Transcript Valuing Water in Watershed in the Absence of Market Prices

Economic Valuation Methods for Efficient
Water Resources Management:
Theory and Applications
Phoebe Koundouri
ARID CLUSTER, May 2005
Outline


Introduction: Economic Framework for Sustainable
Water Resources Management
Valuation Methods:
–
–

Revealed Preference Techniques
Stated Preference Techniques
Applications to Water Resources:
–
–
Cyprus EU Water Management Project
Choice Experiment to Estimate Non-Use Values of
Wetlands
Key Objectives of Public Policy in Allocation of Water
Resources
Efficiency: organization of production & consumption such that all
unambiguous possibilities for increasing economic well-being have been
exhausted. For water, this is achieved where the marginal social benefits of water
use are equated to the marginal social cost of supply, or for a given source, where
the marginal social benefits of water use are equated across users.
Equity: fairness of distribution of resources and impacts across society.
Equal access to water resources, the distribution of property rights,
and the distribution of the costs and benefits of policy interventions
Environment and Sustainability: Consideration of intergenerational equity &
the critical nature of ecological services provided by water resources provide two
rationales for considering sustainability.
Market and Government Failures
-Water is a public good (non-rival; non-excludable)
- Externalities or missing markets
Market Failure
Government intervention is necessary. Often however
governments lack institutional capacity or behave in
myopic manner.
Government Failure
Together these lead to Inefficient Water Resources Allocation
over time and space.
Absence of Market Prices
RESOURCE
COST
FINANCIAL COSTS
CAPITAL OPERATION & RESOURCE
TOTAL
MAINTENANCE ADMIN
ECONOMIC COST
(O&M)
COST
VALUE
COST
COST OF
FORGONE
VALUE OF
ALTERNATIVE
USES
(present/future)
ENVIRONMENTAL
COST
IN SITU VALUE
(Cost of
Saline intrusion
Land Subsidence
Drought Buffer)
GROUNDWATER
ABSTACTION
PAID
BY
USERS
CAPITAL
COST
(credit
often
subsidized)
O&M
COST
(energy often
subsidized)
RES.*
ADMIN
COST
* Frequently not levied or do not cover real costs
Environmental and Resource Costs
Environmental costs: Costs of damage that water uses impose on
the environment and ecosystems and those who use the
environment (e.g. a reduction in the ecological quality of aquatic
ecosystems; salinization and degradation of productive soils).
Resource costs: Costs of foregone opportunities which other uses
suffer due to the depletion of the resource beyond its natural rate
of recharge or recovery (e.g. linked to the over-abstraction of
groundwater).
Source: WATECO glossary
Environmental & Resource Costs in the
WFD
- Art. 9: E & R costs in the cost-recovery of water services
- Art. 9: Member states shall ensure by 2010 that water pricing
policies provide adequate incentives for water users to use water
resources efficiently, and thereby contribute to the environmental
objectives of the WFD
- Annex III and Art. 11: Make judgments about the most
cost-effective combination of measures with respect to water uses to
be included in the programme of measures
- Art. 4: Possible economic justification for derogation
(including designation of water body status).
The Optimal Price of Water:
Impacts of market and government failure
€
MBs
MEC L+G
MEC L
MB
Water resource degradation &
depletion
An Economic Framework to Measure Value of
Environmental Functions
Need for economic efficiency and social equity in WRM over the
long-term. Thus, need to incorporate full cost recovery of water
services.
Structure
&
Processes
Watershed
Environmenta
l
Human
Benefits
Anthropocentri
c
Values
Functions
Use
Values
...A crucial component of Cost-Benefit Analysis
Non-Use
Values
The Total Economic Value of Water
To estimate benefits, need to obtain the TEV of water
resources. This is composed of:
Use Values
Non-Use Values
Direct
Indirect
Option
Existence
e.g.
Hydropower
Drinking water
Irrigation
Fishing
Water in production
Recreation
e.g.
Flood control
Salinity control
Microclimatic
stabilisation
e.g.
Future use
of direct and
indirect values
e.g.
Biodiversity
Cultural Heritage
Bequest values
Future value of
information
Total Economic Value in the WFD
1- Characterisation of the groundwater basin
- Economic significance of water uses
- Trends in key indicators and drivers
- Dynamic path of demand and supply of water
- Gaps in water status by the agreed date of meeting ‘water balance’?
2- Assess current cost-recovery
–
–
–
How much water services cost and who pays this cost?
How much of this cost is recovered?
Potential cost-recovery mechanisms
3- Identification of measures and economic impact
–
–
–
–
Construction of a cost-effective programme of measures
Cost-effectiveness of potential measures
Financial & socio-economic implications of the programme of measures
are costs disproportionate?
Derogations
Steps towards Estimating TEV
1. Identify Uses and Functions
2. Identify Stakeholders (Focus Groups)
3. Choose Appropriate Valuation Methodologies
4. Estimate Monetary Values of Uses
Valuation Methods
and the TEV Components they can estimate
Revealed preference methods (indirect methods):
- Hedonic Pricing Method
- Travel Cost Method
- Averting Behaviour Method
- Residual Analysis (Production Cost Method)
Use Values
Stated preference methods (direct methods):
- Contingent Valuation Method
- Choice Experiment Method
Use & Non-Use Values
(value of conservation)
Meta-Analysis Method
Methods not strictly based on economic welfare:
- Replacement Cost Methods
- Restoration Cost Methods
Hedonic Valuation Method (HVM)
If environmental resource is not traded in any market, because it is a public
good, then no market price exists to reveal WTP. A resource can be defined in
terms of services it yields or an `attribute' it embodies. This attribute may be
embodied in other goods or assets which are marketed, and which do have
observable prices. Using these prices you can derive economic value.
E.g: Farm prices in an area with good groundwater are most likely higher than in an area
without either ground- or surface water. Comparing differences in farm prices across a
region and controlling for other influences, then the difference in prices of these farms
would lie in groundwater access.
Problems:
-Only capable of measuring the subset of use values that people are WTP for
through the related market.
- If consumers are not fully informed about the qualities of the attributes being
valued, hedonic price estimates are of little relevance.
Travel Cost Method (TCM)
Infers the value of a set of attributes from expenditure (time and
money spent on the trip) on outdoor recreational facilities or visits to
nature reserves.
E.g: Valuing the effects on the demand for recreation of a change in
water quality in a river.
Problems:
- Capable of measuring the subset of values that people are WTP for in the
related market.
- Very few applications outside resource-based recreational amenities.
- Data-intensive.
- What value should be assigned to time costs of travel?
- Statistical problems.
Averting Behavior Method (ABM)
Use of expenditures undertaken by households that are designated to
offset an environmental risk, in order to infer WTP for avoiding
environmental degradation.
E.g: Use of water filters.
Problems:
- Limited to cases where households spend money to offset
environmental hazards.
- Insufficient studies to comment on convergent validity.
Residual Analysis Method (RAM)
Values all inputs for the good produced at their market price – except for
the water itself. The remaining value of the good, after all other inputs
are accounted for, is then attributed to the water input.
E.g: Valuing water as an input in production of different crops.
Problems:
- Only part of use-value of water can be captured.
- Market imperfections can bias valuation estimates.
Contingent Valuation Method (CVM)
CVM relies on a constructed, hypothetical market to produce monetary
estimates of value. The value of an environmental resource to an
individual is expressed as:
- Maximum Willingness-to-Pay (WTP)
- Minimum Willingness-to-Accept (WTA, Compensation)
E.g: Conduct survey to obtain peoples’ bids (either WTP or WTAC) for a
specified change in the quality of water in a river, contingent upon the description
of a hypothetical market where water quality is traded.
Problems:
- Interviewing bias
- Strategic bias
- Hypothetical bias
- Non-response bias
- Yea-saying bias
- Information bias
Choice Experiment Method (CEM)
CEM is a survey-based technique which can estimate the total economic
value of an environmental stock/flow or service and the value of its attributes,
as well as the value of more complex changes in several attributes.
E.g: Each respondent is presented with a series of alternatives of the
environmental stock/flow or service with varying levels of its price and nonprice attributes and asked to choose their most preferred option in each set of
alternatives.
Problems:
- Simplified version of reality … but CEM eliminates or minimises several of
the CVM problems (e.g. strategic bias, yea-saying bias, embedding effects).
Operational at the policy level?
Question: How can these methods be made operational in the
context of the development of groundwater management strategies
at the policy level?
Answer: Recent years have seen a growing interest in the potential
for producing generally applicable models for the valuation of nonmarket environmental goods and services, which do not rely upon
expensive and time-consuming original survey work, but rather
extrapolate results from previous studies of similar assets.
This approach is called meta-analysis for the use and non-use
values generated by environmental resources.
Meta-Analysis Method (MAM)
Meta-analysis is the statistical analysis of the summary of findings of
empirical studies: i.e. the statistical analysis of a large collection of
results from individual studies for the purpose of integrating the
findings.
E.g: Freshwater fishing meta-analysis of TC valuation studies (Sturtevant, 1995).
Meta-analytical research seems to have been principally triggered by:
- Increases in the available number of environmental valuation studies.
- Seemingly large differences in valuation outcomes as a result of use of
different research designs.
Environmental Benefits-Transfer



Transposing monetary environmental values estimated at one site
(study site) to another (policy site).
Values must be adjusted to reflect site specific features.
When time or resources are limited, this provides an alternative to
conducting a valuation study. Using meta-analysis for benefits
transfer has advantages.
E.g: Environmental Valuation Reference Inventory (www.evri.ca)
Problems
- May involve bias
- Validity and reliability issues
Applications to Water Resources

Case Studies
–
–
Cyprus EU water management project
A Choice Experiment to Estimate the Non-Use
Values of the Cheimaditida Wetland in Greece
The ‘Cyprus’ EU Project
Water Supply
Water Demand
Surface Water
Household
Groundwater
Agriculture
Diversions
Tourism
Desalination
Environment
Reuse
Water Deficit
-------------------------------------------------------------------------------------------------------------------Predicted Sectoral Growth (GDP: 6%)
• Tourism: 5-10% economic growth.
• Agriculture: 2.2% economic growth and expansion of government schemes
• Residential: 1% population growth
---------------------------------------------------------------------------------------------------------•The approach has been applied in Crete. (http://www.arid-research.net)
• It is now applied in France and Finland.
V a lu in g W a ter in a W a tersh ed in th e A b sen ce o f M a rk et P r ices
Id en tifica tio n o f S e cto r S p ecific W a ter D e m a n d s
H o u seh o ld
T o u rism
A g ricu ltu re
E n v iro n m en t
E co n o m ic M eth o d o lo g ies fo r o f S ecto r S p ecific W a ter D em a n d s: C y p ru s
R E S ID E N T IA L
M eth o d :
E c o n o m e tric
E stim a tio n
O u tc o m e :

P ric e W a te r
D em and
E la stic itie s

In c o m e W a te r
D em and
E la stic itie s

R isk P re fe re n c e s
A G R IC U L T U R E A N D
T O U R IS M
A G R IC U L T U R E A N D
R E S ID E N T IA L
M eth o d : C o m b in a tio n
o f H e d o n ic a n d T ra v e l
C o st
M eth o d : D y n a m ic
M a th e m a tic a l
P ro g ra m m in g
O u tc o m e :

W illin g n e ss to P a y
fo r A g ric u ltu ra l
Land and
g ro u n d w a te r q u a lity
O u tc o m e :

E ffic ie n t se c to ra l
a llo c a tio n o f w a te r

E stim a tio n o f th e
m a rg in a l v a lu e o f
g ro u n d w a te r

Id e n tific a tio n o f th e
O p tim a l T im in g fo r
D e sa lin a tio n U se
E N V IR O N M E N T
M eth o d :
C o n tin g e n t
V a lu a tio n
O u tc o m e :
 W T P fo r
p re se rv in g th e
m a r sh e s.
 E sta b lish th e
re g io n a l n a tu re
of W TP
O b jectiv e B a la n ce B etw een C o m p e tin g a n d A ltern a tiv e D e m a n d s
S ecto r
H o u seh o ld s
A g ricu ltu ra l/
Q u a lity
A g ricu ltu ra l/
Q u a n tity
E n v iro n m en ta l
P E D (-)
0 .4 -0 .8
in creasin g
in co m e
IE D
0 .2 5 -0 .4 8
in d ecreasin g in
in co m e
M a rg in a l V a lu e/
W TP
£ C y0 .4 5 /m
3
-
-
£ C y1 .0 7 / h a
0 .4 8
-
£ C y0 .3 0 /m
-
£ 1 5 p er h o u seh o ld p er
year fo r w etlan d
p reserv atio n
-
3
R isk
P rem iu m
-
18%
-
Policy Recommendations:
• Inter-sectoral allocation of groundwater should be based on the marginal value of
the resource for each sector:
Marginal value higher in residential sector than agricultural sector at current use levels.
Policy should be directed towards reducing the appropriation of water by agriculture.
• Balance demands through efficient pricing:
Groundwater: Include resource cost
Surface water: Long-run marginal cost (LRMC)
• With limited supply, PED can guide pricing policy
PED of water is higher for residential than for agriculture sector.
This means that larger increases in price required for a unit of agricultural demand reduction.
A Choice Experiment to estimate non-use values of
the Cheimaditida wetland, Greece.

Estimated non-use values of 4 wetland attributes:
–
–
–
–
Biodiversity (€15)
Open water surface area (€9)
Education and research extraction (€8)
Local Employment (€0.12 per person)
Can combine these non-use values with direct and indirect use
values of the wetland to obtain TEV…
In general, sustainable management of water resources implies
net benefits exceed net costs. Valuation methods are integral
in determining whether this criterion is met.
Once we know TEV what do we do
with it???
Classification of Economic Instruments
Economic Instrument
1. Standards and Quotas
Advantages
Public is familiar with
this instrument
Disadvantages
Not economically
efficient
2. Water abstraction
charges
Adjustment of price signals to reflect
actual resource costs; encourage new
technologies; flexibility; generation
of revenues
Low charges will have minimal
impact on user behavior and
will continue in resource overutilization
3. Pollution charges
Same as water abstraction
charges; polluter-pays principle
Same as water abstraction
charges
4. Subsidies on water
saving measures
5. Tradable permits
Readily acceptable
Financial Constraints
Quantity based targets that
are able to attain least-cost
outcome. Allows flexibility.
May entail high
transaction costs
6. Voluntary agreements
Readily acceptable
7. Liability legislation
Assess and recover damages
ex-post but can also act as
prevention incentives
Requires good co-operation between
Government and farmers organizations
Require an advanced
legal system; high control
costs; burden of proof
An Additional Instrument: Discounting
`Humanity has the ability to make development sustainable: to ensure
that it meets the needs of the present without compromising the ability
of future generations to meet their own needs.’ WCED, 1987
`There is something awkward about discounting benefits that arise a
century hence. For even at a modest discount rate, no investment will
look worthwhile.‘
The Economist (1991), March 23, p 73
In the decade since that comment in The Economist, the nature of the
problem with long-run discounting has become clearer.
Effect of shift from flat 3.5% to the step
schedule of discounting rates
Project time horizon
Potential effect on project NPV
0-30 years
Small, generally insignificant
30-100 years
Significant (± 50%)
100-200 years
Large impact (± 100%)
200-400 years
Major impact (± 150%)
The Need for Time Declining Social
Discount Rate…
There are powerful reasons for choosing a declining social time
preference rate. This conclusion is supported by robust recent
theoretical work, which has taken several different approaches
to the subject.
Although there is a paucity of empirical evidence on the pattern
of that rate's decline, it may be better to use those data, which
are available rather than to continue practicing discounting
with non-declining rate in the long term. The data best suited
the policy-makers' need were produced by Newell & Prizer
(2003) and Koundouri et al (2005).
C onstant discount
rates (C D R s) s
U tility
discounting
ρ
T im e declining
discount rates
(T D D R s) s(t)
C onsum ption
discounting μg
U ncertainty
about the
future
U ncertainty about
discount rate (s)
W eitzm an
K oundouri et al.
U ncertainty
about
grow th (g)
G ollier
Future
fairness
C hichilnisky
H eal
L i & L öfgren
O bserved
individual
choice
H yperbolic
discounting
C ropper et
al
Suggested Step Schedule of Discount Rates
Period of Years
Discount Rate (%)
0 – 30
3.5
31 – 75
3.0
76-125
2.5
126-200
2.0
201-300
1.5
301 +
1.0
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Thank you.