4. Economic Analysis and Environmental Assessment

Economic analysis is an important element in the evaluation of potential forestry projects, whether these are concerned with creation of protected forest areas, natural forest management, logging or processing. Economists have developed a systematic approach for assessing whether such projects are worthwhile from a national standpoint. However, it is not the purpose here to review the economics of project assessment per se, but to consider the contribution economics can make to assessing the environmental impacts of forest management activities. By using economic analysis, it is possible to monetize many of the physical environmental impacts of forestry projects -- these were the topic of the previous chapter -- and to evaluate the benefits and costs of various mitigation strategies. This is admittedly a more limited task than full project appraisal, but still requires coverage of some basic economic concepts. An attempt has been made to limit the background material to that needed by a non-economist in order to understand how valuation of forest resources is undertaken, as this is one of the most important contributions economics can make to environmental assessment.

To supplement the material in this chapter, a set of Asian forest valuation case studies was prepared and is contained in Appendix 4. These case studies demonstrate many of the principals and techniques introduced in the sections below. They have been organized consistently with the sub-sections of the previous chapter (ie. by type of forest management activity, project or sub-sector) so that they may be used in conjunction with the material presented in that chapter as well.

4.1 Economic Analysis of Environmental Impacts: Key Questions

Even though we may not be concerned with a full project appraisal here, we still need to consider several methodological issues in undertaking an economic analysis of environmental impacts. For example, we will always want to measure the environmental benefits and costs of the forest activity we are concerned with and compare these to the environmental situation which would have existed if the forest management activity were not undertaken. Economists refer to this as the with/without criteria. The following sections describe the most important such methodological considerations, posing these as questions the planner must ask his or herself.

4.1.1 Are We Concerned with a Financial or Economic Perspective?

Perhaps the first question we must be concerned with is whether we are undertaking a financial or economic analysis, or both. The distinction between these two perspectives is important. With a financial analysis we take the viewpoint of a private firm or individual and measure the benefits and costs they would consider. In most cases, these would consist of the following:

• revenues as determined by market prices;

• harvesting costs such as wages payed to labour, as well as transportation and road building costs, again using market prices; and,

• taxes, royalties and other concessionaire payments;

Thus, a financial analysis is concerned with actual monetary flows, either as revenues or costs. A financial analysis is useful in answering specific questions concerned with these flows of revenues and costs:

• Is the forest management activity likely to be financially attractive to the interested parties, which would include government as well as private firms or individuals?

• How are the revenues and costs distributed among these interested parties?

• What are the budget and financial sustainability impacts of the forest management activity?

• Finally, how does the forest management activity's finances affect the country's foreign exchange balance?

A financial analysis typically does not concern itself with environmental impacts, especially where these affect someone else. Occasionally a financial perpsective may be useful if the goal is to assess whether land owners would be prepared to adopt particular mitigating measures which may affect the profitability of their private operations.

In contrast, an economic analysis is concerned with whether forest management activities represent an efficient use of a nation's resources. This involves assessing the opportunity costs of the forest management activity in question. Questions we might be concerned with include:

• What must we forego as a result of the activity?

• Are these lost opportunities of greater or lesser value to the nation than the project in question?

• Is the forest mangement activity likely to be sustainable in an economic sense (how we define sustainability will critically determine the answer here)?

Environmental impacts can be a very important consideration in an economic analysis since they constitute part of the opportunity costs of our actions. If we damage or destroy a forested area while logging it, then the lost possibilities for recreation in the forest represent an economic cost of that logging.

The emphasis is on the ‘net’ effect of an activity, regardless of who may be involved. Not surprisingly, this means that where the forest management activity affects third parties - that is, parties other than the interested parties considered in a financial analysis - these impacts must be taken into account. Moreover, we must extend the analysis to consider benefits or costs for which no market price exists, since these are important in assessing whether an activity has a net positive or negative effect on a nation's welfare. Even where market prices do exist, these might need adjustment because of government intervention in the economy. By paying subsidies, charging taxes or maintaining an undervalued exchange rate, for example, a government distorts prices so that they no longer reflect true market forces. When such adjustment is called for, or prices must be estimated for a good or service and no market exists to help us, we refer to these prices as shadow prices.

Once we have established the correct prices to use, we must go a step further. Economists are not only interested in how much is actually paid for something, but also in how much individuals would have been willing to pay over and above that price, and refer to this concept as willingness-to-pay. With this information, economists can derive what is referred to as consumers' surplus. This measure of value captures the often greater amounts individuals would be prepared to pay, but need not pay because a single price governs the marketplace. Such amounts, while never actually collected, and difficult to measure, are an important component in the true economic value of forest products.

In comparison to the financial analysis, an economic analysis would consider the following benefits and costs associated with forestry operations (see Box 4.1 and Table 4.1 for a specific example):

• market price of production and harvesting inputs, adjusted for any distortions;

• costs of replanting, maintenance and protection;

• environmental costs of harvesting activities.

Typically, public decisionmakers will want to adopt an economic perspective when determining how best to use a nation's limited forest resources. Thus, economic analysis, as opposed to financial analysis, is the appropriate perspective to adopt for most EAs.

Table 4.1 Calculation of Financial and Economic Profitability in Philippine Logging

Source: Paris and Ruzicka, 1991

Notes:

^a Legal operations using selective logging systems are assumed. Private profits of illegal operators will be higher. Different combinations of yield and price are possible to capture the variations in the quality of the standing forest.
^b One ha of old growth forest of 30–50% slope sustainably yielding 100 cu m every 35 years, or 2.86 cu m per annum.
^c For economic calculations, the market price is adjusted upward by 10% to account for low-cost illegal supplies.
^d For economic calculations, costs are reduced by 20% to take account of government intervention in the economy (distorted prices).
^e Amount required for one year to ensure sustainability of production.
^f Loss of the gain from timber production on one ha in perpetuity in the absence of protection.
^g Off-site damage assumed to be limited in duration, to 3 years for Model 1 and 6 years for Model 2. Annual damages are discounted to present.
^h Financial profits are shared with the government through forest charges and environmental fees under existing regulations. Does not contain the cost of mandatory reforestation.

4.1.2 What is the Appropriate Economic Appraisal Approach?

Once the need for either a financial or economic analysis, or both, has been determined, the analyst must assess the nature of the problem and decide what economic appraisal approach is appropriate. In doing so, it is necessary to establish precisely the policy problem at issue. Some situations involve a decision about whether or not to undertake a particular forest management activity, which may cause onsite or offsite damages (or benefits). Here the correct approach is to apply impact analysis, possibly as a component in a broader EA (IIED, 1994). Characterizing this type of policy problem is a concern with the wider environmental effects of the decision. As demonstrated by Box 4.1, these effects consist of peripheral damages and foregone opportunities for deriving benefits from the forest in the future.

A second policy situation is concerned with the conversion of forest areas to other uses, such as agriculture. The choice between one or several alternative land uses will hinge in part on their relative economic attractiveness. To asses this, one must undertake a partial or comparative analysis, which by implication assumes that not all forest values are necessarily at stake. Taking Box 4.1 again, we could restate the problem as one of choosing between sustainable forestry use and converting the land in question to agriculture. To determine the most desirable land use, we would estimate the economic returns in either case, being careful not to double count any potential benefits or costs, and compare the results. For example, comparing Models 1 and 2 we see that Model 1 is preferred (although net benefits are negative). We need not have measured all benefits and costs, as some are common to both models and cancel out in the comparison, thus simplifying the task.

Finally, there may be an interest in the full range of values associated with a forest site as a multifunctional (or multipurpose) environmental resource. Reasons for such a perspective include possible designation of a site as a national park, or there may be a desire to improve the reporting of natural resource values in government economic statistics, necessitating a full accounting of natural resource values. Such an assessment would be termed a total valuation. Clearly, to undertake a proper valuation of this sort would require a comprehensive set of economic values associated with the forest site. Otherwise, the site would stand the risk of being undervalued. The study reported in Box 4.2 takes this approach to valuing Indonesia's standing forest stock.

Once the policy problem has been clarified and the appropriate assessment approach decided, the framework for undertaking the analysis must be selected. How the analysis is actually conducted will hinge on what information is available and what dimensions of the problem are of primary interest to decisionmakers. The most familiar analytical framework (or decision rule, as some prefer to call it) is Cost-benefit analysis (CBA). In fact, CBA is so commonly used, it might seem surprising that other approaches exist. Some of these alternatives include: Cost-effectiveness analysis (CEA), Multi-criteria analysis (MCA), Risk-benefit analysis (RBA) and Decision analysis (DA). A brief review of each technique is provided below.

• Cost-benefit analysis

  Where economic analysis is concerned with placing values on the environmental impacts arising from some forest management activity, CBA is usually appropriate. It involves identifying the full range of benefits and costs of an action, monetarizing these using appropriate shadow prices and then determining the ‘net impact’ of the action. Implicit in CBA is the objective of maximizing net economic benefits from a human welfare perspective. However, CBA requires detailed information on the impacts to be measured and is concerned strictly with the economic efficiency issues involved, and not with other issues which may concern decisionmakers. A good CBA will at least address uncertainty and distributional considerations (see Section 4.1.4), but is incapable of dealing with multiple objectives, for example. Information needs for a CBA can usually be met when a thorough EIA or EA is being undertaken, since physical data gathering is typically a major component.

• Cost-effectiveness analysis

  CEA may be preferred to CBA where measuring benefits of an action is difficult. Instead, a target level of benefits is established and then the least-cost means of achieving this level of benefits is evaluated. For example, it may be difficult to estimate and compare the biodiversity benefits of a number of forest sites, in order to determine the optimal number of sites to designate as natural areas. Applying CEA would entail setting a minimum area to be conserved, estimating the opportunity costs of protecting all possible sites, and then comparing these costs to allow selection of the needed number of sites with lowest costs.

• Multi-criteria analysis

  MCA is most useful where there are several benefits or objectives associated with an action, and these cannot be directly compared. In other words, we cannot simply monetize all benefits and costs and then add these up as appropriate. MCA relies on there being a set of alternative activities which must be evaluated on the basis of a range of criteria. Often, the most important criterium is an economic or financial one, but it is usually supplemented by other criteria. Planners must decide on a range of questions in order to carry out an MCA analysis. These include:

  • the alternatives and criteria to be applied;
  • a grading scale for the non-quantifiable criteria;
  • a set of weights which would be applied to the various criteria; and,

  • an acceptable aggregation and decision procedure.

  It has been argued that MCA is a more effective tool than CBA or CEA, since it can cope with unquantifiables and is better suited to situations where political or other non-economic criteria are important. It may be particularly suited to situations where sustainability is a big factor, since standard CBA may not properly account for it.

• Risk-benefit analysis and Decision analysis

  These approaches are more concerned with the risk and uncertainty associated with an action. Are decisonmakers concerned about risky events and the probabilities of certain outcomes, rather than simple deterministic calulations of ‘net economic benefits’? Where the probabilities of various outcomes are known, we can use RBA. It can be shown that once these probabilities are multiplied by the magnitudes of gains or losses associated with each possible outcome, the analysis reduces to a simple CBA. In contrast, where probabilities may not be known, DA allows us to use alternative decision rules to choose a course of action. If the decision-maker is risk averse -- that is, he/she prefers to err on the side of caution and would turn down a fair bet -- then a DA framework can help in selecting the course of action having the minimum possible loss associated with it, for example.

4.1.3 How are Benefits and Costs in Different Time Periods Considered?

In the first case, they must make allowance for the fact that individuals view more distant benefits and costs differently than more immediate ones. Generally, the pattern observed is that we prefer costs to be postponed and benefits to be received as soon as possible. This situation is referred to as time preference. It is mimicked by financial institutions in that they must pay interest on bank accounts, returning a higher amount to the individual at a later date to make it attractive for individuals' to deposit their savings right now (thus, requiring individuals to postpone their enjoyment from spending that money now).

To account for time preference in valuation and cost-benefit studies, economists use a form of discount rate referred to as a social time preference rate. Like all discount rates, the social time preference rate is used to weight benefits and costs occurring in different time periods, similarly to the use of an interest rate to calculate interest payable on bank accounts. Since we would prefer having a sum of money in the present to waiting until a later time period for it, we must place a greater emphasis (weight) on current values than on ones in distant periods. To accomplish this, we use a discount factor which incorporates the discount rate selected. Weighting a series of benefits or costs and summing these yields a present value. In CBA, we calculate the present values of benefits and costs, and take the difference between the two, the net present value (NPV), as an indicator of an action's viability in economic terms. An NPV greater than zero implies the action returns positive net economic benefits. We can instead calculate the present values of benefits and costs and place these in a ratio, referred to as a benefit-cost ratio (BCR). A BCR greater than one indicates that benefits exceed costs and that the action is considered, in balance, favourable. Box 4.3 provides a more rigorous explanation of NPV and the BCR.

A second approach is to look at the opportunity cost of capital invested in an activity, which refers to the profits which could have been obtained by investing this capital in the next best possible opportunity. These foregone profits represent the cost of the capital employed in the project. The net benefits of our project must at least equal these foregone profits if it is to be considered viable. Thus, when weighting benefits and costs in different time periods, we use the opportunity cost of capital as our discount rate to reflect what the activity should be generating in terms of benefits, if it is to be an attractive investment.

Box 4.3	The Basic Cost-benefit Analysis Criteria Discounting
Cost-benefit analysis (CBA) was referred to in the previous section as being the most commonly used economic appraisal method. Incorporating discounting into CBA is not difficult. It requires that we identify the flow of benefits and costs for each time period we are considering, as well as select the discount rate (r) we intend to use. Assuming we are concerned with some forest management activity, we show forest benefits for period t (Bt), costs for period t (Ct) and environmental impacts for period t (Et), with the latter being either positive or negative (+/-). Project viability can be expressed in several ways. For example, we can estimate the net present value (NPV), which measures the difference between discounted benefits and costs, or the benefit - cost ratio (BCR), which takes the ratio of these two. Whether an activity is desirable hinges on the resulting calculation. Decision rules are shown below. From a strictly environmental assessment point of view, we are only interested in measuring the value of E. However, in practice, environmental impact will be associated with a forest management activity or project which is liable to be evaluated in terms of its overall economic viability. In this case, economic analysis of the environmental impacts constitutes just one component in a full project assessment.

Some forestry projects have positive environmental impacts, in contrast, suggesting a low discount rate might be appropriate, to encourage such activities. In reality, the impacts of forestry activities on the environment range widely, suggesting that the appropriate discount rate might vary with the circumstances.

However, it is generally preferable to use a single rate for all projects evaluated to ensure consistency and to allow for comparisons amongst different projects. But if a single discount rate is to be used, then to accommodate environmental concerns we must decide whether the rate should be high, low or zero. Interestingly enough, the overall impact on the environment of a high or low discount rate applied to all projects is ambiguous. For example, a high discount rate discourages environmentally damaging activities and reduces the overall level of investment; therefore, the rate of natural resource use declines. But this result comes at the expense of emphasizing the interests of the current generation over those of future generations, since net benefits far in the future are heavily discounted. A high discount rate also discourages environmentally-friendly forest management activities. As a result, there is an emerging consensus that no adjustment be made to the standard, economy-wide discount rate when evaluating environmental values, and instead other techniques be used to adjust for any special conditions associated with environmental benefits and costs.

4.1.4 What are Some of the Non-efficiency Concerns in Economic Analysis?

Analysts must be aware of the distribution of the benefits and costs of forest management activities, and this may rely in part upon the underlying institutions such as property rights or rights of access to forest resources. CBA is instead concerned with the economic efficiency aspects of environmental changes stemming from some forest management activity. By this, economists mean that the results of an action can be measured by its net economic benefits, regardless of to whom these may accrue. A project showing a very high net economic benefit would be deemed highly desirable in economic efficiency terms, no matter that the beneficiaries may not be the ones who bear the burden of the costs arising from the action. In this context, financial transfers between individuals or groups, as a result of the management activity, are ignored in a CBA, since they do not constitute usage of economic resources. Thus, payment of subsidies or taxes, which may alter the distribution of benefits and costs from an action, are actually left out of a CBA. However, there is clearly a need to take account of this distribution, particularly as an aid to designing effective mitigation strategies.

Local forest communities may often fall into the category of losers from forest management activities, suffering a loss whether a forest is destructively logged or preserved as a pristine national park. In the latter situation, former subsistence hunting and gathering activities may no longer be permitted. In some cases, this problem may be recognized and addressed through the creation of special funds to compensate villagers for lost access to forest resources. Nonetheless, it is important that the distributional aspects of any proposed tropical forest project or policy be considered along with net return measurements, and that adequate transfers or other special provisions be enacted to deal with inequities. Further discussion of social issues pertaining to EA, particularly the need to identify winners and losers from management actions, is provided in Chapter 5.

All EAs are also undertaken within some institutional context, as discussed in Section 2.3. Most important for economic analysis perhaps are property rights arrangements. Attempts to value tropical forest resources may run into difficulties if estimates are based on a simple observation of current use rates, without taking into consideration the property rights situation. This may be especially important if the property rights system is changing informally (as when indigenous common property systems are reasserted after a period of dormancy), or a change has been mandated as an element in a project or programme affecting a tropical forest area (as when land is suddenly privatized or nationalized). From an economic analysis standpoint, the benefits and costs associated with a management action will be influenced by the property rights regime in place. If a forest area is subject to open access, then measures to improve the physical management of the forest resources will produce few economic benefits unless the property rights situation is also addressed.

4.2 Economic Valuation: Techniques, Problems and Pitfalls

Central to the contribution that economics can make to environmental assessment is the valuation of goods and services whose supply or availability is altered by some activity. Market prices exist for some goods and services and where available these can serve as the basis for economic valuation. But forests produce many goods and services for which there are no market prices, and economists have had to develop techniques to place appropriate values on these. If this is not done, then these goods and services are liable to be ignored when assessing the impacts of forest management activities, and the economic value of environmental impacts will be incorrectly measured. This section first looks at the values associated with forests, primarily tropical Asian forests, and then considers ways of measuring these values and some of the problems that might be encountered. While some representative values of Asian forests are presented, much more detail is available from the range of Asian case studies contained in Appendix 4.

4.2.1 Economic Values of Asian Forests

Timber is widely regarded as the most valuable forest resource in tropical forest countries. This should come as no surprise, since it is usually timber which can generate the most readily captured revenues from forest exploitation, whether we are referring to revenue capture by commercial-scale operators or governments, or both. Even where revenues may not be the primary objective of forest exploitation, and instead it is seen as an opportunity for stimulating economic development, timber harvesting often remains the most attractive forest use for achieving this objective. It is seen as having significant linkages to other sectors, especially processing, and can provide much sought-after jobs in regions with few other industrial alternatives. These are compelling arguments for national planners in tropical countries for supporting timber exploitation at the expense of other forest values.

However, such a view of the benefits available from tropical forests risks the loss of other important forest values. In effect, these other values may be treated as having no value whatsoever, partly because they are not commercially traded, so no market value and by inference no revenue is associated with their use. As noted earlier, the distribution of the beneficiaries of a non-timber forest use may also be important. If this is restricted to local communities, then national decision-makers may be less inclined to take notice of the associated non-timber forest uses. Ultimately, the emphasis on timber values means that these may be encouraged at the expenses of non-timber forest uses, or that decisions about converting forest areas may be made only in terms of the lost or reduced (if timber is salvaged) timber values. Environmental assessment can address this problem by properly valuing the full impacts of timber harvesting and ensuring these effects are taken into account by decisionmakers.

If researchers are to value non-marketed forest uses and decision-makers are to take these into account, then some sort of framework for distinguishing and grouping these values is required. The concept of total economic value (TEV) provides such a framework and there is an increasing consensus that it is the most appropriate one to use. Simply put, TEV makes a fundamental distinction between use values and non-use values, the former being somewhat self-explanatory and the latter referring to values associated with an environmental resource which rely merely on its continued existence and are unrelated to use. The TEV framework, as applied to tropical forests, is illustrated in Table 4.2. Further observations -- and cautions -- concerning use of the TEV framework are provided in Box 4.4.

Table 4.2 Classification of Total Economic Value for Tropical Forests

Source: adapted from Barbier (1991), Panayotou and Ashton (1992), Myers (1992) and Pearce and Warford (1993)

^a Biodiversity is essentially an attribute of the tropical forest; hence, it may also serve important direct and indirect use values. For example, the diversity found in a tropical forest may have direct use value for scientific research, education and as a source of genetic material. Similarly, biological diversity may have an indirect use value in assisting the ecological stability of the entire tropical forest system.

Use values are grouped according to whether they are direct, indirect or option values. The following paragraphs provide descriptions of each of these different values.

• Direct use values

  Direct uses refer to those uses which are most familiar: harvesting of timber and wildlife, collection of non-timber forest products and use of the forest for recreation (the table above lists several others as well). As noted in Section 3.2.3, timber harvesting is often emphasized at the expense of other direct forest uses. In this context, it is important to distinguish between direct uses which may degrade a forest or convert it to an alternative use, and those which are consistent with conserving the forest. The latter refers to maintaining sustainable benefits from the forest and avoiding its destruction. Obviously, if logging practices lead to large standing forest losses without subsequent reforestation, or land is clearfelled to allow cultivation, more benign forest uses will be precluded in the future. In contrast, the use values associated with modest levels of ecotourism or collection of non-timber forest products usually can be sustained indefinitely.

• Indirect use values

  Forests also have ecological functions which support economic activity. These services are referred to as indirect use values since it is not the functions themselves but their contribution to production which is valued. For example, tropical forests have important watershed protection functions, such as prevention of soil erosion and regulating floods. In either case, loss of the forest results in damages to agricultural or other production downstream and measuring these damages provides an indication of the indirect use value. Not all forest researchers agree on the validity of certain indirect use values. There is controversy over the effects of deforestation on rainfall patterns, for instance. In other cases, such as carbon storage values, the magnitude of loss associated with deforesting an area depends on how the land is subsequently used (see Box 4.7 for a more detailed discussion of this topic).

  Many ecological services and amenity values provided by tropical forests have public good qualities. A public good exists where one individual may benefit from the existence of some environmental service or attribute and this does not reduce the benefit another individual can receive for that same service or attribute (this situation contrasts with that of a private good, where two individuals cannot jointly consume the good). For example, if the presence of a forested watershed reduces downstream flood peaks, all downstream property owners benefit from this service, and no one individual can be excluded from the service. Establishing values in such situations can be difficult, and as a result, many of the ecological services provided by forests are liable to remain undervalued.

• Option values

  An additional category of use values is option values, which comprises option value itself and quasi-option value. The former refers to individuals' willingness to retain certain forest values for possible future use, even though they are non-users at present. In contrast, quasi-option value measures something completely different. This term refers to the desire to retain access to an environmental resource with the expectation that information about its usefulness will improve over time. For example, we incur a loss when we develop forest resources now, if in the future we may learn about some useful chemical or medicine which can be derived from the forest. The key concept here is irreversibility, which involves the permanent loss of environmental values, such as occurs when a species becomes extinct. Obviously, if a particular forest management action results in substantial irreversible loss of forest values, the accompanying loss of option values is liable to be significant.

Non-use value is often thought of as coinciding with the concept of existence value. That is, individuals may be concerned about the continued existence of some environmental resource, such as a tropical forest area, even though they have no plans to visit it. Non-use values are typically not commercially expressed since they are unrelated to use and, like many indirect use values, have public good qualities. Tropical forest biodiversity may be valued by persons living in distant developed countries, and because of its public good nature, the non-use value attributable to Europeans does not reduce the same values which may be held by Americans, for example. Whether to consider such values when they are held by non-residents depends on the project in question, its financing and whether some mechanism exists to capture these non-resident values. An additional category of non-use value is bequest value, which signifies the desire to leave an environmental legacy for one's ancestors or future generations at large. Some authors see bequest motivations as falling within the definition of existence value.

The significance of non-use values for a given site is liable to depend upon the area's uniqueness, which may be reflected in a high measure of biodiversity (as indicated by an appropriate biodiversity index -- see Chapter 2) or its species endemism (the number of species not found elsewhere). Due to their nature, non-use values are very difficult to measure. Nonetheless, non-use values are thought to be especially high for moist tropical forest. While there are few studies of non-use values associated with tropical forests to prove this contention, campaigns by international environmental groups to raise funds to support tropical forest conservation hint at the magnitudes involved. For example, several years ago the U.K.'s Royal Society for the Protection of Birds (RSPB) collected £250,000 (US$ 400,000) from a once off membership mailout campaign to help save the Gola rainforests of Sierra Leone in West Africa. A study by a group of World Bank researchers surveyed a large number of U.S. households to determine their willingness to contribute to a hypothetical “United Nations Save the Rainforests Fund”. When the values elicited were extrapolated to the total number of households in the U.S., the resulting amounts were greater than $2 billion (Kramer et al., 1995).

4.2.2 Economic Valuation: An Overview

Having a valuation framework is only the first step in undertaking an economic analysis of the environmental impacts of forest management actions. We must then actually measure the relevant values. However, first it is useful to review what economists mean by the term value. As introduced in Section 4.1.1, economic values are reflected in our willingness-to-pay for something, less what it costs to supply it. Where an environmental resource simply exists and provides us with products and services at no cost, then it is our willingness-to-pay alone, which describes the value of the resource, whether or not we actually make any payment.

Table 4.3 gives a selection of value estimates for direct and indirect uses of Asian (mostly tropical) forests. It is clear from the estimates provided that values range widely for use values in Asian forests, and that indirect use values are by no means insignificant. However, care must be used in interpreting the results of these studies for several reasons. Many studies have used differing assumptions and valuation techniques, so that results, even for similar sites, may not always be comparable. Some figures purport to value non-timber forest products in an all-inclusive sense, but leave out many direct use values. Often the emphasis may be on plants, with values associated with fauna ignored, or vice versa. It is also not always clear whether the figures shown represent sustainable harvest levels or whether they may involve overharvesting (more is said of this in Section 4.2.6). Nonetheless, the indication is that direct and indirect use values can be valued and that there has been some progress in this direction. Some of the valuation studies cited in Table 4.3 are explored in more detail as case studies in Appendix 4.

The value estimates presented in Table 4.3 rely on a large number of valuation techniques, and along with these come many ways of classifying or grouping the techniques. A relatively simple approach is used here, one which accords with most classifications found in the technical literature. Valuation techniques can be divided into those that use market prices to directly measure the economic value of environmental impacts, and those that do not. The latter group constitute methods for non-market valuation, and these can be subdivided into a further three groupings. To summarize, the following loose classification is used (see IIED 1994 for more information):

• market price or direct measurement techniques, which use actual or adjusted market prices.

• non-market valuation techniques, including the following:

  • surrogate market methods, which infer value from related goods;
  • constructed market or stated preference approaches, which ask questions about WTP; and,
  • cost-based valuation, which uses information about the alternative costs of preventing or replacing environmental benefits.

Table 4.3 Value Estimates for Direct and Indirect Uses of Tropical Asian Forests

Source: Godoy et al. (1993)

It is not anticipated that forest planners and managers would actually undertake a valuation exercise themselves, so that detailed knowledge of valuation techniques is not necessary. Rather, a general understanding of the types of approaches available, and how these might be used, should be sufficient. For this reason, only the most commonly used techniques are described in detail in the main text. Further descriptions of these and additional techniques, as well as their advantages and disadvantages, are deferred to Appendix 2. Table 4.4 shows a summary selection of the valuation techniques available, and indicates which types of values they can be used to estimate.

Table 4.4 Selected Valuation Techniques for Assessing Tropical Forest Values

Source: adapted from IIED (1994)

^a signifies valuation technique to be used with caution

4.2.3 Valuation Techniques Using Market Prices

Where market prices are available and either appropriately reflect the social value of goods and services, or suitable shadow prices can be formulated, valuation of environmental impacts is a relatively straightforward exercise. Calculating the value of many direct use values (ie. timber, non-timber forest products) can be done in this way, although in some Asian countries, even timber prices do not properly reflect true economic value so that efficiency or shadow pricing will be needed. Reasons for undervaluation of timber are several, but a key one is inadequate royalty collection - amounts collected do not reflect the full underlying stumpage value of standing timber. As an example, Indonesia received only 50% of potential royalties from log exports and 25% from sawn timber during the 1980s. For the Philippines, the amount captured was less than 10% of its potential. An appropriate shadow price for timber would also have to take account of reforestation costs to include allowance for replacing the timber removed. A discussion of valuation issues pertaining to non-timber forest products is presented in Box 4.5.

There are several techniques which use market prices to directly value environmental damage. Often, we may be interested in assessing the value of changes in productivity resulting from the environmental impacts of forest management activities. For example, if logging disrupts ecological services or the supply of non-timber forest products provided by a forest area, then we can assess this by estimating the resulting loss in production (ie. from downstream flooding or lost rattan production) and multiplying by the appropriate market prices. Adjustments for any changes in costs must also be made.

4.2.4 Non-market Valuation

Where we cannot rely directly on market prices - either they do not exist, or appropriate shadow prices cannot be estimated - we must turn instead to alternatives for non-market valuation. For this there are a large number of techniques, each with advantages and disadvantages according to the valuer's needs and data. Broadly speaking, non-market valuation techniques can be divided into three groups. A first group of techniques use market prices of related goods to infer the value of a given environmental good or service, and these are often called surrogate market methods. Two often used techniques are the hedonic pricing method (HPM) and the travel cost method (TCM), both of which are described in more detail below (and in Appendix 2).

• Hedonic pricing method

  The HPM tries to derive values from the influence that environmental quality has on certain market prices, especially property values. The approach involves assembly of cross-sectional data on housing or farmland prices, along with data on factors liable to influence these prices, including environmental quality (noise, air pollution, etc.). Multiple regression is then used to relate these factors to the prices quantitatively and from this a measure of the impact of environmental quality can be derived. The technique does not actually provide an appropriate measure of willingness-to-pay and can only be applied to environmental quality attributes which influence property prices, thus limiting its usefulness.

• Travel cost method

  A second surrogate market technique is the TCM, which can be used to measure values associated with the recreational site characteristics of tropical forests. It obtains an estimate of how much individuals are willing to pay to visit a site, given site characteristics, other competing sites and the distance from the site. By controlling for differences in demographic characteristics, site quality and the presence of competing sites, the relationship between distance (and therefore travel costs and travel time) and the number of visits to the site in question can be estimated. Specifying this relationship allows construction of a demand curve for the site in question (which is generally required to get an appropriate value measure). Some of the problems associated with TCM include:

  • the treatment of travel time (does it represent a cost, and if so, what is it?).
  • multiple-site trips (how do we allocate trip costs to individual sites?).
  • competing sites (how do we properly account for their influence on demand for the site in question?).
  • the use of estimated rather than real travel costs (are these accurate?).

Several other surrogate market approaches are available. Some techniques make use of surrogate prices, which are market prices of goods related in some way with the environmental value we seek, often as a direct substitute (see Box 4.6). Where these are not available or are inappropriate, we may need to appeal to indirect substitutes, for which no market price may exist, but from which some value can be inferred from the changes in output associated with substitution (again, see Box 4.6 and Appendix 2).

Some indirect valuation techniques make use of production functions, which model the contribution of various inputs to outputs in a production process. Where the environment is just one of many inputs, production function techniques allow the analyst to isolate the contribution to output associated with the environment alone. For example, a coastal mangrove area may support fish reproduction for species subsequently caught by fishermen using fishing gear. Both the mangrove area and the fishing gear are inputs into the production of fish. Modelling this production process, and including the mangrove area as an explanatory variable, allows the analyst to determine the importance of the mangrove support for fisheries. This technique is often used in conjunction with market or shadow prices to value the effects of changes on outputs of natural systems since many of these outputs are sold commercially (ie. fisheries). The HPM and TCM techniques, described above, can also be thought of as special cases of the production function approach.

Similarly, dose-response techniques use information about the physical linkages between environmental changes, such as pollution and damages to health, to estimate the economic value of environmental impacts. Ultimately, damages may be valued in terms of lost earnings due to ill health. However, the procedure involves several intermediate steps, together resulting in the estimation of a damage function. There are five steps in the process of estimating such a function, with all but the last step involving primarily natural scientists:

• measure emissions (ie. the ‘dose’).

• determine the resulting ambient environmental quality.

• estimate human exposure.

• measure impacts (ie. health, aesthetic, recreation, etc. - the ‘response’).

• estimate the values of these impacts.

The first two steps involve the use of diffusion models, while linking of the third and fourth steps requires estimating the dose-response function. Finally, step five is the stage at which economists and valuation tools are required. A similar approach can be employed for valuing the sequestration of carbon in tropical forests, where the ‘dose’ or environmental harm stems from deforestation and damages occur as a result of the build up of greenhouse gases. Box 4.7 examines the issues involved in valuing carbon sequestration by tropical forests in more detail.

The second group of non-market techniques involve constructed markets: in the absence of real market information or possibilities for inferring values indirectly, they ask individuals directly about their willingness-to-pay for an environmental good or service. These techniques are referred to as direct or stated preference methods and the most commonly used of these is the contingent valuation method (CVM). CVM asks people about the values they place on environmental resources, or in other words, their willingness-to-pay for environmental quality, using a survey questionnaire. Initial efforts solicited willing-to-pay directly, in an open-ended format. In current recommended practice, individuals are asked whether they would pay a specified amount for some environmental benefit. The amounts are varied at random from one individual to the next or, less preferably, systematically increased or reduced until the individual choses an amount. The method for collecting the hypothetical bid is called the payment vehicle, and this may be a tax, membership fee or entry charge to a forest reserve, for example. A recent panel of experts reviewed CVM for its usefulness in valuing non-use values and cautiously supported it, but only if certain guidelines are followed. These guidelines are shown in Box 4.8.

CVM has several advantages. It allows valuation of non-use values which cannot be valued any other way, such as option and non-use values (see Table 4.4). Biodiversity, when considered as an attribute of tropical forests in its own right, can only be valued using CVM. Valuation questions also can be broadly defined to include all of TEV, whereas most other techniques only elicit values for single components of TEV. But there are shortcomings, chiefly in the form of biases inherent in asking hypothetical questions or associated with trying to simulate market conditions where markets may not exist for some good reason. In part, the recommendations of the ‘blue ribbon’ panel are meant to address these shortcomings.

A final group of valuation techniques make use of market prices but emphasize the cost side. For example, the value of an environmental impact can be measured by estimating the cost of replacing or reproducing the environmental service or benefits lost. Techniques using this approach include replacement, restoration and relocation costs. Alternatively, the costs of avoiding or mitigating damages to environmental services can be estimated using the preventive cost approach. Related to these methods is the indirect opportunity cost method, which considers the labour time involved in collecting or harvesting forest produce and values this with a local wage rate. These and similar cost-based techniques suffer from disadvantages and should be treated as second-best methods (see Table 4.4 and Section 4.2.5 for discussion of the particular problems inherent in the replacement cost method).

4.2.5 Problems and Pitfalls in Valuing Tropical Forests

As should be clear from the range of techniques cited above, valuation has much to offer decision-makers in assessing the economic implications of the environmental impacts of forestry activities. But as progress is made towards improving valuation techniques, and as the number of case studies increases, the potential for misuse, outright error and for inappropriate applications commensurately increases. The following section is concerned with some of the more commonly made mistakes and problem areas in valuation and should be of particular interest to planners and managers called upon to design and/or review valuation studies of Asian forests.

• Choosing appropriate valuation techniques.

  Selecting the right valuation technique is a task for an economist undertaking a valuation study and should not normally be specified in advance. Although Table 4.4 provides some guidance in valuing individual use and non-use values, which techniques are best suited to a specific EA problem requires a somewhat different perspective. Some generalizations are possible based upon the experience in North America and Europe, where the use of valuation in association with environmental impact assessment is reasonably well-developed. In this regard, Appendix 3 contains recommendations for the valuation of specific environmental impacts, not all of which are associated with forestry operations. For developing countries, these recommendations while useful may have less appropriateness.

  For instance, the hedonic pricing method is concerned with extracting environmental values by analysing their influence on property values. In many rural areas of Asia, property values are unlikely to be useable in this way, nor are sales values likely to be consistently recorded. Similarly, the travel cost method is concerned with recreational values. Again, in most developing country situations, travelling to recreate is not well-developed. However, the travel cost method has been used to assess the values associated with international tourism and ecotourism in tropical forest areas. Finally, contingent valuation may also face difficulties in its application in rural areas of the developing world. Cultural differences may affect interpretation of the survey's intent and result in misleading responses. Rural people may also be less familiar with the notion of monetarizing non-market values. Despite these disadvantages, contingent valuation has been applied to water supply issues and sanitation in various developing countries, apparently successfully (see, for example, Whittington et al.).

  What emerges in comparing developed and developing country conditions is a difference in the types of environmental impacts liable to be encountered. In the latter, the emphasis is more on rural environments and impacts on agricultural production. Markets are also less likely to be developed for many forest commodities used locally. Together these conditions suggest a greater role for valuation techniques such as the changes in productivity approach or various related goods techniques. Where the data are good, production function approaches may also be promising. One possibility for planners is to use value estimates from other sites and to transfer these to the site under study. See Box 4.9 for a discussion of the advantages and disadvantages of this approach, referred to as benefits transfer.

• Market conditions for NTFPs.

  As noted earlier, tropical forests in Asia produce a wide range of non-timber products for local use and sale. Along with the difficulties cited in Box 4.5 the analyst must be cautious when attributing market values to products available over a wide forest area. For example, many products may not be economically harvestable over their entire biological range because of high access or transport costs. Perhaps more important is the role of market conditions. Prevailing demand may not be sufficient to absorb all the available supply, even at a zero price. While consideration must be made for potential future demand, it would in general be incorrect to apply a market value to the entire sustainable supply of this product, just because it is biologically prevalent. Even if there is an expectation increasing volumes could be marketed, this would usually only be the case where prices were lowered (or transport constraints were eased if this represents the key barrier to obtaining the product).

  The analyst must also be cautious in assuming that a product presently collected for subsistence use could easily be marketed on a much wider scale, as conditions governing the distribution and use of subsistence products are quite different from those characterizing marketed goods. In contrast, the analyst should be careful not to overvalue a renewable forest product where it is currently subject to overexploitation. Where harvests are not sustainable and ‘natural capital’ is being depleted, attributing all the annual harvest value as forest income is incorrect. Steps must be taken to adjust for this, such as estimating a depletion premium and adding this to extraction costs.

• Subsequent land use.

  The loss of tree cover associated with deforestation is often assumed to result in the loss of key ecological functions supported by the presence of tropical forest. Examples include protection of tourism and fisheries, as cited in the Palawan, Philippines case study of Appendix 4. However, the way in which land is used subsequent to the loss of tree cover may be a critical determinant of the severity of these impacts. This was similarly shown to be true for valuing carbon sequestration in Box 4.7, where it was shown that the end use of timber determines how much of a carbon release occurs with deforestation. Where scrub or grasses quickly re-establish, the watershed protection function of tropical forest, for example, may remain largely intact. Often this is overlooked in valuation studies and it is implicitly assumed that the land surface condition after logging remains bare earth. Clearly, analysts must be explicit about their assumptions concerning subsequent use of deforested land and value the loss of tree cover accordingly.

• Capturable benefits.

  The Malaysian case study presented in Box 4.10 demonstrates the importance of distinguishing between benefits which can be captured by a tropical forest country and those which cannot. This problem has enormous importance with respect to some use values, such as those attached to genetic resources and biodiversity. The analyst in the Malaysian study wisely adjusts the gross value of these resources using a rate of capture of only 10% by the host country, and then examines the implications of increasing this rate. Other studies, in Africa for example, also have shown low capture rates to be the case for genetic resource values associated with tropical forest. In contrast, when global non-use values exist for a host country's forest resources, host countries are sometimes able to capture a share of these through international transfers (ie. non-repayable financing). Mechanisms for such transfers include the Global Environment Facility (GEF), and their inclusion in a project appraisal can be highly significant to overall project viability viewed from a domestic standpoint. Analysts must take care to use realistic capture or appropriation rates for benefits of global significance, where the scope of the analysis is purely national in focus.

• Replacement costs.

  One valuation technique mentioned earlier but liable to misuse is the ‘replacement cost’ approach. Here, the analyst estimates the value of a natural asset by calculating the cost of replacing its services, often with a human-produced substitute. If tropical forests situated on steep slopes help prevent the loss of soil nutrients from erosion, then it may seem plausible to value this function by calculating costs for replacing these nutrients with inorganic fertilizers. It can be quite easily shown that this leads to very high values associated with the soil fertility maintenance function of tropical forests. The difficulty lies with the productivity value associated with these soil nutrients in the first place. Steep slopes are often only marginal agricultural land because of shallow soils and problems inherent in their cultivation. In the absence of good farming conditions, these shortcomings may inhibit farmers from applying inorganic fertilizers, since the financial returns may be very low. Certainly, the value of the soil fertility maintenance function must be constrained by the magnitude of these financial returns, and not allowed to exceed them. When these returns are not considered, an illogical situation results whereby more remote and difficult terrain is credited with a higher valued nutrient retention function. This land obviously has much lower farming profitability, yet as its inaccessibility increases the cost of transporting and applying the replacement fertilizer rises accordingly.

• Double counting.

  The interaction among the ecological services provided by tropical forests can be highly complex and difficult to disentangle in a neatly additive way (as most valuation studies prefer to present their estimates). These linkages among services can lead to overestimates of indirect use values where more than one economic value is associated with a single ecological attribute. The result may be a ‘double counting’ of values. The valuation of ecological services provided by mangrove wetlands can serve as an example. Where a wetland serves to remove nutrients from a watercourse, thereby reducing the need for expensive water treatment facilities downstream, a clearcut economic benefit is provided by the wetland. If those same nutrients also help support a local fishery, then there would be a second benefit associated with the removal of nutrients. However, double counting would arise if the analyst then considered the full value of the fishery as a distinct, direct use value, as some of this value was already captured in association with the nutrient retention. It seems likely that such conditions may be duplicated for certain functions of tropical forests, requiring care on the part of the analyst to avoid double counting (Barbier, 1994).