Lecture 7 - Natural resource analysis.pdf

LECTURE 7 NATURAL RESOURCE ANALYSIS  Learning outcomes At the end of the lecture students will: appreciate the importance of benefit cost analysis (BCA), cost-effectiveness analysis (CA) and impact analysis (IA) in natural resource decisions. be able to explain the steps...

LECTURE 7 NATURAL RESOURCE ANALYSIS  Learning outcomes At the end of the lecture students will: appreciate the importance of benefit cost analysis (BCA), cost-effectiveness analysis (CA) and impact analysis (IA) in natural resource decisions. be able to explain the steps involved in carrying out BCA, CA and IA and be able to apply them in natural resource decision making. 2  Introduction It is important that society be able to assess in quantitative terms the net benefits flowing to its members from resource development and utilization programmes. We will look at techniques that economists have developed to do this. We will explore different types of analysis that can be pursued: – Benefit-cost analysis, – Impact analysis, and – Cost-effectiveness analysis. 3  Benefit-Cost Analysis in Natural Resource Decisions BCA was originally developed in the United States in the 1930s as a tool for studying natural resource decisions in the public sector – specifically to study water resource decisions. It is simply an attempt to account for and compare, within the same analysis, all the benefits and costs of particular courses of action. It provides a method for determining whether or not an action should be supported. 4 Benefit-Cost Analysis... If the benefits exceed the costs, then the action should be supported. If the costs exceed the benefits, then the action is not desirable. Let B be the benefits from a proposed action and C be the costs. 5  Benefit-Cost Analysis... The decision rule would then be: If B > C, then support the action. Otherwise, oppose the action. If B = C, it wouldn’t make any difference if the action occurs or not. An equivalent formulation would be: If B/C > 1, then support the action. Otherwise, oppose the action. 6 Benefit-Cost Analysis... Given several alternative forms of a project the one for which the difference between benefits and costs is greatest should be chosen. Costs and benefits can only be added and subtracted if they are expressed in the same units. Therefore, BCA attempts to place monetary values on them, money being a convenient measure of value. 7 Benefit-Cost Analysis... Since the costs and benefits of a project will occur over a period, future ones are discounted to convert them into their ‘present value’. If the ‘net present value’ (NPV) is positive, the project is held to be worth undertaking. 8 Benefit-Cost Analysis... BCA explores social feasibility rather than commercial feasibility (though commercial aspects may enter in) – in the sense of whether the benefits to society exceed the costs to society of undertaking particular courses of action. Commercial revenue/cost analysis deals only with inputs and outputs that move across markets. BCA typically involves estimating the value of both market and non-market inputs and outputs. 9 Benefit-Cost Analysis... Practice Question: Describe briefly the methodology you would adopt if you were required to undertake a benefit-cost analysis of a habitat protection programme to help preserve a certain endangered species of wildlife. What are the types of benefits and costs that are involved when forests that were previously open to commercial forestry are now placed in preservation status? 10 Benefit-Cost Analysis... Steps in BCA Essentially 7 steps in BCA. 1. Decide on the Perspective 2. Specify the project 3. Measure inputs and outputs 4. Value inputs and outputs 5. Discounting of costs and benefits 6. Compare benefits and costs 7. Sensitivity analysis 11  1. Decide on the Perspective Decide the overall perspective from which the analysis is going to be done. BCA is a tool of public analysis, but there are actually many publics. Which “public” is the relevant one? 12 1. Decide on the Perspective... A BCA of a new town park or a wetlands preservation regulation might be done strictly from the perspective of the local community – that is, the objective may be to estimate the benefits and costs impinging on town residents only. However, a BCA of a global treaty on natural resource use might be undertaken considering the entire population of the earth as the public. 13  2. Specify the Project This involves a complete (as complete as possible) specification of the project or program, including – its location, – timing, – groups involved, and – connections with other programs. In any BCA, some assumptions have to be made. – These assumptions have to be made as transparently and as realistically as possible right at the beginning. 14  3. Measure Inputs and Outputs Involves describing quantitatively the inputs and outputs of the program – that is, all the physical consequences that will flow from it. While it is relatively easy to measure inputs (costs), many types of data outputs (benefits) are more difficult to measure. For example, the inputs required to carry out a wildlife ranch may be fairly easy to estimate, but estimation of the number of visitors that can be expected in this wilderness area or at this wildlife viewing area can be difficult. 15 3. Measure Inputs and Outputs... Virtually all projects and programs extend over time, usually over long periods of time. So the job of specifying inputs and outputs requires making predictions about the future – these are always going to be subject to some uncertainty. 16  4. Value Inputs and Outputs This step involves estimating the social values of all these inputs and outputs – In effect, estimating the benefits and costs of the project or program. This could be done in any units, but typically this implies measuring benefits and costs in monetary terms, money being a convenient measure of value. This does not mean in market-value terms because in many cases effects, especially on the benefit side, are not directly registered on markets. 17 5. Discounting of cost and Benefit flows After all relevant cost and benefit flows have been expressed in monetary terms and are aggregated at each time period in the project life, – they are then converted into their present values. 18  6. Compare Benefits and Costs This can be done in the following ways: Net benefits: Total benefits minus total costs gives net benefits. If the net benefit is positive, then the project is viable. Net present value (NPV): NPV is the present value of benefits minus the present value of costs. If NPV > 0, then the project is viable. 19 6. Compare Benefits and Costs... Internal rate of return (IRR): An alternative to NPV is to determine the project’s IRR. The IRR is the rate of interest which makes NPV = 0. A project is viable or acceptable if the IRR exceeds the discount rate, r. Benefit-cost ratio (BCR): BCR is total benefits divided by total costs; Or PV of benefits divided by the PV of costs. A project is viable if BCR > 1. 20  7. Sensitivity analysis The last stage in BCA. The main reason for sensitivity test concerns uncertainty. In all stages of the BCA, a lot of predictions are made concerning future physical flows and future relative values. The sensitivity analysis involves recalculating NPV by changing certain parameters such as the discount rate, r, physical quantities and qualities of inputs and outputs, project lifespan, etc. The intention is to discover to which parameter the NPV outcome is most sensitive so that efforts can be made to manage these parameters carefully. 21  Critique of BCA The application of BCA to environmental issues is fraught with problems. Problem areas include: The valuation of non-market goods, such as wildlife and landscape. – Many commentators have criticised the procedure of BCA in its attempt to express all benefits and costs in monetary terms, even where we have no market in the benefit or cost in question. The idea of discounting and the choice of the discount rate. – The farther into the future benefit and costs streams occur, the lower their present value. – As the discount rate is increased, this time bias increases. – Decisions over discount rates may be influenced by lobbying from pressure groups. 22  Cost-Effectiveness Analysis This is a useful alternative to benefit-cost analysis when the measurement of benefits is impossible or estimates are unavailable. This involves the minimization of the costs of: – achieving a policy target such as an emissions standard; or – undertaking a project such as the preservation of an endangered species 23 Cost-Effectiveness Analysis... Illustration Suppose a community has decided that it needs to increase the capacity of its public water supply system. Assume that to accommodate future expected population growth, the community has decided it must find an additional 100,000 gallons of water per day. 24 Illustration... There are a number of ways the community could do this: – drill several new wells into an aquifer that is currently not being used, – hook up to the system of a neighbouring town that has (at least for now) some excess water, – build a new reservoir, – plug the leaks in the existing system, – find a way of getting consumers to reduce their water use, etc. 25  Illustration... A cost-effectiveness analysis would estimate the costs of these different alternatives to compare them in terms of costs per thousand gallons of water available for use by town residents. In other words, a cost-effectiveness analysis takes as given the objective of the project, in this case the 100,000 gallons of additional water, and then costs out the different ways of reaching this objective. 26  Illustration... A minimum-cost solution requires the equalization of the marginal costs of all possible alternatives. This is the Second Equimarginal Principle or the Cost-Effectiveness Equimarginal Principle. The principle states that ‘the least-cost means of achieving an environmental target will have been achieved when the marginal costs of all possible means of achievement are equal. 27  Illustration... In the community water supply example, how much of the water supply responsibility should each technique bear? The cost-effectiveness equimarginal principle suggests that the techniques should be used such that the desired quantity of water is achieved and the cost of achieving the last unit of water increase (in other words the marginal cost) should be the same for all sources or techniques. 28  Impact Analysis ‘Impact’ is a very general word, meaning the influence that one set of events has on another. In general, impact analysis seeks to measure the impact of a public action, such as regulation, on a designated sector of the society/economy. An impact analysis, regardless of whether it focuses on economic impact or environmental impact or both, attempts to quantify the consequences of various actions. 29 Impact Analysis... In contrast to benefit-cost analysis, a pure impact analysis makes no attempt to convert all these consequences into a one- dimensional measure, such as cedis, to ensure comparability. Several different types of impact analysis are important in natural resource economics. 30 Environmental Impact Analysis /Assessment (EIA) An EIA is essentially an identification and elaboration of all repercussions of a designated activity on all or part of the natural and environmental resource base. Many countries have laws requiring that environmental impact analyses be carried out before a substantial public program or project is undertaken. Analyses are sometimes required also of private actions. The end result of an EIA is an environmental impact statement (EIS), sometimes called an Environmental Impact Report (EIR). 31 Economic Impact Analysis Economic impact analysis centres on how particular public or private actions affect certain dimensions of an economic system. The perspective might be local, for example, how the opening of a community or regional park will affect local employment rates. It might be national, for example, how a new law on harvesting timber in national forests will affect the price of building materials. 32  The range of economic impacts that may be of interest is very wide. These may include: – Employment numbers (or unemployment rates), total or in certain industries; – Household incomes; – Rates of technical change in certain resource extraction industries; – Rates of inflation; etc. 33 Impact analysis … Social impact analysis Socio-economic impact analysis 34