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Centre for Development, Environment and Policy

P522

Environmental Valuation:
Theory, Techniques and Application

Prepared by Iain Fraser, Laurence Smith and Alberto Zanni

This module is partially based on the earlier module:

Environmental Valuation: Theory, Techniques and Applications, prepared by Helen


Bright, Uwe Lohmann and Jamie Morrison in 2001 and revised in 2002

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P522 Environmental Valuation: Theory, Techniques and Application Introduction

MODULE INTRODUCTION

ABOUT THIS MODULE


The main issues of this module relate to the ways in which values can be placed on
the environment, enabling environmental issues to be included in economic decision-
making. Neoclassical economics can be used as a tool to assign monetary values to
environmental goods and services and these values can then be incorporated into
decision-making at the project, sectoral and national levels. Although the methods
and techniques which this module introduces represent the mainstream approach to
environmental economic decision-making, there are many criticisms of such an
approach, and the module also addresses these concerns and outlines alternative
approaches to analysing economyenvironment links.

The module first contrasts the ways in which the environment is viewed by
environmentalists, by ecologists and by economists within different economic
paradigms. The justifications for attempting to put a value on the environment are
put forward, and the place of environmental valuation within the core concept of
sustainable development is discussed. Neoclassical economics is then used to provide
a theoretical basis for environmental valuation and introduce the different ways of
measuring welfare change, using the concepts of consumer surplus, willingness to
pay and willingness to accept. The components of environmental value are analysed,
with distinctions made between use values and non-use values, including option
values and existence values.

Later units introduce the techniques of environmental valuation and their policy
applications. There are many techniques available for valuing the environment, some
of which are demand curve approaches and some non-demand curve approaches.
The main demand curve approaches examined include the travel cost method,
hedonic pricing methods, contingent valuation methods and choice experiments. The
non-demand curve techniques reviewed are the effect on productivity method,
opportunity cost measures, human capital measures, the replacement cost method,
and averting behaviour approaches. The benefit transfer approach is also reviewed
and assessed.

The penultimate unit examines applications of environmental valuation as part of


costbenefit analysis (CBA). Finally, criticisms of environmental valuation are
considered and a range of alternative methods, including environmental impact
assessment, are briefly reviewed.

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P522 Environmental Valuation: Theory, Techniques and Application Introduction

STRUCTURE OF THE MODULE


The module consists of ten units which are divided into three parts.

Part I

Part I introduces the reader to the main concepts, ideas and theory of environmental
valuation. This part of the module provides an understanding of how environmental
valuation emerges from a particular view (ie neoclassical) of how the economy and
environment relate to each other. Based on this view many economists accept the
justification of pricing the environment, and the role of money as a common
measuring tool to weigh up the costs and benefits of environmental change is
therefore discussed. We then develop the key theoretical concepts that underpin the
economics of environmental valuation. Specifically, the theory develops various
measures of economic welfare that are the focus of applied environmental valuation
research.

Part II

Part II covers the main approaches to environmental valuation. The material in this
part of the module covers a wide array of methods that draw on the theory
developed in Part I. We consider environmental valuation methods that can be used
very rapidly and those which require far more work on the part of the researcher to
collect and analyse data. An important aspect of the material covered in this part of
the module is that many of the statistical techniques employed in the research
literature will take the reader beyond the methods they will typically cover in basic
econometrics courses. Advice on appropriate methods will be provided.

Part III

Part III of the module provides an insight into how the results of environmental
valuation can be used in practice. We also consider various criticisms of
environmental valuation as well as suggested alternatives that are implemented in
practice.

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WHAT YOU WILL LEARN

Module Aims
To compare critically and contrast different perspectives on valuing the
environment.

To present the development of the theory of environmental valuation.

To explain a range of environmental valuation methods and techniques.

To critically evaluate these valuation techniques.

To provide illustrations of the application of the valuation techniques in


practice.

To show how environmental values can be incorporated in economic decision-


making at the national and project level.

Module Learning Outcomes


By the end of this module, students should be able to:

understand and assess critically the neoclassical theory of environmental


valuation

explain and evaluate critically a range of environmental valuation methods and


techniques

select examples to illustrate the theoretical and practical challenges of the


application of valuation techniques in practice

understand and critically interpret the results of published environmental


valuation studies

demonstrate and interpret how environmental values can be incorporated in


economic decision-making at the national and project level.

The examination for this module will focus on these learning outcomes. In the
module some detailed mathematical derivations relating to theory and to valuation
estimates are provided, and some guidance on selection of econometric estimation
methods appropriate for specific valuation techniques. This more advanced
quantitative material is provided for students with the appropriate prior study of
quantitative methods as guidance for application of certain valuation methods in
practice. Detailed mathematical derivations and econometric estimation techniques
will not normally be the subject of examination questions for this module.

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P522 Environmental Valuation: Theory, Techniques and Application Introduction

ASSESSMENT
This module is assessed by:

an examined assignment (EA) worth 20%

a written examination in October worth 80%

Since the EA is an element of the formal examination process, please note the
following:

(a) The EA questions and submission date will be available on the Virtual Learning
Environment.

(b) The EA is submitted by uploading it to the Virtual Learning Environment.

(c) The EA is marked by the module tutor and students will receive a percentage
mark and feedback.

(d) Answers submitted must be entirely the students own work and not a product
of collaboration. For this reason, the Virtual Learning Environment is not an
appropriate forum for queries about the EA.

(e) Plagiarism is a breach of regulations. To ensure compliance with the specific


University of London regulations, all students are advised to read the
guidelines on referencing the work of other people. For more detailed
information, see the User Resource Section of the Virtual Learning
Environment.

STUDY MATERIALS
There are two textbooks accompanying this module.

(a) Champs, P.A., Boyle, K.J. & Brown, T.C. (Eds.) (2003) A Primer on Nonmarket
Valuation. Netherlands, Kluwer Academic Publishers.

This book provides a comprehensive overview of the economics of environmental


valuation. Each chapter is written by experienced researchers in the area of
environmental valuation who are able to draw on a sound body of knowledge. It
covers all of the main topics in this module at a high level. In particular, the book is
very comprehensive in linking the theory of environmental valuation with the various
methods examined. All the chapters that consider the various valuation methods
provide applications that give the reader a real feel for the results that can be
generated using the many methods covered in this module. Finally, this book has a
companion website (www.fs.fed.us/nonmarketprimerdata). This website provides
access to various data sets used in the book to illustrate the various non-market
valuation methods. It is recommended that students visit this website and look at the
various data sets provided.

(b) Pearce, D., Atkinson, G. & Mourato, S. (Eds.) (2006) CostBenefit Analysis and
the Environment Recent Developments. Paris, Organisation for Economic Co-
operation and Development (OECD) Publishing.

This book takes a slightly less technical approach to the issue of environmental
valuation. The strength of this text is the link it makes with the many uses of the
results which are generated by environmental valuation. It also covers various

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important topics that surround environmental valuation which we only consider in


passing. Specifically, this book provides a greater understanding of how the results
of environmental valuation are employed in costbenefit analysis.

For each of the ten units some Key Readings are also provided. These Key Readings
are drawn mainly from relevant academic journals and agency reports, and provide
applied research examples and applications of the key concepts covered. The Key
Readings are intended to extend the material covered in the units to provide a
broader and more thorough treatment of the material being covered, and their
content is examinable.

A large number of Further Readings and References are also listed. These texts are
not provided but many are available on the Internet. All references cited in the unit
text are listed here. Students are not expected to follow up each and every further
reading, but can follow up specific points of interest.

Further Readings

For each of the ten units, Further Readings and References are also listed. These
texts are not provided but many are available on the internet. Students are not
expected to follow up each and every Further Reading, but can follow up specific
points of interest. They aim to provide a range of perspectives and more depth on
the unit subject matter.

Key Terms and Concepts and Acronyms

At the end of each unit you are provided with a list of Key Terms and Concepts which
have been introduced in the unit. The first time these appear in the text guide they
are Bold Italicised.

As you progress through the module you may need to check unfamiliar acronyms
that are used. A full list of these is provided for you at the end of the introduction.

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P522 Environmental Valuation: Theory, Techniques and Application Introduction

INDICATIVE STUDY CALENDAR

Part/unit Unit title Study time


in hours

Part I Introduction to Environmental Valuation and Theory

Unit 1 The economy, environment and valuation 10

Unit 2 Economic theory and environmental valuation 15

Part II Environmental Method Approaches

Unit 3 Non-demand curve methods 10

Unit 4 Travel cost method 15

Unit 5 Hedonic pricing methods 15

Unit 6 Contingent valuation 15

Unit 7 Choice experiments 15

Unit 8 Benefit transfer 15

Part III Applications and Criticism of Environmental Valuation

Unit 9 Costbenefit analysis 15

Unit 10 Criticisms of stated preference methods and alternatives 10

Examined Assignment 15
Check the Virtual Learning Environment for submission deadline

Examination entry July

Revision and examination preparation September

End-of-module examination October

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ACRONYMS AND ABBREVIATIONS


BL budget line

BT benefit transfer

CBA costbenefit analysis

CE choice experiment

CEA costeffectiveness analysis

CM choice modelling

CR contingent ranking

CS consumer surplus

CV compensatory variation

CVM contingent valuation method

DMV deliberative monetary valuation

DO dissolved oxygen

EIA environmental impact assessment

EIS environmental impact statement

EOP effect on productivity

EPA Environmental Protection Agency

ESA environmentally sensitive area

EV equivalent variation

FV future value

GIS geographic information systems

HPM hedonic pricing method

IIA independence from irrelevant alternatives

ITCM individual travel cost method

LCM latent class model

LDC less developed country

MCA multi-criteria analysis

MD marginal damage

MNL multinomial logit

MPC marginal private cost

MSC marginal social cost

MXL mixed logit

NGO non-governmental organisation

NOAA National Oceanic and Atmospheric Administration

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NPV/PV net present value/present value

OLS ordinary least squares

PV property value

RUM random utility model

SCF standard conversion factor

SEA strategic environmental assessment

SIA social impact assessment

SMS safe minimum standards

SP stated preference

SRTP social rate of time preference

SSSI site of special scientific interest

SWR shadow wage rate

TCM travel cost method

TE transfer error

TEV total economic value

VSL value of a statistical life

WD wage differentials

WTA willingness to accept

WTP willingness to pay

ZTCM zonal travel cost method

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Unit One: The Economy, Environment and Valuation

Unit Information 2

Unit Overview 2
Unit Aims 2
Unit Learning Outcomes 2
Unit Interdependencies 3

Key Readings 4

Further Readings 5

References 5

1.0 Some opening remarks 6

Section Overview 6
Section Learning Outcomes 6
1.1 The demand for environmental values 6
1.2 Environmental valuation remains controversial 8
Section 1 Self Assessment Questions 11

2.0 The economyenvironment relationship 12

Section Overview 12


Section Learning Outcomes 12
2.1 Defining economics and the environment 12
2.2 Links between the economy and the environment 13
2.3 The first two laws of thermodynamics 15
Section 2 Self Assessment Questions 18

3.0 Placing an economic value on environmental goods and services 19

Section Overview 19


Section Learning Outcomes 19
3.1 Why value the environment? 19
3.2 Developing a pluralistic approach to environmental valuation and
decision-making 23
3.3 Environmental valuation and neoclassical economics 25
Section 3 Self Assessment Questions 29

Unit Summary 30

Unit Self Assessment Questions 32

Key Terms and Concepts 33


P522 Environmental Valuation: Theory, Techniques and Application Unit 1

UNIT INFORMATION

Unit Overview
This unit begins by introducing the main motivation for undertaking environmental
valuation. To understand the approach to environmental valuation in practice we
then explain the links between the economy and the environment, and the different
points of view of economists, environmentalists and ecologists. The need to do this
stems from the fact that environmental valuation emerges from a particular view (ie
neoclassical) of how the economy and environment relate to each other. Based on
this view, many economists accept the justification of pricing the environment.
Finally, the role of money as a common measuring tool to weigh up the costs and
benefits of environmental change is therefore discussed.

Unit Aims
To review the main differences between neoclassical, ecological and
institutional economics and their perspectives on valuing the environment.

To assess the role of environmental valuation within the core ideas of


sustainable development.

To review the differences between weak and strong sustainability.

To evaluate critically the use of money as a common measuring tool in


assessing environmental costs and benefits.

Unit Learning Outcomes


By the end of this unit, students should be able to:

evaluate support for environmental valuation from different schools of thought


on economicenvironmental linkages

understand how environmental valuation techniques can aid in the goal of


sustainable development

present arguments for and against the use of monetary values in


environmental policy-making.

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Unit Interdependencies
Unit 2

In Unit 2 we introduce and explain the key aspects of economic theory that underpin
non-market valuation. These build upon the relationship between the economy and
the environment, examined in this unit.

Unit 3
In Unit 3 we describe and explain the main non-demand curve approaches to non-
market valuation. These methods are based on specific aspects of the physical
relationship between the economy and the environment.
Unit 4

In Unit 4 we introduce and explain the travel cost method. This approach to non-
market valuation takes behaviour observed in an existing market and infers values
about the environment. This approach is based on a specific view of the relationship
between environmental goods and services and the wider economy.

Unit 5

In Unit 5 we introduce and explain the hedonic pricing method. This approach to
non-market valuation takes behaviour observed in an existing market and infers
values about the environment. This approach is based on a specific view of the
relationship between environmental goods and services and the wider economy.

Unit 6
In Unit 6 we introduce and explain the contingent valuation method. This approach to
non-market valuation produces non-market valuation estimates based upon a
hypothetical market context. This method allows us to place economic values on
another aspect of the economy-environment relationship: non-use values.

Unit 7
In Unit 7 we introduce and explain the choice experiment method. This approach to
non-market valuation produces non-market valuation estimates based upon a
hypothetical market context. This method allows us to place economic values on
another aspect of the economy-environment relationship: non-use values.

Unit 8

In Unit 8 we introduce and explain the various approaches to benefit transfer. Benefit
transfer takes non-market valuation estimates from existing studies and employs
these in similar decision-making contexts. As with all the valuation methods
examined, benefit transfer allows us to place economic values on the environment.

Unit 9
In Unit 9 we examine how estimates of economic value of the environment are
employed in costbenefit analysis. This is an important activity as it frequently
motivates the generation of economic values using the various methods considered
in this module.

Unit 10

In Unit 10 we examine various limitations of the economic valuation and alternative


approaches. The issues examined in this unit raise important questions about how
the environment is assumed to relate to the economy and how we might examine
this using alternative approaches.

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KEY READINGS

 Farber, S., Costanza, R., Childers, D.L. Erickson, J., Gross, K., Grove, M.,
Hopkinson, C.S., Kahn, J., Pincetl, S., Troy, A., Warren, P. & Wilson, M. (2006)
Linking ecology and economics for ecosystem management. BioScience, 56 (2),
121133.

This paper provides a very neat overview of how economics and the environment are linked and
how, in turn, this relates to environmental valuation. Specifically, the paper uses a very
comprehensive example (agricultural landscape management options) to show how
environmental valuation can be linked to environmental resource management that is informed
by understanding the links between the components of the system. The need to understand
these links arises because the ecosystem service approach explicitly links ecology and
economics so that policies that impact an ecosystem are understood in terms of their impact on
society and the environment.

 Freeman, A.M. (2003) Economic valuation: what and why. In: Champs, P.A.,
Boyle, K.J. & Brown, T.C. (Eds.) A Primer on Nonmarket Valuation. London,
Kluwer Academic Publishers. pp. 125.

This chapter provides a very nice introduction to the relationship between the economy and the
environment. It also places the overall topic covered in this module economic valuation
within its broader context.

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FURTHER READINGS

Bennett, J. (Ed.) (2013) The International Handbook on Non-Market Environmental


Valuation. Cheltenham, Edward Elgar.

Freeman III, A.M. (2003) The Measurement of Environmental and Resource Values:
Theory and Methods. 2nd edition. Resources for the Future, Washington DC.

Hanley, N., Shogren, J.F. & White, B. (2001) Introduction to Environmental


Economics. UK, Oxford University Press.

Stavins, R.N. (Ed.) (2012) Economics of the Environment: Selected Readings. 6th
edition. Norton.

Turner, R.K., Pearce, D. & Bateman, I. (1994) Environmental Economics: An


Elementary Introduction. Hemel Hempstead, Prentice Hall/Harvester Wheatsheaf.

REFERENCES

Arrow, K., Solow, R., Portney, P.R., Leamer, E.E., Radner, R. & Schuman, H. (1993)
Report of the NOAA Panel on contingent valuation. Federal Register, 58, 46014614.

Common, M. & Stagl, S. (2005) Ecological Economics. An Introduction. UK, Cambridge


University Press.

Hanley, N., Shogren, J.F. & White, B. (2007) Environmental Economics in Theory and
Practice. 2nd edition. UK, Palgrave Macmillan.

Pearce, D. (1998) Costbenefit analysis and environmental policy. Oxford Review of


Economic Policy, 14 (4), 84100.

Turner, R.K., Pearce, D. & Bateman, I. (1994) Environmental Economics: an


Elementary Introduction. Harlow, UK, Pearson Education Limited.

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1.0 SOME OPENING REMARKS

Section Overview
In this section we examine the motivation and reasons why economists advocate the
placing of economic values on environmental goods and services. Specifically, we
consider how the demand for environmental valuation has driven the need to devise,
improve and refine the approaches employed to undertake such valuation. This
demand also helps to explain some of the inherent tensions that exist in terms of
employing environmental values in policy analysis and decision-making in general.

Section Learning Outcomes


By the end of this section, students should be able to:

understand and assess critically the motivation driving the demand for the
generation of environmental values

understand that the demand for environmental values is not universally


accepted and that environmental valuation remains a controversial area of
research and practice

outline for themselves the main points in the debate about the merits of
environmental valuation.

1.1 The demand for environmental values


Environmental economists face an ever-increasing demand for environmental values
to be estimated. This demand stems from the fact that environmental issues are
taking an ever-greater prominence in decision-making at both the micro and macro
level of economic policy formulation. This is partly due to the growing awareness by
society of the environment and how human activity affects it, locally, regionally and
globally. The growth in societal awareness of the environment has led, both directly
and indirectly, to the need for new and more complex environmental policy. Of
course, many of the policy options that are considered are not complementary to
existing forms of economic activity. They can be competitive, involving trade-offs
between the benefits of production, other human activity and the minimisation of
environmental degradation. These are not just abstract trade-offs, but in the real
world they involve competition between the interests of different groups in society.
These interests can include income, jobs and livelihood opportunities. They can also
consist of values and preferences relating to quality of life issues and to natural
resources and how they are used. The competitive nature of the relationship between
many forms of economic activity and the environment inevitably means that policies
to deal with these issues have real and significant opportunity costs. As policy-
makers have become faced with choices that have real and often very large
opportunity costs, they have demanded additional information so that all costs and
benefits can be more fully considered.

In this evolving policy environment it has become important to produce evidence to


support the design and implementation of environmental policy. Sound scientific
evidence can also be an important means of raising awareness, improving

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understanding and helping to build consensus between competing groups. At the


heart of much of this policy change have been many examples of policy analysis that
weigh up the costs and benefits of the policy choices being confronted. As part of this
process we have experienced a growing demand on the part of policy-makers for
evidence about the costs and benefits associated with environment change.

The key issue here is that the vast majority of environmental goods and services are
not traded in markets. Indeed, many of the concerns expressed about the state and
use of the environment are a result of the lack of prices, with which society can
express their preferences about and for the environment. It is inevitable that goods
which are not priced may be overused and degraded. An example of this is the use of
the atmosphere to dispose of waste gases. In response to this demand for prices that
accurately reflect societys preferences, economists have devised an array of
techniques and methods for putting economic values on environmental goods and
services that are not marketed. These non-market values can then be incorporated
into decision-making frameworks such as costbenefit analysis (CBA), which remains
a key economic decision-making tool. There is also a view that considers that
environmental concerns have not been adequately addressed in the past because
they have been ignored in CBA and, consequently, not taken into account when
decisions were made and development planning formulated. The approach is
reflected in the following statement:

Our central message ... is: economic (monetary) valuation of non-


marketed environmental assets may be more or less imperfect given the
particular asset together with its environmental and valuation contexts;
but, invariably, some valuation explicitly laid out for scrutiny by policy-
makers and the public, is better than none ...

Source: Turner et al (1994) p. 109.

This approach to environmental decision-making has become accepted and adopted


by many institutions and organisations around the world. National governments have
instituted environmental procedures and guidelines for public sector projects that
emphasise the need for environmental valuation and CBA. Thus, for example, various
government departments in the UK charged with designing and implementing
environmental policy and the Environmental Protection Agency in the USA, all employ
environmental CBA as an important part in designing rules and regulations for
industry and society.

The result of these changes in societal awareness, in policy priorities and in valuation
methods is a large and growing demand for all forms of environmental valuation. It
is also the case that this demand will grow and that this in turn will drive the
development of new and improved methods. This is explicitly reflected, at least in
part, in the leading environmental economics journals which publish an ever
increasing number of papers that develop, implement and evaluate alternative
environmental valuation techniques. Furthermore, the wider acceptance of the utility
and validity of environmental valuation methods by researchers other than
economists has led to frequent publication of environmental valuation study results
in environmental science and management journals, and also in interdisciplinary
sector and problem-focused journals.

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1.2 Environmental valuation remains controversial


Whilst the economics approach to environmental valuation and environmental
decision-making represents the mainstream view, and is central to this module, it is
not without controversy, as the quotes in 1.2.1 illustrate. Although these extracts are
from an article that is somewhat dated in its reference to UK agencies, many of the
themes and issues identified are still confronting those who advocate and practice
environmental valuation today.

1.2.1 Valuation, costbenefit analysis and environmental policy

Obstacles to the further use of CBA (within UK government and regulatory agencies).
there continue to be doubts about the reliability of CBA studies, and especially about
benefit estimation.
CBA has developed from a mix of studies prepared unilaterally by academics for
research interest, and by academics and consultancies for individual agencies and
government departments. While the number of studies is surprisingly large, it is not
large enough to provide a statistical base for benefits transfer. Combined with the fact
that the science of economic valuation has evolved and still is evolving, uncertainty is
endemic in the estimates. This uncertainty presents government with several problems.
First, if policy were directly related to benefit estimates, then it is conceivable that the
policy could be subject to legal challenge. This prospect is discounted by some experts
because policy is, ultimately, whatever politicians decide it is. Only judicial review
relating to unreasonable behaviour could challenge it. None the less, there is some
explanation here for the distancing of policy from CBA results.
there is outright hostility within some parts of government to some aspects of CBA,
whatever the official guidance. Some of the traditional arguments against monetization
are often emotive and irrational, but some coherence is afforded to these views from
the belief that environmental assets are somehow different and should not be subject
to trade-offs.
it is often argued that CBA is not transparent. Highly varied and different costs and
benefits are reduced to single numbers, giving the impression of a black box
approach to policy.
CBA crowds out flexibility by presenting a clear cut result subject to the
uncertainty of the estimates. At its worst this view says that politicians will do whatever
they want, and that they do not want to be troubled by costbenefit studies that might
produce the opposite answer.
CBA works best when the goal of policy is economic efficiency. Other goals such as
distributional issues, employment creation, protection of competitive position, and the
desirability of the process of decision-making, tend to be omitted from CBA studies.
the science of benefit estimation changes very rapidly. Understandable ignorance
of the literature does account for some continuing hostility to monetization.
CBA is practised with varying degrees of sophistication. If it is poorly executed, critics
will use poor practice as a basis for criticising the technique per se. The risk of poor
practice are highest in benefits transfer since the temptation of use existing studies to
provide estimates for new sites is a strong one: it saves the cost of an original study
and is highly suited to approaches based on guidelines and manuals of practice.
Source: Pearce (1998) pp. 92, 94, 95.

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The issues raised by Pearce (1998) in 1.2.1 are still important. There are still many
environmentalists and politicians who are uncomfortable, if not openly hostile, to the
methods employed by economists to undertake environmental valuation. Some of
the criticisms are based on sound observations about limitations that exist with the
methods currently employed. Even for those who accept environmental valuation and
stated preference techniques, there are technical issues. These relate to eliciting
individuals' true values using survey-based methods as there are many biases that
can influence responses.

However, some of the criticisms stem from a rejection of the use of economic value
as a means with which to inform and undertake resource management. Critics
question the ethics of placing monetary values on the environment for what they see
as a purely selfish, human-centered motivation (the neoclassical economics rationale
which assumes that individuals are self-interested in their motives and that social
decisions should reflect what individuals want). The controversy could be lessened by
understanding that it is not the environment itself that is being valued, but individual
preferences for environmental goods and services, these being a measure of the
well-being (or utility) that those affected attach to these goods or services. These
preferences can be motivated by any number of factors, including altruism and
concern for the rights of non-human species. Individuals may include in their non-
market valuation an element of intrinsic value, as they perceive an obligation on
society to protect the environment for its own sake and to conserve it for the future.

Valuation is also said by some to debase the environment by setting it on a par with
goods such as a cup of coffee or a piece of furniture. However, environmental
conservation is not without cost and any cost is a forgone benefit, as the resources
making up that cost could have been put to alternate use. Opportunity costs include
opportunities (and even rights) to generate a livelihood, or to obtain clean water and
health care. Thus it can be argued that far from debasing the environment the
correct ethical framing is one of trade-offs, whether expressed in terms of monetary
values or competing ethical priorities.

Only if the environment has some higher order moral status than, say,
helping the poor or the elderly, can there be a moral justification for
ignoring cost.

Source: Pearce (1998) p. 97.

Arguably, use of non-market valuation and CBA gives weight to the interests of
groups in society who may otherwise be excluded from decision-making processes;
since not everyone has a well-organised lobby or access to legal and technical
advisors.

These issues will continue to remain controversial. We shall explore them further in
this introductory unit and will return to them later. What is important to understand
is that the economics profession, and environmental economists in particular, view
environmental valuation as an ever-evolving activity. Indeed, much of the literature
is concerned with improving the methods employed such that the criticisms made
about environmental valuation can be overcome. There is, therefore, a growing
understanding of how to design, conduct and evaluate data collected so that the
criticisms of the inaccuracy of environmental valuation are not endlessly repeated,

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and many of the changes in implementing environmental valuation have stemmed


from mistakes that have been made in the past.

Furthermore, economists have been prepared to listen and learn from other
academic disciplines, especially psychology, marketing and sociology, about how to
conduct, engage and frame issues that are the subject of environmental valuation.
This means that the current state of environmental valuation has strong
methodological and philosophical links with these other disciplines, and it is highly
likely that these links will only get stronger in future.

Finally, despite the many advances made by economists in relation to environmental


valuation, its approaches are unlikely ever to be perfected. We believe this means
that environmental valuation remains an active and very exciting part of the study of
applied environmental economics. The challenges that confront environmental
economists who undertake environmental valuation, only act to provide an incentive
to improve the way in which environmental valuation is conducted, evaluated and
implemented.

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Section 1 Self Assessment Questions

Q uestion 1

True or false?

The demand for environmental valuation research is still increasing.

Q uestion 2

Briefly explain why environmental valuation studies are often controversial.

Q uestion 3

True or false?

Economists have worked in isolation in developing environmental valuation methods


and techniques.

Q uestion 4

How can the criticism that CBA and environmental valuation are non-transparent,
black-box approaches be addressed?

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2.0 THE ECONOMYENVIRONMENT RELATIONSHIP

Section Overview
In this section we begin by outlining the field of economics, environmental economics
and the role of this module within environmental economics. Specifically we develop
a conceptual model of the relationship between the economy and the environment
that places in context many of the activities undertaken by environmental
economists, in particular, environmental policy design and implementation. The
model we develop draws attention to some of the key relationships between the
economy and the environment and the varying importance attached to these
relationships by the environmental economics profession.

Section Learning Outcomes


By the end of this section, students should be able to:

understand the complexity of the interaction of economy and environment


understand the extent to which economic activity can use the environment
before resource sustainability becomes an issue.

2.1 Defining economics and the environment


Our starting point is to place this module within the field of environmental
economics. To do this, we need first to have an idea of what we mean by economics
and the environment.
A dictionary definition of economics would be something like the science of the
management of the material resources of an individual, community or country.
Thus, economics is about the allocation of scarce resources amongst competing uses.
What about environment? A broad definition of the environment might be the
surroundings: the conditions influencing development or growth. Thus, you might
include any number of things that are around you as being part of our environment.
For example, the environment can be defined to include all flora and fauna, aquatic
ecosystems, energy and material resources, and the atmosphere (Hanley et al, 2007).
There are many examples of the way in which the economy and the environment
interact and are interdependent, for example, agriculture and the environment.
Society has become very aware of the environmental impact of agriculture over the
last few decades because of increased understanding of the negative consequences
of certain agricultural practices. At the same time it has become apparent that many
of these practices have resulted from the policies introduced to encourage farmers to
produce agricultural output. Examples of the negative consequences of agriculture
include: water pollution (both surface and groundwater), soil erosion and soil
compaction, the loss of wetlands because of drainage, air pollution, acidification of
soil as a result of livestock activity, and the loss of biodiversity because of land
clearance for more agriculture as well as the adoption of new technologies. These
outcomes have resulted because many commodity-specific price and income support

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programs, such as those in the EU, North America and Australia, did not require
farmers to take account of the environmental consequences of their actions.

2.2 Links between the economy and the environment


Let us begin by considering in general the ways in which the economy and the
environment are interlinked. Then we will look at how environmental economics has
developed and the scope of the subject. We employ the typical characterisation
found in many textbooks and assume the economy can be divided into two sectors:
production and consumption. These sectors use the environment in three main ways:

as a supplier of natural resource inputs

as a supplier of environmental and amenity goods

in its capacity as a waste sink.

Using the environment in one of these ways may affect the other uses, as will
become clear in the following discussion.

Supplier of natural resource inputs

Land, water and stocks of raw materials are important inputs to production. These
resources frequently vary between countries and so will affect the countrys
economy. Some countries will have large stocks of minerals, while others have good
arable land.

Natural resources are either renewable (eg trees) or non-renewable (eg crude oil).
This distinction is important as it influences the way the resources have to be
managed in production.

These resources are used by the production sector to create goods and services for
use by consumers, or as inputs for another part of the production sector, but in the
process waste products will also be produced.

 Can you think of an example from your country where a natural


resource is used in a production process, resulting in both a product for
use by consumers and a waste product?
Answer
An example could be coal, which is used to generate electricity. As the coal
is burned, it produces electricity, but at the same time, carbon dioxide and
sulphur dioxide are also produced and these may have detrimental effects
on the environment.

Supplier of environmental and amenity goods

Economic benefits (ie increased utility) may be directly derived from the consumption
of the flow of services that are forthcoming from a stock of environmental goods.
There are many examples of where the environment provides amenity benefits for
society. For example, some countries enjoy beautiful landscapes and the public
benefit from these via their associated recreational services and tourism.

Environmental stocks of trees can offer global services such as climatic regulation

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because the trees absorb carbon dioxide, which might otherwise contribute to climate
change.

Many people get enjoyment from the biodiversity that exists in the world, and this
can also be considered as a form of public consumption of environmental good.

Waste sink capacity

This is the capacity of the environment to assimilate the waste products of


production and consumption and convert them into harmless or ecologically useful
products. This use of the environment is the one we are most concerned with in this
module, as we look at the introduction of policies which affect how and at what level
the environment is used as a waste sink.
The environment is not only affected by waste products, but also by intentional
release of chemicals, such as pesticides, wood preservatives, paints and lubricants.
Let us put some figures on to these wastes and intentional releases.
The impact of human activity on the composition of chemicals in the atmosphere is
clear. Since 1750, the pre-industrial period, carbon dioxide concentrations have
changed from 280 parts per million to 380 parts per million in 2000. There have also
been significant increases in other gases such as methane and nitrous oxide. There
are serious concerns being expressed about these increasing concentrations in the
atmosphere and climate change.
We are thinking here about the physical assimilative capacity of the environment.
This is the physical capacity of the land, water and the atmosphere to absorb wastes
and is determined by physical factors such as the climate, rainfall, wind patterns and
geographical location.

When thinking about waste we need to distinguish between degradable and


cumulative pollutants. With cumulative pollutants we need to understand if there are
any important thresholds that need to be avoided. The figure in 2.2.1 illustrates the
importance of assimilative capacity for threshold and non-threshold cumulative
pollutants.

2.2.1 Pollution damage functions

C B
Damages
(physical units) A

Threshold Pollution

Source: adapted from Hanley et al (2007) p. 4.

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In the figure in 2.2.1 we have drawn three damage functions. Function A shows a
simple linear damage function, function B an exponential damage function, and
function C a damage function with a threshold. The important issue captured by
function C is that there is point beyond which a pollutant has a significantly increased
impact on the environment. An example is the level of oxygen in water which if it
falls below a particular level becomes extremely dangerous for fish.

It is common practice to describe the assimilative waste capacity of the environment


mathematically.

Stock of degradable pollutant ( S ta ) at time  is given by

S ta = Ft At
Stock of cumulative pollutant ( S tc ) at time   is given by

t =t*
S = Ft
c
t*
ti

where  is the positive flow in a year

 is the amount assimilated in a year

 is the starting date for emissions

Environmental management can require that we take actions to prevent further


pollution because we think that any important threshold might be breached. The
term used to describe this type of environmental management is the precautionary
principle.

The precautionary principle states that action on preventing or restricting


environmental damage should not be delayed just because there are uncertainties
about how the damage is caused or the level of damage (Hanley et al, 2007).

2.3 The first two laws of thermodynamics


The natural laws which govern the environment and which are, therefore, of interest
to us, are the first two laws of thermodynamics. These relate to closed systems.
Strictly speaking, the earth is not a closed system as it receives energy from the sun,
but it is almost a closed system.

First law of thermodynamics

The first law states that whenever energy is converted in form, its total quantity
remains unchanged. In other words, energy (or matter) can be neither created nor
destroyed.

Common and Stagl (2005) use the example of a coal-fired electricity generating
plant. The coal is heated, which produces electricity. A by-product of this process is
waste heat that is transported away as cooling water or gases. In addition, various
waste gases are emitted into the atmosphere, which cause pollution, such as acid
rain.

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Second law of thermodynamics

This law states that in a closed system, entropy does not decrease.

Entropy could be described as a measure of the degree of disorder of energy. For


instance, ordered energy is useful and an example of this is the energy stored in a
battery. However, disordered energy is not useful, and an example is the energy
dispersed into the environment by a fire.

Entropy is a thermodynamic property of matter and is related to the amount of


energy that can be transferred from one system to another in the form of work. For a
given system with a fixed amount of energy, the value of the entropy ranges from
zero to a maximum. If the entropy is at its maximum, then the amount of work that
can be transferred is equal to zero, and if the entropy is at zero, then the amount of
work that can be transferred is equal to the energy of the system.

During an irreversible process the entropy of a system always increases.

The key points to remember from the above are that, because of these natural laws:

increased extraction of minerals by the production process leads to an increase


in wastes

there is a limit on the substitutability of inputs

since production and consumption lead to the dissipation of matter, scarce


energy is needed for recycling.

The importance of these two laws relates to the use, re-use and recycling of the
environment after interactions with the economy.

Let us look more closely at the subject of recycling, as this would seem to offer a
chance for the economy to retain the use of scarce resources.

Recycling

There is a hierarchy of resource use that includes recycling. This is referred to as the
three Rs reduce, re-use, and recycle. The final and least appealing option after
resource use is to dispose of any remaining waste.

There are now many materials which are routinely recycled and re-used. For
example, glass bottles have been collected and re-used by a number of drinks
companies for many years. In various countries this practice is encouraged by the
use of deposit-refund schemes. Other examples include paper, metal, glass, plastic,
textiles, and garden waste.

For instance, in the Netherlands, household waste that can be composted is collected
separately from other household waste and is composted by the local authorities. To
encourage citizens to participate in this scheme, householders received some free
compost soon after the scheme was set up. However, there are clearly costs involved
in such a scheme:

separate waste bins were provided for the compostable waste

information was provided to householders

householders spend time separating their waste

costs of separate collection and of dealing with the compost.

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In the Netherlands, chemical household waste is also collected separately, with


similar costs involved. There are numerous examples of different economic
instruments used to deal with waste at both household and industry levels.

There are clearly limits to what resources can be re-used and recycled. These limits
are not only dictated by the laws of thermodynamics, but also the costs associated
with re-using and recycling many items.

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Section 2 Self Assessment Questions

Q uestion 5

According to Hanley et al (2007), what are the main components of the


environment?

Q uestion 6

What are the three ways in which society uses the environment?

Q uestion 7

True or false?

(a) According to the first law of thermodynamics energy can be destroyed.

(b) The three Rs of resource use are reduce, re-use, and recycle.

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3.0 PLACING AN ECONOMIC VALUE ON ENVIRONMENTAL


GOODS AND SERVICES

Section Overview
In this section we explain that the need to value the environment can be motivated
by efforts to achieve sustainable development. We also examine why environmental
valuation can be a multifaceted activity.

Section Learning Outcomes


By the end of this section, students should be able to:

understand the relationship between environmental valuation and sustainable


development

appreciate that economists (as well as other environmental scientists) have a


range of approaches and attitudes towards environmental valuation.

3.1 Why value the environment?


As a result of increased demands for the sustainable development and improved
management of environmental resources, and because environmental issues now
take ever greater prominence in decision-making, economics provides an array of
techniques and methods for putting economic values on the environment. To help
understand these methods we can consider the in relation to sustainable
development broadly defined. So how does valuing the environment relate to
sustainable development?

To answer this question we first introduce five basic concepts of sustainable


development:

Efficiency: ensuring the efficient use of resources (including environmental


and natural resources) and the integration of environmental values into
decision-making, policy design and implementation.

Social equity: a commitment to meeting at least the basic needs of the poor
of the present generation (as well as equity between generations).

Environmental integrity: a commitment to protecting environmental


resources and amenities and to living within the limits created by the carrying
capacities of the biosphere.

Quality of life: a recognition that human well-being is constituted by more


than just material wealth and economic growth.

Participation: the recognition that sustainable development requires the


political involvement of all groups or stakeholders in society.

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How the five concepts are interpreted yields different interpretations of sustainability.
The most common distinction is between weak and strong sustainability.

Weak sustainability is typically understood as the requirement to keep the sum of


capital (that is, natural plus man-made capital) intact over time.

Strong sustainability is interpreted as the requirement to keep each individual type of


capital stock intact over time. Thus, there is no ability to simply substitute human
capital for natural capital which is allowed under weak sustainability.

What this difference in interpretation implies for each of the concepts is outlined in
the table in 3.1.1, below.

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3.1.1 Weak and strong sustainability

Weak sustainability Strong sustainability


Efficiency. This is the most highly stressed Efficiency. Economic efficiency and
concept in neoclassical economics. In very growth are not regarded as the primary
weak definitions it involves selecting determinants of human welfare. Pursuit
projects that maximise net benefits with no of economic efficiency may be
requirement that those who are constrained by other key objectives such
detrimentally affected by the project as maintaining ecological integrity and
receive compensation. improving social equity. Greater
emphasis on providing compensation to
those detrimentally affected by a
project or policy.

Equity. Inter-generational equity is assured Equity. Inter-generational equity


by passing on to future generations a stock requires that we maintain the level of
of capital of equal value in monetary natural capital across generations. Intra-
terms. This capital stock includes both generational equity may require explicit
man-made and natural capital. Intra- incorporation of distributional issues into
generational equity may be less environmental policies and projects.
emphasised, particularly if it represents a
challenge to current global consumption
patterns and international relations.

Ecological integrity. Puts less emphasis on Ecological integrity. Greater emphasis


environmental limits or constraints by on maintaining critical natural capital
adopting an optimistic view of the role of stocks. Adherence to real physical
technology in alleviating resource scarcity ecological limits that may constrain or
and the scope for substitution between modify economic growth. Belief that
different types of capital, including human- there are limits to the extent to which
made and natural capital. natural capital can be replaced or
substituted by human-made capital. Less
optimistic about the role of technology
in alleviating resource scarcity.

Quality of life. Economic growth is seen as Quality of life. Rejects the notion that
the main route to achieve improved quality economic growth can be taken as a proxy
of life. Less weak versions of sustainability for quality of life. Includes a wide range
would support gross national product (GNP) of socioeconomic, environmental and
adjustments to take account of political factors.
undervalued environmental resources.

Participation. The market provides the Participation. Adopts a bottom-up


main voice for public wants, but for public interpretation of participation, in which
and environmental resources that are not objective setting as well as project
marketed, there may be a top-down implementation is open to participative
process of consultation with identified processes.
stakeholders.
Source: previous module

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The tools and methods that are of use when putting sustainability into practice are
summarised in the table in 3.1.2, below. Sustainable development involves not only
economic efficiency (as is often assumed) but also a number of other aspects; for
example, social equity, ecological integrity, and the participation and quality of life.
The various academic disciplines concerned with sustainable development have
developed their own sets of tools for putting sustainable development into practice.
Some of these tools are illustrated in 3.1.2, and this module will focus on the tools
developed by economists economic efficiency-based concepts of environmental
valuation and costbenefit analysis. Although we will not examine many of these
methods and tools in this module, the table gives you an idea of how the economic
tools of environmental valuation and costbenefit analysis (and cost-effectiveness
analysis) form part of the whole range of techniques applicable to sustainable
development.

3.1.2 Methodological tool kit: towards sustainable development

I II III IV
Economic Social equity Ecological integrity Participation and
efficiency quality of life
environmental distributional environmental stakeholder analysis
valuation weights impact participatory
methods discounting assessment appraisal methods
costbenefit adjustments cost-effectiveness citizenship juries
analysis social impact analysis multi-criteria analysis
assessment sustainability
constraints
environmental
shadow projects
risk/uncertainty
adjustments
Source: previous module

Economic efficiency is the cornerstone of neoclassical economics and is concerned


with the allocation of scarce resources in society between competing uses. The
principle of economic efficiency underlies the methods of costbenefit analysis (CBA)
and environmental valuation methods.

Once we have estimated our environmental values these are then typically
incorporated into CBA a key economic decision-making tool employed by
economists. The underlying rationale for this approach is the premise that
environmental concerns have not been adequately addressed in the past because
they have been ignored in CBA and, consequently, not taken into account when
decisions were made and development planning formulated that would result in
sustainable outcomes. Essentially, placing economic (monetary) values on
environmental goods and services which are not traded in markets, as we will
explain, is far from a perfect science. However, valuation exercises which are
transparent and provide information for policy-makers and the public are frequently
a valuable approach to resource and environmental management.

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This approach and its underlying philosophy to environmental decision-making has


become accepted and adopted by a whole host of institutions and organisations.
National governments have instituted environmental procedures and guidelines for
public sector projects that emphasise the need for environmental valuation and cost
benefit analysis. For both the Environment Agency in the UK, and the Environmental
Protection Agency in the USA, environmental costbenefit analysis plays a central
role in designing rules and regulations for industry.

For developing countries, environmental valuation is becoming an increasingly


important aspect of decision-making. Multilateral agencies such as the World Bank
have initiated environmental valuation procedures and guidelines as an integral part
of the planning process.

3.2 Developing a pluralistic approach to environmental


valuation and decision-making
Whilst the economics approach to sustainable development and environmental
decision-making represents the mainstream view, and is the one central to this
module, it is not without controversy.
Why?
There is a very obvious but important dilemma that confronts any form of
environmental valuation. Economists typically rely on individuals revealing their
preferences for goods and services as a result of market transactions. However, the
vast majority of environmental goods and services are not traded in markets: they
are not bought or sold. Thus, non-market valuation is an attempt to correct for a
form of market failure. Environmental valuation as practised by economists is an
attempt to place monetary value on these goods and services so that efficient
resource allocation decisions can be made.

Defining market failure

Neoclassical economics is concerned with markets for goods allocating scarce


resources to alternative uses, and prices being established which reflect the scarcity
of, and levels of demand for, goods.
Think for a moment about our daily lives and what affects them. We live in a
particular environment, breathing the air. However, we do not pay a price for the air,
as there is no market in air. As a result, we cannot reflect our preference for
breathing clean rather than dirty air through the market. This is an example of
market failure.
Market failure occurs when the conditions for perfect competition are not met. If the
market fails, then government intervention designed to correct the market failure
may bring benefits to society. However, government intervention may fail to secure
these benefits, even making matters worse and resulting in market failure. This is
known as government failure.
We know that the market mechanism will lead to the socially optimal outcome only
under very specific conditions. However, it is highly unlikely that these conditions will
be fully satisfied. The existence of perfect competition in reality as it is defined in
textbooks is itself highly unlikely. For example, we require that prices will result from

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the realisation of all possible markets working and existing. This is only likely to
occur when a complete and effective system of property rights exist, including
property rights to environmental goods such as clean air.
When either condition is not satisfied, markets fail, and this can, deliberately or
unintentionally, bring about undesirable consequences.
Let us work through the argument for a negative externality. In this case, the
marginal private cost (MPC) is less than the marginal social cost (MSC). The marginal
private cost represents the short-run market supply curve. Hence, with a negative
externality, the short-run market supply curve is lower than would be societys short-
run supply curve. The difference between the MSC and MPC are the marginal
damages (MD). MDs are the amount of the negative externality which, as the
quantity of output increases, increase as well. These are damages being inflicted on

society as a result of the private producer not taking account of the costs that result
from production, such as air or water pollution. This situation is illustrated in 3.2.1.

3.2.1 Effect of a negative externality

Price
MSC = MPC + MD

MPC = supply
B
P*
P A

demand

Q* Q Quantity

Source: previous module

A shows the equilibrium position with a negative externality. Price is  and quantity
supplied is  .  shows the point of allocative efficiency or Pareto optimum, where
price is   and quantity supplied is   . Hence, with a negative externality, too much
of the externality-producing good is supplied at too low a price (relative to the Pareto
optimum). This is an example of market failure. It results from the absence of
property rights and a market for the MDs produced by this activity.

Issues with non-market valuation

As we will see, there are many criticisms associated with the use of the various non-
market valuation methods. How can we value the ozone layer? Many would also
observe that many environmental goods and services have value in their own right.
As a result, environmental valuation as practised by economists is not without its
critics and it still remains a controversial activity.
However, the economics profession has developed a wide array of techniques to
measure environmental value. Methods have been developed to measure the use

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value associated with the direct use of a resource such as walking or bird watching
in forests. There are also a set of methods that allow non-use values to be
estimated. Non-use values would be if somebody values the continued existence of
the birds in the forest without actually ever visiting the forest. To estimate these
values economists frequently employ a wide range of survey methods that ask the
public what they might be willing to pay for a benefit (seeing the birds), or what they
would accept in compensation for its loss (cutting down of the forest). The use of
these methods has entered mainstream environmental and resource management.
This can partly be traced to the NOAA Panel (Arrow et al, 1993), which published a
highly influential report on the use of contingent valuation for non-market valuation.
The NOAA Panel report came about as a result of the 1989 Exxon Valdez oil spill in
Alaskas Prince William Sound. In the resulting legal case that followed the oil spill
extensive use was made of Contingent Valuation in an effort to determine the
magnitude of the various fines to be paid for the spill. As a result of the huge time
and effort expended on the various Contingent Valuation exercises the NOAA Panel
provided important guidance on how to implement Contingent Valuation in practice
so as to minimise many of the problems and issues associated with these methods.

3.3 Environmental valuation and neoclassical economics


The main philosophical approach to environmental valuation and decision-making
used in this module is that of neoclassical economics, as this provides the principal
methods used at the present time. However, while working through the module, you
should keep in mind that economic methods (such as environmental valuation and
costbenefit analysis) need to be placed within a broader framework that
encompasses a wider range of decision-making tools, including environmental and
social impact assessment, sustainability constraints, and participatory environmental
appraisal. Within the economics discipline, some of these broader aspects of
decision-making have been adopted by economists who describe themselves as
being ecological economists.

What are the main differences between neoclassical and ecological economics?

(1) Environmental and economic linkages

The neoclassical approach treats the environment as a commodity which can be


broken down into different components and analysed, just like any other commodity.
For example, the economic value of a wetland ecosystem can be broken down to
show the value of different wetland products, such as wild plants, fish, and building
materials derived from wood, palm leaves, grasses, and soils. There are also
important ecological functions of the wetland, such as water filtration and climatic
regulation, which may have impacts on the agricultural or other economic sectors.
These indirect economic impacts will also be factored into the economic valuation
estimate.

This is essentially a mechanistic conception of the environment, in which the overall


value of nature is broken down into its constituent parts and reconstructed, rather
like a machine. It assumes that the environmental system can be reduced to its parts
and that the essentially deterministic relationships between the different elements
are governed by predictable laws.

Ecological economists argue that environmenteconomic linkages are not

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characterised by short-term deterministic relationships, but are governed by


synergy, irreversibility and ecological thresholds. They view economic, social and
ecological systems as having a dynamic and interconnected relationship that evolves
over time. This approach rejects universal policy prescriptions that flow directly from
the neoclassical model, arguing for a more pluralistic approach in which
environmental policy decisions are tailored to the specific circumstances in each
case, and in which ecological thresholds or sustainability constraints are applied to
economic decision-making.

(2) Human behaviour and the environment

The neoclassical approach emphasises the instrumental use of environmental


resources for human preference satisfaction. The central assumption of free will and
consumer sovereignty elevates the role of humankind to environmental managers. In
ecological economics the human species is seen more as an environmental steward
rather than merely a consumer of environmental goods and services. Some would
take a stronger stance, rejecting the underlying utilitarian ethic of neoclassical
economics by arguing for the extension of rights of existence to other species,
independently of the interests of humankind. Institutional economists also argue that
environmental behaviour and preferences are largely determined by the economic
system and societal norms, hence suggesting a greater role for environmental
education.

(3) Future generations

The utilitarian ethic of neoclassical economics is concerned with maximising net


human welfare across generations. If the interests of future generations are not
explicitly protected, this approach allows the welfare of one generation to be traded
off against that of another generation. The aim of protecting the interests of future
generations has now become a central component of the widespread commitment to
sustainable development. However, the meaning of protecting the interests of future
generations is subject to multiple interpretations, and differs in neoclassical and
ecological approaches to the environment. For example, followers of the weak
sustainability school might allow economic development that degrades the
environment so long as the overall stock of wealth (which includes both man-made
and natural capital) does not decline in value terms over time. Ecological economists
remain sceptical of this interpretation of inter-generational justice, arguing that there
is a need to conserve a critical stock of natural capital to pass on to future
generations. This approach to sustainability may be described as a strong
sustainability approach.

(4) Social choice and decision-making tools

Neoclassical economics is a market-orientated approach, which means that resource


allocations in society are largely governed by the forces of demand and supply.
Society expresses its choices and preferences through the types of products and
services that are demanded, and producers respond by utilising the resources of
society (such as land, labour, machinery and equipment, and environmental
resources) to supply products and services that satisfy consumer demands.
Neoclassical economists label institutional factors that pervert ideal market outcomes
as market and government policy failures, requiring corrective government
intervention. This requires a range of tools and policies that enables the market to
work more efficiently. For example, when the economic values of environmental

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resources are not revealed in actual market prices, surrogate market prices can be
imputed using environmental valuation techniques. These values can then be used to
guide rates of environmental taxation (such as carbon taxes on fossil fuels), or can
be used to guide project decisions through their integration into costbenefit
analysis. This approach has been effectively used in order to advance environmental
ends, and has been supported by many environmental NGOs. However, there are
many loud objections to this approach on the grounds that normative issues of wide
public significance should be open to broader public debate and negotiation. This
involves developing the institutions of social choice beyond the marketplace to allow
greater public participation in environmental and economic decision-making.
Ecological economics also embraces a more pluralistic approach to decision-making,
drawing on an array of tools and methodological approaches from a range of
disciplines. As the issues are multidimensional, so must be the policy framework,
allowing case-specific, tailor-made approaches to decision-making.

The differences in opinion/philosophy between neoclassical economists and ecological


economists are also related to differences between economics and environmental
science more generally. This can be explained by how economists and ecologists
interpret the following concepts, and how this affects their perspective on valuing the
environment.

Scale, scarcity, technology and resource substitution

Although natural resource limits have not caused the crises predicted by the Limits
to Growth adherents in the 1970s, the issue of physical constraints plays a central
role in ecology, whereas economists are more preoccupied with the concept of
relative scarcity. The scale argument has now been refined to stress the real scale
constraints on economic activity posed by energy sources and critical natural stocks
essential for life support.

Neoclassical economics is more concerned with marginal changes than large


structural shifts. For this reason they are often criticised by ecologists who are more
aware of the potentially catastrophic changes associated with small marginal changes
around ecological thresholds. In the market system, relative scarcity is expressed
through the price mechanism. In an efficient market, increasing resource scarcity will
give rise to increasing prices, technological innovations are induced by relative price
changes and substitute materials are found or developed. Technological dynamism
explains why the pessimistic predictions of the classical economists (and ecologists)
have not come true, but technological optimism may not be sufficient to enable us to
overcome the threats posed by depleting critical natural resource stocks.

Environmental valuation is seen as the best way to reflect natural resource scarcity
by the neoclassical economist. Putting a price on natural resources and
environmental resources, and thus integrating them into the market economy, is
more sustainable than letting natural resources remain free, and thus over-exploited,
resources. Ecologists are less supportive of this approach, preferring more traditional
conservation measures and environmental standards as environmental management
tools.

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P522 Environmental Valuation: Theory, Techniques and Application Unit 1

Irreversibility and resource divisibility

The key difference between economists and ecologists is not about whether
irreversible change occurs, but whether it matters or not. For the economist, it is
okay to kill the goose that lays the golden eggs so long as the benefits exceed the
costs. This is why economists may ask whether it is optimal to make a species
extinct; whereas to an ecologist such a question would not make sense within the
context of an integrated ecosystem. For an economist, natural resources are
divisible, whereas ecologists are more interested in the relationships and connections
between different elements of the ecosystem. The assumption of divisibility is crucial
for environmental valuation methods which break down the different aspects of an
ecosystem into its component parts. Various environmental valuation methods can
then be used to assign monetary values to different aspects of the ecosystem.

Discounting the future

Neoclassical economists apply discount rates to future costs and benefits. Discounted
costs and benefits can then be presented in present value terms. The practice of
discounting future costs and benefits has important implications for inter-
generational equity. Many people have called for adjustments to the discount rate
either for it to be lowered, adjusted to zero, or in some cases to be made negative.
Others call for the explicit incorporation of sustainability constraints (or safe
minimum standards) into economic appraisal as a means to protect the interests of
future generations.

Intrinsic values

Environmental valuation methods are based on the neoclassical assumption that


people will be willing to pay for environmental benefits (or accept compensation for
environmental losses). The extent of their willingness to pay will be based on their
preferences. This ignores environmental values which are not based on preferences,
such as intrinsic values independent of human preference. Ecological economists
tend to stress the importance and pervasive nature of intrinsic values and other
environmental concerns that are not motivated by utilitarian values.

Safe minimum standards

Safe minimum standards (SMS) add a more precautionary dimension to project


appraisal and are recommended by many ecological economists, particularly when
there are issues of risk, uncertainty and irreversibility. SMS can be thought of as a
particular type of sustainability constraint, based on a more risk averse approach to
environmental management.

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P522 Environmental Valuation: Theory, Techniques and Application Unit 1

Section 3 Self Assessment Questions

Q uestion 8

What is meant by market failure?

Q uestion 9

What happens to the level of output produced when there is a discrepancy between
private and social costs?

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P522 Environmental Valuation: Theory, Techniques and Application Unit 1

UNIT SUMMARY
In this unit, we began by introducing and placing environmental valuation within its
current policy context. That is, we explained that there is an increasing demand for
environmental valuation as an important component of policy analysis and
implementation. We then briefly examined some of the main issues surrounding
environmental valuation and why environmental valuation remains a controversial
topic.

We then looked at the links between the environment and the economy. We defined
the environment as including the atmosphere, all flora and fauna, and energy and
material resources, and stated its main uses for the economy as:

a supplier of resource inputs

a supplier of public consumption of environmental or amenity goods

a waste sink.

We looked at the difference between degradable and cumulative pollution and noted
that, in mathematical terms, stock of degradable pollutant at time  is given by

S ta = Ft At
stock of cumulative pollutant at time   is given by

t =t *
S = Ft
c
t*
ti

where  is the positive flow in a year

 is the amount assimilated in a year

 is the starting date for emissions

The natural laws (that is, the first two laws of thermodynamics) which the
environment obeys mean that increased extraction of minerals leads to an increase
in wastes; there is a limit on the substitutability of inputs; and, since production and
consumption lead to the dissipation of matter, scarce energy is needed for recycling.

Recycling was examined in more depth, leading to the following conclusions:

not everything can be recycled

recycling uses scarce resources, so may not be either economically or


environmentally desirable.

The unit then considered the scope of environmental economics. It examines the
links between economics, ecology and the environment and places environmental
valuation within a pluralistic and multidisciplinary approach to incorporating
sustainability issues into decisions that affect the environment.

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P522 Environmental Valuation: Theory, Techniques and Application Unit 1

Next, the unit considered why neoclassical and ecological economics have different
perspectives on: the relationship between the economy and the environment; the
relationship between humankind and nature; the rights of future generations; and
the role of the market in environmental resource allocations. These different
perspectives have important implications for the role of environmental valuation in
environmental management at the project level.

Neoclassical and institutional economics give different perspectives, with neoclassical


economics emphasising the market failure approach to the environment while
institutional economics concentrates on the property rights approach. Individuals
preferences are assumed exogenous (ie external to the model) by neoclassicists,
but endogenous (ie internal to the model) by institutionalists, and moral and social
norms are given more prominence by institutional economists.

Sustainable development can be defined in terms of five core principles: economic


efficiency; social equity; ecological integrity; quality of life; and public participation in
decision-making. These five principles have different interpretations and emphasis
according to weak and strong sustainability.

Environmental valuation and costbenefit analysis focus on the efficiency aspects of


sustainable development and form part of the range of methodological approaches to
incorporating sustainable development into decision-making.

Environmental valuation uses money as a common measuring tool to weigh up


environmental costs and benefits.

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P522 Environmental Valuation: Theory, Techniques and Application Unit 1

UNIT SELF ASSESSMENT QUESTIONS

Q uestion 1

From your reading of this section and using your imagination sketch a diagram that
captures the three functions that the environment provides when interacting with the
economy.

Q uestion 2

To what extent are the concepts of weak and strong sustainability associated with
the different schools of thought (neoclassical and ecological)?

Q uestion 3

Can you think of examples of environmental goods and services for which there are
no markets, or, if there is a market, the price does not reflect the full social value?

Q uestion 4

Draw a diagram to show the effect on prices and quantities, relative to the Pareto
optimum, of a positive externality.

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P522 Environmental Valuation: Theory, Techniques and Application Unit 1

KEY TERMS AND CONCEPTS


endogenous variable A variable whose value is determined by one of the relationships
specified by the model under consideration.

entropy A measure of the degree of disorder.

existence value The willingness to pay to keep a good or service in existence


even when no direct use is ever intended.

exogenous variable A variable whose value is not determined by one of the


relationships specified by the model under consideration.

externality An unintended consequence, good or bad, from the actions of


another economic agent.

non-excludable An individual cannot be deprived of useful consumption of the


good even though he or she may refuse to pay for it.

non-rival Use or consumption is non-rival if that use means that the


quantity of that particular good available to others is not
diminished.

non-use value The willingness to pay to keep a good or service in existence


even when no actual, planned or possible use is intended.

option value The value associated with preserving the option to use a good or
service in the future.

Pareto A policy change that makes society better off and nobody worse
optimality/criterion off is referred to as a Pareto improvement. The Pareto optimum
is achieved when we reach an allocation of resources such that
any change must make somebody worse off.

public goods A good which is non-rival and non-excludable.

use value A measure of value that stems from the actual use, planned use
or possible use of a good or service.

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