How and Why: Economic Valuation of Nature

Since I started working on my PhD thesis, I have been asked many times what it is about. I must admit that it is hard for me to explain. First, because attaching price tags to forests or wetlands is not quite something that people expect to be done by scientists. It is strange. Second, because most people do not like the idea. Even if they are not aware of this term, what they fear is going by the name of “commodification” and is a highly controversial topic in scientific literature, including a famous commentary in the prestigious journal Nature by Douglas McCauley, aptly titled Selling Out on Nature. While I do have some answers to the questions and doubts of my friends and relatives, they are too complicated and comprehensive for a casual conversation at the coffee table. Therefore, I decided to write a blog piece about this, at least for those of my friends and relatives who understand English.

Before we come to the “why?”, I will start with answering the easier question of “how?”. So, how do economists estimate the economic value of, say, a forest? The starting point for this is the notion of Total Economic Value (TEV), which is quite unfortunate a name, since economists are actually aware that the TEV does not cover all sources of value an ecosystem has. This should be kept in mind: TEV is, despite its name, not the total value of an ecosystem! In the end, it is only an unfortunately named analytical tool that helps us define more specific value categories. There are three main categories of economic value (components of) an ecosystem can have (see also picture below): use value, option value and non-use value. Option value reflects mainly the idea that the preservation of an ecosystem may lead to future benefits (e.g., when some substances of pharmaceutical usefulness would be found there in the future). Direct-use values are for instance the value of fuel wood or game extracted from a forest, but also the ecosystem’s contribution to (eco-)tourism in terms of aesthetics. Indirect-use values are mainly related to such things as flood protection or prevention of soil erosion or pollination. Bequest and altruistic values do represent inter- and intragenerational equity concerns, respectively. I may value a coral reef because I hope that it will benefit my grand-children (bequest) or that it benefits other people who live in its proximity (altruistic). Existence value is essentially what some call the intrinsic value of an ecosystem: that we value it just because it exists, regardless of whether we or anybody else use it.

The Total Economic Value framework (click to enlarge).

The Total Economic Value framework (click to enlarge).

As you may have noticed from what I have written so far, the economic approach is inherently anthropocentric. Ecosystems’ values result only from our preferences for them (but regardless of what the source of those preferences is and what ethical perspective we ourselves adopt). This is clearly a serious limitation of the economic approach, but I do not think that this makes it useless by itself.

Now that we have an overview of what are the values that economists try to assess, let us turn to the valuation techniques. To make them more plausible, I will use “forest” as an example. There are many different methods used to assess the different components of TEV of a forest ecosystem. We can put them in three large categories:

  1. Market-based methods: these methods are applicable only for some use values, namely those components of the forest that have market prices or where market prices of similar goods can be found. E.g., timber, game etc. are traded in markets, so they have prices, which are assumed to reflect their economic value. Other aspects of the forest are not traded in markets, but have market substitutes. E.g., a riparian forest protects nearby settlements from floods.  If the forest were cut down, this ecosystem service (flood protection) would have to be replaced, e.g. by building dikes. The cost of the dikes is then assumed to be reflecting the value flood protection has for us. It should be noted, however, that this does not mean that the cost of building a dike is equal to the economic value of the forest in general–since it provides many more ecosystem services, e.g. water cleaning, carbon storage, food etc., its overall value is likely to be much higher. Market-based methods are nice because their application is rather straightforward and relevant data is mostly available. The downside is that they provide estimates for only very few aspects of the value of an ecosystem.
  2. Revealed-preference-based methods: here, the assumption is that the value of an ecosystem is reflected in our choices regarding the consumption of specific market goods, namely tourism (the travel cost method) or real estate (hedonic pricing method). In the former case, let us assume that our forest is a national park. Its use value can be estimated based on data on the costs that people incur to visit it. Alternatively, we may assume that there are settlements near our forest. In this case, the assumption is that part of its use value is reflected in the rent differences between otherwise identical flats that differ only in their proximity to the forest. Both these methods work quite nicely in theory, but are very complicated in practice (e.g., are there any “otherwise identical” flats out there?). And, again, they cannot capture non-use or option values.
  3. Stated-preference-based methods: this method class is the only one that provides an opportunity to capture bequest, altruistic and existence values. It is also the most controversial class. Stated-preference methods are based on questionnaires, in which people are asked how much they would be willing to pay to prevent a negative change or to facilitate a positive change in the state of an ecosystem. E.g., a forest area might be meant to be expanded. People would then be asked how much more taxes they would be willing to pay for this to happen. [My description of this method class is very simplistic, in fact they are much more sophisticated than that. There are also large differences between specific methods belonging into this class. But for the sake of this post it should suffice.] As a response to the critique that the goods people are asked to value in questionnaires are unfamiliar to them and often quite abstract, a new class of so-called deliberative methods has been introduced: here, people are presented the task in workshops and are given the opportunity to discuss the issue and reflect upon it, before being asked to fill out a questionnaire. In my PhD thesis, I will likely apply deliberative valuation methods.

This brief overview should provide a general impression of how economic valuation of ecosystems works. Of course, the more important question is: Do we need all this? I already wrote a couple of posts about the criticism of economic valuation (e.g., here and here). My opinion on the issue is the following: since appeals to morals, as called for by, for example, Douglas McCauley or the philosopher Mark Sagoff, obviously have not changed our attitude towards nature, which continues to be largely extractive, narrow and short-sighted, maybe the expression of the value of ecosystems in a language understood well by most people (at least in the global North) could help. So, economic valuation should have mainly a signalling or communicative role. There are many ways how this may specifically be done–be it by presenting the estimates of the economic value of a specific ecosystem, be it by constructing some metrics of sustainability (NOT green-GDP, though) where ecosystem values as expressed in money terms might be incorporated. The main idea behind economic valuation is that managing ecosystems involves trade-offs, e.g. between food production and conservation of intact ecosystems. Economic valuation helps by expressing these trade-offs in a common scale (which is money).

However, a few caveats are in order. First, there is no need for valuation where there is societal agreement regarding land-use options. If people would agree that there should be, say, a natural park in the northern Schwarzwald in south-western Germany, there would be no need for economic valuation. Furthermore, it should be clear that the monetary values attached to ecosystems by economists are not to be taken at face value. They provide an impression of the relevant order of magnitude at best. So, if an economist tells you that the forest near your city is worth 100€ per ha, you should be aware that 1) this number depends on the method used (both with regard to the value categories estimated and the quality of the method’s application), 2) even if the respective study was conducted according to best practice standards, the 100€ per ha are only the estimation of the relevant order of magnitude. Economic valuation methods are much too complex and limited in some respects to provide really precise values. Third, as I already mentioned above, economic values are not all that counts. There are many value components which cannot be sensibly expressed in money terms. So, economic value estimates can only be seen as inputs to a broader discussion, not as final arguments. And fourth, I should stress that these 100€ per ha are not meant as a market price. There is a significant difference between this value estimate and the price that one would have to pay to “own” a ha of the forest. It may well be that the forest has an economic value, but is nevertheless considered not for sale. This is often forgotten by both some environmental economists and their critics.

I dedicate this post to A.S., who recently asked me discomforting questions about the topic of my thesis.

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2 thoughts on “How and Why: Economic Valuation of Nature

  1. “While I do have some answers to the questions and doubts of my friends and relatives, they are too complicated and comprehensive for a casual conversation at the coffee table”

    At the coffee table or similar occasions I often resort to the following example for the benefits of the commodification of nature. It concerns the access to water, and as there usually is the instant reaction that there should be a “human right to free access to water” this example makes most people all the more think twice:

    So the story goes like this: In India (and many other countries around the world) there is no price for water extractions from the ground – anyone can use this water freely to whatever use. Over the past decades this policy has led to the following situation: Large agricultural and food corporations (i.e. Coca Cola – very evil by nature) made excessive use of the groundwater with the result that the ground water level has substantially lowered. Today, in many areas only these very corporations are still able to extract groundwater (from ever deeper levels) with sophisticated and costly technology unavailabe to ordinary people. On the other side, traditional wells got dry and peasants find it increasingly difficult to go on with their business while the general population is often forced to buy bottled water now.

    The moral of this story is that free goods of course benefit the poor – but they often benefit the large, greedy corporations even more. And large, greedy corporations will keep exploiting the free good until there is nothing left for the poor. By contrast, if natural resources have a price (are “commodified”) excessive use becomes quite costly and will by the laws of economics decrease. Finally, the issue of extremely poor people not being able to afford water anymore when priced can be easily solved in various ways (examption of taxation for domestic use, progressive water pricing, compensation via social policies etc.).

    _____
    Reference and further reading regarding the water-issue (both in German):

    http://www.spiegel.de/wissenschaft/natur/asien-grundwasserspiegel-sinken-dramatisch-a-315195.html

    http://www.ufz.de/export/data/global/26154_DP_3_2011_Gawel_Recht_auf_Wasser.pdf

  2. Nice example, indeed. However, it does not offer a solution to my main concern: the issue is much more complex than that. I strongly assume that it is so in your research area and I am certain that it is in mine. The fact is that I am not convinced by all arguments in favour of economic valuation myself. And I think that commodification is an important problem. The problem is that many critics of commodification think that it is an inevitable consequence of economic valuation, which is simply not true. According to the Oxford English Dictionary, a commodity is “a raw material or primary agricultural product that can be bought and sold” (emphasis mine). Public goods more often than not cannot, at least not in the ordinary sense of private market exchange. Since many environmental goods and ecosystem services are public goods or common pool resources (or open access resources, which makes the problem even more complicated), they logically cannot be commodified. This is related to setting equal “economic value” and “price”, which also is wrong, since prices are the result of market exchange. Something that is not traded in markets cannot have a “price”, but it can have an economic value.

    In the end, the problem with the economic valuation debate is similar to many others: vague, abstract terms are used without being properly defined and complexity is underplayed. You cannot have a fruitful debate under these conditions. And that’s why I am always very hesitant to explain my PhD thesis at the coffee table.

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