achieved by having a better understanding of human
activities in a market system.
Environmental economics is a distinct branch of economics that
acknowledges the value of both the environment and economic activity
and makes choices based on those values. The goal is to balance the
economic activity and the environmental impacts by taking into account
all the costs and benefits. The theories are designed to take into
account pollution and natural resource depletion, which the current
model of market systems fails to do. This “failure” needs to be
addressed by correcting prices so they take into account “external”
costs.1 External costs are uncompensated side effects of human
actions. For example, if a stream is polluted by runoff from
agricultural land, the people downstream suffer a negative external
cost or externality.
The assumption in environmental economics is that the environment
provides resources (renewable and non-renewable), assimilates waste,
and provides aesthetic pleasure to humans. These are economic
functions because they have positive economic value and could be
bought and sold in the market place. However, traditionally, their
value was not recognized because there is no market for these services
(to establish a price), which is why economists talk about “market
failure”.2 Market failure is defined as the inability of markets to
reflect the full social costs or benefits of a good, service, or state
of the world. Therefore, when markets fail, the result will be
inefficient or unfavorable allocation of resources.3 Since economic
theory wants to achieve efficiency, environmental economics is used as
a tool to find a balance in the world’s system of resource use.4
Another basic term in environmental economics is the idea of
“scarcity.” Historically, goods and services provided by the
environment were seen to be limitless, having no cost, thus not
considered scarce. Scarcity is a misallocation of these services
(which are not limitless) due to a pricing problem. If resources were
properly priced to include all costs, then the resource could not be
over-exploited because the actual cost would be too high. This is a
powerful tool in environmental problems…proper pricing.
Environmental economics is not the same as ecological economics.
Ecological economics is a new model with the basic premise being that
market-based activities are not sustainable, so a “grand new theory”
is needed to describe the world and determine how to conduct
activities in a sustainable manner. It uses an entirely different
framework. This paper will discuss only environmental economics.
The key to the environmental economics approach is that there is value
from the environment and value from the economic activity…the goal is
to balance the economic activity with environmental degradation by
taking all costs and benefits into account.
What is environmental valuation?
In order to help correct economic decisions that often treat
environmental functions as free, it is important to define and measure
their value. Valuation measures human preferences for or against
changes in the state of environments. It does not value the
environment on its own.5 If there is no human attachment to it, then
the service has no economic value. Although other types of value are
often important, economic values are useful to consider when making
economic choices – choices that involve tradeoffs in allocating
resources.6
“Measures of economic value are based on what people want – their
preferences.
Economists generally assume that individuals, not the government, are
the best judges
of what they want. Thus, the theory of economic valuation is based on
individual
preferences and choices. People express their preferences through the
choices and
tradeoffs that they make, given certain constraints, such as those on
income or available
time. In a market economy, dollars (or some other currency) are a
universally accepted
measure of economic value, because the number of dollars that a person
is willing to pay
for something tells how much of all other goods and services they are
willing to give up to
get that item. This is often referred to as ‘willingness to pay.’” 7
Many economists have been criticized for putting a ‘price tag’ on
nature. However, decisions are being made every minute regarding
resource allocation. These decisions are economic decisions and
therefore are based on society’s values. In essence, the environment
itself is not being valued, instead individual preferences for the
environment are what are being measured and compared.8 Environmental
valuation can be a useful, yet also difficult and controversial tool.
There are two types of values: use and non-use. ‘Use value’ is defined
as the value derived from the actual use of a good or service, such as
hunting, fishing, bird-watching, or hiking. Use values may also
include ‘indirect uses,’ such as the value of a bug that a fish may
eat, which then a fisherperson may catch. Though that bug is not
directly used by the fisherperson, it has an indirect value because of
its place in the food chain. A large part of environmental economics
has been devoted to valuing ‘use’ services.
‘Non-use values,’ also referred to as ‘passive use’ values, are values
that are not associated with actual use, or even the option to use a
good or service. Existence value is a type of non-use value and is the
value that people place on simply knowing that something exists, even
if they will never see it or use it.9 Many people value the Amazon
rainforest, even though they may never go there. Non-use value is the
most difficult type of value to estimate.
Total economic value is the sum of all the relevant use and non-use
values for a good or service.
How is valuation used? – Cost/Benefit Analysis
The main method used for valuation is cost-benefit analysis (CBA).
This analysis is basically compiling the costs of a project as well as
the benefits, then translating them into monetary terms and
discounting them over time. (Discounting is the process of determining
the present value of future benefits and costs.) Ideally, only
projects with benefits greater than costs would be acceptable.
Cost - benefit comparisons have some problems. First, environmental
benefits often lack market value, yet their costs are known. Second,
benefits are often collected over time, while costs are up front. This
creates a dilemma, since the question to be answered is in present
time. Third, it is often difficult to understand what is being
measured or to determine values for what is being measured. And
fourth, results are often controversial and in some cases, could be
used against you. However, it is good to remember that you are
empowered just by describing each benefit, even if you can’t value it.10
The first step is always to compare what would happen with and without
the proposed project. Economic analysis is not possible without a
clear understanding of how the project would affect the area. When
this exercise is complete, the analyst should have a list of project
impacts, classified according to the type of value they are likely to
affect (use or non-use) and the group or groups that would benefit
from the project.11
To continue with the analysis, one must next describe clearly what
each benefit is and convert it into human needs. These need to be
broken into measurable units, values per unit need to be established,
and then discounted to the present value. For example:
Year
Benefit Description
Benefit Units
Unit Values
$ Value of Benefit
Discounted Present Value Benefit
1
2
There are several different methodologies used to determine the value
of a benefit. Which methodology is used is often determined by the
time and expense of the analysis.
The following methods are used:
1.) Market Price Method
Estimates economic values for ecosystem products or services that are
bought and sold in commercial markets. For example, a cultural site
could be valued based on the entrance fees collected.
2.) Productivity Method
Estimates economic values for ecosystem products or services that
contribute to the production of commercially marketed goods. For
example, the benefits of different levels of water quality improvement
would be compared to the costs of reductions in polluting runoff.
3.) Hedonic Pricing Method
Estimates economic values for ecosystem or environmental services that
directly affect market prices of some other good. Most commonly
applied to variations in housing prices that reflect the value of
local environmental attributes.
4.) Travel Cost Method
Estimates economic values associated with ecosystems or sites that are
used for recreation. Assumes that the value of a site is reflected in
how much people are willing to pay to travel to visit the site. For
example, adding up the costs people would expend to travel and
recreate at a particular area.
5.) Damage Cost Avoided, Replacement Cost, and Substitute Cost Methods
Estimate economic values based on costs of avoided damages resulting
from lost ecosystem services, costs of replacing ecosystem services,
or costs of providing substitute services. For example, the costs
avoided by providing flood protection.
6.) Contingent Valuation Method
Estimates economic values for virtually any ecosystem or environmental
service. The most widely used method for estimating non-use, or
“passive use” values. It asks people to directly state their
willingness to pay for specific environmental services, based on a
hypothetical scenario. For example, people would state how much they
would pay to protect a particular area.
7.) Contingent Choice Method
Estimates economic values for virtually any ecosystem or environmental
service. Based on asking people to make tradeoffs among sets of
ecosystem or environmental services or characteristics. It does not
directly ask for willingness to pay—this is inferred from tradeoffs
that include cost as an attribute. For example, a person would state
their preference between various locations for siting a landfill.
8.) Benefit Transfer Method
Estimates economic values by transferring existing benefit estimates
from studies already completed for another location or issue. For
example, an estimate of the benefit obtained by tourists viewing
wildlife in one park might be used to estimate the benefit obtained
from viewing wildlife in a different park.12
The researcher should first narrow the types of benefits by their
importance and then balance accuracy and costs in choosing methods.
Sometimes the easiest analysis often provides substantial benefits
that show large values. Usually, a benefit measured from market-based
techniques or various kinds of extractive use values are the easiest
to measure. If one method alone provides an answer, then the analysis
can stop. The data requirements and limitations of the methods should
be taken into account when deciding which to use. Discounting, which
is the process of reducing future benefits and costs to their present
value, is the last step. Choosing an acceptable discount rate is often
a challenging task. It is highly controversial since the rate chosen
will have a big effect on the results of the analysis. Sometimes the
discount rate is chosen by federal regulation.
Once more it should be noted that:
“Because it focuses only on economic benefits and costs, benefit-cost
analysis
determines the economically efficient option. This may or may not be
the same as
the most socially acceptable option, or the most environmentally
beneficial option.
Remember, economic values are based on peoples’ preferences, which may
not
coincide with what is best, ecologically, for a particular ecosystem.
However, public
decisions must consider public preferences, and benefit-cost analysis
based on ecosystem valuation is one way to do so.”13
Why is environmental valuation important?
Currently, in the U.S., environmental valuation is used in five
different ways:
*
Project evaluation
*
Regulatory review
*
Natural resource damage assessment
*
Environmental costing
*
Environmental accounting
*
Cost Benefit Analysis (CBA) is used in project evaluation and
regulatory review. In the United States, CBA started out as an attempt
to incorporate economic information in public investment decisions
involving water resources.14 The Army Corps of Engineers was the first
federal agency to develop economic analytical processes in their
project evaluations.
In the early 1980’s, CBA became part of the requirements of regulatory
review. President Ronald Reagan signed Executive Order #12291 in 1981,
which was rescinded and changed by President Bill Clinton in 1993 to
become Executive Order #12866. This order states that “significant
regulatory actions require economic analysis.”15 This has changed the
fundamental basis on which Agency rulemakings are evaluated. It
requires that an Agency “shall…propose or adopt a regulation only upon
reasoned determination that the benefits of the intended regulation
justify its costs”.16 Some states are also adopting similar
requirements for regulatory review. Washington State, for example, has
a state law similar to the national executive order for legislative
rules (Washington State RCW 34.05.328(1)(c)).
Natural resource damage assessment (NRDA) is another way that
valuation is used in the U.S. The Comprehensive, Environmental
Response, Compensation and Liability Act (CERCLA), which was passed by
Congress in December 1980, created “Superfund” to finance clean-up of
waste sites and established a liability system for parties to pay for
injuries to natural resources.17 The oil spill in 1989 by the Exxon
Valdez in Alaska, brought natural resource litigation into the
forefront and also produced the Oil Pollution Act, which dealt
primarily with natural resource damages. The National Marine Sanctuary
Act and the Park System Resource Act also have liability provisions
for injuries to protected resources from any source.18
Environmental costing is used in decisions regarding investments and
operation. The costs of producing something along with the social
costs (including external costs) are all included in the cost of the
good. It has been used in the energy sector and somewhat in waste
disposal.19
Environmental accounting is a way to account for the services of
environmental assets within the framework of economic activity or
business. It is an assessment and evaluation of the results, costs,
and savings attributable to environmental protection activities. Some
examples include pollution prevention, environmental life cycle
assessment or environmental performance reporting.20
It is clear that environmental economics is being used more often for
discussing environmental issues. Whether utilized as a tool to
determine which projects have the greatest benefits or to determine
natural resource damages, those individuals who have an understanding
of some of the concepts, will have a distinct advantage.
How to use the resources on ELAW’s website
There are a wide variety of resources in the “Economics” resource
section of ELAW’s website that can help environmental lawyers,
depending on their goals.
Economics: General Information
For a more in-depth understanding of the basic concepts discussed in
this paper, the web page “Ecosystem Valuation” (http://www.ecosystemvaluation.org)
does a very good job of laying out these ideas. Many of the
publications on ELAW’s website have been downloaded from the World
Bank Group Environmental Economics and Indicators site (http://lnweb18.worldbank.org/ESSD/envext.nsf/44ByDocName/EnvironmentalEconomicsandIndicators).
Under the sub-heading “Other Resources” (http://www.elaw.org/resources/text.asp?id=1999),
is a compilation of environmental economic journals, which also
provide relevant material (sometimes at a cost). Under the sub-heading
“Related Links” then “Guide to Environmental Economics Textbooks” (http://www.ucl.ac.uk/~uctpa15/envecontexts.pdf),
a world-renowned environmental economist has compiled a listing of
textbooks and his recommendations that may be useful to persons who
want a more in-depth understanding of this area.
Many of the “Related Links” are of an international nature and provide
a variety of information (http://www.elaw.org/resources/topical.asp?topic=Economics).
Economics: Natural Resource Damages
From a legal standpoint, the paper titled “What is the Role of
Environmental Valuation in the Courtroom?” (http://www.elaw.org/resources/text.asp?id=2039)
gives an overview of how valuation is used, mostly from a natural
resource damage angle. The National Oceanic and Atmospheric
Administration has a damage assessment and restoration program, which
has lots of useful information if one is determining damages (http://www.darp.noaa.gov/legislat.htm).
Economics: Regulatory and Incentive Systems
From a regulatory viewpoint, the paper from U.S. Environmental
Protection Agency (U.S. EPA) titled “OAQPS Economic Analysis Resource
Document” (http://www.elaw.org/resources/text.asp?id=1997) outlines
the guidelines used for regulatory analysis. In addition the U.S. EPA
National Center for Environmental Economics website, (http://yosemite.epa.gov/ee/epa/eed.nsf/webpages/homepage)
has more information. Also the link “Guidelines and Discount Rates for
Benefit-Cost Analysis of Federal Programs” (http://www.whitehouse.gov/omb/circulars/a094/a094.html#top)
is very comprehensive.
There are also several relevant laws on the ELAW site.
Economics: Valuation Methods
The paper titled “Economic Analysis of Investments in Cultural
Heritage” (http://www.elaw.org/resources/text.asp?id=1976) gives a
simple comparison between various valuation methodologies. Also, the
paper titled “Economic Valuation of Health Impacts” (http://www.elaw.org/resources/text.asp?id=1978)
is a good example of how environmental economics can be used to
influence decision makers.
I hope that this information will be useful. To be able to quantify
environmental services is often more persuasive than just making
general statements. The growth of literature and organizations in this
area show the potential of what can be accomplished.
1 The Chartered Institution of Water and Environmental Management.
(CIWEM) Environmental Economics. p.2.
http://www.ciwem.org.uk/policy/policies/economics/index.asp Accessed
July 17, 2003.
2 Turner, R. Kerry, David Pearce and Ian Bateman. Environmental
Economics: An Elementary Introduction. John Hopkins University Press,
1993; p. 8
3 King, Dennis and Marisa Mazzotta. 2001. Ecosystem Valuation.
http://www.ecosystemvaluation.org
Accessed July, 2003.
4 Turner,et. al.; p. 2
5 Turner et. al.; p. 38
6 King and Mazzotta, loc. cit.
7 King and Mazzotta, loc. cit.
8 CIWEM, p. 4., loc. cit.
9 King and Mazzotta, loc. cit.
10 King and Mazzotta, loc. cit.
11 Pagiola, Stefano. June 1996. Economic Analysis of Investments in
Cultural Heritage: Insights from Environmental Economics. p. 5-6.
Environment Department – World Bank.
12 King and Mazzotta, loc. cit. This website has much more detailed
information on these methods. http://www.ecosystemvaluation.org
13 King and Mazzotta, loc. cit.
14 Navrud, Stale and Gerald J. Pruckner. 1997. Environmental Valuation
– To Use or Not to Use? Environmental and Resource Economics v 10:
1-26. p. 3.
15 U.S. Executive Order #12866, Regulatory Planning and Review,
September 30, 1993.
16 U.S. Executive Order #12866.
17 Navrud and Pruckner, p. 11.
18 Jones, Carol Adaire. No date. Use of Non-Market Valuation Methods
in the Courtroom: Recent Affirmative Precedents in Natural Resource
Damage Assessments. p.1.
19 Navrud, et. al. p. 5.
20 Environmental Management Accounting International website.
http://www.emawebsite.org/index.htm Accessed August 5, 2003.
A Brief Introduction to Environmental Economics
Authored by: Marlies Wierenga
ELAW – August 2003
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