Valuation Issues

As explained earlier, much of the original literature was concerned with correcting the effect of macro “distortions” on the valuation of costs and benefits often in the appraisal of projects in traded sectors. However, as the aid portfolio has shifted to infrastructure and various social sectors, problems of benefit valuation have had to be addressed.

The development of approaches that value non-marketed outputs, including environmental valuation, has extended the scope for CBA considerably. This book aims to demonstrate the applicability of some of these valuation methods.

Concepts of non-market valuation techniques originated in the 1940s. The proposal of Ciriacy-Wantrup (1947) to use stated preference methods to value natural resources and the environment, in addition to the idea of Hotelling (1949) to use travel costs to value economic benefits of national parks, are the pioneering work on environmental valuation. The literature on environmental valuation has increased significantly, but despite this rise in academic research on the subject, its use in actual project analysis has been limited (Adamowicz 2004).21 _{Broadly speaking,}

two approaches dominate the applied literature on non-market valuation

21 _{For example, Silva and Pagiola (2003) found that at the time of their survey only about one-third of}

the relevant World Bank projects used environmental valuation methods, although this was a big rise from 10 years previously.

methods—revealed preference and stated preference approaches.22

Revealed preference studies aim to infer how individuals value a good or service from their observed behavior. In the application for non- market valuation, the non-marketed good or service is valued using a related market.

Revealed preference methods to value non-market goods can be further subdivided into direct revealed preference and indirect revealed preference methods. The direct revealed preference method uses the market price of a good or service that is directly related to the non- market activity. For example, the productivity change method uses the prices of agricultural products to value the cost of soil erosion. Here, the non-market good—soil quality—serves as an input to produce a market good (agricultural produce). The valuation of soil conservation benefits of a forestry or conservation farming project, and benefits of irrigation projects for example, generally use the productivity change method. Similarly, the benefits of mangrove conservation are estimated using incremental change of fishery output.

Indirect methods use surrogate markets to value non-market goods. The hedonic pricing method is a widely used indirect non-market valuation method which assumes that in some markets, environmental factors will influence price and if their independent influence can be identified, this should give an estimate of willingness to pay (WTP) for an improvement in the environmental factor concerned. The approach is used most frequently in relation to property markets, where it is reasonable to assume that air and noise pollution, access to scenic sites and recreational facilities, as well as the location of environmentally hazardous facilities, impact property prices. In development projects, its application is mainly in urban air quality improvement and water supply and sanitation.

The travel cost method is another indirect revealed preference approach. The basic idea is that individuals and their families incur costs in terms of travel in visiting sites of natural beauty and recreation, such as parks or beaches, and that this cost can be used as a means of eliciting what people are willing to pay for these environmental ‘services’, even when no access charges are imposed. Travel cost—defined broadly to include the cost of time—can be used to establish a demand curve for visits to a site of natural beauty where travel cost acts as the price to which

22 _{See ADB (1996), Champ et al. (2003), Gunatilake (2003), and Freeman (2003) for a detailed}

demand is related.23 _{The travel cost method can be applied considering}

zones or individuals with repeated visits. A demand curve for recreation is estimated incorporating income and other data that determine visitation rate from a zone (zonal method) or number of visits (individual method). The area under the demand curve gives total WTP, and per person figures must be multiplied by zonal population to give a total WTP per zone. The approach can also be applied where environmental damage affects the attractiveness of visiting a site.24 _{The hedonic travel cost method}

assumes that the travel cost is a function of site characteristic (such as pollution level, congestion, etc.) and estimates the demand under different site qualities (Brown and Mendelssohn 1984).

The stated preference method directly elicits people’s WTP using survey methods when direct or indirect market information is not available to value non-market goods. This method has two broader categories: contingent valuation and choice experiments. The contingent valuation CV method questions the WTP for a composite commodity whereas the choice experiments unbundle various attributes of the commodity and value each attribute separately. CV studies adopting this approach have been a major growth area for non-market valuation. Water is one of the sectors where this approach was pioneered (Whittington et al. 1991), although it has been applied to value a variety of environmental goods and services including non-use values such as bequest and existence values.

Chapter 4 gives a detailed discussion of the CV method and clear guidance as to how it can be applied in the context of the water supply and sanitation sector. Chapter 5 describes an application of the CV method to water supply and Chapter 6 demonstrates its application for sanitation and solid waste management. The choice experiments method is a recent addition to the toolkit of non-market valuation and the application of which is rapidly increasing in many different sectors.

Health is an area where benefit valuation has proved both difficult and controversial. Health benefits are sometimes divided into avoided mortality and morbidity costs. The averted morbidity effects of an environmental improvement, for example, involve lost wages, averting expenditures (such as expenditure on filtering and boiling water), actual medical expenditures, and disutility of sickness (Freeman 2003). Most

23 _{For example, Day (2002) uses a travel cost approach to value game parks in South Africa.} 24 _{Bolt et al. (2005) provide an example of this approach to value the impact of sea pollution on the}

of the estimates exclude the last component and use actual market data to value the first three components. This reduced method is known as a “cost-of-illness” approach. In order to apply this to value the cost of air pollution, for example, the emission should first be converted to concentrations and then a dose−response function used to estimate the increase in deaths and morbidity. This dose−response methodology, where an environmental change (increase in air pollution) is linked with a change in response (number of sick days, number of premature deaths) makes it possible to value the impacts. CV studies on WTP to reduce risk of illness or death is an alternative way to estimate benefits of health improvements.25 _{CV studies can be used to estimate the total benefits of}

health improvements, including the cost of disutility.

Mortality costs can be estimated using the “human capital” approach, where the loss of productivity of human beings due to premature death, defined as the present market value of lost earnings, becomes the measure of benefits. This method has a number of shortcomings (Gunatilake 2003) and the alternative statistical value of life method, based on insurance premia is generally preferred to value mortality costs.26 _{The statistical}

value of life can also be estimated using the contingent valuation method. For example, Cropper (1992) provides an influential illustration of a revealed preference approach to the valuation of life by focusing on the decisions of the US Environment Planning Agency in restricting the use of pesticides to reduce the risk of cancers; the decision to forego use of pesticides had a cost in lower output which was compared with reduced cancer risk to obtain an implicit value for lower risk.

All attempts to put monetary values on health benefits remain controversial and for that reason there has been frequent use of cost- effectiveness analysis. In the health sector, for example, days of improved health or years of life saved are often used as indicators of project impact with comparison across projects based on a ratio of a health indicator to discounted project costs. For example, detailed work at the World Health Organization in the 1990s developed an influential and widely used set of health indicators, the Disability Adjusted Life Years (DALYs) (Murray 1994, Murray and Lopez 1996). This allowed standard cost- effectiveness comparisons across health projects using discounted costs

25 _{These studies are surveyed in Pearce et al. (2006, Chapter 14).}

26 _{If, for example, an average WTP to reduce risk of death (from say 5 in 10,000 to 3 in 10,000) is}

found to be $50, then the value of a statistical life will be the average figure ($50) multiplied by the number of individuals affected (10,000) divided by the lives saved (2). Thus, in this instance, the value of a statistical life is ($50*10,000)/2 or $250,000.

per discounted DALY as the basis for analysis. ADB (2000) shows in detail how the DALY indicator could be adapted for use in project analysis.

Virtually all studies of this type originated in developed countries and their application is still used in these countries. However, some of the methods are becoming popular among academics in developing countries. In applied work, non-market values estimated elsewhere are borrowed or adapted to developing countries. This method is broadly known as benefit transfer. When applied in a developing country, the initial estimated non-market values are scaled by the difference in income per capita between two countries. This has been recognized as a controversial and unsatisfactory form of benefit transfer because it could result in large errors. A more reasonable approach is to transfer the benefit function estimated in one location in a country to a similar location in the same country or to the same location at a different time. This approach is illustrated in Chapter 6 in the context of urban development projects.