Cost benefit analysis and the environment

Social Cost-benefit analysis Cost-benefit analysis, CBA, is the social appraisal of marginal investment projects, and policies, which have consequences over time It uses criteria derived from welfare economics, rather than commercial criteria. CBA seeks to correct project appraisal for market failure Environmental impacts of projects/policies are frequently externalities, both negative and positive CBA seeks to attach monetary values to external effects so that they can be taken account of along with the effects on ordinary inputs and outputs to the project/policy.

NPV We rank projects on the basis of NPV We rely on consumer’s WTP for public goods Non market benefits Non mkt costs Market vs social rates Issue: integrating non market factors into CBA

(BETTER) ALTERNATIVES?

Benefit cost ratios NPV of benefits / NPV of costs We choose projects if B/C>1 and rank Critical issue: 10000/2000 = 1000/ /200 =5 > 10000/5000=2

INTERNAL RATE OF RETURN

The rate that equalises costs and benefits Two projects with the same NPV may present different rates of returns NPV being equal, the criterion favors projects with short run benefits

Break even In a similar way, the break even (covering costs as soon as possible) may favor investments which provide benefits in the first part, overlooking future benefits

Social cost benefit analysis and the environment

Pearce D.W. Atkinson G. Mourato S., Cost Benefit analysis and the Environment, OECD, 2006

Key concept: TOTAL ECONOMIC VALUE Example: a forest Use values –Direct – consumptive- logging –Indirect non consumptive – Tourism below carrying capacity Non use values –Option value (WTP for an option to visit in the future –Pure Existence values

Issue: valuation of non use values and indirect uses (next lecture) viamo le preferenze su mercati –Direct uses: market values –Indirect: revealed preferences approaches /WTP Travel costs Hedonic pricing (public values incorporated in assets such as houses) –Non use values (only option to value ex ante), stated preferences / WTP Contingent valuation Choice experiments (avanzata)

14 Cost-benefit Analysis: Methodology Cost-benefit Analysis: Methodology Define Project Identify and Quantify Positive and Negative Project Effects Price (Value) the project effects (i.e. Benefits and Costs) Determine Present Value of Benefit Stream and Present Value of Cost Stream Apply Project Selection Criteria & Conduct Sensitivity Analysis / Quantified Risk Assessment Identify the Distribution Effects of the Project Incorporate Non-monetary Considerations Make Decision

Objections to environmental cost-benefit analysis ECBA is based in welfare economics which is consequentialist and subjectivist. Essentially it accepts that the natural environment should be subject to consumer sovereignty Two main classes of objection at the level of principle. 1. Accept that only human interests count, but reject consumer sovereignty as proper guide to those interests on the grounds of inadequate information about consequences insufficiently deliberative lacking self-knowledge preference shaping 2. The interests of other living entities should be taken into account Some question the ECBA agenda at the level of practice – can Chapter 12 methods actually deliver the necessary information?

Limits to applicability of ECBA -sustainability and environmental valuation There is no guarantee that the subjective assessment of their utility losses by individuals will be large enough to stop a project that threatens resilience, and thus sustainability. Implicit in ECBA is the assumption of ‘weak’ sustainability, which ignores critical natural capital and non-substitutabilities as between reproducible and natural capital. ECBA should be restricted in its application

Alternatives to environmental cost-benefit analysis Two stage processes Assessment of consequences – Environmental Impact Assessment, Impact Assessment, Social Impact Assessment. ( Assessment = estimation ) This can be left to ‘experts’ Evaluation of consequences Not to be left to experts Multi-criteria analysis Deliberative polling Citizens’ juries

9/28/ Cleaning the Ganges A Cost Benefit Analysis Based on Markandya and Murty Environment and Development EconomicsEnvironment and Development Economics, Volume 9, Issue 01, Feb 2004, pp 61-81Volume 9Issue 01