Improving the Benefit/Cost Analysis of Ecosystem Projects

1. Improving the Benefit/Cost Analysis of Ecosystem Projects NBWA Board of Directors Meeting July 10, Novato, Ca. Manuel S. Gaspay, Ph.D. Green MBA Faculty, Dominican University

2. BCA and Ecosystem Management • Role of Benefit/Cost Analysis (BCA) in the management of ecosystems: • Tool for the evaluation of alternative interventions • Tool for communication and facilitation of discussion with ecosystem stakeholders • Important determinant for capital budget allocation

3. BCA and Economic Valuation • Benefits and costs, as presented in the usual use of BCA, are economic values that are measured in monetary terms. • Therefore, there is almost always an effort at economic valuation of the benefits and costs associated with proposed interventions in the management of ecosystems. • However, there is a class of interventions, usually associated with what is termed as existence values that suffer from the difficulty of making such economic valuation.

4. The Napa Salt Marsh Restoration • Feasibility study in April 2003 to evaluate alternative habitat restoration plans. • Purpose of study is to evaluate potential Federal interest in habitat restoration with possible funding from a non-Federal sponsor. • The purpose of habitat restoration itself is mostly for the benefit of fish, aquatic species, fowl and birds (migrant and resident) that use the marsh as its habitat. • Evaluation of the benefit of alternative plans were measured in non-monetary terms (i.e. habitat units).

5. Disadvantages of Non-Monetary Economic Valuation • Lack of proper appreciation by the general public of the true benefits, especially when the project competes with other projects that show monetary benefits that justify the monetary cost of the project. • Has to rely on a drawn-out political process of fund allocation rather than the more expeditious capital budgeting process for economically valued investment projects.

6. Problem of Economic Valuation • The problem of using BCA in the management of ecosystems is the tendency to under-estimate the full economic value of the benefits provided by ecosystem services and the full costs of unsustainable usage of ecosystem assets. • This is mainly due to the difficulty posed by the monetary valuation of ecosystem services that are non-marketed, use values that are not fully accounted for by markets, and non-use values of environmental asset.

7. Why Markets Fail in Valuing Ecosystem Services • Public good nature (jointly consumed and impractical to privately appropriate) of most of these services do not make markets for them feasible. • Market prices for those that are marketed fail to capture externality effects (effect on others not parties to the market transaction). • Market prices essentially reflect scarcity values and not use values (price of clean air is zero, but no economist will tell you it has no economic value).

8. Types of Values of Ecosystem Services • Use values • Direct use value - recreation services • Indirect use - climate control • Non-use • Option value - deferred use • Bequest value - use by future generation • Existence value - pure non-use

9. What is the Value of the World’s Ecosystem Services? • A full value method done by Constanza in 1997 gave an estimate of $33 trillion a year, which was almost double the $18 trillion total value of the world’s GDP (marketed goods and services).

10. Marketed Goods (GDP) vs. Ecosystem Services

11. 10,000 Value (USD/ha) 5000 Coastal protection ($34,453) Shrimp (net): $8,340 Fishery nursery ($420) Less subsidies (-$7,176) Timber and non-timber products ($823) Pollution Costs (-$951) 0 Restoration (-$5,656) Shrimp farm Mangrove Net present value [market] per hectare Mangrove: $823 Shrimp farm: $8,340 Net present value [real] per hectare Mangrove: $35,696 Shrimp farm: -$5,443 Note: 10% discount rate Source: Sathirathai and Barbier 2001 Ecosystem Services: A Guide for Decision Makers

12. Methods for Discovering Value:Discovering the WTP (willingness to pay) • Market method - commercial fishery • Market-based methods • Productivity change - soil formation • Hedonic pricing - majestic scenery • Travel cost - park visits • Avoided/replaced/substituted cost - flood damage avoided, private flood control measures substituted

13. Methods for Discovering Value:Discovering the WTP (willingness to pay) • Contingent methods (hypothetical markets or choice situations) • Contingent valuation method (CVM) - how much people state they are willing to pay for ensuring the continued existence of a species they will experience • Contingent choice experiments (CCE) - choice scenarios of changes in environmental services with associated costs are asked • Benefit transfer method - adopting values revealed by studies of similar ecosystem services situations

14. Sample Question in CVM • Would you connect your house to a public water distribution network or sewage treatment system if water quality would improve by ___? • Yes No • If yes, how much would you be willing to pay for such services? • $ $ $ $ $ $ Over $

15. Sample Choices in CCE • Choice Questions:

16. CVM for Non-Use Value Estimation • Strengths of CVM • Except possibly for the benefit transfer method, other methods can not be applied • Can produce good estimates if the method is professionally applied • The logic of the method is easily understood and communicated to the public

17. CVM for Non-Use Value Estimation • Weaknesses of CVM • Prone to value statement biases • May produce inconsistent valuation • Prone to accuracy and reliability challenges

18. History of Legal Acceptability of CVM • In 1986, Federal agencies began to include option, existence and bequest values measured by CVM for natural resource damage assessments. • In a 1988 challenge by industry reps, the District Court of Appeals ruled that the CVM was an appropriate method for existence value, and that existence value itself was intended by CERCLA (Comprehensive Environmental Response, Compensation and Liability Act). • NOAA Blue-Ribbon Panel concluded that CVM was a valid tool for discovering economic value in the Valdez Oil spill damages to wildlife habitat. • Inclusion in NOAA, EPA, USDA handbooks as part of their standard practice.

19. Case Study: Mono Lake • In the 1980s legal challenges to allocating water by Ca. Water Resource Control Board from Mono Lake to Los Angeles that would impact the nesting and migratory birds around the lake. • A CVM was conducted in 1987 to discover the WTP of Ca. households to maintain water levels in Mono Lake to protect the birds. • An estimate of an average $156/year for every household led to a total WTP value of $1.3 billion, which was 50 x the $26 million cost of maintaining the water level. • In 1994, the Water Resource Control Board reduced by half the water rights of LA from Mono Lake to 50,000 from 100,000 acre-feet.

20. Usefulness of Dual Prices in LP Models of Water Resource Mgt. • What is a Dual Price? • Sometimes called shadow prices, they are the prices of changing the level of a constraint (ex. water discharge level to protect a species) in an LP (linear programming) model. • A dual price is essentially a scarcity value, and is zero if the constraint is not binding. • However, if the constraint is binding, then a price is revealed and may be useful for imputing what the social value (WTP) may be if a non-use constraint is agreed upon and limits the use of the resource.

21. Usefulness of Dual Prices in LP Models of Water Resource Mgt. • Usefulness of Dual Price Info • LP models are commonly constructed for the efficient management of a resource with multi-purpose usages, such as a water resource. • Preferences on ecosystem non-use standards are often agreed upon by communities in non-monetary terms, which can be included as an additional constraint in such an existing model. • The change in the optimal pattern of usage because of this added constraint, and the change in the benefit value being optimized will reveal the social WTP through the dual price of the associated constraint.

22. The Ticklish Issue of Discounting • Why discount future values? • Opportunity cost of capital • Impatience • Risk premium • We need a social discount rate to compare social preferences for future consumption over present consumptions of environmental and natural resources!

23. Relevance to the NBWA • Ecosystem approach is necessary to properly value uses that are due to system attributes. • Non-use values are now being recognized by stakeholders and becoming critical issues in policymaking in the management of ecosystems, such as in a watershed area. • There are acceptable and credible methods of valuation for these non-use values. • The NBWA should consider initiatives for using the CVM, benefit transfer, or even the dual prices of water resource LP models for discovering indirect and non-use values for a BCA analysis of their projects.

24. Major References • Arrow, Kenneth et al, “Report of the NOAA Panel on Contingent Valuation”, Jan. 1993. • Constanza, R. et al, “The Value of the World’s Ecosystem Services …”, Nature Vol. 387, 1997. • Goldberg, Jeffrey, “Economic Valuation of Watershed Systems …”, OAS Dept. of Sustainable Development, 2007. • Karousakis, K. and Koundouri, P., “Economic Valuation Methods for Water Resource Management”, Arid Cluster, May 2005. • King, Dennis and Mazzotta, Marissa, “Ecosystem Valuation”, NOAA and USDA funded website www.ecosystemvaluation.org, developed 2000. • Knight, Richard and Bates, Sarah eds., A New Century of Natural Resource Management, Island Press, 1995. • Lipton, Douglas et al. “Economic Valuation of Natural Resources: A Guidebook…”, NOAA Coastal Ocean Program Decision Analysis Series #5, 1998. • Loomis, J., “Public Trust Doctrine…”, Journal of Soil and Water Conservation, June 1995. • Napa, Sonoma and Solano Counties, “Napa Salt Marsh Restoration”, Draft Feasibility Report, April 2003. • Shabman, L. and Stephenson, K., “Environmental Valuation …”, Visiting Scholar Program, US Army Corps of Engineers, 2007.