INTRODUCTION TO ENVIRONMENTAL VALUATION AND COST BENEFIT ANALYSIS

INTRODUCTION TO ENVIRONMENTAL VALUATION AND COST BENEFIT ANALYSIS

By

Mustapha Muktar, PhD

Department of Economics

Bayero University, Kano-Nigeria

mmukhtar.eco@buk.edu.ng and muktaronline@gmail.com

http//:www.mustaphamuktar.blogspot.com

Introduction

Cost Benefit Analysis (CBA) is a procedure for comparing alternative possible causes of action with reference to the net benefits that they are likely to produce. Net benefit refers to the differences between benefits and costs. The costs and benefits are measured in money terms. CBA is aimed at finding out whether the welfare of a society would rise or fall as a result of contemplated project. Cost-Benefit Analysis is an important tool of environmental decision making in environmental management.

 

After the necessary valuation, the costs and benefits are compared using profitability indicators of benefit cost ratio (BCR) and Net present value technique (NPV), algebrically;

BCR=∑Bt,          NPV= ∑Bt-∑ct   

                ∑Ct                      (1+r)ⁿ

 

decision is taken thereof. A project is a viable if BCR is greater than one or if it has a positive NPV, however for choice among mutually exclusive projects, we chose one with  the highest BCR or NPV, if the BCR=1 or NPV=0, then the cost of project is exactly equals to the benefit.

 

 

 

Environmental Cost-Benefit Analysis

The objective of every project is to increase welfare of the beneficiaries, any project or investment which does not have the prospect of improving the socio-economic well being of the majority of population is irrational. governments therefore face resource allocation decisions guided by CBA. One unique feature of environmental CBA is how the changes associated with environmental assests are valued.

 

Valuing Environmental Changes

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 is meaningless here to for example, ask “how much are the African National Parks worth?”. A reasonable question in this case would be: ‘If governments have 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.

 

The policy relevance of valuation information is extensive, but might include:

• demonstrating the value of biodiversity: awareness rising;

• 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 and

• choosing economic instruments for saving biodiversity (e.g. taxes, subsidies) etc.

 

Valuation has an important role to play in environmental planning and management activities because it helps to answer many questions including the following about any given natural resource:

• What is the value of conserving a certain natural resource (e.g. forest)?

• To whom does the value accrue?

• How does degradation and loss of the natural resource lead to costs to different segments of society?

• Who gains and who loses when a natural resource is conserved or degraded?

• How can natural resource conservation be efficiently and equitably financed?

• How can people be motivated to take into account natural resource benefits and costs of its loss in the course of their economic activities?

• How can policy, planning and decision making with regard to natural resources be better influenced?

 

Some Basic Valuation Tecnniques

The Stated Preference Methods (SP)

This is an umbrella term used to explain various methods. The most widely applied SP is the contingent valuation (CV) method. Using an appropriately designed questionnaire were environmental assets will serve as a good in question to be traded. Example of traded assests are; human health, water sources to be financed, parks to be build or land to be mined. The CV define the good, then the institutional context to which it should be provided and the way it would be financed. Respondents are then asked to express their maximum willingness to pay (WTP) or minimum willingness to accept compensation (WTA) for a hypothetical change in the level of provision of good or service. This method is used to assess all benefits associated with a change in the level of provision of goods or services. This method has been applied in both developed and developing countries to address, water quality, outdoor recreation, species preservation, forest protection, air quality, visibility, waste management, health, natural resource damage etc.

 

Other less frequent method under the SP methods includes choice-modeling based on choice experiment (CE). In (CE) survey respondents are required to choose their most preffered out of a set of alternative policy options, for example in case of improving the quality of water such as river, the attributes might be boost the rivers ecology (indicated by fewer fish death), decrease health risk to those who are exposed to water (swimmers and rowers etc). CE is applied where changes are multi-dimensional and where trade-offs between these dimensions are of particular interest.

 

Revealed Preference Methods (RP)

This looks at the “second market” that is it analyses or make information for non-market goods as implied by past behavior in associated market.

RP is based on central behavior and hence enjoy higher credibility, for example if a person pay N200 for disposal of his waste/refuse, then that is where his preference is revealed. But one of its limitations is its inability to estimate non use values, as it is based on market footprints of some form of user related behavior. The two main RP techniques are Travel Cost method and hedonic pricing method.

 

Travel Cost Method (TC) has been used to value spartial non market goods, particularly outdoor locations (parks, wood land, beaches etc). Individuals produce recreational experiences through a number of factors which in some way attract prices, the factors are for example, and recreational areas, travel to and fro, and staying overnight etc, the information about these factors are collected and carefully analyzed. From there the total utility is estimated and compared with the total cost; this is however being estimated using econometric techniques.

 

The Hedonic Pricing Method (HP)- the starting point here is that price of most goods is function of a number of characteristics. For example, price of a house is likely to reflect, safety, sanitation facilities, access to roads, utilities etc. The HP method is sometimes used to estimate the value of avoiding risk, death or injury by looking for price differentiates between two alternatives with different exposures to risk. It is used to identify the value of non-market goods (or bads) affecting housing prices such as road traffic, air craft noise, and air pollution, water quality, planning restrictions to open spaces in and around the urban areas etc. This technique depends on collection of large sample of data on prices and characteristics of properties in an area and applying econometric as well as statistical techniques to estimate the hedonic price functions, relating to each characteristics of interest to the house price.

 

Combining SP and RP however is most appropriate as they are found to be complementary to each other and can be used to jointly estimate preference and that can be facilitated by using Geographical Information System (GIS), which provide geo-coded data especially in the context of recreation demand researches and hedoure analysis.

SUMMARY OF BASIC TECNIQUES OF VALUATION

 

• Market Price Method: Estimates economic values for ecosystem products or services that are bought and sold in commercial markets

• Productivity Method (net factor method, derived value method, effect on production): Estimates economic values for ecosystem products or services that contribute to the production of commercially marketed goods

• Hedonic Pricing Method (HPM): 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.

• Travel Cost Method (TCM): 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.

• Damage cost Avoided, Replacement Cost, Substitute Cost Method, Avertive behavior: 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

• Contingent Valuation Method (CVM): Estimates economic values for virtually any ecosystem or environmental service. The most widely used method for estimating non-use, or “passive use” values. Asks people to directly state their willingness to pay for specific environmental services, based on a hypothetical scenario

• Contingent Choice Method (CM): 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. Does not directly ask for willingness to pay—this is inferred from tradeoffs that include cost as an attribute

• Benefit Transfer Method: Estimates economic values by transferring existing benefit estimates from studies already completed for another location or issue.