Cost Benefit Analysis

Environmental Vauation

Cost-Benefit Analysis

03/03/09

Carlos Ferreira

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Cost-Benefit Analysis ● ●

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Social appraisal of investment projects Attempts to appraise investment projects in ways that correct for market failure Accounts for consequences stretching over future time: - Future market benefits - Future market costs - Future positive externalities - Future negative externalities

03/03/09

Carlos Ferreira

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Intertemporal Welfare Economics ●

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Socially optimal (Pareto efficient) decision sought after (Kaldor-Hicks) Must achieve efficient allocation of resources over time Utility not measurable, but a function of consumption - How is total consumption divided between the individuals during the time period? - Total consumption levels in each period

03/03/09

Carlos Ferreira

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The “standard case” ● ●

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Development vs Conservation Development has well defined societal benefits (B) and costs (C) Conservation has a number of benefits not priced in markets – loss is a cost (EC) Project given “go-ahead” if ∑(B) > ∑(C)

03/03/09

Carlos Ferreira

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Method (1) 1.Choose a discount rate (real rates, adj. for inflation) Marginal rate of return on the investment ● Consumption discount rate ● Some “standardized” social discount rate ●

2.Calculate the Present Value of Market-Based Costs (Ct): PVC = ∑(Ct/(1+r)t)

3.Calculate the Present Value of Market-Based Benefits (Bt): PVB = ∑(Bt/(1+r)t) 03/03/09

Carlos Ferreira

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Method (2) 4.Determine the value of foregone, Non-Market Environmental Benefits – Environmental Cost of the Project (ECt) TC, HP, CV NOTE - EC depends of time as well (Krutilla-Fisher model): ● Substitution possibilities of extracted goods ●Technical progress ● Income elasticity of demand for environmental goods

5.Calculate NPV NPV = Bt – Ct – ECt

6.Decision Rule NPV > 0 – proceed with development NPV < 0 – don't develop (conservation) 03/03/09

Carlos Ferreira

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Final Considerations ●

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Time frame: when calculating costs, the time variable must translate the period of impact, not of operation Sensitivity analysis: re-test for different discount rates, to see how robust is the analysis outcome Magnitude of result: due to uncertainty, a barely positive or barely negative CBA can't be trusted to decide whether to develop or not.

03/03/09

Carlos Ferreira

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Example

The e c o no m ic s o f b io d iv e r s ity c o ns e r v a tio n: a s tud y o f a c o ffe e g ro w ing re g io n in the We s te r n G ha ts o f Ind ia

03/03/09

Carlos Ferreira

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The problem ●

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Economic forces drive are driving down ecosystems and biodiversity Tropical forests are being converted quickly, especially into agricultural land (66.8% of the total between 1981 and 2002) Biodiversity's value to society is not accounted for by market price – externalities Valuing the costs and benefits of conservation will allow appropriate policies to be enacted in order to conserve biodiversity

03/03/09

Carlos Ferreira

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Objectives 1.To estimate the opportunity cost of biodiversity conservation in terms of the coffee benefits foregone. 2.To assess the external costs borne by the local community due to wildlife conservation. 3.To analyse the local community’s willingness to pay for participatory biodiversity conservation and the socio-economic and other factors influencing the same. 03/03/09

Carlos Ferreira

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Method, sample, data ●

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CV study 125 respondents, living in a village in the vicinity of a reserve forest, coffee plantation dominant activity

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Stratifies sample, according to size of owned land

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Discrete choice, “yes”/”no” to bids

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Opportunity cost of conservation

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Measure of damages caused by wildlife

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Measure of transaction costs in claiming compensation for wildlife-caused damages

03/03/09

Carlos Ferreira

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Opportunity Cost of Biodiversity Conservation ●

Coffee is the main competitor for land use

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Carlos Ferreira

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NPV of Cultivating Coffee ●

2 types of coffee (Arabica vs Robusta) - grown in different areas - very different yields - very different market prices

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“Internal” costs of agriculture: establishment, recurring

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“External” costs of defence from wildlife

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Life-span: 50 years

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Discount rates: 8%, 10% and 12%

03/03/09

Carlos Ferreira

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Costs faced by farmers

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Carlos Ferreira

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NPV of Cultivating Coffee

03/03/09

Carlos Ferreira

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Sensitivity Analysis

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Carlos Ferreira

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External Costs

03/03/09

Carlos Ferreira

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Transaction Costs of Claiming Compensation for Wildlife Attacks

03/03/09

Carlos Ferreira

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WTP for Conservation

Reasons (general)

Reasons (elephants)

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Future generations (36%)

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Existence value

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Livelihood function (26%)

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Aesthetic value

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Ecosystem functions (25%)

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Livelihood function

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Option value

03/03/09

Carlos Ferreira

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Conclusions ●

Authors don't compute benefits of conservation

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They take the high benefits of coffee and compare it to its costs

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Opportunity cost of conservation is high...

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… since the benefits of coffee are very high...

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… even considering external costs and transaction costs involved in compensation The cost of conservation is directly linked to the market price of coffee. Policy-wise, changing the rules for obtaining compensation might help conservation It is possible to have a reasonable WTP but be disincentivized towards it at the same time 03/03/09

Carlos Ferreira

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References ●

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Ninan, K. N., Sathyapalan, J. (2005). The economics of biodiversity conservation: a study of a coffee growing region in the Western Ghats of India. Ecological Economics, 55, pp. 6172. Perman, R., Ma, Y., McGilvray, J., Common, M. (2003). Natural Resource and Environmental Economics. Essex: Pearson Addison-Wesley.

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Carlos Ferreira

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