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Economics – Valuations Total Value Accounting, Benefit-Cost Analysis
We have now spent some considerable time understanding the following principles: • The connection between environmental policy and natural systems, including the role of science in helping to understand the impact of human actions on natural systems. Ecosystem-based management as a method or style of management that follows systems principles by focusing on the energy flows within and between system components and applying an adaptive management approach to environmental policy development and implementation (including the role of precaution in such a management approach). The role of box modeling as a means of applying systems thinking in understanding environmental problems, whether that is calculating current problems or forecasting future problems in environmental policy directions. Focus in this area is on understanding the inputs, interactions, outflows, and feedback loops to see how the system reacts to specific stimuli. Once can use this modeling process to understand existing phenomena as well as forecast potential interactions of future policy directions. Categories of economics, including the distinction between natural resource economics and ecological economics as a way of understanding the different approaches an economic model might take in accounting for environmental harms in policy planning. Goals of economics, including the major goal of maximizing human wellbeing, and the measures developed – like GDP – to understand wellbeing in context. An important goal of this section is to understand the assumptions made in economic theory about wellbeing and how those assumptions may impact environmental goals. Important concepts reinforced in this section include equity and intergenerational considerations.
With these principles in-hand, we now take time to develop the two important conceptual tools explained in this section so that we can construct a means of engaging in environmental policymaking. In the case of this course, the two major tools we will use in developing environmental policy are the following: • Total Value Accounting: A framework that allows us to identify all of the major values associated with an existing or potential environmental policy direction. Using systems theory as a background principle of analysis, direct, indirect, and
non-use values are categorized. • Benefit-Cost Analysis: Using our accounting sheet developed under our total value analysis, the relative benefits and costs of a particular policy direction are analyzed. Key to this analysis is an up-front identification of assumptions used in distinguishing between a benefit and a cost. This is where the information provided thus far becomes important. For example, the assumption that our environment provides the outer limits of our economic activity. Or, the assumption that natural system integrity (including preserving background rates of equilibrium) is a foundational requirement (goal) of any environmental policy direction.
B. Applying Total Valuation and Benefit-Cost Analysis
Probably the best way to place the concepts of total value accounting and benefit-cost analysis into context is to use an example problem. Consider the following scenario representing an airport abutting a wetland area:
The figure above represents an existing airport that abuts a wetland area. The airport wishes to expand the runway into the wetland area. The question for our consideration is what environmental impact might the expansion of the runway have on the wetland. Using the conceptual tools we have developed thus far in this course, we will answer this question using a total value approach and benefit-cost analysis. The first step in our analysis is to understand the extent of the expansion into the wetland, represented here:
With the above figure we now have a clearer sense of how much of the wetland resource is at-stake in the proposed expansion; literally we have a clear sense of the direct area of impact.1 In addition, we can identify the areas around the black expansion area (the yellow box and beyond) and consider the impacts of the expansion on those areas as well. However, fundamentally, we have a starting point for our analysis here because we know the physical extent of the proposed expansion. The job now is to identify and account for the different values that exist in the wetland area so the potential benefits and costs can be calculated and compared.
Note the difference between the direct area of impact (the proposed expansion represented in black) and the surrounding area that likely will also be impacted (the area that includes the yellow square and possibly beyond). In order to understand this concept we must consider edge effects, or the effects of changes that impact not only the specific area altered, but also the physically unaltered areas that exist in proximity to the specific area altered. One of the arguments against developing casinos is the effects that extend beyond the immediate location of the casino itself. Communities often argue these ancillary effects (greater crime rates in the community, etc.) come with the casino and move into the community itself; this is one small example of an edge effect (without considering the evidence to support the proposition). One that is observed in the environmental arena is the effect on fishing effort that occurs at the border of protected areas. Often a policy tool implemented in fisheries management is to close off certain areas to fishing because those areas are identified as critical habitat for a target fish species. The effect of creating these closed areas has often been to change behavior patterns of fishermen (more on behavior in Chapter 4); the fishing effort tends to congregate at the edges of the closed area because there tends to be aggregation of target fish in these areas (just beyond the protected area).
The values at-stake in the proposed expansion, using our total value approach, include direct, indirect, and non-use values. A very simple evaluation of these values (categorically) might include the following:
The direct values are identified as low because the wetland is likely not being utilized as a source for provisioning services that are then bought and sold in a free market.2 The indirect values at-stake likely include nursery habitat for fish, habitat for wildlife, and water filtration depending on the hydrological connections between the wetland and water resources for the surrounding community (for example if the community uses well water that includes water moving through this wetland). Non-use values include, at the least, a buffer between an adjoining residential neighborhood and the airport and any cultural/historical/aesthetic considerations based on the location of the wetland, how the wetland is utilized, and how that is connected to human use of the area.3
It is important to note that the analysis would pretty much end here under a natural resource economics framework; the direct values would be the primary way of identifying costs, and these costs would then be compared to the benefits of the airport expansion. The remainder of this analysis includes considerations under an ecological economics framework.
For example, if the wetland exists in an urban area, it may represent one of the only areas where waterfowl (ducks, geese, herons, etc.) utilize the area and as such it may provide an important source of visual and aesthetic connection to nature for the surrounding community.
Once the different categories of value have been identified, the process of accounting and evaluation can occur. The process would generally proceed in something resembling the following manner: • Determine the total value of the area (per unit – value/acre for example). The value identified in each category will depend heavily on the assumptions utilized in the valuation process – this is key! Remember, indirect and non-use values are often not easy to calculate because there is no direct market transaction for these services. Thus, alternate methods of valuation (contingent valuation, willingness to pay) must be utilized. Compare the total value number achieved against the projections of value added by the runway expansion. (Include any discount rates that might apply in this analysis). Decide. Decisions can be affirmative (yes or no), or they can be laid out by establishing a set of alternative options based on different assumptions (playing with the assumptions of value and discount rates).
Visually, the way in which we can compare relative costs to benefits may be represented like the following figure:
By looking at the figure, we can see the goal is to make a decision where the amount of total environmental harm is balanced against the costs in reducing that harm – essentially
getting the policy decision to ‘fit’ within the green box identified in the figure. If the policy direction allows the amount of environmental harm (damage) to move into the redhatched line, then the policy is inefficient. Similarly, if the policy allows the costs of protecting the environment (the costs to human wellbeing) to move into the solid red line, then the policy is also inefficient.4 The key in the process identified here is the attempt to internalize all of the values atstake in a proposed action that has the potential to impact environmental values. By going through this process and utilizing scientific information (systems thinking) as a means of understanding the potential impacts, the end result is a clearer identification of relative costs and benefits of our actions. Collectively this leads to greater transparency in connecting our human actions to environmental impacts, and in many ways, this is precisely what we can hope for when we think of the role of environmental policy in our society. Now that we have a sense of how to connect economic analysis to our understanding of natural systems (science), we need to add one further consideration to complete our understanding of environmental policy in context. This final consideration has to do with the expression of value through human behavior patterns. Our final section looks at the role of human behavior in helping us understanding how humans internalize information and make decisions. Even though we may better identify the potential benefits and costs of our actions through a transparent total value approach as described above, there is no indication this ‘better’ information will lead to ‘better’ (more efficient) decisions regarding our environment. Thus, the final section in our studies here is to get a handle on how humans go about making decisions. This includes a consideration of how we internalize risk objective and subjectively, how we develop and express personal values, and how our expression of value is influenced by scale (individual expressions vs. group expressions). END OF SECTION.
The argument here is that a policy that protects the environment at substantial cost to human wellbeing may not be a desirable outcome because human wellbeing is a valid goal of policy (the pendulum can swing too far in a direction that unnecessarily harms environmental assets, and swinging in the other direction, unnecessarily harms human wellbeing).
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