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Putting the right price on nature: environmental economics

Summary

Growing populations and an increasing demand for greater material wealth are placing unprecedented pressure on the earth's natural systems. But assigning values to such systems is a difficult process — not least because they are generally thought of as free goods that everyone has a right to use. Environmental economics offers a number of tools to help policymakers ensure that the benefits we obtain from ecosystems are properly valued, enabling a framework to be built for sustainable use and conservation of the environment.

Introduction

There is no doubt that 'ecosystem services' (the benefits people obtain from ecosystems) are critical for human well-being. Yet we do little to ensure their sustainability for future generations: the Millennium Ecosystem Assessment shows that nearly two-thirds of them are in decline worldwide. Take biodiversity — extinction rates today are estimated as up to a thousand times the background rates of just a few hundred years ago. Such unprecedented declines in biodiversity deplete the food gene bank and directly affect pollination and water purification for present and future generations.

Why do we continue to deplete or destroy the ecosystems we depend on for our well-being? One reason is that until recently, the vast majority of people regarded most ecosystem services as free, or valued them at lower prices than they are worth. This is especially true of 'public goods' like fresh air and flood regulation, for which property rights cannot easily be defined because no one can be excluded from benefiting from them and everyone can use them at the same time. Similarly, the true cost of public hazards such as pollution has not been reflected in the market prices of industrial products because natural systems were assumed to absorb and clean all the waste we created.

Placing a true value on these types of goods, together with finding the optimal balance between ecosystem service use and pollution, has become the focus of a discipline known as environmental economics.

Valuation strategies

Environmental economists distinguish between the value people derive from directly (or indirectly) using a good or service, and the value derived from ensuring we have the option to use it later. A third distinction is the value gained from simply knowing that a resource — for example, an endangered species — exists.

Two approaches have traditionally been used to compute these values in monetary terms. [1] The first springs from the idea that consumers' preferences are reflected in the choices they make, so purchasing habits can reveal what is most valued. Ecosystem services may not have a market as such, but proxy markets can be examined instead. For example, in valuing biodiversity, ecotourism can indicate how much people will pay to see species in their natural habitats. A 1998 World Trade Organization report estimated the size of this market at approximately US$90 billion a year, and rising. If no proxy markets exist, surveys and questionnaires can be used to estimate the 'willingness-to-pay' of individuals for ecosystem services.

Both these methods have also been used to gather information on what people are willing to accept in terms of pollution damage.

More recently, however, a growing body of literature favours using a deliberative participatory process to reach a consensus on the allocation of ecological services. [2]

Putting valuations into practice

Once an ecosystem service has been given a value, there are a number of measures that can ensure it is accounted for in our use of natural resources.

Environmental report cards

In particular, tracking changes in the value of 'natural capital' at the national level can help ensure long-term sustainability. The majority of environmental economists argue that the Gross National Product (GNP) is an inadequate measure of wealth for this purpose, because it only measures capital produced by humans. Instead, they make a case for macroeconomic indicators like the Genuine Savings Index (GSI) or the Natural Wealth Indicator (NWI), both of which take into account assets such as natural resources and environmental quality. [3]

Pollution penalties

Environmental economics can also help reduce pollution. For example, penalties, in the form of fines, are an efficient way of cutting pollution. Other measures like carbon trading can provide incentives for technological innovation and economic growth in an environmentally sustainable way. The United States have used tradable permits of sulphur dioxide to reduce the emissions of many electric utilities.

Common property rights

Another contribution has been the development of common property rights to encourage sustainable development of communal land. Well-defined property rights allow for ownership transfer that is essential to develop a successful market. But property rights can be difficult to define. This is especially true for ecosystem services that are considered public goods. Indeed, many view the act of defining property rights for these as unethical.

Ongoing work in common property, however, offers alternatives to the conventional economic approach. For example, Namibia's 1997 Amended Nature Conservation Act gave people living in communal areas the right to use wildlife and receive economic benefits from activities such as tourism and controlled trophy-hunting. The World Wildlife Fund report that improved management, reduced poaching and less conflict between humans and animals has led to a significant impact on wildlife numbers in these communal areas. [4]

Cost-benefit analyses

To make informed choices, we need appropriate frameworks for evaluating the alternatives. Environmental economics offers many of these, including analyses that use a monetary metric as the basis for evaluation, as well as multi-criteria analyses that use a number of weighted factors — for example, employment, public acceptability or sustainability — to judge performance.

Evaluation frameworks allow potential trade-offs between preserving and converting ecosystems to be assessed in monetary values. For example, the net benefit analysis in Figure 1 shows that sustainably managed ecosystems result in larger US dollar values per hectare than converted ecosystems.




Figure 1: Net benefit analysis of maintaining ecosystems in four countries. [5]

But these frameworks are sensitive to the actual valuation given to ecosystem services in the first place and, although much progress has been made in the development of valuation strategies, a number of problems with this system persist.

Problems in assigning values to ecosystem services

Valuations over time and space

One such problem is that the cost of using ecosystem services may not be immediate, as is the case for climate change. Discount rates — used to evaluate future economic consequences of today's choices — tend to undervalue environmental costs, which usually occur much later in time than the benefits.

Moreover, many environmental impacts are not restricted by political boundaries, making cross-border valuations problematic. Although there is no easy answer to the dilemmas this can cause, ways of identifying who is responsible and the extent of that responsibility are beginning to emerge.

Reducing economic competitiveness

A second problem is the myth that penalising polluters will reduce the economic competitiveness of many industries. In fact, empirical evidence suggests that industries can become more efficient in the face of pollution penalties, and can increase their productivity by using cleaner technologies. [6]

Defining property rights for pollution

A more common problem is that assigning ownership to pollutants has proved difficult. This is especially true when rain, snowmelt or irrigation water gets contaminated flowing across or through land and pollutes water systems like rivers, lakes or underground aquifers. In these cases it is difficult to isolate a single polluter because the final impact is the sum total of all pollutants picked up along the way.

Interdependencies of ecosystem services

Accurate valuations are also often difficult because our understanding of ecosystems services is still evolving. The Millennium Ecosystem Assessment has highlighted the large degree of interdependency across such services, and their link to human well-being. For example, valuations of a strand of forest may show that timber production is individually more profitable than flood regulation or water purification. But all three ecosystem services are interlinked — exploiting one will affect the others. So, in actuality, conserving all three may be more lucrative than exploiting just one.

Moving towards a sustainable future

One criticism often heard of environmental economists is that their need for monetary analyses leads to a lack of appreciation of the physical limits to natural systems. To address this issue, a new discipline — ecological economics — was established in the late 1960s and early 1970s. [7] Ecological economists adopt a holistic approach that sees the human economy as embedded within a broader natural system.

Despite this difference, there are many overlaps between the two disciplines, especially in the valuation strategies used. The gap between the two fields has further narrowed through their mutual support of 'sustainable development' — meeting the needs of today without compromising the needs of future generations.

The challenge to policymakers

One of the challenges to policymakers concerned about environmental issues is that in many developing countries, environmental ministries hold little or no authority for making economic decisions. Over the last five years, the mainstreaming of environmental issues within poverty reduction strategy papers and the Millennium Development Goals has helped to overcome this problem. An increased awareness of the links between ecosystem services and human well-being, and a deeper understanding of the trade-offs and physical limits involved in using these services has made investment in environmental infrastructure easier.

But there is still a lingering perception that conserving the environment is a luxury, not a necessity. More education is needed at the national, regional and international levels.

Furthermore, policymakers are more likely to act when they are given hard numbers. Providing quantified estimates of the costs and benefits of intervention — however crude — helps in both decision-making and budget allocations.

Conclusion

That a decline in ecosystem services has a negative effect on human well-being is now accepted. But burgeoning populations and the increasing demand for greater material wealth is putting unprecedented pressure on the earth's natural systems. Policymakers need to put frameworks in place that will allow realistic values to be placed on these systems.

Environmental economics can help identify how people value ecosystem services, and offers decision-making frameworks to help design policies on how to use these services and provide them in an efficient, equitable and sustainable way.

Anantha Duraiappah leads the Analysis and Emerging Issues unit for the UN Environment Programme in Kenya.

References

[1] Pierce D. An intellectual history of environmental economics. Annual Review of Energy and the Environment 27, 57-81 (2002)

[2] Kaplowitz M. D. and Hoehn J. P. Do focus groups and personal interviews cast the same light on natural resource valuation? Ecological Economics 36, 237-247 (2001)

[3] Hamilton K. and Clemens M. Genuine savings rate in developing countries. World Bank Econ. Rev. 13, 333-356 (1999)

[4] Le Quesne T. and McNally R. The green buck: using economic tools to deliver conservation goals. A WWF field guide. Available at: http://www.wwf.org.uk/filelibrary/pdf/thegreenbuck.pdf  [64KB].

[5] Millennium Ecosystem Assessment Synthesis Report (2005)

[6] Jaffe A., Peterson S., Portney P. et al . Environmental regulation and the competitiveness of U.S. manufacturing: what does the evidence tell us? Journal of Economic Competitiveness 1, 132-163 (1995)

[7] Ropke I. Trends in the development of ecological economics from the late 1980's to the early 2000s. Ecological Economics 55, 262-290 (2005)