Topic 5: Decision Making for Environmental Management

Topic 5 in my Environmental and Ecological Economics for Sustainable Development topic dealt with decision making for environmental management. As always, Id love to hear your feedback in the comments below!

5A ‘Why cost benefit analysis is inadequate when evaluating environmental choices’. (200 words)

A cost benefit analysis (CBA) is a technique employed to make a systematic comparison of a project based on monetary assessments of value and costs (Sullivan, 2012e). The procedures of a CBA i) identifies the problem being analysed, ii) assesses the socioeconomic costs and benefits triggered by the project iii) measures the costs and benefits using conventional methodology. The resulting data is then subjected to a discount rate to determine the net present value and compares it to other quantitative values to aid management decisions.

Positive (benefit – cost) > Negative (benefit – cost)

Equation 1: This equation summarizes the momentary assessment of a Cost Benefit Analysis (CBA). During a CBA, the positive and negative outcomes are compared. The associated costs are deducted from identified benefits on each side of the equation. A project with a overall positive value is deemed favourable.

All costs must be represented by present day prices which are achieved through applying a Discount Rate (DR) (Asafu-Adjaye, 2009). The problematic nature of DR is well documented (Knetsch et al., 1984; Pearce et al., 1993; Asafu-Adjaye, 2009; Sullivan, 2012e) and may not represent current values or future consumer behaviours (Pearce et al., 1993; Shogren et al., 2008). Additionally, determining costs and benefits are subject to biased methodologies and interpretations. Furthermore, benefits are hard to measure and not all outcomes can be understood. Moreover there is little consideration on how the costs and benefits may be affected by time.

NSB = WTP – OC

Equation 2: When determining the Net Social Benefits (NSB) of a Cost Benefit Analysis (CBA), we must determine the Willing To Pay (WTP) price and the Opportunity Costs (OC). The Opportunity Cost refers to the benefits lost from the projects implementation.

Previously we recognised that many environmental goods and services (EGAS) are underpriced and worse, unpriced entirely in the market (Pearce et al., 1993; Asafu-Adjaye, 2009; Sullivan, 2012a, 2012b, 2012c, 2012d).  During CBA procedures, unvalued EGAS are disregarded, highlighting a serious flaw to the system. The unvalued, distorted representation and ignored nature of the CBA impacts on EGAS results in the exploitation and degradation of these scarce resources (Sullivan, 2012e).

Figure 1: Much of Indonesia forests have been cleared (both legally and illegally) for lucrative palm oil plantations. A Cost Benefit Analysis (CBA) performed on projects involving future clearing may return a favorable result as the goods and services provided by the forests are ignored from the evaluation process due to difficulties in identifying and valuating them. The end result is more clearing of old growth forests for agricultural benefit. Image Credit (Gilbert, 2012)

5B(i) What is the difference between cost effectiveness analysis and cost benefit analysis? (80 words)

The choice between employing a CBA or a CEA depends on

i)                    Size and complexity of the project

ii)                  The extent of quantifiable benefits

iii)                The extent that the benefits can be valued. (Asafu-Adjaye, 2009).

CEA are utilised when it is not possible to value all the benefits of a project in monetary terms or when two projects have identified similar economic benefits. CBA are favoured on larger projects where all major costs and benefits can be employed and valued (Sullivan, 2012e).

Figure 2 The use of cost effective analysis is widely used throughout society. According to a report entitled ‘Cost-effectiveness of the Baha solution’, “The use of cost effectiveness studies to prove whether reimbursement of a medical device is supportable will become increasingly important in the future.” (Cochlear Baha, 2012)

5B(ii) What are the steps needed to carry out a Multi-Criteria Analysis, and what are 3 major advantages this approach has over other methods? (80 words)

MCA benefits include; i) clearly outlines competing or conflicting objectives, ii) are not exclusively quantitatively measured and iii) can value benefits in qualitative terms.

Procedural MCA steps are:

• Identifies the problem being analysed
• Identifying alternatives to the project
• Identifying the criteria employed for comparison analysis
• Listing the alternatives in preferential order in accordance with the criteria
• Evaluating alternatives utilising a wide variety of tools
• Risk analysis
• Producing a ranked list of alternatives with recommendation

Figure 3 It is difficult to identify the problems and potential future issues from a project. As such, some projects may go into development without all risks being given due analysis. It is perhaps important to realize the genius of Einstein with this memorable quote in view of the above work.

5B(iii) Explain what is meant by ‘Net Present Value’ and why it is considered useful. (80 words)

NPV is method used to calculate (projected) future costs and benefits in present values for comparison with alternatives to aid the decision making process (McTaggart et al., 2003; Asafu-Adjaye, 2009; Sullivan, 2012e). In theory, the method should safeguard future interests. A positive NPV figure indicates a favourable outcome for the project. Its major flaw, however, is that future needs can not be assumed with certainty and are subject to diminishing returns (McTaggart et al., 2003; Asafu-Adjaye, 2009; Sullivan, 2012c, 2012e).

 

References

Asafu-Adjaye, J. (2009). Environmental economics for non economists: techniques and policies for sustainable development. (2nd ed.). Singapore: World Scientific Publishing Co. Pty. Ltd.

Butler, R. A., Laurance, W. F., & mongabay.com (2009). Will palm oil drive deforestation in the Amazon?  Retrieved 23 March, 2012, from http://www.commercialpressuresonland.org/press/will-palm-oil-drive-deforestation-amazon

Cochlear Baha (Producer). (2012, 23 March 2012). Cost-effectiveness of the Baha solution. [Clinical Review Newsletter] Retrieved 23 March 2012 http://www.cochlear.com/files/assets/baha/pdf/clinicalreview/Clinical_Review_2012_January.pdf

Gilbert, D. (2012). Brazil vote sparks fears for future of rainforest. CNN. Retrieved from http://edition.cnn.com/2012/03/05/world/americas/brazil-indonesia-rainforest/index.html

Knetsch, J. L., & Sinden, J. A. (1984). Willingness to Pay and Compensation Demanded: Experimental Evidence of an Unexpected Disparity in Measures of Value. The Quarterly Journal of Economics, 99(3), 507-521. doi: 10.2307/1885962

McTaggart, D., Findlay, C., & Parkin, M. (2003). Economics (4th ed.). Sydney, New South Wales: Pearson Education Australia Pty Ltd.

Pearce, D. W., & Warford, J. J. (1993). World without End; Economics, Environment and Sustainable Development. New York, New York: Oxford University Press, Inc.

Shogren, J. F., & Taylor, L. O. (2008). On Behavioral-Environmental Economics. Review of Environmental Economics and Policy, 2(1), 26-44. doi: 10.1093/reep/rem027

Sullivan, C. A. (2012a, 21 February). [Topic 1 Lecture: How Economy Works].

Sullivan, C. A. (2012b, 28 February). [Topic 2  Lecture: Ecological or Environmental Economics?].

Sullivan, C. A. (2012c, 6 March). [Topic 3  Lecture: Enviromental Valuation].

Sullivan, C. A. (2012d, 13 March). [Topic 4  Lecture: Market Systems: Supply and Demand].

Sullivan, C. A. (2012e, 21 March). [Topic 5  Decision Making for Environmental Management].

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