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Appendix 2: Valuation Techniques for Environmental Assessment of Forest Projects

VALUATION TECHNIQUEADVANTAGESDISADVANTAGES
Market Prices
Use prevailing prices for goods and services traded in domestic or international markets.
Market prices reflect willingness to pay for costs and benefits of forest land use options that are traded (eg timber, fuelwood, food, medicines, utensils, recreation). They may be used to construct financial accounts to compare alternative land use options from the perspective of the individual or the firm concerned with private profits and losses. Price data are relatively easy to obtain.Market imperfections and/or policy failures may distort market prices which will therefore fail to reflect the economic value of goods or services to society as a whole. Seasonal variations and other effects on prices need to be considered when market prices are used in economic analysis,
Efficiency (Shadow) Prices
Use market prices but adjust for transfer payments, market imperfections and policy distortions. May also incorporate distribution weights, where equity concerns are made explicit. Shadow prices may also be calculated for non-marketed goods.
Efficiency prices reflect the true economic value or opportunity cost, to society as a whole, of goods and services that are traded in domestic or international markets (eg timber, fuelwood, food, medicine, utensils, recreation).Derivation of efficiency proces is complex and may require substantial data. Apparently ‘artificial’ prices may not be accepted by decision-makers.
Hedonic Pricing Method
The value of an environmental amenity is imputed from property or labour markets. The basic assumption is that the observed property value (or wage) reflects a stream of net benefits (or working conditions) and that it is possible to isolate the value of the relevant environmental amenity or attribute.
Hedonic pricing may have potential for valuing certain tropical forest functions (eg micro-climate regulation, groundwater recharge) in terms of their impact on agricultural land values, assuming that the link between forest functions and agricultural productivity is widely known and fully reflected in agricultural land pricesApplication of hedonic pricing to the environmental functions of tropical forest requires that these values are reflected in surrogate markets. The approach may be limited where markets are distorted, choices are constrained by income, information about environmental conditions is not widespread and data are scarce.
Travel Cost Method
The travel cost approach derives willingness-to-pay for environmental benefits at specific locations by using information on the amount of money and time that people spend to visit the location.
Widely used to estimate the value of recreational sites, including public parks and wildlife reserves. It has been used to estimate willingness-to-pay for eco-tourism to tropical forest areas in some developing countries.Data intensive; restrictive assumptions about consumer behaviour (eg trip multi-functionality); results highly sensitive to statistical methods used to specify the demand relationship.
Production Function Approach
Estimates the value of a non-marketed resource or ecological function in terms of changes in economic activity, by modelling the physical contribution of the resource or function to economic output.
Widely used to estimate the impact of deforestation, soil erosion, wetlands and reef destruction, air and water pollution etc, on productive activities such as crop cultivation, fishing, hunting etc.Requires explicit modelling of the ‘dose-response’ relationship between the resource or function being valued and some economic output. Application of the approach is most straightforward in the case of single use systems but becomes more complicated with multiple use systems. Problems may arise from mis-specification of the ecological-economic relationship or double counting.
Related Goods or Surrogate Price Approaches
Uses information about the relationship between a non-marketed good or service and a marketed product to infer value. The barter exchange approach relies on actual exchange of non-marketed goods for marketed goods. The direct substitute approach simply assumes that a marketed good can substitute for a non-marketed good. The indirect substitute approach also relies on a substitute good but if the latter is not exchanged in markets its value is inferred in terms of a change in economic output (ie the direct substitute approach combined with the production function approach).
These approaches may provide a rough indicator of economic value, subject to data constraints and the degree of similarity or substitution between related goods.The barter exchange approach requires information on the ‘rate of exchange’ between two goods. The direct substitute approach requires information on the degree of substitution between two goods. The indirect substitute approach requires information on the degree of substitution and on the contribution of the substitute good to economic output.
Constructed Market Techniques
Measure WTP and WTA by directly eliciting consumer preferences.
Simulated Market
(SM) construct an experimental market in which money actually changes hands.
Contingent Valuation Method
(CVM) construct a hypothetical market to elicit respondents' WTP.
Contingent ranking
(CR) rank and score relative preferences for amenities in qualitative rather than monetary terms.
Directly estimates Hicksian welfare measure - provides best theoretical measure of WTP.
SM: controlled experimental setting permits close study of factors determining preferences.
CVM: only method that can measure option and existence values and provide a true measure of total economic value.
CR: generates value estimate for a range of products and services without having to elicit WTP for each.
Practical limitations of constructed market techniques may detract from theoretical advantages leading to poor estimates of true WTP.
SM: sophisticated design and implementation may limit application in developing countries.
CVM: results sensitive to numerous sources of bias in survey design and implementation.
CR: does not elicit WTP directly, hence lacks theoretical advantage of other approaches.
Cost-based Valuation
Based on assumption that the cost of maintaining an environmental benefit is a reasonable estimate of its value.
To estimate willingness to pay:
Indirect Opportunity Cost Method
(IOC) uses wages foregone by labour in production of non-marketed goods;
Restoration Cost Method
(RSC) uses the cost of restoring ecosystems or goods and services;
Replacement costs method
(RPC) uses the cost of artificial substitutes for environmental goods and services:
Relocation Costs Method
(RLC) uses the cost of relocating threatened communities:
Preventive Expenditure Approach
(PE) uses the cost of preventing damage or degradation of environmental benefits.
Damage Costs Avoided Approach
(DC) relies on the assumption that damage estimates are a measure of value. It is not a cost-based approach as it relies on the use of valuation methods described above.
In general, it is easier to measure the costs of producing benefits than the benefits themselves, when costs comprise traded goods and services and benefits are non-marketed. Hence cost-based approaches are less intensive in terms of data and resource requirements.
IOC: useful in evaluating subsistence benefits where harvesting and collecting time is a major imput.
RSC: potentially useful in valuing particular environmental functions.
RPC: useful in estimating indirect use benefits when ecological data are not available for estimating damage functions with first-best methods.
RLC: only useful in valuing environmental amenities in the face of mass dislocation such as dam projects and establishment of protected areas.
PE: useful in estimating indirect use benefits when prevention technologies are available.
DC: first-best methods to estimate damage costs are useful for comparison with cost-based approaches, which implicitly assume damage is worth avoiding.
These second-best appproaches assume that:
1. Expenditures provide positive net benefits, and
2. Net benefits generated by expenditures match the original level of benefits.
IOC: may understate benefits significantly if there is substantial producer or consumer surplus.
RSC: diminishing returns and difficulty (and time lag) of restoring previous ecosystem conditions make application of this method questionable.
RPC: difficult to ansure that net benefits of the replacement do not exceed those of the original environmental function. May overstate WTP if only physical indicators of benefits are available.
RLC: in practice, benefits provided by the new location are unlikely to match those of the original location. May over or under-state WTP.
PE: mis-matching the benefits of investment in prevention to the original level of benefits may lead to spurious estimates of WTP.
DC: data or resource limitations may rule out first-best valuation methods.

Source: IIED (1994)


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