Transcript Environmental Decision Making

Part II. Environmental Valuation
A. Value
B. Environmental Decision Making
B. Environmental Decision
Making
Chapter 5
Intro
• Once you value the environmental good/service,
can be used to test the “economic efficiency” of a
potential decision or outcome.
• One aspect of this process is the measurement of
both the value of environmental resources and the
value of changes in the level of environmental
quality.
• This is essential information when comparing the
benefits of environmental policy against the costs
of obtaining those benefits.
Decision-Making Criteria
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Economic efficiency
Equity
Sustainability
Environmental Justice
Ecological impact/environmental
stewardship
• Ethics
Economic Efficiency
• Economic efficiency has to do with maximizing
the difference between the social benefit and
social cost of an economic activity, policy, or
project.
• Economic efficiency is usually measured in one of
two different ways:
– Net economic benefit – preferred by economists and
explored in Chp. 4;
– Gross domestic product – preferred by international
development and lending agencies.
Economic Efficiency –
Net Economic Benefit
• As the information presented in Chapter 4
indicated, the demand curve represents marginal
WTP and the supply curve represents marginal
opportunity cost of production.
• Net economic efficiency subtracts total
opportunity cost from total WTP and is
represented by the area under the demand curve
and above the supply curve for a particular good
or service.
Economic Efficiency –
Gross Domestic Product?
• Gross Domestic Product is a measure of the total
value of all goods and services produced in an
economy.
• Because expenditures become income, GDP is
also a measure of national income.
• GDP is not a measure of social welfare because it
does not measure other dimensions of the quality
of life, such as health, environmental quality,
social justice, freedom from crime, etc.
Economic Efficiency –
GDP?
• GDP also fails as a measure of economic
efficiency.
• It does not consider the opportunity costs of
producing the good or service.
• This failure means that GDP would rise because of
a rise in HIV/AIDS due to the increased
expenditure on health care costs.
• Net economic efficiency would not rise – damages
from disease, opportunity cost of using those
monies in next best option.
Economic Efficiency –
Pareto Criterion
• What constitutes an improvement in economic
efficiency?
• One option is the Hicks-Kaldor criterion, or the
criterion of potential Pareto improvement.
• Pareto improvement – resources are reallocated in
such a fashion that some people are better off and
no one is worse off.
• Potential Pareto improvement – is reallocation
whereby the gain of people who are helped is
larger than the losses of those made worse off. If
the gainers could compensate losers, the gainers
would still be better off.
Equity
• Potential Pareto improvement does not
consider equity issues.
• The equity criterion for evaluating policy
considers how costs and benefits are
distributed among members of society.
• These distributional impacts could be within
a country, across international borders, or
across generations.
Equity Across Generations
& Sustainability
• Intergenerational equity is important because
many of the decisions regarding resource use
today may generate important environmental costs
for future generations.
• The process of discounting future costs and
benefits can exacerbate this problem.
• An alternate criterion of sustainability is based on
improving the condition of the current generation
without compromising the ability of future
generations to meet their needs and improve their
quality of life.
Equity Indicators
• Income is one component of equity.
• Two different measures are the primary tools for
considering the inequality of the distribution of
income, the Lorenz curve and the Gini coefficient.
• The curve illustrates the % of income received by
a given % of the population.
• Equity is illustrated by the diagonal line bisecting
the origin. Along this line the two % are equal.
• Inequity in income distribution is illustrated by a
curved line.
Equity Measures - Lorenz Curve
Equity Measures –
Gini Coefficient
• The farther the Lorenz curve is skewed away from
the diagonal line, the more inequitable the income
distribution.
• This curve can be transformed into a single
variable, the Gini coefficient.
• Calculated by taking the area between the diagonal
line and the Lorenz curve and dividing by the
entire area under the diagonal line = 100*A/(A+B)
This value is then multiplied by 100.
• Can range from 0 to 100, where greater numbers
are associated with greater inequity.
Gini Coefficient
Environmental Justice
• Studies have suggested that certain segments of
the population face disproportionate exposure to
environmental risk.
• In the US, minorities, especially those of low
income living in rural areas, face greater exposure
to carcinogenic and mutagenic hazardous
chemicals.
• In developing countries, with giant cities, levels of
air pollution as well as exposure to toxic waste
surpass that of developed countries.
• Environmental justice is an issue in rural areas
where high levels of pesticide use by large
plantation owners impacts villages downwind.
Ecological Criteria
• There is no consensus on how to develop
measures for quality and functionability of an
ecological system.
• The first question is how to define a desirable state
of an ecosystem.
– Ecosystem health – measures a system’s ability to
provide a flow of ecological services.
– Ecosystem integrity – measures the closeness of the
system to a hypothetical reference system that is
completely undisturbed by human activity.
Operational Indicators of
Environmental Quality
•
At least 4 methods have been suggested to
develop operational indicators:
1. The use of “representative” environmental
variables.
2. The use of a “green” GDP.
3. The development of satellite accounts for
National Income and Product Accounts.
4. The development of indices of sets of
environmental variables.
“Representative”
environmental variables
• Sulfur dioxide’s Environmental Kuznets Curve
(EKC): U-shaped relationship between
environmental quality and income – indicator of
air quality
• Spotted owl – indicator species for Pacific oldgrowth forests
• Abundance/biodiversity of mussels – biodiversity
indicator for rivers in Tenn. River Valley
Green GDP
• Many economists have argued that disastrous
consequences for the environment result when
macroeconomic policy is based on growth of GDP.
• While net domestic product (NDP) subtracts the
depreciation of human-made capital from GDP, it
does not consider the depreciation of natural
capital (forest clear cut, soil degraded, stocks of
minerals depleted, etc.)
• If increasing NDP is the primary policy goal, then
the loss of future income from depleted natural
capital is important.
Satellite accounts
• Physical measures of environmental
variables maintained side by side with GDP
accounting (not integrated like GGDP)
• Presented in flow and balance sheets just as
GDP accounting
• Idea is that rough monetary estimates can be
made from these accounts
Indices
• US Environmental Protection Agency’s
EMAP (Environmental Monitoring and
Assessment Program) – develops overall
indicators for individual ecosystems
(forests, wetlands, estuaries)
• E.g., Estuaries – 20 indicators: water clarity,
presence of trash, etc. Then aggregate index
created by summing individual indicators
Ethics
• Particularly important and particularly difficult to
quantify.
• Does the firm or agency have an ethical obligation for
environmental stewardship independent of the impact
on social welfare?
• Should decision-making have an anthropocentric or
biocentric approach?
• “Deep ecology”, developed by Arne Ness, rejects
management of the environment. All components of
an ecosystem, as well as the ecosystems themselves,
have an intrinsic value and an inherent right to exist.
• Ethics can be treated as constraints to the decisionmaking process.
What do you think?
• Should decisions be based solely on
anthropocentric ideals?
• Do ecosystems have inherent rights?
• Is it okay to put a price on environmental
goods/services?
• If not, how to reconcile for policy making?
The Use of Multiple Criteria in
Decision Making
• How do policy makers take multiple decisionmaking criteria and jointly employ the criteria so
as to inform the actual decision?
• If too much aggregation is done across criteria,
then a lot of the information that is contained in
the different criteria will be lost.
• Cost-benefit analysis is one approach which has
been frequently employed and is even legally
required of governmental agencies in many
countries.
Cost-Benefit Analysis
• The most important concept is that cost-benefit
analysis is NOT a decision-making tool; it is only
an information organizing tool
• There is no single correct answer to a cost-benefit
analysis exercise
• Different assumptions about future states of the
world or key analytical parameters will have a big
impact on the final outcome
• The analysis should produce a suite of numbers
reflecting the sensitivity of the analysis to
alternative analytical assumptions
Cost-Benefit Analysis
• Cost-benefit analysis should be a dynamic
analysis, investigating costs and benefits far into
the future, where future costs and benefits are
discounted.
• The simplest version of a discounting formula is
PV = FV(1/(1+r))t,
• where PV is present value, FV is future value, r
represents the discount rate and t is the time
period.
Cost-Benefit Analysis
• The objective of cost-benefit analysis is to
identify the alternative project, plan, or
policy that has the greatest net present
benefit, which will therefore maximize
economic efficiency.
Choice of the discount rate
• A critical aspect of the analysis is the choice of the
appropriate discount rate
• The market rate of interest is not appropriate
because it includes inflation rates and risk
components
• Inflation should be removed from interest rate
because CB calculations should be conducted in
real (inflation-adjusted) terms (using CPI)
Choice of the discount rate
• The risk component reflects a compensation for
the variations in risk of default across different
types of borrowers
• Because risks of public investment are shared by
all citizens, and because society has a diverse
portfolio of projects, many analysts argue that the
rate used should be the real, risk-free rate of
interest (btw. 3-4% historically)
Choice of the discount rate
• The choice of discount rate is critically important
because it represents the relative importance of the
future.
• Even small differences in discount rate can
become very important.
• This is illustrated in Table 5.3, where the present
value of a future stream of income decreases by 90
percent with a 1 percent change in the discount
rate.
• This difference in value is much less at greater
distances in the future where the value in the
distant future is unimportant.
Choice of the discount rate
Cost-Benefit Analysis
• The first step in implementing any cost-benefit
analysis is to determine what should be evaluated.
• The analyst must identify the credible alternatives
to the proposed project and include them in the
cost-benefit analysis.
• In defining alternatives, the analyst must consider
political feasibility, technical feasibility, and
economic feasibility.
Cost-Benefit Analysis
• The next step is to list the costs and benefits to
make sure that all relevant issues are considered.
• Care must be taken to factor in environmental
costs, both on-site and off-site.
• In some cases religious, cultural, and historical
significance must be taken into account.
• Indirect costs must also be considered.
Cost-Benefit Analysis
• In general, benefits are easier to measure than
costs.
• It is important to recognize alternative solutions in
the measurement of the benefit of one project.
• It is also important to recognize both private and
social benefits associated with a project.
• It is important to recognize the difference between
the creation of new benefits and the transfer of
benefits from one area to another.
Cost-Benefit Analysis –
Multiple Scenarios
• It is important to build different scenarios when
conducting a cost-benefit analysis.
• These different scenarios need to consider
differing assumptions or predictions about the
future states of the world.
• Among these are:
–
–
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Rates of population growth
Rates of growth in GDP
Level of global climate change
Rate of technological innovation
Change in environmental policy.
Cost-Benefit Analysis –
Decision Rules
• Each scenario should also be evaluated using
different discount values.
• Various decision rules can be made to allow
qualitative comparison and determination of
which projects are best.
• Examples of decision rules include:
– Choose the project that is in the top ranking in the most
states of the world.
– Choose the project that is in the top two categories in
the most states of the world.
Cost-Benefit Analysis –
Missing Values
• One of the major problems with cost-benefit analysis is
how to deal with missing values.
• It is not appropriate to use a value of zero.
• If the missing value is associated with environmental costs,
then it is possible to conduct an analysis without the costs
and then consider how the answer might change with those
costs factored in.
• Alternative approaches to comparing projects with missing
information include:
– The dominance method choose the option that is best across multiple
scenarios;
– Estimate how big the missing value would have to be to change the
outcome.
– Provide general impressions of the unmeasured environmental benefits.
Marginal Analysis
• Cost-benefit analysis is a good tool for choosing
between a set of discrete alternatives.
• Marginal analysis is useful when a choice must be
made about which level to choose from a
potentially infinite spectrum.
• How many hectares of wetlands to preserve, how
much deforestation to allow, how large a fish
harvest should be, etc.
Marginal Damage Functions
• As discussed in Chapter 3, marginal damage
functions and marginal abatement functions can be
used to identify the optimal level of pollution.
• A marginal damage function specifies a
relationship between an incremental unit of
emissions and the damages the emissions generate.
• As Figure 5.5. illustrates, this relationship is
actually a complex series of cause-and-effect
relationships.
Marginal Damage Functions
• The first set examines how pollution emissions
generate concentrations of pollution in the
environment.
• The next set considers how exposure occurs.
• The next considers the impact of exposure.
• The next considers the damages which result and
finally, the resulting change in social welfare.
MDF & Policy Analysis
• It quite unlikely that it will be possible to
completely identify the set of marginal
abatement cost functions and marginal
damage functions for a particular problem.
• Even so, knowledge of the properties of a
particular damage function can help identify
policy goals.
MDF & Policy Analysis
Damages
Emissions
e1
e2
e3
Marginal Damage Function and
Policy Analysis
• Identify key points along function
• Between 0 and e1 – damages not great
• As increase between e1 and e2, assimilative
capacity of environment becomes
overtaxed, damages begin to increase
• e3 on, damages may cause systemwide
collapse
Marginal Damage Function and
Policy Analysis
• Use information from figure 5.5 to make estimates
about these turning points
• For example, makes little sense to have target
level of pollution less than e1 unless abatement
very low
• Similarly, want to avoid very steep portion (after
e3)
• Broad range from e1 to e3 – can then use other
criteria to narrow this range
Summary
• Various research and analytical tools can help
narrow the decision set and further guide the
decision process.
• Cost-benefit analysis has proven to be a useful
tool in organizing information about economic
efficiency.
• The most important need in terms of making better
decisions is the need to develop better indicators
related to the nonefficiency related decisionmaking criteria.
Expected Value Analysis
(Appendix 5b)
• A way to compare alternatives where each
alternative has several possible outcomes,
each of which occurs with a different
probability
• Example: deciding which of 3 games going
to play. Fee for playing each $1.00. First
game flip coin – heads $2, tails $0.
• EV = – $1.00 + 0.5($2.00) + 0.5(0) = 0
Expected Value Analysis
• 2nd game: 3 cards. Pick Jack, get $1. Pick
Queen, get $2. King, get $3.
EV = – $1.00 + 0.33($1) + 0.33($2) +
0.33($3) = $0.98
• 3rd game: 4 marbles. Pick red: $2, blue: $1,
green: $0.50, yellow: $0.
EV = – $1.00 + 0.25($2.00) + 0.25($1.00) +
0.25($0.50) + 0.25($0) = – $0.13
Expected Value Analysis
• In general, if pi is probability of outcome i,
and NBi is net benefits of outcome i, then
the EV of an alternative with m potential
outcomes is:
m
EV   pi ( NBi )
i 1
Expected Value Analysis
• Can be very useful in CBA, because many
outcomes uncertain
• But, does not consider risk (risk neutral)
• If replace $1 in first game with $10,000 –
same EV – equivalent?
• Most say no (risk averse)
Expected Value Analysis
• Many cases decision maker should be risk neutral:
– Risks spread over many people, so total loss high but
individual loss not
– Risks spread over many projects, so even if some fail,
enough successful to compensate for those that fail
• However if consequences irreversible (protection
of rain forests, storage of nuclear waste, etc.) –
risk averse attitude may be better