Economic values do not exist in isolation. They merely provide an economic perspective of the value of goods and services associated with an activity or set of activities. They are attached to the inputs and outputs in production or transformation processes. Thus, a first, essential step is to identify the inputs and outputs that will be associated with a proposed change being looked at by the decision maker.
Goods and services can be associated with negative monetary values (costs) or positive values (benefits). It all depends on who is looking at them. Thus, to the worker, a wage is a benefit with positive economic value; it is an income. From the perspective of the forest company hiring the worker, the wage is a cost and takes on a negative value in the company's calculations.
At the same time, it should be kept in mind that valuation involves attaching positive values to goods and services. They become “costs” (and take on a negative sign) when we have to give them up. They take on a positive sign and become “benefits” when we obtain them. For example, even though we may use any number of proxy measures to estimate the cost of pollution, it fundamentally is equal to the positive value of the health benefits we give up due to the pollution.
From society's point of view, the value of the labor will depend on the value of what it produces. When labor is hired away from one use and put into a new use, there is an “opportunity cost” involved. Opportunity cost is nothing more than a reflection of the value of the goods or services lost when a resource is diverted from one use to another.
The same physical good or service can have different economic and social values, depending on location and timing of the production of that good or service
The example in box 1.1 illustrates the point that the same physical service (in this case the same reduction in erosion and soil loss, but in different locations) can be associated with quite different economic and social values. The basic point to remember is that there are no absolute economic values. They all depend on the particular conditions faced with regard to where and when the good or service is available, how much of the good or service is being produced, how much individuals want it, and how many people are willing to pay for it.
When a change in forest use or management is proposed, then the relevant costs and benefits to consider are the incremental ones associated with the change, i.e., the costs and benefits with and without the change. Here are three things to watch out for:
With and without a proposed change often is different from “before and after” the change
The estimated with and without magnitudes may not be the same as the before and after magnitudes. The example in box 1.2 illustrates this point.
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Box 1.1. Translating environmental impacts into economic and social terms. A forester suggests to a regional governor that reforestation and related activities could reduce soil erosion rates on abandoned agricultural land in a river valley by as much as 7 tons per hectare per year. Reducing soil erosion is a positive environmental impact. However, in and of itself, the reduced soil loss is not necessarily a benefit to humans. The governor immediately asks how the environmental impact will affect the people in his jurisdiction, i.e., what are the social and economic impacts. In fact, the social and economic benefits involved depend directly on where the environmental impact occurs. At die one extreme, if the river valley is unpopulated and the river flows into the ocean with little or no use by humans, the benefits from the reduced erosion are likely to be quite small in terms of social and economic values. The governor most likely will not be interested unless other social/economic benefits from the tree planting can be shown to exist. At the other extreme, if the river flows into a dam reservoir that provides hydropower and drinking and irrigation water for hundreds of thousands of people in the governor's territory, the reduced erosion could reduce sediment buildup and loss of needed capacity in the reservoir and thus avoid losses below the dam that have direct social and economic impacts. The social and economic benefits from the reforestation leading to reduced sediment could be quite significant in this case, even though the environmental impact (erosion reduction) will be the same as in the former case. The basic point is that a positive environmental impact due to a reduction in erosion will mean little to the decision maker unless it is translated into social and economic terms, i.e., into impacts on people, e.g., through avoidance of loss of on-site production values, reduction in loss of life due to flooding, and reductions in loss of irrigated crops and in hydropower values. |
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Box 1.2. Example 1. Soil protection project Assume a situation where a given piece of land is eroding at a fairly rapid and constant rate, thereby reducing crop production on the land. A forestry conservation project has been proposed to stop the erosion and restore the land to a higher level of productivity (from level A now to level CD eventually). The situation is shown below: If we did not apply the with and without principle, we might end up defining the benefits of the project as the area ACDE. In point of fact, without the project erosion and soil depletion would continue along the line AB, rather than staying constant at AE. Applying the with and without principle, we see that the actual benefits due to the project include area ACDB.
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Supply and demand are both important in looking at values with and without an activity or project.
An increased supply of a good or service due to a project is of no economic value unless a demand exists for the increased supply. Thus, the increased output times an existing unit value does not provide a measure of value of that increased supply unless there is a demand for it. Box 1.3 illustrates this point.
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Box 1.3. An example of applying the with and without rule. Watershed Project: Identification of Water
Benefits |
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|
Supply Reservoir Capacity |
Demand Reservoir |
Use |
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|
(1) |
(2) |
(3) |
(4) |
(5) |
(6) |
(7) |
|
Year |
Without project |
With project |
Difference |
Without projecta |
With projectb |
Differencec |
|
0 |
100 |
100 |
0 |
86 |
86 |
0 |
|
1 |
96 |
99 |
3 |
86 |
86 |
0 |
|
2 |
92 |
98 |
6 |
87 |
87 |
0 |
|
3 |
88 |
97 |
9 |
87 |
87 |
0 |
|
4 |
84 |
96 |
12 |
84 |
88 |
4 |
|
. |
. |
. |
. |
. |
. |
. |
|
. |
. |
. |
. |
. |
. |
. |
|
. |
. |
. |
. |
. |
. |
. |
|
21 |
16 |
79 |
63 |
16 |
79 |
63 |
|
22 |
12 |
78 |
66 |
12 |
78 |
66 |
|
23 |
8 |
77 |
69 |
8 |
77 |
69 |
|
24 |
4 |
76 |
72 |
4 |
76 |
72 |
|
25 |
0 |
75 |
75 |
0 |
75 |
75 |
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a/Constrained by demand for water during first 4 years then constrained by capacity as demand outstrips supply. b/Constrained by demand for first 10 years then constrained by capacity as demand outstrips capacity even with the project. c/This is the measure due to the project, i.e., the difference in use with and without the project. Column 4 often is erroneously taken as the measure of benefits. In fact, column 7 provides the best measure, i.e., where both demand and supply are considered. |
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The illustration is of a watershed management project that will reduce sediment flowing into a reservoir downstream and thus increase the capacity of the reservoir “with” as compared to “without” the project. The difference in capacity (supply) with and without the project is shown in column 4, derived from columns 2 and 3. Quite independent of the supply of water is the use of water, shown in columns 5 and 6 with and without the project. Note that demand for water (use of water) for the first four years is the same with and without the project. That is because supply in either case will be above demand and thus use is constrained by demand. However, by year 4, capacity (supply) without the project is lower than demand and use is thus constrained by supply. With the project, capacity is higher and thus use can be higher, as indicated in column 7. Column 7 provides the measure of project benefit with and without the project to which we have to attach values. Often, because they ignore the demand side, analysts mistakenly attach values to column 4 figures. In fact, increase in capacity only has value if someone wants to use that increase.
Policy prices reflect the reality of the policy environment
In theory, values assigned to a given good or service should reflect the best alternate use for resources (true opportunity cost), or the true willingness to pay for goods and services, excluding government interventions and including all externalities. In practice, this is not possible, nor always desirable.
The example in box 1.4 reflects the situation with regard to using policy prices for land. The situation is that a given area of land has been legally established by the legislature as a national forest, for use as forest. The question is whether the valuation of the opportunity cost of the land should consider options such as agriculture, or industrial park use, when in fact they would not be allowed under the existing law, which is expected to hold in the future.
We argue here that the opportunity cost associated with a proposed land use change should reflect only options that are permitted under policies that exist (and are expected to remain in effect during the life of the proposed change). The resulting values we call “policy prices,” or prices/values constrained by the existing and expected policy environment. The cost of continuing the policy is another, separate and legitimate question.
Remember that the relevant policy environment is not only the one set by public law, but also through social and religious custom or law. A classic example is the sacred cows of India. They define certain realities of the country that should, appropriately, be reflected in any realistic economic valuation involving cattle.
Under this heading there are several points that the decision maker ought to be aware of regarding forest values.
Biological resources have both flow and stock (capital) values
Forests have a standing stock of trees that can produce flows of timber, fruits, nuts, and other products. Both sets of values are relevant in considering proposed changes in forest use. The same is true of other forest plants and animals.
Flow and stock value relationships lie at the heart of debates about sustainability of biological resource systems.
In fact, much of the argument for introduction of natural resources accounting, or taking changing stocks of natural resources into account in national accounts, relates to this point.
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Box 1.4. Policy prices in forestry project evaluations. Assume that an area of currently idle land technically could be used for two mutually exclusive purposes: agriculture or a forest plantation. The plantation alternative would yield $150 of benefits per year net of all costs except land cost. The agricultural alternative would generate a benefit of $200 per year net of all costs except land. There is, however, a policy restriction: the government has on various considerations decided that only forestry will be allowed in the area. The analyst is asked to estimate the economic worth of the plantation alternative. To do this, he will need to estimate, among other things, the value of the land that will be used by the project. This value is equivalent to the net benefits given up by not being able to undertake the best alternative use for the land. Since the main technically feasible alternative is agriculture, with a net benefit of $200 annually, some would argue that this is the value of land which should be entered as the opportunity cost in the economic analysis of the afforestation project. Others would say that, since a policy decision has ruled out the agricultural alternative, the relevant value of land for the afforestation project should be equal to the net benefits foregone by not undertaking the next best forestry alternative. If this next best forestry alternative generates a net benefit of $60 per year, again exclusive of land cost, which value should be entered in the analysis, $200 or $60? Depending on which value is chosen, two radically different estimates of project worth might occur. As mentioned, the plantation would yield net benefits of $150, excluding consideration of land opportunity cost. If $200 is taken as the economic value of land, the economic worth of the plantation project would be equal to $150 - $200, or -$50, and the economic analyst would recommend against implementation on the grounds that costs outweigh benefits. On the other hand, if the policy restriction is taken into account, the net benefit generated by the afforestation project would be $150 - $60 = $90, and the project would have the chance to be approved since its worth is positive. Which approach is the correct one? Using the traditional “with and without” principle, the analyst should consider only the estimated actual difference. The restrictive policy imposes real boundaries to feasible opportunities, as real as those imposed by technological constraints. Therefore, the value of the potential agricultural output should not enter the analysis of the plantation project. Failure to observe this principle would lead to the wrong decisions. In the example, if the policy restriction is considered as irrelevant, there would be no economic argument for approving the afforestation project. The project would not be implemented, but neither would the superior agricultural option, for the policy is in fact real. In consequence, society would receive neither the benefits of afforestation nor the benefits of the agricultural option. The above should not imply that the worth of the unfeasible agricultural option is irrelevant. Quite the opposite. While this value should not be entered into analysis of the plantation project, it is very relevant in an analysis of the restrictive policy on land use. Since without this policy, $200 of net benefits would be generated, while with the policy the best alternative would yield only $150, the difference of $50 surely represents part of the societal cost of the restriction. This is relevant information. Decision makers might or might not find this loss of $50 acceptable in pursuing noneconomic societal objectives associated with the land in question. The loss is of obvious importance in the analysis of policy implications, but it is not relevant to the evaluation of the afforestation project, given the policy. |
Recently there has been a growing interest in developing such natural resources accounts associated with forests and other natural resources. To a great extent, this is due to an anomaly in national income accounts that leads to an overestimation of the value of income generated by natural resources by not deducting an amount for depreciation. Depreciation is an imputed cost that reflects both the declining productive capacity of a human-made asset - buildings, factories, equipment - and the investment that is necessary to sustain a certain level of productive capacity over time.
Unlike human-made capital assets, the value of production stemming from natural resources is calculated in national income accounts without deducting the cost associated with their depletion or degradation. Thus, when forests are cleared, no depreciation that would reflect their decreasing productive capacity is recorded. The resource itself is treated as free good, clearly a measurement failure. By including only the value of production without netting out the value of natural resources inputs, national income accounts overestimate income generated and provide wrong signals for decision making. Policies, which deplete forests or degrade the environment and decrease future productive capacity, appear to be desirable activities.
To deal with this valuation problem, modified approaches have been designed. These approaches essentially try to redress the valuation discrepancy between human-made and natural capital by allowing a certain amount to be deducted from the value of production. This allows for the decrease in the productive capacity of natural resources associated with depletion and degradation.
Financial values refer strictly to market priced goods and services. Financial values are always looked at from the perspective of a particular person or other unit. Thus, for that unit, financial costs represent outflows of money/resources, while financial returns are inflows of money to the unit. Economic value is a broader concept, as discussed above.
Costs and returns, or benefits, occur over time and not all at the same time. For example, some costs may be borne today, with their corresponding benefits occurring sometime in the future. The basic question is how to compare present values with future values, since we know they are different. (A dollar in hand today is worth more than having to wait ten years to get that same dollar.) Economists use the widely accepted practices of discounting (bringing future values back to the present) and compounding (bringing present values forward to some future date). The basic concepts are explained in the companion FAO Forestry Paper 106 (Gregersen and Contreras 1992). The key to comparing values that occur at different times is to bring them back or forward to some common point in time so they can be compared.
It should be noted that in carrying out an analysis using any of the above means, it is important to distinguish between value in use (consumer value estimates) for some nonmarket goods and services and value in exchange (market prices) for market-traded goods and services. Thus, one should not compare, e.g., market priced values for timber with estimates of value in use for recreation. The two represent different concepts and often differ. Thus, for example, the market price paid (value in exchange) for an ecotourism trip to a Kenyan game park may be far below what a particular consumer actually is willing to pay (value in use) for the trip. The market price only reflects wtp at the margin. In sum, erroneous conclusions about relative values can be easily reached if the two are compared.
