Environmental Policy Analysis: A Guide to Non‑Market Productivity Commission Valuation Staff Working Paper January 2014 Rick Baker Brad Ruting The views expressed in this paper are those of the staff involved and do not necessarily reflect the views of the Productivity Commission. Commonwealth of Australia 2014 ISBN 978-1-74037-468-2 This work is copyright. Apart from any use as permitted under the Copyright Act 1968, the work may be reproduced in whole or in part for study or training purposes, subject to the inclusion of an acknowledgment of the source. Reproduction for commercial use or sale requires prior written permission from the Productivity Commission. Requests and inquiries concerning reproduction and rights should be addressed to Media and Publications (see below). This publication is available from the Productivity Commission website at www.pc.gov.au. If you require part or all of this publication in a different format, please contact Media and Publications. Publications Inquiries: Media and Publications Productivity Commission Locked Bag 2 Collins Street East Melbourne VIC 8003 Tel: (03) 9653 2244 Fax: (03) 9653 2303 Email: [email protected] General Inquiries: Tel: (03) 9653 2100 or (02) 6240 3200 An appropriate citation for this paper is: Baker, R. and Ruting, B. 2014, Environmental Policy Analysis: A Guide to Non-Market Valuation, Productivity Commission Staff Working Paper, Canberra. JEL codes: D61, H41, Q26, Q51, Q58. The Productivity Commission The Productivity Commission is the Australian Government’s independent research and advisory body on a range of economic, social and environmental issues affecting the welfare of Australians. Its role, expressed most simply, is to help governments make better policies, in the long term interest of the Australian community. The Commission’s independence is underpinned by an Act of Parliament. Its processes and outputs are open to public scrutiny and are driven by concern for the wellbeing of the community as a whole. Further information on the Productivity Commission can be obtained from the Commission’s website (www.pc.gov.au) or by contacting Media and Publications on (03) 9653 2244 or email: [email protected] Contents Acknowledgments v Key points 2 Overview 3 1 Introduction 11 1.1 Understanding environmental values 11 1.2 Why do non-market values matter for policy? 15 1.3 About this paper 21 2 When can non-market valuation provide good estimates? 23 2.1 Methods for valuing non-market outcomes 24 2.2 Can estimates be valid and reliable? 30 2.3 What makes a good study? 44 3 Use in environmental policy analysis 53 3.1 Comparison with alternatives 54 3.2 Non-market valuation: when and how? 65 3.3 Building confidence in non-market valuation 70 A Workshop participants 77 B Australian studies 79 B.1 River red gum forests 79 B.2 The Murray–Darling Basin 84 B.3 Television and computer recycling 89 B.4 Bulli Seam coal mining 93 B.5 Underground power supply 99 C Validity and reliability of stated preference methods 105 C.1 Criterion validity 105 C.2 Convergent validity 109 C.3 Construct validity 113 CONTENTS iii C.4 Reliability 124 C.5 Benefit transfer 124 References 129 iv CONTENTS Acknowledgments The idea for this paper was initially suggested to the Productivity Commission by David Pearce (Centre for International Economics) and Jeff Bennett (ANU). A workshop attended by non-market value practitioners, economists with an interest in environmental policy and policymakers was held in the early stages of the project (participants are listed in appendix A). The authors would like to thank those who participated for their insightful and helpful contributions. We would also like to thank the following people for their help and advice on the drafting of this paper: Drew Collins (BDA Group), Jeff Bennett, Richard Carson (University of California San Diego and University of Technology Sydney), Jenny Gordon, Ana Markulev, Paul Loke, Anthea Long, Rosalyn Bell, Lisa Gropp, Larry Cook, Noel Gaston and Alan Johnston. The views in this paper remain those of the authors and do not necessarily reflect the views of the Productivity Commission or of the external organisations and people who provided assistance. ACKNOWLEDGMENTS v OVERVIEW Key points • Government policies aimed at generating environmental benefits almost always impose costs on the community. Weighing up these trade-offs is challenging, in part because environmental benefits are difficult to value, particularly those that are not reflected in market prices (so called ‘non-market’ values). • There are several non-market valuation methods that can be used to evaluate such trade-offs, but they are not widely used for environmental policy analysis in Australia. • There are two main types of non-market valuation methods: revealed preference and stated preference. – The validity of revealed preference methods is widely accepted, but there are many circumstances where they cannot provide the estimates needed for environmental policy analysis. – Stated preference methods can be used to estimate virtually all types of environmental values, but their validity is more contentious. • The evidence suggests that stated preference methods are able to provide valid estimates for use in environmental policy analysis. However: – there are many elements that practitioners need to get right to produce meaningful results – value estimates are likely to be less reliable when respondents are asked about environmental assets that are especially complex or relatively unfamiliar to them. • Benefit transfer involves applying available value estimates to new contexts. Its accuracy is likely to be low unless the primary studies are of high quality and relate to similar environmental and policy contexts. These seemingly obvious cautions are often not observed. • Because non-market valuation methods can generally provide objective estimate of the value that the community places on environmental outcomes, they offer advantages over other approaches to factoring these outcomes into policy analysis. • The case for using non-market valuation varies according to circumstances. It is likely to be strongest where the financial or environmental stakes are high and there is potential for environmental outcomes to influence policy decisions. • Where non-market valuation estimates are made they should generally be included in a cost–benefit analysis. Sensitivity analysis should be provided, as well as descriptive information about the environmental outcomes of the proposed policy. • There is a range of steps that could be taken to realise more fully the potential of non-market valuation, including developing greater knowledge about it within relevant government agencies. 2 A GUIDE TO NON-MARKET VALUATION Overview Governments are often faced with decisions about whether to impose costs on the community to improve the condition of the environment (or prevent its deterioration). How such policy trade-offs should be made is a matter of considerable debate. Some stakeholders favour prioritising environmental outcomes above other considerations, while others argue that jobs and economic development should come first. The former approach effectively assigns an infinite value to environmental outcomes, while the latter assigns a value of zero. The Australian, State and Territory Governments generally favour analysing policy decisions using a cost–benefit framework. In many inquiries, the Productivity Commission has supported this approach because it allows decisions to be informed by the trade-offs that the individuals who make up the community would be prepared to make. By applying a cost–benefit framework (ideally through cost– benefit analysis), governments can endeavour to make decisions that make the community better off overall. However, applying a cost–benefit framework to environmental policy is not easy. Some of the costs, such as the budgetary cost of investing in environmental programs, are straightforward to determine. Others, like the costs to business of restricting development or applying environmental regulations, can be somewhat more challenging to assess. But estimating the benefits can be harder still. There are two parts to estimating benefits. First, information is needed on how the condition of the environment will be changed by the policy. Such information can be hard to obtain because of incomplete understanding of ecological processes and behavioural responses to policy. Second, a value needs to be placed on the change in condition. This can be particularly difficult where values are not reflected in market prices (so called ‘non-market’ values). For example, while it is clear that many people value the experience of bushwalking in a national park or knowing that particular ecosystems are being maintained in a healthy condition, there are no market prices that directly reflect these values. Over the last few decades several non-market valuation methods have been developed to estimate such values, but to date they have not been widely used in policy analysis in Australia. These methods appear to have considerable potential for improving environmental policy and so their limited use is a puzzle. Either the OVERVIEW 3 potential is illusory because the methods cannot reliably do what is claimed, or the reluctance to use them is a lost opportunity that should be rethought. This paper examines these issues by: • assessing the validity and reliability of various non-market valuation methods • reviewing the case for using non-market valuation in environmental