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Valuing externalities

Valuing externalities

The lack of valuation and recognition of natural and social capital continues to be a significant gap in the economic and financial models and methods we apply when identifying and developing business cases for solutions to meet social and economic infrastructure needs.

Inconsistent policy, a lack of long running registers of natural capital and unavailability of guidance for business have contributed to this gap. At the international level there has been a recent effort to fill this gap with consistent accounting frameworks. These frameworks at the base level are aimed at attaining a better estimate of the Total Economic Value of some resource, allowing a truer accounting for costs incurred against natural capital. 

It is critical that natural and social capital are valued and integrated in solutions identification, options analysis and business case’s, to assist with uncoupling the politics from critical social and economic decision making, to attract alternative forms of funding and financing and to shift to regenerative and intergenerational social, economic and environmental outcomes.

This is a brief synopsis on the methods and state of play with respect to valuing social and environmental considerations. It is also therefore in essence a call to action to advocate and promote the need to value and include social and economic aspects in decision making processes and business cases.
 

Methods

The inclusion of environmental considerations into a Cost Benefit Analysis (CBA’s) is dependent on having a valid value assigned to the existence, loss or use of the good being considered. For instance, the value of clean water has been determined for some policies by finding the substitute cost of purifying or buying water after the degradation/loss of some source of water, i.e. watershed valuations. However, in this example the inherent value of the good isn’t considered, i.e. the existence value of the native area that is purifying the water, nor the ethical value of clean water in the environment to an individual. Another example would be the cost/benefit of health care related to an increase/decrease of air pollution from a policy. This will give a direct value to the policy outcome, however does not factor in the willingness of an individual to pay to reduce air pollution for any other reasons. This value is a non-market value, one to which a value has not been assigned in a trade or provision of service. These non-market values can have a significant effect on the total cost benefit analysis.

Non-market valuations are a large research area due to the importance of their inclusion into CBAs. The valuations fall into three main categories. Revealed preference techniques seek to determine a value for a good by analysing the behaviour of individuals in regards to their use of the good. For example, one could determine the value of a good examining the amount of money and time spent visiting a place, this is known as travel cost analysis. This approach has been used to value the Great Barrier Reef. Stated preference techniques seek to determine a value for a good by asking individuals to place values on different outcomes or policies and the prices that are associated with each option. The analysis leads to an estimate of willingness to pay for some good. This approach has been used in the wake of the Exxon-Valdez oil spill to determine the willingness to pay for the existence of populations of birds and fish in the spill area. This result was subsequently used as the basis of a punitive fine against Exxon. Thirdly, the most recent and least accepted is the use of wellbeing scores to give a value to a change in goods. This approach would determine the difference in wellbeing for either a time or place that differs with the change in access to or existence of the good, and would then calculate a value based on the wellbeing to income ratio. This method has as yet not been applied widely, but can theoretically address some of the biases involved in stated preference and revealed preference studies.

Benefits transfer is a method used to apply the results of a primary study conducted elsewhere to the policy site that is being analysed. Benefits transfer is according to (PC, 2014) the most used method to incorporating non-market values into cost benefit frameworks, as it is the lowest cost method. The reliability is greatly influenced by similarities between the primary study (or studies) in the ‘policy’ and ‘site’ being applied. This reliability problem is widely known in academia, yet is often ignored in policy analysis (PC 2014).

The secondary studies for benefits transfer are usually sourced from two environmental studies databases, EVRI and Envalue. EVRI is based in Canada and is backed by the Australian Federal government. It includes around 500 recent environmental and social valuation studies. This database has been used as a replacement for Envalue, as it has more recent studies and a larger number of studies available. Envalue was developed by the NSW Office of Environment and Heritage, and contained around 1000 studies from Australia. However, it has since been discontinued although access is still available.
 

ISCA

ISCA is in the process of developing Version 2 of the IS scheme, which will include an Economics’ Theme which will include best practise in business cases, valuing externalities and benefits realisation. This is one means through which ISCA is partnering and working with both the public and private sector to raise awareness of the importance of valuing material externalities (specifically social and environmental).

Antony Sprigg

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