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IDEC 8053- Essay Topic 6

Costbenefit analyses of projects that affect the environment provide a better guide to whether the projects should go ahead than other analytical methods are able to provide

Abstract
Environmental Cost Benefit Analysis (ECBA) is challenging due to the complexity in monetizing non-market values of environmental goods and amenities in the presence of uncertainty and irreversibility. In response to technical complexity and resource demanding of CBA, alternative methods such as Cost-Effectiveness Analysis (MEA), Multi Criteria Analysis (MAC), deliberate pooling, citizen juries, have been introduced. However, considering its information generation and systematic process, CBA provides a better guide for decision making than their alternatives. CBA methodology can also be flexibly modified to address the concerns of intra-generation fairness, intergeneration fairness, uncertainty and irreversibility via applying social distributional weight, time decreasing discount rate, sensitivity analysis and quasi option value respectively. In spite of these advantages, CBA informs decision rather than dictate the final answer, and CBA is not the only exclusive mean for provision of advice. Other tools can also play roles whenever possible in guiding the decision. Considering uncertainty and irreversibility of environmental problems and the fact that CBA efficiency criteria do not guarantee equity and sustainability, the combination of CBA result and other noneconomic criteria including ethics and sustainability together with precautionary principle should jointly provide inputs for decision makers.

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Cost Benefit Analysis (CBA) is a systematic method of calculating and comparing benefits and costs in monetary term, of a project to determine the soundness of each option according to economic efficiency criteria. CBA is often used to inform decision of projects affecting environment by weighting between the status quo of environment conservation and development alternatives. With the complex environmental problems especially climate change and biodiversity loss, together with technical limitation and high cost of CBA, alternative methods have come into use. The essay argues that CBA is a better approach and more appropriate for environmental valuation by pointing out how CBA methods fit into the complexity of environmental costs and benefits valuation, discussing solution to key CBA criticisms , reviewing alternative methods to CBA, and finally looking into the recent development of CBA.

CBA in Environmental valuation

Environmental problems are by nature complex and multidimensional, involving uncertainty and irreversible consequence and existing at local, regional, or even global, therefore cannot easily be separated in the analysis from broader social, cultural, and economic aspects (Sderbaum 2006, p 182). Valuation of environmental costs and benefits become a challenging task involving clarifying the standing (whose costs and benefits should be counted) as well as quantifying both use and non-use value of environmental goods and amenities. According to Perman and al (2011), the environmental use value can be consumptive use and non-consumptive use, both of which can be priced at the market. However, the major source environment values are no-use values and generally dealing with non-market public goods and externalities whose values exist based on their ecological function and how individuals indirectly derive their satisfaction from the environments. These indirect environmental values include existence value or intrinsic value (satisfaction from continued existence of the environmental goods ), option values (value of potential future use) , bequest value ( value deriving from the concern of future generation), altruistic value (concern for other humans who may benefit from the resource). Valuation of those environmental costs and benefits requires a systematic approach that allows meaningful comparison amongst various options, CBA provides a healthy dose of market and non-market valuation tools with two major approaches--Reveal Preference Method (RP) and Stated Preference Method (SP). RP develops surrogate

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hypothetical markets using various techniques such as travel cost, hedonic pricing, production function techniques, replacement cost or defensive expenditure. RP associates non-market goods and services with the actual market goods and services by observing the individual behaviors in the market such as how much people pay to travel to an recreation area, how much the asset price changes as a result of change in environmental characteristics. State Preference (SP) is a survey-based method employing contingent valuation and choice experiment method to measure people willing to pay(WTP) and willingness to accept (WTA). Contingent valuation elicits response from a representative sample by asking their WTP and WTA to enjoy the benefits or to compensate the loss of environmental goods and services, while choice experiment method allows respondents to choose from a number of discrete alternatives which are described in some details so that respondents are able to decide their most preferred one (Perman & al 2011).

Alternatives to CBA
Rigorous application of CBA is resource demanding and technically complicated; thus alternative methods have been developed and applied in different circumstances. Perman and al (2011) provides a brief review of some alternatives to CBA , which generally provide a less cost and short-cut project assessment; however they are also exposed to criticism (pp.401-405). Cost Effectiveness Analysis (CEA) is a method of selecting the option that gives some specified object at the least cost. Under CEA, the benefit is not expressed in money units and thus it does not provide an absolute measure of the benefit to the economy of the project. The criticism is CEA gives absolute priority to one aspect of performance and cost saving and ignore other social and environmental impacts (Perman & al 2011, p. 402). Multi-Criteria Analysis (MCA) is ranking the projects based on various relevant selection criteria (usually six or eight criteria) which assessed by the decision makers. These assessment criteria are weighted and scored and summed up which reflect the preference of the decision makers. (Perman & al 2011, pp. 402-403). According to Arckerman (2008, pp.11-12), MCA can be well-suited to situations of different stakeholders with different objectives; the method allow consolidation of everyone's 3

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favourite issues to be calculated; however, arbitrary judgments about the criteria by a group of experts is a major concern on subjective bias; MCA relies on criteria and preference of decision makers to resolve the situation. Deliberative pooling involves running an opinion pool and then participants will collectively consider the issues by hearing and questioning expert and debate amongst themselves. Participants are, at the end, asked to respond to the survey questions. This approach promotes participatory decision making; nonetheless, this approach is often lack of representativeness as the participants may not be equally motivated to join and give their opinions; those who attend are usually supportive and opinionated. Also, the moderator may sometimes influence the discussion. Another major problem is that it is costly to pool random sample of sufficient size to produce results up to the standard of opinion polling (Perman & al 2011, p. 404). Citizen juries involves 12 to 16 juries to be chosen based on combination of random and stratified sampling, to be broadly representative of the community; Their main tasks is to response to questions about policy and planning. First, they are briefed about the background to the questions, and asked to discuss possible approaches. Citizens are asked to become jurors and make a judgement in the form of a report. The questions of discussion are usually the ones affecting wide community where a representative and democratic decision-making process is required (Perman & al 2011, pp. 404-405). These above alternative methods basically involve two steps. First, experts knowledge is used to estimate project impacts and then preference are used to reach a decision on the basis of information; these methods are subject to criticism just as CBAs; nonetheless, CBA is much more favourable as it use preference of those who are affected rather than those of experts Perman et al (2011, p. 405) Ergas (2009), in his comparison of CBA and MCA, also favours CBA based on six critical differences between CBA and its competitors. First, on evaluative standpoint, the valuation of policys effects under CBA is derived from individuals who will bear those effects. In monetary valuation, CBA allow market price to be corrected from distortion of tax, subsidies or price control, for traded good or services. As the market price truly reflect the willingness to pay and willingness to access. Second, based on economic decision-relevance in term of the efficiency criteria, the project is wealth 4

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increasing if its total benefit exceeds the total cost including the forgone opportunity cost of pressuring alternative projects. Third, regarding comparability reason, systematic application of CBA allows consistent values to be compared across projects according project inputs or outcomes. CBA allows different projects and different options to be evaluate. Fourth, for the sake of verifiability, market and non-market valuation of CBA can be tested in terms of their consistency with market and nonmarketed inputs and outputs. This verifiability an improve on the principal-agent problems as the stakeholders can look into the CBA reports and check what price, discount rate, etc., are used. Fifth, considering accountability, CBA estimates all

costs and benefits in quantitative terms with specified underlying assumptions so the result can be traced back to see what goes wrong . Finally, with scientific progression, CBA gets better over time due to its systematic approach are comparable from study to study. A body of knowledge and lesson on quantitative techniques of impacts have been generated from past studies. Dobes and Bennett(2009) acknowledge the complexity of CBA but warn of the consequence of avoiding technical complexity CBA the jeopardy of exposure to the special pleadings of interest groups (p. 26). In his conclusion of CBA and its alternatives, Perman et al (2011) suggests that all these methods should not be considered as mutually exclusive means of providing advice. All project appraisal methods should be practically considered as providing information for the decision makers and not necessarily give them the answer.

How CBA tackle its criticisms

Perman and al( 2011, pp.398) describes Environmental Cost benefit Analysis (ECBA) is an applied welfare economics based on utilitarianism which is consequentialist and subjectivist in nature. The method suggest the idea of consumer sovereignty, in which emphasis is placed only on human individuals; only human have moral standing and they are the ones who assess what is good for them based on his or her preferences which is reveal in behaviour.

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With its strong economic efficiency emphasis, CBA is exposed to criticism from other social and environmental standpoints; Hansjrgens (2004, p.244) systematically summarize those criticisms of CBA into 3 categories: (1) the ethic-based fundamental of efficiency criteria; (2) methodology shortcoming or insufficient specification of CBA; (3) CBA in the political decision-making process . However, CBA methods can be flexibly modified to address these concerns as discussed in the following paragraphs. With regard to ethical consideration of CBA, the criticism mainly lies on monetarybased valuation, lack of equity consideration vis-a-vis efficiency, and tyranny of future discounting. First, the criticism on efficiency criteria based on monetary value rejects the principle of comparing human life and health as a result of environmental change, against economic interest. In response, CBA is just trying to make things comparable as people are exposed to more risk to their lives which is considered as the value of statistical life under CBA. (Hansjrgens 2004, p.244). Second, regarding the equity or distribution-related consideration, CBA addresses this shortfall in two ways. First, by classifying project-related costs and benefits by society groups and CBA then recalculate a projects net benefit using explicit distributional weights to the benefits and costs for each societal group. Dobes and Bennett (2009) consider this approach is more transparent as it allows the decision-maker to balance equity and political considerations against the overall social welfare (p.23). Second, placing the emphasis on efficiency does not necessarily means equity or distribution is not important. Dobes and Bennett (2009) and Ergas (2009) favour the separation of the two criteria; efficiency and equity objectives should be addressed separately. The income inequity across society should be addressed directly through progressive taxation or social and environmental policies, rather than by distorting the specific CBA analysis. Third, regarding the choice future discount, environment impacts such as climate change or biodiversity gain or loss extending over a longer time horizon and the effect of discounting is often very low or even zero to events in the far-off future. CBA methodology solves this by using smaller discount rate including social discount rate, time-declining discount rate, or environmental discount rate introduced by Krutilla and 6

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Fisher (cited in Atkinson & Mourato 2008, pp.230-231). The choice of lower discount rate of social and environmental impacts reflects inter-generational fairness as the higher discount rate means caring less about the future generation. Another major criticism on inadequate technical specification of CBA concerns mainly on the issues of insufficient data, uncertainties, arbitrariness and manipulation of result. Though, these problems are not rooted in CBA itself, but on how CBA is conducted and people who conducted CBA. CBA methodological criteria provides a standard that can be verified against the CBA findings and procedure used. Therefore CBA-based decision is more transparent and accountable (Hansjrgens, 2004, pp. 246-47), Finally, disapproval of CBA is mainly attributed to the fact that CBAs are often influenced by certain interest groups, and CBA cause delays in regulatory process. In response to this critique, the existence of CBA should be considered as value addition by improving rationality and transparency in political discussion. Furthermore, CBA provides useful inputs for developing an intelligent regulation. Therefore, the trade-off between the good information and the time and resources needed must be taken into account in the regulation planning. (Hansjrgens, 2004) With current on-going research and development of CBA in the academia, government departments and funding institutions; CBA guidelines, lessons learned, and bestpractices are continually built-up. CBA is getting better, more reliable and affordable over time. Furthermore, technology has significantly helped improving CBA application. For instance, in hedonic model analysis, given the intrinsic spatial relationships between properties, a Geographical Information Systems (GIS) is usefully applied to improve the estimation of independent variables (Atkinson & Mourato 2008, p. 326). Another contribution to CBA is the benefit or value transfer from previous CBA studies which save time and resource in conducting new CBA with the available secondary data, especially the consolidation of original data on nonmarket values where values can be taken off the shelf and readily applied or further adjusted to CBA study (Atkinson & Mourato 2008). To conclude compared with its alternatives, CBA is more informative, rigorous and systematic in guiding decision making. CBA benefit transfers and technology integration has significantly contributed to the improvement of accuracy and speed of 7

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estimation, making CBA become more convenient and affordable over time. Nonetheless, CBA and its alternatives should not be considered as mutually exclusive but complementary to one another. In the presence of uncertainty and irreversibility of environmental impacts, CBA results should informed the decision making rather than dictating the final answer which should be based on combination of efficiency criteria, ethics and sustainability, as well as precautionary principle. Given time and resource demanding, CBA itself should pass its own CBA (the expected benefit should exceed the cost of conducting CBA).