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Analysis

A component-based approach to discounting for natural resource


damage assessment
Edi Defrancesco
a,
, Paola Gatto
a,1
, Paolo Rosato
b,2
a
Department TESAF - Territorio e Sistemi Agro-forestali, University of Padova, Agripolis, Viale dell'Universit, 16, 35020 Legnaro, PD, Italy
b
Department DICAr - Ingegneria e Architettura, University of Trieste, Piazzale Europa 1, 34127 Trieste, Italy
a b s t r a c t a r t i c l e i n f o
Article history:
Received 12 April 2013
Received in revised form 23 December 2013
Accepted 30 December 2013
Available online 24 January 2014
Keywords:
Damage compensation
Remediation
Environmental liability
Social discount rate
Dual discounting
Declining discounting
The paper proposes a component-based approach to guide the choice of the social discount rate in natural
resources damage assessment, where time and discounting are key features. It is a multi-rate discounting
scheme, which draws on concepts from dual-rate and time-declining approaches. Each damage component is
discounted at a component-specic constant rate, related to its time-trajectory. Assuming a normatively dened
declining schedule of rates as a starting reference, components with longer time proles generally represented
by welfare losses are discounted at lower rates than short-termdamage components mainly remedial costs.
The rationale behind this choice is that the longer the duration of the damage component, the higher the related
nonincident specic uncertainty on the resource values and the more relevant the equity issues. When estimat-
ing the total damage, the resulting implicit average discount rate depends onthe durationof eachcomponent and
its relative relevance in the total damage in each moment. Froman operational point of view, anchoring the rates
to government prescriptions would support the robustness of the damage estimates in a court of law, whereas
the dual-based environmental discount rate is based on ad-hoc assumptions that are more difcult to justify.
2014 Elsevier B.V. All rights reserved.
1. Introduction
Natural Resource Damage Assessment (NRDA) is the process
through whichinjuries to natural resources are identied andmeasured
and actions dened in order to compensate the public for the loss of
ecosystem services. The approach has been enforced by normative
acts the Comprehensive Environmental Response, Compensation,
and Liability Act (CERCLA) for the USA (NOAA, 1999) and the Environ-
mental Liability Directive (ELD) for the European Union (2004/35/CE).
The basic principles underpinning both the US and EU legislation are
the denition of damage liability and the rights of injured parties
the authorities acting as trustees for natural resources on behalf of
society to receive compensation. The preferred form of compensation
is full restoration, when possible, of the injured resources, dened by
the ELDas primary remediation; when interimand/or permanent losses
occur, compensatory and/or complementary remediation measures
should also be undertaken, even off-site, to cover those losses. The
costs incurred in these actions, together with the damage response
and assessment costs, represent the measure of damage (Dumax
and Rozan, 2011; Jones and Pease, 1997; Thur, 2007; Zafonte and
Hampton, 2007).
Habitat Equivalency Analysis (HEA) (Dunford et al., 2004; NOAA,
2006; Roach and Wade, 2006), now rened in Resource Equivalency
Analysis (REA) (Zafonte and Hampton, 2007) is the method used to
assess equivalency between discounted values of restoration gains
and interim losses until full remediation is reached, when possible
(NOAA, 2006). If the costs of the actions are a measure of the damage,
HEA/REA allow grading of the remediation project to the appropriate
spatial scale.
Although greeted as a paradigmshift fromapproaches based solely
on a monetary evaluation of ecosystem services (Flores and Thacher,
2002) and allowing law courts' difculties in using evidence from Con-
tingent Valuation studies in NRDA to be overcome (Thompson, 2002),
there have recently been criticisms about the use of HEA/REA. Indeed,
HEA/REA are based on the implicit assumption that the public is willing
to accept a one-to-one trade-off between a unit of lost habitat services
and a unit of restoration project services (NOAA, 2006 p. 3), thus,
under certain circumstances, dispensing with the problemof measuring
monetary values for these trade-offs. However, in the real world, this
assumption may not hold, mostly for three reasons (Zafonte and
Hampton, 2007): i) differences in type and quality between restored/
replaced resources and those injured; ii) variation in time preferences
and iii) heterogeneity of preferences. To put it simply, HEA/REA do not
fully take into account human welfare considerations (Martin-Ortega
et al., 2011). Conversely, it has been claimed that monetary evaluation
allows heterogeneity of preferences and their variations over time to
be considered (Flores and Thacher, 2002), including both efciency
and equity concerns in the assessment process. Operational purposes
Ecological Economics 99 (2014) 19
Corresponding author. Tel.: +39 049 8272721; fax: +39 049 8272750.
E-mail addresses: edi.defrancesco@unipd.it (E. Defrancesco), paola.gatto@unipd.it
(P. Gatto), rosato@dicar.units.it (P. Rosato).
1
Tel.: +39 049 8272719; fax: +39 049 8272750.
2
Tel.: +39 040 5588092; fax: +39 040 558358.
0921-8009/$ see front matter 2014 Elsevier B.V. All rights reserved.
http://dx.doi.org/10.1016/j.ecolecon.2013.12.017
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j our nal homepage: www. el sevi er . com/ l ocat e/ ecol econ
also call for a measure of the damage in economic terms, on the grounds
that this allows judgement of whether compensation is adequate or, on
the contrary, the costs of the restoration project are disproportionate to
the benets obtained(Flores andThacher, 2002). This is also inline with
some normative approaches, for example the Italian legislation permits
compensation via monetary equivalent when primary, compensatory
and/or complementary remediation is technically or economically
unfeasible (Article 2058 of Italian Civil Code). Based on the claim that
evaluation of the economic dimension of damage still has a key-role to
play in NRDA, various theoretical papers and case studies have been
published attempting to complement HEA/REA with economic analysis
(Brouwer and Martin-Ortega, 2012; Brown Gaddis et al., 2007; Dumax
and Rozan, 2011; Kosugi et al., 2009; Loureiro et al., 2009; Martin-
Ortega et al., 2011; Thur, 2007), or working specically on violations
of HEA/REA assumptions (Zafonte and Hampton, 2007). In line with
the ideas expressed by these papers, the monetary evaluation in NRDA
is also central in this work.
All approaches based only on HEA/REA, as well as those coupling
REA with economic approaches and, even more so, strict monetary
approaches to damage evaluation, emphasise that a key feature of
damage and its remediation process is its time-dimension. Time passes
between the injury and the start of the remediation process and time is
needed for the complete (or partial) re-establishment of the baseline
conditions and for completing complementary/compensatory projects.
In a given ecosystem, depending on the extent and gravity of the
damage, it may happen that more than one resource and more than
one service are impaired or lost because of the injury. In order to return
to the baseline condition, each resource and/or service may have a
specic recovery trajectory, stretching over a different time-scale. Each
NRDA is thus characterised by a specic time-prole, whose complexity
depends on the starting conditions, the extent and gravity of the damage,
the possibility of undertaking mitigation and/or remediation actions, and
the specic recovery trajectory of each affected resource component and/
or service. Damage components' time-proles and how they can be
framed in the NRDA context is the rst issue discussed in this paper.
Intertwined with the issue of time-proles is the problem of
identifying present values of the damage components, which implies
choosing an appropriate discount rate. This choice is critical, given the
several cost and welfare elements with different time-proles (short,
medium, long and sometimes perpetual term) that have to be taken
into account (Boyd, 2000; Defrancesco et al., 2008; EU Commission,
2001; Howe, 1990; Oara, 2002). The setting of an appropriate social
discount rate has long been debated in the Cost Benet Analysis (CBA)
literature. Controversy has arisen over the theoretical foundation of the
standard exponential discounting approach and the use of single-rate
discounting mainly when valuing projects with a very long time
horizon which arguably substantially under-evaluates events in the
distant future. Inthe last decades there has beena strong upsurge of inter-
est in social discounting issues when the debate on sustainable growth
and prominent environmental problems, e.g. the climate change related
risks, has arisen in the policy arena, and relevant intergenerational equity
issues have emerged. Given this increased interest, in more recent years
theoretical and empirical justications have been provided for time-
declining discounting (for a review, see: Oxera, 2002; Pearce et al.,
2003; Groom et al., 2005; Hepburn, 2007, among others). In line
with the literature ndings starting with the Ramsey (1928) argument
in favour of a zero utility discount rate developed countries have
generally reduced the recommended rates to adopt when valuing public
projects (Harrison, 2010). Alternatively, discrete time-declining discount
rates have been set (HMTreasury, 2003; Lowe, 2008), helping to achieve
a trade-off between intergenerational equity and efciency issues
(Hepburn, 2007).
Given the richness of contributions and operational indications
provided in the CBA context on the choice of the discount rate and
also its relevance in the damage assessment context (Kopp, 1994), our
paper draws on concepts from dual rate discounting and from time-
declining discounting approaches and proposes a hybrid component-
based approach to discounting in NRDA. With this approach each
damage component is discounted at a component-specic constant
rate, which is related to the component's time trajectory. Assuming as
a starting reference a normatively dened stepwise-declining schedule
of rates, components with longer time proles generally represented
by individuals' welfare losses are discounted at lower rates than
short-term damage components mainly remediation costs. When
estimating the total damage, the resulting implicit average social
discount rate depends on the duration of each damage component
and its relative relevance on the total damage measure at each time t.
The approach is developed within the rationale of monetary damage
evaluation, but is also consistent with a HEA/REA perspective. The
component-based approach is exemplied through a case-study
referring to a coastal contamination that occurred in Northern Italy.
2. Damage Components and NRDA Time-Prole
The theoretical framework of reference for the monetary evaluation
in NRDA lies in individuals' utility theory (Jones and Pease, 1997; Flores
and Thacher, 2002; Defrancesco et al., 2008) and looks at environmental
damage as an event diminishing the welfare of the affected individuals.
Welfare losses can be assessed through observation of changes in the
expenditure function (Nicholson, 1995) and are at least equal to the
costs that society is willing to pay in order to stop the damage, mitigate
its effect, restore the resource or substitute the environmental goods
and services lost because of the injury (World Bank, 1998).
An additional source of complexity in NRDA lies in two attributes,
one accruing to the damage and the other to the affected resource,
namely the damage reversibility and resource remediability. The former
is considered here in relation to the capacity of the damaged resource
to recover, i.e. to return spontaneously to the baseline condition prior
to the injury.
3
Instead, resource remediability means the possibility of
catalysing, accelerating the process and fully or partially resolving the
damage through human intervention.
With both a monetary evaluation approach and HEA/REA, combined
damage and resource attributes produce composite damage scenarios,
which also depend on the specic features of the remedial process.
Table 1 presents four scenarios referred to one resource providing one
service.
The defensive costs i.e. the costs met for measures taken in
response to an event with a view to preventing or minimising the
damages and the damage monitoring and assessment costs are
components that occur in any scenario. Other additional components
are scenario-specic:
i) if the resource is remediable, the damage components include the
cost for remedying the injured environmental resource and the
interim (temporary) welfare losses. The human intervention can
compensate for lack of capacity of spontaneous natural regeneration
or accelerate it;
ii) if the resource is not remediable, two cases can occur: a) the damage
is reversible, i.e. the resource is capable of spontaneous recovery:
interim welfare losses occur; b) the damage is irreversible: there
are permanent welfare losses.
The occurrence of either interim or permanent welfare losses
implies the adoptionof compensatory/complementary remedial actions
in HEA/REA and, more generally, generates substitution costs.
Finally, not only can the damage components be of different types
linked to damage and resource characteristics, but they can also have
3
This characteristic is, to a certain extent, what the ELDcalls capacity for natural regen-
eration, dened as the capacity to recover, within a short time and without intervention,
[] to the baseline condition [], solely by virtue of the dynamics of the species or habi-
tat, with no direct human intervention in the recovery process.
2 E. Defrancesco et al. / Ecological Economics 99 (2014) 19
different time trajectories. In other words, they can emerge and termi-
nate at different times and also overlap for some periods. This adds a
further dimension to the discussion of the damage components i.e.
the damage time-prole as depicted in Fig. 1. The time axis represents
the baseline condition, i.e. the status quo without the damage.
In order to deal with the complexity of components and time trajec-
tories froman operational point of view, three moments are relevant: 0,
the moment of damage occurrence; m, the moment of the claim for
compensation; n the threshold between the temporary phase and the
permanent phase of damage. These are dened as:
i) temporary phase (time 0n), during which the capacity of the
damaged resource to provide public goods and services is lower
thanthe baseline andsociety meets the costs to mitigate the damage
and remediate or compensate for its effects (Fig. 2). This phase is
characterised by the variability of some damage components over
time, as a consequence of the time trajectories of the primary,
compensatory and/or complementary remediation. During this
phase, individuals may suffer interim welfare losses linked to use
values and possibly also to option values and permanent welfare
losses (Fig. 1). After moment n the baseline conditions are regained
and the damage streams end or, alternatively, an innite stream of
constant welfare losses continues into the permanent phase. From
an operational point of view, as m is the moment of the claim for
compensation and, consequently, the reference time of the analysis
(Kopp, 1994), the temporary phase can be divided in two sub-
periods marked by the moment m.
ii) permanent phase (n), if any, during which only the permanent
welfare losses due to use and passive values remain and are
constant over time. This phase, even if possible, is relatively uncom-
mon in most damage cases (Thur, 2007). It occurs only when the
damage is irreversible and the resource not fully remediable; it is
characterised by annual permanent welfare losses that do not vary
over time. When the permanent losses do vary, the permanent
phase does not occur.
Under the monetary approach, the estimated environmental dam-
age present value DPV
m
is the sumof all the K components compounded
or discounted to the moment m of the claim for compensation. The
general formulation, which applies to any injury scenario, is:
DPV
m

X
n
t0
X
K
k1
D
tk
1 r
mt

r
1 r
mn
1
where: D
tk
is the expected value of the damage component k at time t in
the temporary phase (cost, interimor permanent welfare loss); D

is the
expected value of the annual permanent welfare loss in the permanent
phase; r is the social discount rate.
Under the HEA approach, the NOAA (2006) general formula
equating the sum of the present discounted value of the services lost
at the damaged site with the sum of the present discounted value of
the services provided at the replacement site is:
JV
j
X
n
t0
1 r
mt
b
j
x
j
t

b
j
2
4
3
5

b
j
x
j
tn1

b
j
2
4
3
5
1
r
1 r
mn

2
where: J is the extent of the injury (in physical terms); V
j
is the expected
value of the annual unit value of the services provided by the damaged
resource; P is the number of compensatory/complementary units; V
p
is
the expected value of the annual unit value of the services provided by
the compensatory/complementary project; b
j
is the baseline level of
services provided by the injured resource; x
t
j
is the level of services
provided per unit by the injured resource at time t; b
p
is the initial
level of services provided by the resources at the compensatory/
complementary site; x
t
p
is the level of services provided per unit by the
resources at the compensatory/complementary site at time t; l is the
time when the compensatory/complementary project reaches full
maturity i.e. maximum services provision is reached and the services
provision continues perpetually or the compensatory/complementary
project senesces.
Table 1
Damage components according to four scenarios linked to damage reversibility and resource remediability.
Resource
Remediable Not remediable
Damage Reversible Defensive costs Defensive costs
Monitoring and assessment costs Monitoring and assessment costs
Remediation costs
Interim welfare losses (compensatory remediation) Interim welfare losses (compensatory remediation)
Irreversible Defensive costs Defensive costs
Monitoring and assessment costs Monitoring and assessment costs
Remediation costs
Interim welfare losses (compensatory remediation) Permanent welfare losses (complementary remediation)
Fig. 1. Damage time-prole: interim and permanent welfare losses.
3 E. Defrancesco et al. / Ecological Economics 99 (2014) 19
The restoration scale P is obtained from Eq. (2):
P J
V
j
V
p
X
n
t0
1 r
mt
b
j
x
j
t

b
j
2
4
3
5

b
j
x
j
tn1

b
j
2
4
3
5
1
r
1 r
mn
X
l
t1
1 r
mt
x
p
t
b
p

b
j
" #

x
p
tl1
b
p

b
j
2
4
3
5
1
r
1 r
ml
: 3
3. A Component-based Approach to Discounting
The debate about the social discount is very critical, from the the-
oretical and operational point of view, especially when intergenera-
tional equity problems arise (Hepburn, 2007; Portney and Weyant,
1999) as in the case of permanent welfare losses due to environ-
mental damage.
This paper lacks the space to adequately summarise the current the-
oretical and operational debate on social discounting. Relevant theoret-
ical and empirical reasons justifying a time-declining approach to
discounting over a long time horizon have been provided in the last
years, and numerous papers have critically reviewed this issue (Oxera,
2002; Pearce et al., 2003; Groom et al., 2005; Rambaud and Torrecillas,
2006; Stern et al., 2006; Hepburn, 2007; Almansa and Calatrava, 2007,
among others). In a nutshell, the theoretical and empirical foundations
of time-declining discounting are mainly related to: i) the uncertainty
about the future state of the world, namely, the future path and
persistency of the discount rate (Newell and Pizer, 2003; Weitzman,
1998, 2001), the future growth rate of consumption (Gollier, 2002,
2010, 2011) and life expectancy (Kula, 1984, among others); ii) the
sustainability and intergenerational equity issues that are explicitly
taken into account in order to avoid the dictatorship of one generation
(present or future) over the others (Chichilnisky, 1997; Chichilnisky
and Heal, 1997; Li and Lfgren, 2000); and iii) the increasing
experimental evidence that individuals discount hyperbolically when
making intertemporal choices (for an overview, see Frederick et al.,
2002).
Persuasive theoretical and empirical arguments apart, declining
discounting may help to reduce the tension between intergenerational
equity and efciency, even if it does not eliminate the problem
(Hepburn, 2007). However, the risk of time-inconsistency (Strotz,
1955) of the time-varying rates has been underlined (Oxera, 2002),
while the effective seriousness of the problem is debated (Henderson
and Bateman, 1995; Pearce et al., 2003).
In line with the theoretical ndings, the UK government has provid-
ed a schedule of declining discount rates over a long time horizon in its
Green Book on government project and policy appraisal: 3.5% for the
years between 0 and 30; 3% for the year-range 3175; 2.5% for
76125; 2% for 126200; 1.5% for 201300 and 1% for the years beyond
the 300th (HMTreasury, 2003). Weitzman(1998) and Newell and Pizer
(2003), among others, addressed the rationale of applying a constant
exponential discounting to the time horizon up to 30 years. For the
former, the uncertainty on the discount rate begins beyond the limits
of the nancial markets, while for the latter the short-term rate
forecasts are relatively constant, though persistent uncertainty starts
immediately. More recently, and according to Stern et al. (2006), the
declining rates have been further lowered when major environmental
impacts of climate change are expected and irreversible wealth
transfers occur between generations, raising relevant intergenerational
ethical issues (Lowe, 2008).
A related strand in the recent literature on CBA of climate change
refers to the dual-rate discount approach, which proposes to discount
the whole streamof environmental costs and benets with an Environ-
mental Discount Rate (EDR) lower than the social discount rate used for
nancial ows. The rationale of the approach (that can be traced back to
Fisher and Krutilla's (1975) contribution, despite the fact that those
authors did not use dual rates) is related to the growing scarcity of
natural resources, which increases individual willingness to pay for
environmental services. Dual-rate discounting has also been justied
by the non-substitutability between natural and man-made capital
(Kgel, 2009; Neumayer, 1999) and on the grounds of the need to
acknowledge adaptive management of ecosystems (Carpenter et al.,
2007). More recently, the theoretical foundations of an EDR lower
than the social discount rate reecting non-renewable resources
depletion and the related rise in willingness to pay for environmental
quality have been analysed by Yang (2003), Tol (2004), Almansa and
Calatrava (2007), Kula and Evans (2011), Almansa and Martinez Paz
(2011), among others. Traeger (2007, 2011) and Kgel (2009) have
explored the conditions under which both the EDR and the social
discount rate decline over time. However, the specic choice of EDR
has been questioned as being based on ad hoc assumptions that are
difcult to justify (Tol, 2004).
Specically within NRDA, literature on the choice of the discount
rate has mostly an operational nature. Kopp (1994) frames the issue
in a general analysis, while also pointing out the NRDA specicities;
he discusses the discounting choices and provides operational indica-
tions according to the different damage components, seeming to sug-
gest that different components need different discounting rationales.
The debate continues under a regulatory perspective: recommenda-
tions are providedto discount the damage cost components and welfare
losses at different rates: the former have to be discounted at the rate on
US Treasury securities of comparable maturities to the length of
restoration and assessment, while a lower social discount rate
(3%) is suggested for the latter (NOAA, 1999; US Federal Register,
1996a and b). In the European Union context, REMEDE (2008)
recommends referring exclusively to the ofcial guidelines on social
discounting provided by the member countries. Finally, a number
of papers discuss the issue by specically incorporating it into the
HEA/REA approach (Dunford et al., 2004; Moilanen et al., 2009,
among others).
Fig. 2. Damage time-prole: defensive and remediation costs.
4 E. Defrancesco et al. / Ecological Economics 99 (2014) 19
However, judging from the literature, the debate on discounting
in NRDA seems to have received less attention than in the parallel
CBA context. This is despite the choice of r being equally important,
as it may signicantly affect both the DPV
m
under the monetary
approach and the scale P of compensatory and/or complementary
remedial actions under HEA/REA. This apparently scarce consider-
ation could be explained on the grounds that the underlying theoret-
ical basis on discounting is common to CBA and NRDA, or that the
legal context of the latter requires that social discount rates are
decided upon by public authorities' guidance documents. Whatever
the reasons, we feel that the choice of the social discount rate
deserves to be more specically addressed in the specic context of
NRDA.
Our paper proposes a component-based approach to social
discounting in NRDA that is a hybrid approach combining the ratio-
nale of dual-rate discounting with that of time-declining social
discounting, the latter being the one currently prevailing in the
CBA context.
Sharing the theoretical justications of the dual-rate discounting,
our approach draws the idea fromit that different discount rates should
be used when considering either tangible (cost components) or
medium-long term intangible effects (i.e. welfare losses). In addition,
NRDA focuses on a specic illegal action causing an injury to the envi-
ronment: consequently, lowering the discount rate allows the incorpo-
ration of the uncertainty related to imperfect information on the
resource values outside the incident-specic losses. From a NRDA
operational point of view, this solution is a more feasible alternative
than modelling the impact on values of e.g. the increasing resource
scarcity or reduced availability of substitutes (Yang, 2003; Kgel, 2009,
among others in the CBAcontext). General uncertainty about the future
income growthrate, life expectancy anddiscount rate as well as sustain-
ability and intergenerational equity issues, which support declining
discounting, are also relevant in the NRDAcontext. Our hybrid approach
links all these off-site non environmental- and environmental-related
uncertainty issues, as well as the intra- and inter-generational equity
ones, to the specic time-span of each damage component via the
choice of component-specic rates: the longer the duration of the
damage component the higher the uncertainty. Conversely, most of
the literature indicates that the damage-specic uncertainty about
predicted outcomes should preferably be taken into account by
properly incorporating it into the values of losses due to the injury
and gains from the restoration project (NOAA, 1999; Dunford et al.,
2004; Moilanen et al., 2009, among others). However, the literature
suggests that a lower discount rate can be chosen when a specic
damage component, including a cost, is persistently uncertain
and therefore difcult to evaluate because of its very long time-
span. Consequently, the component-based approach discounts
each damage component with a constant separate rate chosen from
a menu of declining rates. The choice criterion is the duration of
the damage component: the longer the damage effect, the lower
the associated rate. Using constant separate rates for the different
damage components qualies our approach as a multi-rate discounting
scheme, in principle an extension of the dual-rate approach, as it shares
its theoretical foundations.
However, the specic legal context of NRDArequires that the chosen
rates are anchored to social discount rates recommended by public
authorities, especially when societal value judgments based on equity
issues are incorporated, as is the case of rates associated to welfare
losses. To our knowledge, no prescriptions on dual-rates are provided
by governments, apart from in the USA (NOAA, 1999; US Federal
Register, 1996a and b). The component-based approach lls this gap
by making reference to country-specic declining either continuous
or approximated by a discrete schedule rates, which are recommend-
ed in some CBA national frameworks. This link provides a robust
operational support to the choice of the discount rate associated to
each damage component.
Formally, each damage component k is discounted with a selected
social rate r
k
chosen according to its length among those prescribed by
the public authority: the chosen rate is that associated to the last year
in which the signicant effect occurs.
Whenoccurring, the whole permanent welfare losses stream which
constantly continues after moment n andequals D

is discountedat the
lowest social rate r
klo
.
Under these assumptions, and according to the monetary approach
to NRDA, Eq. (1) becomes:
DPV
m

X
n
t0
X
K
k1
D
tk
1 r
k

mt

r
klo
1 r
klo

mn
: 4
Let us focus on the temporary phase, the rst part of Eq. (4), and
dene the total damage at time t:
D

t

X
K
k1
D
tk
: 5
Multiplying and dividing the temporary phase part of Eq. (4) by D
t

,
DPV
m
becomes:
DPV
m

X
n
t0
D

t
X
K
k1
1 r
k

mt
D
tk
D

t
!

r
klo
1 r
klo

mn
: 6
So, within the temporary phase, at a given time t the total damage
(D
t

) is discounted with an implicit average discount factor d


t

that is
the weighted average of the discount factors associated to the damage
components (D
tk
); the weight associated to each D
tk
equals its share in
the total observed damage (D
t

):
d

t
1 r

t

mt

X
K
k1
1 r
k

mt
D
tk
D

t
7
while, at each time t, the implicit average social discount rate r
t

is the
solution to Eq. (7).
Consequently, the resulting implicit average rate r
t

varies over
time according to the time-prole and to the relative weight on
the estimated total damage (D
t

) of each component of the damage


under evaluation. Thus, when an environmental damage occurs
that has no relevant long-term interim or permanent welfare losses,
r
t

is relatively high over the damage time path the cost compo-
nents of the damage prevailing while r
t

is reduced when long-


term interim welfare losses are relevant; r
t

is equal to r
klo
in the
permanent phase, where most ethical issues arise.
It is interesting to note that in some frequently-occurring environ-
mental damage cases a not increasing prole of each damage compo-
nent is generally observed
4
and the most relevant costs are usually
concentrated at the initial stage of the temporary phase, while the inter-
im losses damage components show a longer time-prole than that of
the remedial costs. It follows that, in several typical environmental
damage cases, a substantially time-declining prole of the implicit
average rate is obtained.
Our proposed approach can also be adopted under HEA/REA. On the
one hand, in frequent cases, the time-prole of the primary remediation
costs determines a cost-specic time-varying r
t

, where r is constant if
the remedial measures are undertaken within a limited length of time
(e.g. 30 years when HM Treasury social rates schedule is adopted). On
the other, the scale P of the compensatory and/or complementary reme-
diation measures is determined adopting differentiated social rates r
k
chosen according to the partial or total damage remediation trajectories
and the maturation functions of the compensatory and complementary
4
Increasing restorationand/or substitutioncosts canbe observedwhent is very close to
0, so r
t

might increase for a limited length of time.


5 E. Defrancesco et al. / Ecological Economics 99 (2014) 19
projects. So Eq. (3) is replaced by Eq. (8) in order to determine the scale
P of the compensatory/complementary actions:
P J
V
j
V
p
X
n
t0
1 r
j

mt
b
j
x
j
t

b
j
2
4
3
5

b
j
x
j
tn1

b
j
2
4
3
5
1
r
j
1 r
j

mn
X
l
t1
1 r
p

mt x
p
t
b
p

b
j
" #

x
p
tl1
b
p

b
j
2
4
3
5
1
r
p
1 r
p

ml
:
8
When the injured resource provides the baseline services at the end
of the temporary phase, the second part of the numerator equals zero
and r
j
is chosen according to the length of recovery time, while r
j
= r
klo
when permanent welfare losses occur. Similarly, in the denominator, r
p
is selected according to the compensatory/complementary maturation
function. If the project senesces at time l, the second part of the denom-
inator equals zero, while r
j
= r
klo
when the service provision continues
perpetually. Consequently, a damage-specic time-varying discount
rate is implicitly determined by the NRDA.
However, when compared to the monetary approach, HEA/REA
requires an additional source of uncertainty to be considered linked to
the non-monetary nature of the remediationactions, since the effective-
ness of both primary and compensatory/complementary measures is
not fully guaranteed. Moilanen et al. (2009) have thoroughly explored
this issue and proposed a framework to incorporate this source of
uncertainty when estimating a robustly fair P. As already pointed out
under the monetary case, solving this problem by adjusting the rate
(e.g. increasing it when the uncertainty regards the success of the
compensatory actions) is not a recommended option.
Stemming from the theoretical discussion of the component-based
approach, some operational rules to help in the choice of the discount
rates r
k
can be sketched out:
each damage component has to be identied, as well as the duration
of its signicant effects;
the damage-specic uncertainty about predicted outcomes should
preferably be taken into account by incorporating it into the
estimations;
the off-site non-environmental and environmental related
uncertainty, as well as the intra- and inter-generational equity
issues, are resolved through the choice of component-specic
rates: the longer the duration of the damage component, the
higher the uncertainty and the equity issues arising and the
lower the associated rate;
given the specic legal context, using social rates recommended
by public authorities lends robustness to the selected rates.
Country specic discrete schedules of declining rates could
provide a credible operational reference to support the choice of
the discount rate to be associated to each damage component:
the chosen rate being that associated to the last year in which its
signicant effect occurs;
the choice of the specic reference schedule, from those recom-
mended by the government (as in the case of the UK), can be
strictly related to the specic damage context: while the HM
Treasury (2003) rates can be generally considered, the lowest
schedule of declining rates (Lowe, 2008) is recommended only
when the extent and/or intensity of the injury to the environment
affects intergenerational welfare in a very relevant way.
4. An Exemplicative Case-Study
The discount rate decisions across a schedule of declining rates
under the component-based approach are exemplied through a
case-study located in Italy, on the Northern Adriatic Sea coast. It
refers to the building of an embankment 800 m long and 35 m wide
(2.8 ha) to protect part of the coastline from storm surges. According
to the project prescriptions, the embankment had to be built using
blocks of natural rock obtained from excavation works and/or inert
material coming from building demolition. In order to create a seaside
recreational area, the project required turng the embankment,
planting trees and building some kiosks. Violating the prescriptions,
the building company used wastes classied as special and hazardous
according to the Italian waste disposal law
5
as material for the embank-
ment. This illegal action caused environmental damage.
An investigation of the material in the embankment was commis-
sioned by the local council in order to identify the specic sources of
pollution (Bevilacqua, 2010; Dazzan et al., 2010) and to assess the risk
of dispersion of pollutants into water and air (Bevilacqua and D'Aprile,
2011). The results led to the zoning of the embankment into four differ-
ently polluted sub-areas. An in-depth CBA (Massiani, 2010; Massiani
and Barbieri, 2013) was performed in order to choose the best remedi-
ation activities with the aim of regaining, as fully as possible, the recre-
ational uses. Two actions were undertaken on the whole area (Table 2)
in order to reduce the risk generated by the polluted materials, namely:
(i) the construction of a permanent steel sheet pile on the sea front to
avoid the pollutants being washed out by the waves; (ii) the implemen-
tation of a monitoring system of the contaminant leaching into the
groundwater and the sea. In addition, other specic defensive and
remedial actions were designed for each sub-area according to the
type and extent of contamination. Table 2 also highlights the original
recreational uses of the different sub-areas (without the damage
representing the baseline) and the present with the damage ones,
after the remedial actions.
Four damage components having different time trajectories and
characteristics are identied (Table 3): i) several defensive and remedi-
al actions, which occur in the rst two years; ii) monitoring of pollut-
ants, which occurs till year 50; iii) permanent recreational welfare
losses affecting both present and future generations, starting at year 2,
when the remedial actions nish; and iv) interim welfare recreational
losses, which affect the present generation from year 2 to 35. The
occurrence of damages, and the moment in which they emerge, are of
course determined by comparing the with the damage scenario to
the without the damage baseline.
6
Under a monetary approach to NRDA, the values have been estimat-
ed andsubsequently discounted to the reference time for the analysis m,
which in our case coincides with the damage occurrence (m = 0). The
following values have been considered:
(i) the defensive and remedial costs, assessed on the basis of the
project estimates;
(ii) the costs for monitoring of pollutants, estimated as 1500 per
year. This long-term monitoring is needed to control the risk of
pollutant losses until recovery stabilisation;
(iii) the permanent recreational welfare losses, due to the unavail-
ability of sub-area 3 for sporting activities, sun-bathing and
swimming. Only 25% of sub-area 3 is affected by these losses,
while the remaining 75% would anyway have been used for in-
frastructure and services, even without the damage. Massiani
(2010) has estimated the permanent recreational losses for the
area using a Value Transfer approach (Spash and Vatn, 2006).
The willingness to pay for sporting activities/sun-bathing/
swimming in the area is 4.90 per person-day in the high season
(MaySeptember). With the more conservative estimate, around
16,000 person-days per year were lost in sub-area 3, giving per-
manent welfare losses of almost 78,000 /year;
5
Legislative Decree 152/2006 prescribes that these types of wastes must only be dis-
posed of in appropriate landlls and cannot be used for building purposes.
6
Evenwithout the damage, the recreational activities could not have takenplace for the
rst two years, since the original project would also have required two years to complete.
6 E. Defrancesco et al. / Ecological Economics 99 (2014) 19
(iv) the interim recreational welfare losses in the other sub-areas,
due to the temporary loss of reputation of the site caused by
pollution. It is well-known that a polluted site, even after reme-
diation, is affected by a loss of appreciation by users (Easterling,
1997; Levi and Kocher, 2006; Miller and Sinclair, 2012) for a
length of time that depends on their risk aversion. The remedia-
tion of the site does not achieve the complete removal of
contaminants: consequently, we have assumed a rather slow
reputation recovery. Under a conservative assumption, we
have considered that risk aversion affects only one third of the
total users and that it exponentially diminishes over time: the
initial value of the interim welfare losses is 503,067 (102,667
lost person-days at 4.90 /person-day) becoming negligible
after the 35th year.
The next step of our component-based approach requires the
duration of each damage component to be analysed and to associate
an appropriate discount rate to each of them. The rates choice problem
has been solved according to the provided operational rules. With
reference to the rates menu of declining rates recommended by HM
Treasury (2003), we have chosen the rates reported in the last column
of Table 3, namely 3.5% for duration until 30 years; 3% for duration
until 75 years and 1% for permanently persisting welfare losses.
This environmental damage example shows a rather common time
prole, with the majority of the costs arising within a limited time
horizon and the welfare losses spanning a longer period of time. In
similar cases, the environmental and economic uncertainty over the
future state of the world affects the welfare-related values in a more
relevant way than the remedial costs. Therefore, lower discount rates
are justied for the former. In our case, discounting the permanent
recreational welfare losses at a lower rate than the interim ones to
account for the higher off-site uncertainty and the intergenerational
equity issues affecting them is even more justied since the same
expected annual unit value is used for both.
Fig. 3 shows the time prole of the implicit average social discount
rate, which, in our example, is declining. The DPV
m
estimated with the
component-based approach is compared with that obtained using
different approaches in Table 4. With our approach, the DPV
m
equals
12.3 million, while directly adopting the Green Book (HM Treasury,
2003) declining rate, it reduces to nearly 8 million. The latter is
signicantly lower as the discount rate is the same for all the damage
components in each moment and therefore the rate declines more
slowly over time when compared to the implicit average rate of our
approach. Finally, the DPV
m
obtained by discounting all the damage
components at the 3.5% constant rate (EU Commission, 2008) provides
the lowest damage estimate ( 6.7 million). These results are obviously
case-specic, depending on the time trajectories of the damage
components.
5. Conclusions
The component-based approach provides a rationale for social
discounting within the NRDA framework, where the issue of
discounting has not been adequately explored, despite the key role
played by the discount rate in the context of environmental damage
being undeniable. Indeed, it can dramatically inuence the DPV
m
when a monetary approach is adopted, but also the scale P of com-
pensatory and/or complementary remedial actions under HEA/REA
approaches.
The proposed approachis a combination of some theoretical founda-
tions of dual-rate discounting and time-declining social discounting.
The former provides the principle that different discount rates should
be used when considering either tangible (cost components) or
medium-long term intangible effects (i.e. welfare losses), the latter
that uncertainty and intergenerational equity issues play in favour of
time-declining social discount rates. Our approach agrees on the princi-
ple that very long-term welfare losses, e.g. the permanent components
of the damage, have to be discounted at a low rate in order to mitigate
the tyranny of the present effect and take into account the relevant
uncertainty affecting the values. Conversely, when the interim welfare
losses time-prole does not exceed the present generation's lifetime, a
Table 3
The damage components, their time trajectories and the associated discount rates.
Damage component Cost / value () Time-trajectory Discount rate (%)
Frequency Duration
Defensive and remedial actions:
Construction of steel sheet pile 800,000 Single sum 0 3.5%
Removal/disposal of special wastes (sub-area 1) 918,000 Single sum 0 3.5%
Removal/disposal of hazardous wastes (sub-area 2) 300,000 Single sum 0 3.5%
Covering with clean topsoil (sub-areas 1 and 2) 480,000 Single sum 1 3.5%
Capping (hard) (sub-area 3) 500,000 Single sum 1 3.5%
Capping (light) (sub-area 4) 420,000 Single sum 1 3.5%
Monitoring of pollutants 1500 Constant annuity 050 3.0%
Interim welfare losses 503,067 Annually declining 235 3.0%
Permanent welfare losses 77,794 Constant annuity 2 1.0%
Table 2
The defensive and remedial actions and the sub-areas uses with and without the damage.
Sub-area 1 Sub-area 2 Sub-area 3 Sub-area 4
Size (m
2
) 13,500 2500 5000 7000
Actions Construction of a steel sheet pile
Implementation of a monitoring system
Removal and disposal of thespecial
and hazardous wastes and
replacement with clean topsoil
Capping (hard) Capping (light)
With-the-damage uses Sports, sun-bathingand swimming Sports, sun-bathing and
swimming + Services
Sports, sun-bathing and swimming
Without-the-damage uses (after remediation) Sports, sun-bathingand swimming Parking + Services Sports, sun-bathing and swimming
7 E. Defrancesco et al. / Ecological Economics 99 (2014) 19
higher social rate is considered. The rationale behind this choice is that
the interimwelfare losses are mainly due to temporarily reduced values
of the damaged resource and individuals may generally adapt their
behaviour to the temporary change, so the tyranny of the future effect
could be mitigated.
Overall, our component-based approach discounts each damage
component with a constant separate rate chosen from a menu of
declining rates prescribed by the government: the choice of the rate is
anchored to the damage component duration. Thus, an implicit average
social discount rate r
t

is derived that varies over time. The distinctive


characteristic of our approach is that the r
t

switch from one rate to


another, which characterises the discrete time-declining approach
and its value at a given time t are tailored to each specic damage
prole. In other words, given the chosen time-declining r which
reects the social rate of time preferences r
t

time-varying prole
(which is declining in some frequently-occurring cases of environmen-
tal damage) is more intrinsically related to the specic time-prole of
each damage component. When the recommended rates incorporate
societal value judgements based on equity issues (Baum, 2009) and
general uncertainty about the future, r
t

is adapted, in a sense, to the


relative relevance and duration of the welfare losses of the affected
individuals.
An additional advantage of the proposed approach is that anchoring
the choice of the rates to government prescriptions may help to support
the robustness of NRDA estimates in a court of law, while EDR is based
on ad-hoc assumptions that are more difcult to justify.
Acknowledgements
The authors are grateful to the anonymous reviewers for their valu-
able comments and suggestions for improving earlier versions of the
paper. The usual disclaimer applies. They also thank Paolo Bevilacqua
and Bruno Della Vedova of the Department of Engineering and Architec-
ture at the University of Trieste for the technical information provided
on the case study.
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1.0%
1.5%
2.0%
2.5%
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0 10 20 30 40 50
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