Decision Support for Environmental Policy

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Decision Support for Environmental Policy

• Chapter 5

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Background Problem

• The ancient challenge design public programs
  that improve private individuals welfare
• We need a method to measure individual gains and
  losses to decide impacts to society
• This method is called Benefit Cost Analysis
  (until recently Cost-Benefit-Analysis)

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Chapter Objectives

• Summarize the rationale for and uses of
  benefit-cost analysis (BCA)
• Explain the economic principles used for
  conducting a BCA.
• Describe the steps for computing the net present
  value of policies.
• Identify methods to account for benefits, costs,
  and time.
• Discuss issues that affect both benefits and
  costs.
• Describe the advantages and limits of BCA.

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Why measure benefits and costs?

• One persons benefit can be anothers loss.
• BCAs aim is to improve the general welfare, not
  any special interest welfare.
• BCA is the governments equivalent of a private
  businesss profit and loss statement.
• BCA measures net return to a wider group society
  as a whole (or large segments of society).

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Definition of BCA

• BCA evaluates overall economic merits of public
  actions by translating positive and negative
  effects into a common denominator, usually
  dollars.
• Proposed U.S. legislation in 1990s would have
  expanded the role of BCA by requiring its use in
  the design of environmental regulations (ongoing
  debate).
• BCA Supporters Its use leads to informed
  economic decisions.
• BCA Opponents Its use reduces flexibility in
  policy design. Slows things down. Costs a lot.

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What BCA Does

• A BCA organizes information to promote rational
  policy analysis.
• A BCA can be used to supply information needed
  for three important kinds of decisions
• Simple ranking of actions
• Optimal size or scale or programs
• Optimal timing or sequencing of decision elements.

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What BCA Does

• Formal use of BCA started in the U.S. in 1930s
  for federal water projects
• BCA has seen hundreds of applications since then,
  especially in last 5-10 years
• Decision rule If sum of benefits gt sum of
  costs, action should be adopted (if the goal is
  economic efficiency).

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A few special features of BCA

• For private revenue, BCA substitutes benefit to
  society.
• For private cost, BCA substitutes opportunity
  cost (of not allocating scarce inputs to other
  activities).
• For profits, BCA uses benefit minus cost.

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How BCA is Used

• For Design, Implementation and Review of policies
• Ex Ante Analysis looks forward to ask about
  benefits and costs of actions net yet taken.
• Ex Post Analysis looks backward by asking how
  well existing programs have performed.
• Analyzes history of benefits and costs to review
  accuracy of previous ex ante analyses.
• Revises old analyses where mistakes are
  discovered.

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Economic Principles of BCA

• Three important challenges assigned to BCA
• Defining policy goals
• Scope of analysis (accounting for which people
  are affected by a policy) Stakeholder
  identification
• Identifies incremental impacts of a policy.

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Policy Goals What ends are served by government
action?

• Economic Efficiency For a program to be
  economically efficient, total benefits must
  exceed total costs, regardless of who benefits
  and who loses.
• Equity BCA can help design programs for which
  benefits gt cost to groups society says deserve to
  receive benefits or pay costs. (social
  weights)
• Administrative Ease
• Multiobjective goals BCA can account for
  different weights assigned to different goals.

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Scope of Analysis in a BCA(Stakeholder
Identification)

• Accounting stance defines which affected people
  have standing.
• Major classes of gainers and losers are
  identified.
• National accounting stance all taxpayers of a
  nation
• More limited accounting stances for more limited
  public programs
• local
• regional
• Wider scopes (e.g. greenhouse gas control
  proposals)
• International
• Intergenerational

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Incremental Analysis

• Efficiency gains in policy through incremental
  analysis avoids all or nothing analysis
  considers added benefits v. added costs
• Example endangered species
• 100 and 0 survival probability are
  all-or-nothing proposals
• Percents in the middle are likely to produce
  programs with larger net benefits.

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Incremental Analysis

• Equimarginal principle (EMP) considers added
  benefits and costs from one more policy unit
• MB MC for max. efficiency by expanding scale or
  scope
• Scale Number of stakeholders affected by
  proposed policy
• Scope Geographic coverage of proposed policy
• For policies that re-allocate resources over
  multiple uses
• (net)MBi (net)MBj for max efficiency for all
  competing uses of a single scarce resource

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Example for EMP
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Example for EMP with Resource Re-allocation
If only 5000 trout are available, how should they
be allocated? How about 10,000? 15,000?
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Incremental Analysis (cont.)

• With and Without Principle measure benefits and
  costs with the program compared to without it
  (not before and after)
• Baseline policy defined (without program)
• Alternative policy is compared (with program)
• Use of before and after assigns benefits and
  costs to a program that may have occurred even
  without it.
• Example Flood control before after dam, when
  there is insufficient precipitation to cause a
  flood with or w/o dam(so the dam prevented
  flood would be an incorrect statement)

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Incremental Analysis (cont.)

• Timing
• Question can net benefits be increased by delay
• Example Wait with fish stocking until drought is
  over to increase survival rates
• Sequencing
• Changing the order of new program elements can
  matter
• Example Perform river restoration before
  stocking fish to increase survival rates

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Ten steps to net present value

• Background question should we enact some
  particular policy or program
• With a known set of program elements
• That produces benefits and incurs costs in a
  known time sequence
• Or should we maintain the status quo and do
  nothing new at all?
• Simple yes/ no situation
• Not a choice amongst multiple programs
• Not a question of optimal scale

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Policy Example

• Proposed policy Remove Derby Dam on the Truckee
  River downstream of Reno
• Status Quo Dont do it.

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Remove Derby Dam

• Benefits
• More water to Pyramid
• More / better spawning runs for cui-cui
• More food for Lahontan cutthroat trout
• Better fishing
• More attractive / better river recreation (ex
  Rafting from Reno to Pyramid)

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Remove Derby Dam

• Costs
• No more irrigation water from Truckee to Fallon
  ag. community
• Reduced harvests (Prim. Alfa-Alfa)
• Reduced revenues to Fallon farmers
• Less water for Fallon National Wildlife Refuge
  (FNWR)
• Reduced habitat for water fowl
• Reduced hunting and bird watching opportunities

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BCA Step 1 Scoping

• Define proposed action and services it produces
• Remove Derby Dam
• Identify ways it could be carried out
• Simple Divert River temporarily, take out dam,
  re-route river back into original bed
• Select range of relevant decisions
• Not really an issue here Its either all or
  nothing
• Choose accounting stance (stakeholders)
• Fallon farmers
• Local Truckee River Recreationists / Outfitters
• Bird watchers, hunters (At FNWR)
• Payute tribe (Own fishing rights to Pyramid lake)

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Step 2 Identify benefits per unit

• Priced services (e.g. hydroelectric power,
  irrigation water) requires using market prices
  
• Unpriced services (e.g. environmental regulations
  that save lives, endangerd species, recreation)
  requires estimating wtp.
• WTP is often hard or expensive to measure.
  (Special field of Resource Economics Valuation
  of Non-market goods)

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Step 4 Measure output quantity

• E.g. acre feet water used for crops
• E.g. visitor days of wildlife watching from
  wildlife habitat
• E.g. lives saved or lengthened through regulation
  that controls environmental pollution (see ch 16)
• E.g. environmental risk reduced through stricter
  workplace safety regulation (see ch 17)

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Steps 2 4 Example
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Step 3 Costs per unit

• Step 3 Measure cost per unit (Cs)
• Inputs purchased to support a project or program
• e.g., trees planted
• e.g., acres riparian habitat improved
• All other benefits displaced by the program
• e.g., higher goods prices from environmental
  regulations
• e.g., reduced chemicals effectiveness from
  safety regulations.

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Step 5 quantity of inputs

• Measure quantity of inputs (Is), i.e. physical
  resources used to support carrying out the
  proposed policy (PLUS displaced benefits)
• E.g. acres owl habitat set aside
• E.g. fish ladders installed to support recovery
  of endangered fish population
• E.g., conservation measures subsidized to give
  irrigators incentives to conserve water.

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Step 3 5 Example
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Step 6 Gross benefits by period
Ex. Year 1 10,0003010012080008376,000
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Step 7 Gross costs by period
Ex. Year 1 8015,00050004050401,402,000
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Step 8-10 Net benefits by period,discounted net
benefits, and NPV
Ex. Year 1-1,026,000(1/(10.07)) -958,879
Year 2 -554,800(1/(10.07)2) -484,584
etc
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Sensitivity Analysis Different interest rates
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Two net-benefit streams with equal NPV (see table
p. 105)
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Concentrated costs, diffuse benefits
Diffuse costs, concentrated benefits
Note These annual values are already discounted!
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NPV quiz, example 1
NB
5
5
5
5
5
r 0.06
Project A
year
-5
-5
-5
-5
-5
Project B
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NPV quiz, example 2
Project A
Project B
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NPV quiz, example 3
NB
r 0.06
Project A
0
year
Project B
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NPV quiz, example 4
NB
r 0.06
Project A
0
year
NB
5
4
3
r 0.06
2
1
Project B
year
-1
-2
-3
-4
-5
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Solution ex.1
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Solution ex. 2
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Solution ex. 3
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Solution ex. 4
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Reno flood control example
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Butler Ranch Retention Basin/Regional
Park(currently Bella VistaProperty)
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Turn Bella Vista area into flood retention
basin / Regional Park

• Benefits
• 700 acres of regional recreation
• Values of homes in vicinity of Park will approve
• Costs
• Build Basin / Park
• Forego residential development (about 1000 to
  1500 homes)

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Closer Look at Benefits

• Regional Park
• Sports fields (baseball, soccer)
• Walking / jogging trails (6 miles)
• BBQ / picnic sites (4 sites)
• Kids playground
• Home values
• Currently about 6000 homes w/in 1 mile of Park
• 2500 more to be built in next 3 years

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Closer Look at Costs

• Park / Basin construction
• Straightforward simply measured in construction
  days / year
• Foregone development
• 1000 to 1500 homes NOT built
• These homes would have been built w/in next 5
  years