Economic Valuation Economic Valuation of Natural Resources of Natural Resources

Specialization Module for Specialization Module for Fisheries Fisheries SocMonSocMon WorkshopWorkshop

Peter Peter SchuhmannSchuhmann, Ph.D., Ph.D.University of North Carolina WilmingtonUniversity of North Carolina Wilmington

James Casey , Ph.D.James Casey , Ph.D.Washington & Lee UniversityWashington & Lee University

Economic Valuation of Natural ResourcesEconomic Valuation of Natural Resources

““ Public policy should reflect an understanding Public policy should reflect an understanding of the public's values. This is especially true of the public's values. This is especially true with respect to the environment. Because with respect to the environment. Because public values about the environment are not public values about the environment are not generally expressed in the marketplace, nongenerally expressed in the marketplace, non--market valuation has become an important market valuation has become an important source of information for environmental source of information for environmental decision making decision making ””. .

From: Champ, Boyle, and Brown, "A Primer on From: Champ, Boyle, and Brown, "A Primer on NonmarketNonmarket Valuation"Valuation"

OutlineOutline

IntroductionIntroductionWhat is What is ““valuevalue”” to an economist?to an economist?Market failuresMarket failuresMarket vs. nonMarket vs. non--market goodsmarket goodsCommon misconceptions regarding valueCommon misconceptions regarding valueResource management & benefit cost Resource management & benefit cost analysisanalysisCategories of valueCategories of value

OutlineOutlineBenefits of conducting a valuation Benefits of conducting a valuation exerciseexerciseNatural resource valuation scenariosNatural resource valuation scenariosValuation methods & applicationsValuation methods & applicationsValuation in national legislationValuation in national legislationPrerequisites for valuation studiesPrerequisites for valuation studiesObstacles & budget considerationsObstacles & budget considerationsConclusionConclusionExerciseExercise

““ValueValue””

““Economic ValueEconomic Value”” refers not only to what refers not only to what people actually pay (direct contribution to people actually pay (direct contribution to the economy), but also includes what the economy), but also includes what people are willing to pay (or give up).people are willing to pay (or give up).

Example: you pay $25 for a snorkel trip with Example: you pay $25 for a snorkel trip with turtles that is worth $100 to you. turtles that is worth $100 to you. The true economic value of this trip is $100. The true economic value of this trip is $100.

““Economic ValuationEconomic Valuation”” simply means simply means estimating what something is worth. estimating what something is worth.

Valuation & Resource ManagementValuation & Resource Management

From an economic perspective, the From an economic perspective, the primary goal of resource management is primary goal of resource management is to find the to find the ‘‘stockstock’’ size that maximizes the size that maximizes the net benefits from the resource. net benefits from the resource. Maximizing net benefits is only one piece Maximizing net benefits is only one piece of the policy puzzle. Other factors such as of the policy puzzle. Other factors such as moral and cultural norms, equity and moral and cultural norms, equity and fairness, and political feasibility must be fairness, and political feasibility must be considered. considered.

Economic ValueEconomic ValueValue is only meaningful relative to what people Value is only meaningful relative to what people are willing and able to give up for the good or are willing and able to give up for the good or service. service. If people are not If people are not willing to paywilling to pay or trade or trade something to obtain a particular good, something to obtain a particular good, economists say that good has zero value. economists say that good has zero value. Hence, in economics, value is Hence, in economics, value is anthropocentricanthropocentric(human(human--centered). centered). The process of valuation is The process of valuation is utilitarianutilitarian, because , because its purpose is to aid policy in improving the its purpose is to aid policy in improving the wellbeing of wellbeing of peoplepeople..

Economic Value and Willingness to AcceptEconomic Value and Willingness to Accept

Oftentimes we lose something of valueOftentimes we lose something of valueSo we can look at value as willingness to So we can look at value as willingness to pay to avoid loss, or pay to avoid loss, or willingness to acceptwillingness to acceptcompensation for loss.compensation for loss.

Example: Coastal development infringes upon Example: Coastal development infringes upon societysociety’’s s ““windows to the seawindows to the sea””. Value of this . Value of this loss can be measured as societyloss can be measured as society’’s willingness s willingness to pay to avoid that loss, or the amount of to pay to avoid that loss, or the amount of compensation they would be willing to accept compensation they would be willing to accept to be just as well off with the loss. to be just as well off with the loss.

Economic Value & TradeoffsEconomic Value & TradeoffsPeople value natural resources and the People value natural resources and the environment for many reasons.environment for many reasons.People also value goods and services that People also value goods and services that cannot be produced without exploiting or cannot be produced without exploiting or damaging natural resources (most market damaging natural resources (most market goods).goods).Unlike market goods, the value of Unlike market goods, the value of environmental goods goes largely environmental goods goes largely unmeasured because markets do not unmeasured because markets do not provide these goods. provide these goods.

BenefitBenefit--Cost AnalysisCost AnalysisOne method that helps inform us of the relative One method that helps inform us of the relative tradetrade--offs of alternative resource management offs of alternative resource management strategies and outcomes is Benefitstrategies and outcomes is Benefit--Cost Analysis. Cost Analysis. BenefitBenefit--Costs Analysis (BCA) provides for a Costs Analysis (BCA) provides for a systematic enumeration of the gains (benefits) systematic enumeration of the gains (benefits) and losses (costs) of particular decisions, in and losses (costs) of particular decisions, in common units, for comparison purposes.common units, for comparison purposes.Valuation can be an important component of BCA Valuation can be an important component of BCA as it informs decision makers about what as it informs decision makers about what something is worth (in dollars) or what something something is worth (in dollars) or what something will cost (in dollars). will cost (in dollars).

Market failureMarket failureMarkets fail to capture the value of Markets fail to capture the value of environmental and natural resources environmental and natural resources due to two common market failures: due to two common market failures:

The nonThe non--rivalry and/or nonrivalry and/or non--excludability excludability of public goods causes traditional market of public goods causes traditional market forces to break down.forces to break down.External costs created by the production External costs created by the production or consumption of market goods are not or consumption of market goods are not reflected in the market prices of those reflected in the market prices of those goods.goods.

Economic ValueEconomic ValueMarket goods (with known value) and Market goods (with known value) and environmental goods (unknown value) are environmental goods (unknown value) are often often mutually exclusivemutually exclusive. Can. Can’’t have both.t have both.

Common MisconceptionsCommon Misconceptions1. Economic Value vs. Economic Activity:1. Economic Value vs. Economic Activity:

Economic activity (sales, jobs) is often Economic activity (sales, jobs) is often confused with economic value.confused with economic value.Measures of the amount of money that Measures of the amount of money that changes hands may not reflect the benefits changes hands may not reflect the benefits or worth to society. or worth to society. These measures do not account for These measures do not account for alternatives that are foregone, and do not alternatives that are foregone, and do not take into account goods and services that take into account goods and services that are not traded in marketsare not traded in markets..

Common MisconceptionsCommon Misconceptions2. Economic Value vs. Economic Cost2. Economic Value vs. Economic Cost

The cost of an item or The cost of an item or ““price paidprice paid”” is not is not always a good reflection of value.always a good reflection of value.For example, it would cost a lot to take 12 For example, it would cost a lot to take 12 tons of sand from the Caribbean to the tons of sand from the Caribbean to the Sahara, but the value would be quite low.Sahara, but the value would be quite low.Similarly, you may pay $20 for a pair of Similarly, you may pay $20 for a pair of shoes that yields considerably more than shoes that yields considerably more than $20 in value. They last long, comfortable.$20 in value. They last long, comfortable.

Common MisconceptionsCommon Misconceptions

3. Value is only revealed in markets.3. Value is only revealed in markets.Economic value is often thought of as only Economic value is often thought of as only pertaining to those goods that are traded pertaining to those goods that are traded in the market place in the market place –– i.e., market goods i.e., market goods have value as observed by people willing have value as observed by people willing to buy and sell them. Yet, goods that are to buy and sell them. Yet, goods that are not traded in the market (not traded in the market (““nonnon--market market goodsgoods”” such as clean air, clean water, or a such as clean air, clean water, or a view of the sea) have real economic value view of the sea) have real economic value as well (just more difficult to measure).as well (just more difficult to measure).

Common MisconceptionsCommon Misconceptions4. 4. The Broken Window Fallacy The Broken Window Fallacy

Wars or natural disasters Wars or natural disasters ““goodgood”” for an economy? for an economy? After the war or disaster there is a an upswing in After the war or disaster there is a an upswing in economic activity! economic activity! This line of reasoning (This line of reasoning (““The broken window The broken window fallacyfallacy””) fails to recognize ) fails to recognize opportunity costopportunity cost. Money . Money that is spent recovering from disaster (replacing the that is spent recovering from disaster (replacing the broken window) could be spent on something else. broken window) could be spent on something else. Jobs created in the wake of something bad are not Jobs created in the wake of something bad are not necessarily necessarily ““new jobsnew jobs””, as that labor could have , as that labor could have been used for something else. been used for something else.

Summary of ValueSummary of ValueValue is what something is worth to people.Value is what something is worth to people.What something costs and the value or What something costs and the value or benefits it delivers are not necessarily equal.benefits it delivers are not necessarily equal.Value need not be revealed in markets.Value need not be revealed in markets.The value of foregone activities (The value of foregone activities (““opportunity opportunity costcost””) must be considered. Tradeoffs are a ) must be considered. Tradeoffs are a fact of life when resources are scarce.fact of life when resources are scarce.Understanding total economic value can help Understanding total economic value can help inform decisions regarding those tradeoffs.inform decisions regarding those tradeoffs.

Components of Economic ValueComponents of Economic ValueExample: Coral Reef Ecosystem

ValuationValuation““Economic ValuationEconomic Valuation”” simply means estimating simply means estimating what something is worth what something is worth to peopleto people. . Valuation involves measuring use values and Valuation involves measuring use values and nonnon--use values, market values and nonuse values, market values and non--market market values. values. Many situations call for valuation.Many situations call for valuation.Economic valuation does not establish absolute Economic valuation does not establish absolute values for the environment.values for the environment.Estimated values may constitute lower bounds, Estimated values may constitute lower bounds, capturing only the more obvious and readily capturing only the more obvious and readily calculated values.calculated values.

Should we bother with valuation?Should we bother with valuation?

According to Prato, there are three According to Prato, there are three ways to handle the nonways to handle the non--market market benefits and costs of environmental benefits and costs of environmental resources:resources:(1) ignore them(1) ignore them(2) record them in physical, natural and (2) record them in physical, natural and

environmental accounts, or environmental accounts, or (3) estimate them through the use of non(3) estimate them through the use of non--

market valuation techniques.market valuation techniques.

What are the benefits of conducting What are the benefits of conducting a valuation exercise? a valuation exercise?

1.1. Having a common unit of measureHaving a common unit of measureUses of natural resources create a range of Uses of natural resources create a range of impacts, usually not in comparable units impacts, usually not in comparable units (generated revenues, changes in fish stocks, (generated revenues, changes in fish stocks, loss of tourists, water quality changes, reef loss of tourists, water quality changes, reef degradation). Many impacts are not recognized degradation). Many impacts are not recognized by markets. So markets cannot always be relied by markets. So markets cannot always be relied upon to allocate resources to their best use.upon to allocate resources to their best use.Production of goods can reduce the nonProduction of goods can reduce the non--market market values of natural resources by more than the values of natural resources by more than the gain in benefits from them, leading to losses in gain in benefits from them, leading to losses in social welfare.social welfare.

What are the benefits of conducting What are the benefits of conducting a valuation exercise? a valuation exercise?

Objective decisionObjective decision--making is fostered when making is fostered when all these impacts expressed in the same units. all these impacts expressed in the same units. Economic valuation facilitates this comparison Economic valuation facilitates this comparison by expressing all impacts in monetary units. by expressing all impacts in monetary units.

Coastal development project?

vs.

What are the benefits of conducting What are the benefits of conducting a valuation exercise? a valuation exercise?

2. Valuation can be used in conjunction 2. Valuation can be used in conjunction with benefitwith benefit--cost analysis and cost analysis and provide information that provide information that can be used to inform can be used to inform complex management complex management decisions.decisions.

Policy Decision

What are the benefits of conducting What are the benefits of conducting a valuation exercise? a valuation exercise?

3. The services provided by the natural 3. The services provided by the natural environment directly affect human environment directly affect human welfare in myriad ways, but welfare in myriad ways, but are often are often overlooked overlooked by some policy makers who by some policy makers who only focus on jobs and revenues. only focus on jobs and revenues.

Valuation reminds everyone that although Valuation reminds everyone that although that the environment is that the environment is ““freefree””, this in no way , this in no way implies that it is not valuable.implies that it is not valuable.

What are the benefits of conducting What are the benefits of conducting a valuation exercise? a valuation exercise?

4. Estimating monetary benefits for natural 4. Estimating monetary benefits for natural resources avoids several problems that resources avoids several problems that often plague policy debates. often plague policy debates.

For example, valuation avoids the frequent false For example, valuation avoids the frequent false characterization of some polices as being a characterization of some polices as being a choice between "the economy versus the choice between "the economy versus the environment.environment.””

(Loomis, (Loomis, ChoicesChoices, 2005), 2005)

What are the benefits of What are the benefits of conducting a valuation ? conducting a valuation ?

5. Understanding costs and benefits.5. Understanding costs and benefits.Who gains? Who gains? Who loses? Who loses? When are the gains to be realized? When are the gains to be realized? When are the costs to be borne? When are the costs to be borne?

Because of the complex nature of many Because of the complex nature of many environmental goods and natural environmental goods and natural resources, more than one type of method resources, more than one type of method may be necessary to better understand all may be necessary to better understand all the components of valuethe components of value

Valuation Scenarios & Examples

What is the economic loss as beach width diminishes?

Measure monetary damages from natural resource degradation

Determining the economic & environmental implications of a fishery regulation

Analyze potential economic impacts of a proposed policy or regulation change

Determine the net economic benefit of increasing use of reef balls or mooring buoys

Complete a benefit-cost analysis of a conservation project

ExampleScenario

Valuation MethodsValuation Methods

Over the past 5 decades economists have Over the past 5 decades economists have developed techniques to assess the value developed techniques to assess the value of environmental goods. of environmental goods. These techniques, which can estimate These techniques, which can estimate value for both users as nonvalue for both users as non--users, are users, are being employed intensively throughout the being employed intensively throughout the world and are being constantly refined and world and are being constantly refined and improved.improved.

Valuation MethodsValuation Methods Revealed Preference TechniquesRevealed Preference Techniques

Rely on observations of peopleRely on observations of people’’s s behavior in related markets to behavior in related markets to understand the value of associated understand the value of associated nonnon--market goods. market goods.

Travel Cost MethodsTravel Cost MethodsHedonic Pricing Hedonic Pricing

Revealed Preference TechniquesRevealed Preference TechniquesThese methods require that a link be These methods require that a link be established between changes in the established between changes in the environmental resource and changes in environmental resource and changes in the observed behavior of people.the observed behavior of people.

For instance, changes in beach width or reef quality For instance, changes in beach width or reef quality may result in people moving to another location or may result in people moving to another location or taking fewer trips. taking fewer trips.

“Free” disposal of rubbish actually has a large economic cost in terms of the impact of beach quality on people’s enjoyment of the resource and resulting economic effects.

Valuation MethodsValuation MethodsTravel Cost Method (TCM)

Uses information on travel to estimate a trip demand function, based on the idea that costs incurred in travel are a lower limit on willingness to pay for access to the natural resource. Typically applied to situations involving recreationSurvey data should include:

Individual visitation data Travel costs & other expendituresEnvironmental quality measures Demographic information

Travel Cost Method (TCM)

Values derived from a TCM study include:Values derived from a TCM study include:Value of the visit to the visitor over and above Value of the visit to the visitor over and above the price he already pays (consumer surplus). the price he already pays (consumer surplus). The recreational value of the natural area The recreational value of the natural area (deducted by aggregating the consumer surplus (deducted by aggregating the consumer surplus per visit per visitor over all visitors). This is what per visit per visitor over all visitors). This is what would be lost when the natural area disappears would be lost when the natural area disappears or is closed for recreation. or is closed for recreation. The value of changes in the quality or The value of changes in the quality or characteristics of the recreation site or area. characteristics of the recreation site or area.

Valuation MethodsValuation MethodsHedonic Pricing Method (HP)Hedonic Pricing Method (HP)

Demand for natural resources will be Demand for natural resources will be reflected in the prices people pay for reflected in the prices people pay for associated goods such as housing. associated goods such as housing. The value of environmental amenities or The value of environmental amenities or changes in them can be estimated. changes in them can be estimated.

House characteristics House characteristics Associated environmental attributes Associated environmental attributes

HP ApplicationsHP Applications

Example: People pay more for housing Example: People pay more for housing located closer to the sea. By comparing located closer to the sea. By comparing prices and characteristics of similar prices and characteristics of similar houses, we can derive the value of the houses, we can derive the value of the coastal amenity. coastal amenity. What are the economic benefits of What are the economic benefits of increased erosion protection to coastal increased erosion protection to coastal property owners? property owners?

Stated Preference TechniquesStated Preference Techniques

Rely on peopleRely on people’’s responses to survey s responses to survey questions regarding willingness to questions regarding willingness to pay, willingness to accept or pay, willingness to accept or hypothetical choices between hypothetical choices between alternatives to understand value. alternatives to understand value.

Contingent Valuation Method Contingent Valuation Method Choice Modeling / Conjoint AnalysisChoice Modeling / Conjoint Analysis

Valuation MethodsValuation MethodsContingent Valuation Method (CVM)Contingent Valuation Method (CVM)

Survey method where people indicate Survey method where people indicate willingness to pay (or accept) for changes willingness to pay (or accept) for changes described in a hypothetical market. described in a hypothetical market. Survey data should include:Survey data should include:

Detailed description of a program or changeDetailed description of a program or changeMechanism for eliciting value or choice Mechanism for eliciting value or choice Payment vehiclePayment vehicleInformation on respondent attitudes and Information on respondent attitudes and characteristics characteristics

CVM ApplicationsCVM Applications

Coral reef value Coral reef value –– what are people what are people willing to pay for reef improvement? willing to pay for reef improvement?

Beach value Beach value -- What is the nonWhat is the non--use use value of beaches to residents? value of beaches to residents?

Preservation value Preservation value –– How much are How much are citizens willing to pay to preserve the citizens willing to pay to preserve the coastal environment?coastal environment?

Valuation MethodsValuation Methods

Choice Modeling (CM)Choice Modeling (CM)Survey method whereby preferences Survey method whereby preferences are elicited through a series of paired are elicited through a series of paired choice alternatives. Each alternative is choice alternatives. Each alternative is described in terms of different levels of described in terms of different levels of attributes that comprise the product.attributes that comprise the product.

Description of 2 options for a Description of 2 options for a ““productproduct””specified with levels of attributes that make specified with levels of attributes that make up the product.up the product.Respondent attitudes and characteristics Respondent attitudes and characteristics

PrerequisitesPrerequisitesBefore valuation techniques can be employed, a Before valuation techniques can be employed, a sound understanding of the biophysical sound understanding of the biophysical relationships between resource use decisions relationships between resource use decisions and the ecological system needs to be and the ecological system needs to be established. established. (Bennett, 2003)

Budget and Time ConstraintsBudget and Time Constraints

NonNon--market valuation studies can be market valuation studies can be expensive to undertake, depending on the expensive to undertake, depending on the size and scope of the problem at hand. size and scope of the problem at hand. The method of The method of ““benefits transferbenefits transfer”” is a lowis a low--cost alternative that may be applicable in cost alternative that may be applicable in some situations where time and/or money some situations where time and/or money are limited.are limited.Benefits transfer uses functions and Benefits transfer uses functions and estimates from similar policy questions estimates from similar policy questions and adapts them to the local issue.and adapts them to the local issue.

Is it worth the time and expense?Is it worth the time and expense?Are the benefits of these studies (more efficient Are the benefits of these studies (more efficient use of natural resources) worth their costs?use of natural resources) worth their costs?Given that policy decisions are (and should be) Given that policy decisions are (and should be) affected by many concerns besides economic affected by many concerns besides economic efficiency (e.g. equity, sustainability), it is rare to efficiency (e.g. equity, sustainability), it is rare to be able to point to any one information source in be able to point to any one information source in the policy process as the definitive factor. the policy process as the definitive factor. Yet, it would appear foolish to make millionYet, it would appear foolish to make million--dollar decisions without carefully considering the dollar decisions without carefully considering the full range of benefits and costs of the available full range of benefits and costs of the available alternatives. alternatives. (Loomis, 2005)(Loomis, 2005)

ConclusionsConclusionsWhat can nonWhat can non--market valuation contribute to market valuation contribute to better resource management and policy making? better resource management and policy making? In some cases it can change the character of the In some cases it can change the character of the debate from being "the economy versus the debate from being "the economy versus the environment" to one of recognizing people care environment" to one of recognizing people care about the environment in the same way they care about the environment in the same way they care about market goods. about market goods. In other situations, nonIn other situations, non--market valuation can market valuation can bring balance to questions of "how safe is safe bring balance to questions of "how safe is safe enough?" given scarce resources in society. enough?" given scarce resources in society. Valuation can also call attention to otherwise Valuation can also call attention to otherwise undervalued resources. undervalued resources. (Loomis, (Loomis, ChoicesChoices, 2005), 2005)

ConclusionsConclusionsThe value of valuation lies in providing a The value of valuation lies in providing a more complete accounting of the benefits more complete accounting of the benefits and costs to all of the people. and costs to all of the people. WithoutWithout economic valuation, the following economic valuation, the following predictions are frequently realized: predictions are frequently realized: (a) those who would bear concentrated costs (a) those who would bear concentrated costs

can block resource reallocations that benefit can block resource reallocations that benefit society as a whole, and society as a whole, and

(b) those few that stand to gain concentrated (b) those few that stand to gain concentrated benefits can spread even larger costs out benefits can spread even larger costs out over millions of taxpayers. over millions of taxpayers.

ConclusionsConclusionsValuation studies have the potential to provide Valuation studies have the potential to provide an effective way to lessen the role of an effective way to lessen the role of special special interestsinterests in the policy process. Although policy in the policy process. Although policy makers and society will often have other makers and society will often have other objectives in addition to economic efficiency, objectives in addition to economic efficiency, more informed trademore informed trade--offs can be made between offs can be made between objectives if the benefits and costs of each objectives if the benefits and costs of each alternative are known. alternative are known. Although it is true that Although it is true that benefits and costs are not benefits and costs are not all that matterall that matter, it is rare that, it is rare that benefits and costs benefits and costs do not matter at alldo not matter at all to public decision makers to public decision makers and society. and society. (Loomis, (Loomis, ChoicesChoices, 2005), 2005)