Techniques to Value Environmental Resources:
an Introductory Handbook

Published as a joint exercise by the
Commonwealth Department of the Environment, Sport and Territories,
the Commonwealth Department of Finance,
and the Resource Assessment Commission
Australian Government Publishing Service, 1995

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Chapter 2 - WHAT CAN ECONOMICS OFFER?

This chapter outlines the role of economics and monetary valuation in providing information for environmental decision-making.

Economics is concerned primarily with the efficient allocation of resources in order to maximise society's welfare. Economic analysis can show, albeit imperfectly, how different resource allocations affect the welfare of society as a whole and of different groups in society. However, economic analysis alone cannot decide which is the best allocation since society has goals other than efficiency.

Two kinds of environmental problems

Decision makers in government are usually faced with two types of environmental problems to manage.

The first involves the allocation of resources between competing uses. For example, should an area be set aside as a park or should logging be permitted? These issues require decision makers to weigh up the benefits of resource preservation against the benefits and costs of resource development.
The second concerns the harmful or beneficial consequences of resource uses which fall on those who do not pay for or receive income from the uses. How should these consequences be managed, who should pay for them, how and in what amounts?

Economists call the second type of environmental problem an externality. Externalities are seldom traded in markets. They can take many forms ranging from physical externalities, such as downstream pollution due to upstream sewage, to spiritual and cultural externalities, such as the desecration of an Aboriginal sacred site.

Externalities can also be positive. For example, trees planted by a farmer for salinity reduction will also provide salinity reduction benefits for downstream farmers, as well as control stream flow, reduce soil erosion and protect water supplies.

Box 2.1: Valuation in two environmental issues

Issue                                Dam a river?



Example                         The decision on the Gordon below Franklin dam


Benefits                        Mainly finical (revenue from producing
                                hydro-electric power).  Some non-financial
                                (reduced flooding, security of  water
                                supply)

Cost                            Financial (equipment, building) and on-financial
                                (loss of wildlife habitat or loss of Aboriginal
                                sites)  


Decision problem                Do the net financial benefits
                                exceed the net non-financial 
                                costs?          



Valuation problems              What is the value of lost habitat 
                                or lost site? If some costs can't
                                be valued, how do we decide? If
                                economic data are inadequate, how
                                do we decide?


Issue                            Control beach pollution?


    
 


Example                         The decision to dispose of Sydney's effluent


Benefits                        Mainly non-financial (improve
                                health, improved aesthetics and
                                improved recreational quality) and
                                some financial  (increase tourism,
                                Fisheries production)




Cost                            Mainly financial (equipment, 
                                buildings)


 

Decision problem                Do net non-financial benefits
                                exceed net financial cost?
        

Valuation problems              what is the value of improved
                                health, aesthetics? If some
                                benefits can't be valued, how do we
                                integrate benefits and costs?

Economic problem solving

Economics has a useful part to play in both kinds of environmental problems. It recognises that different aspects of the environment are scarce and therefore have economic value, and that all decisions involve the allocation of these scarce resources to satisfy human wants. Economic analysis provides a general framework to help manage resource uses to maximise social well-being. As such it:

provides a framework for management of the environment
indicates the relative net benefits of competing resource uses
assesses the impacts of different policies and programs on externalities
provides information on gains and losses to different groups in society.

Economics is a human-centred subject and most of economic theory is based upon the view that human well-being is to be improved. In the case of environmental decisions this requires use of the available resources to maximise benefits (net of costs) to society over time. As Morris, Wilks and Wonder (1992, p.6) point out:

The economic objective is thus not necessarily to minimise land degradation, or to preserve certain species or areas of land, or to attain some other physical or technical target; it is to ensure that all resources are applied in their highest valued combination of end-uses, both currently and in the future.

From an economic perspective, resource management problems are posed in terms of whether resource conservation will result in greater social well-being than resource development. Or in the case of issues such as pollution, are there net benefits to society in implementing stricter or more lax pollution controls? Economics recognises that in any decision there will be costs and benefits to different parties and that unless all of these effects are considered it is difficult to make good decisions.

ECONOMIC VALUES, FINANCIAL VALUES AND ENVIRONMENTAL EFFECTS

In economic analysis, any action which increases welfare is a benefit and any action which decreases welfare is a cost. A benefit is the value that people assign to goods and services, including those provided by the environment. Such values can be revealed by an individual's willingness to pay to obtain those goods and services or willingness to accept compensation for a loss of goods or services (see Box 2.2).

Box 2.2: Willingness to pay or willingness to accept?

In measuring environmental benefits, values can be ascertained by an individual's willingness to pay to maintain an existing environmental amenity or their willingness to accept compensation for the loss of an amenity. Economic theory says that maximum willingness to pay is equal to minimum willingness to accept.

However, empirical evidence from contingent valuation studies and experiments using traded goods and services indicates large differences between people's responses to willingness to pay and willingness to accept, with willingness to accept generally two to three times higher. This suggests that individuals value what they have at present more than a gain in an existing amenity. While economic theory cannot explain this phenomenon, the psychological explanation is that people define their identity in terms of their rights, privileges and possessions, so that the prospect of losing something after it has been possessed for some time represents a loss of an individual's identity.

A cost is the income forgone in other potential uses of environmental resources. Opportunity cost is the measure of the economic cost of the loss of options for using resources that results from making a particular choice. This would include financial costs since spending money in one way precludes the same money from being spent in a different way.

In financial analysis, values concern just monetary profit. Financial values are therefore inadequate to capture all environmental effects and are inadequate representations of the welfare of society. The distinctions between economic analysis and financial analysis are made in Box 2.3.

Box 2.3: Differences between economic and financial analysis

                        Economic                         Financial analysis




Viewpoint                Society as a whole              Individual, firm or  household

Objective                Increase in welfare             Increase in individual,
                                                        firm or household profit or income
  

Benefit          Any kind of satisfaction        Monetary revenue 
                        or increases in welfare, 
                        including monetary revenue  


Benefit measurement      Willingness to pay or           Monetary revenue
                        accept measurement  


Cost                     Any kind of dissatisfaction     Monetary cost
                        or decrease in welfare,  
                        including monetary cost  

Cost measurement         Opportunity cost                Monetary cost


Value                    Net change in welfare           Net change in
                                                        monetary revenue

Environmental effects clearly have value in economic terms because they increase or decrease welfare even though they may not be traded in markets with monetary prices. In financial analyses, environmental effects are considered only when they directly affect revenue streams or cost outlays.

In this guide, value is used in its economic sense of a change in welfare and valuation is used to mean the process of valuing or estimating these values. The emphasis that economics places on maximising social welfare requires an awareness of all benefits and costs and so includes those environmental values such as clean water or species preservation that are not fully or even partially revealed in financial markets. While these unpriced values are difficult to reveal, they have economic meaning nonetheless because any thing or action from which individuals gain satisfaction is deemed to be of value.

MEASURING VALUES

The study, measurement, and ranking of environmental values is at the heart of many social and biological sciences. Disciplines as diverse as law, sociology, philosophy and economics are all concerned in their various ways with how people understand and act upon their values. Each discipline has developed its own set of questions, theories, and methods to identify and measure values for its own purposes (Resource Assessment Commission 1993, p.9).

As noted earlier, values associated with environmental amenities may be measured in either quantitative or qualitative terms and combinations of quantitative and qualitative assessments are possible. Quantitative assessment involves valuing environmental benefits and costs in a common unit. For example, in cost-benefit analysis the common unit of valuation is the Australian dollar.

Box 2.4: The environment isn't free-a role for monetary values

Value and valuation can be used to demonstrate the environmental resources are not free and have values in the same sense as marketed goods and services have values. The absence of markets should not be allowed to disguise this. By giving a dollar value to the environment, we are forced into more rational decisions that will include a more complete consideration of gains and losses of different resource management options.

Monetary measures

Economists measure environmental values in terms of an individual's willingness to pay or accept compensation. For environmental amenities to have economic value, a person must be willing to pay an amount of money to obtain the amenity or willing to accept an amount of money as compensation for its loss.

Monetary values are readily observable for commodities regularly exchanged in the market place. However, because many environmental resources such as clean air, wilderness, the existence of wildlife and scenic vistas are not exchanged in markets they are unpriced. Nonetheless, these non-market resources have monetary value as long as people are willing to trade some of their income and wealth for them. In this way monetary values do not depend upon whether people actually trade money for the benefits received.

THE CONCEPT OF ECONOMIC VALUE

A comprehensive concept

The economic concept of value has been broadly defined as any net change in the welfare of society. This concept does not restrict environmental values to benefits from the direct use of a resource. For example, the benefits received from environmental resources (such as enjoyment of national parks and clean air) add to an individual's well-being, as do the benefits obtained from the consumption of goods (such as steel and sawn timber). The benefits that individuals obtain in satisfying altruistic desires that arise from their own moral beliefs also have economic value. From an economic perspective, values can be associated equally with the consumption of goods and services purchased in markets and with the services from environmental amenities for which no payments are made. In this sense, anything from which an individual gains satisfaction is deemed to be of value, so long as the individual is willing to give up scarce resources for it.

Use and non-use benefits

The total economic value of environmental amenities comprises explicit use benefits as well as implicit non-use benefits. Use benefits are those that accrue from the physical use of environmental resources such as visiting a national park or recreational fishing. The benefits from productive activities such as agriculture, forestry or fisheries are also included in this category. Use benefits also comprise benefits unaccompanied by market exchanges or explicit activities. For example, people may derive use benefits simply from experiencing a place without actually participating in any explicit activities.

Non-use benefits, on the other hand, refer to the benefits individuals may obtain from environmental resources without directly using or visiting them. They are classified into five types:

1. Existence value-the welfare obtained from the knowledge that an environmental resource exists. The concept may also include the benefits obtained from knowing that culturally important resources are protected.

2. Vicarious value-the welfare obtained from the indirect consumption of an environmental resource through books and other media.

3. Option value-the welfare obtained by retaining the option to use an environmental resource at some future date. Option value stems from the combination of the individual's uncertainty about future demand for the resource and uncertainty about its future availability.

4. Quasi-option value-the welfare obtained from the opportunity to get better information by delaying a decision that may result in irreversible environmental loss. This kind of value may be obtained when future technologies or knowledge enhance the value of a natural resource.

5. Bequest value-the welfare that the current generation obtains from preserving the environment for future generations.

Each of these non-use benefits can increase welfare and so each must be recognised in any analysis.

Economic value

The concept of economic value can therefore be summarised as follows:

Economic value = use values + non-use values

Non-use values = existence value + vicarious value + option value

+ quasi-option value + bequest value

In this way all the benefits from environmental changes may be incorporated.

LIMITATIONS OF MONETARY VALUATION

The limitations of economic values must be fully appreciated when using the resulting dollar figures. Ethical and technical limitations are especially important in environmental management.

Ethical issues

It is not always feasible or desirable to convert all environmental benefits and costs into dollar values. Some benefits and costs may be difficult to identify because of a lack of knowledge about ecosystems. Driver and Burch (1988) argue that information could be lost in the process of translating the diverse benefits of a resource into a single monetary value. Other people argue that the benefit to society of environmental resources is too complex to be captured by a single dollar value and to attempt to do so is to trivialise the importance of the environment (Cameron 1992, p.159). Other benefits and costs may be controversial, such as the value of life, and tend not to be measured in dollars.

The main moral limitations to economic valuation of the environment are as follows:

Certain conventions about equity and morality are assumed in an economic analysis. For example, most economic studies assume that the values given to a resource should be limited by people's ability to pay for them, and that the current distribution of wealth is acceptable. Some people's economic votes therefore have a higher value than others because a rich person is more likely to be willing to pay more to protect (or degrade) an environment than a poor person. In consequence, some individual's preferences count a great deal and others' hardly count at all.
Any valuation implies that natural resource attributes are of relative and not absolute importance-a judgement that is not shared by all. Furthermore, for some people no amount of money can compensate for damage to environmental resources.
Whose values should be assessed? Do we take into account only human values, only the values of Australians or only the values of current generations? Even a perfect valuation of the preferences of existing consumers cannot provide any indication of the preferences of people in the future.
Individual economic preferences are not necessarily preferences that are moral or proper from society's perspective. In an economic framework, ethics is reduced to the efficient satisfaction of human demands.
Monetary valuation is generally part of an assessment undertaken in a cost-benefit framework. Cost-benefit analysis focuses on efficiency in a narrow economic way and does not address issues of social equity or other social concerns.

Technical issues

Despite advances in the sciences and economics, there remain a number of unresolved technical problems with monetary valuation:

Monetary information is usually required on complex and poorly understood effects, such as the full value of ecological services.
The comparability of dollar values for different goods is limited by distortions in markets because of various forms of government intervention. For example, tariffs on parts for imported tractors and on the tractors themselves cause their market price to diverge from their true scarcity value. As a consequence, the monetary value of the repair and use of tractors cannot easily be compared with other costs of agricultural production.
Like most quantitative information, dollar values provide no more than an estimate for a single point in time. Shifts in social attitudes, improved information, and a declining resource base can all lead to large changes in valuations.

THE USEFULNESS OF ESTIMATES OF VALUE

The extent to which specific economic values can be estimated for the management of particular environmental resources is limited by many factors including:

Subjectivity in the application of valuation techniques. Despite developments in the various valuation techniques, application of them still depends on professional judgement.
We can never know future values even if the environmental amenities were traded in markets, so additional decision-making rules are required to deal with risk and uncertainty. For example, the rule of the safe minimum standard and the principle of maintaining the existing stock of natural capital are important for any decision having significant irreversible consequences (Bishop 1978; ESD Working Group Chairs 1992, pp.41-42; Pearce and Turner 1990, pp.48-58).
The advantages of obtaining non-market environmental values must be assessed against the cost and feasibility of obtaining them. As there is no guarantee that monetary values will ever be exact, scarce research resources should be used to obtain the best available estimate for the valuation problem. Sometimes research should be directed away from difficult environmental valuations to the relatively simpler task of competent evaluations of the true economic benefit of resource development options or to scientific research.
Economic values and cost-benefit analyses rarely constitute the sole inputs to decision-making. Information about equity, cultural and social significance are also important inputs. Political considerations also have a strong and sometimes over-riding influence on decisions (Hanley 1992, p.38).

For all these reasons it may be best to consider monetary valuations as bounding values, as improvements over the values of zero or infinity claimed by parties in dispute, or as orders of magnitude of the value of an environmental effect. Monetary valuations can help decision makers but they will never in themselves provide easy answers to difficult decisions.