IEP 511: Environmental Decision Making

AWAYMAVE - The Distance Mode of MA in Values and the Environment at Lancaster University

Week 1 Monetary valuation of the environment and its critics 1

I. Utilitarian background to economic approaches to environmental values

Utilitarianism: The right action or policy is that which has the consequences which maximises the well-being or happiness of affected agents i.e. the best action is that which produces the greatest improvement in well-being.

a. How do you measure improvements or declines in welfare?

i. Hedonisitic utilitarianism: well-being consists in pleasure and the absence of pain. Hence the need to measure the pleasure and pain produced by different outcomes.
How?
Direct: (Bentham) – felicific calculus – direct measures of pleasures: intensity, duration, certainty, propinquity.
Indirect: (Jevons) – how much a person is willing to pay at the margin for a good is a measure of how much pleasure the person expects to receive from that good. How much a person is willing to pay to avoid a good is a measure of how much pain they expect from that good.
(Note: Bentham’s account can include non-human sentient beings in a way that the indirect monetary approach does not.)

ii. Preference utilitarianism: Well-being consists in the satisfaction of preferences, the stronger the preference then, for that person, the greater the welfare improvement given its satisfaction.
How do we measure preference satisfaction? One possibility - the strength of a person's preference for a good is measured by their willingness to pay at the margin for its satisfaction.

b. How do you decide which policy is best?

i. Hedonistic calculus: Sum the pleasures over pain for affected agents – choose the action which produces the greatest amount of pleasure over pain.
ii. Cost-benefit analysis: Compute the costs and benefits of a project through willingness to pay measures and choose the policy which maximises benefits over costs. The benefits are identified by summing the different amounts that affected individuals are willing to pay for the project, the costs by summing the different amounts affected individuals are willing to pay for the project not to proceed. The best policy is that which maximises benefits over costs.

Interpersonal comparisons of well-being - some complications.
Why cost benefit analysis?

Answer 1: because it produces the greatest improvement to overall well-being. That answer assumes you can make ‘interpersonal comparisons of well-being i.e. that you compare the gains and losses in well-being of different individuals.

Interpersonal comparisons: Many economists are sceptical about making such comparisons. Why? The argument runs something along the following lines. For some agent, Joe, with a given budget, that Joe's willingness to pay more for a beer than lemonade shows that the beer increases his welfare more than a lemonade. However, nothing can show that for another individual, Janet, with the same budget who is willing to spend more on a lemonade than Joe is on a beer, that the lemonade will produce a greater improvement in welfare for Janet than the beer does for Joe, unless one assumes an 'equal capacity for satisfaction' across the agents. Since that assumption can't be verified it should not form part of economics. Economics should avoid interpersonal comparisons in welfare.

Pareto-optimality – choice without interpersonal comparison

If interpersonal comparisons of well-being are rejected, the economist needs another way of trading off different costs and benefits without making such comparisons. The criterion used is that of Pareto-optimality. Pareto-optimality can be characterised through the idea of a Pareto improvement as follows:

• Pareto improvement: a proposed situation A represents an improvement over another situation B if some one prefers A to B but no one prefers B to A.
• Pareto optimality: a situation A is Pareto optimal if there are no possible Pareto improvements which can be made over it.

Web tip: a useful site with this on Pareto "Named after Italian sociologist and economist Vilfredo Pareto (1848-1923), Pareto optimality is a situation which exists when economic resources and output have been allocated in such a way that no-one can be made better off without sacrificing the well-being of at least one person" is here

The Pareto optimality criteria are taken to be criteria of efficiency. A point to notice about the criterion is that one doesn’t have to make any comparison between different agents in order to use it. If one is considering whether a new situation is more efficient than an old one, it is enough to know that some one prefers the new situation over the old and no one prefers the old to the new. This feature, however, makes the criteria unhelpful for actual decision making: as is clear in most environmental cases practical decision making normally involves both winners and losers, not just winners. Welfare economist introduced a variant of Pareto optimality introduced to solve the problem of making it relevant to actual choices. The variant it uses is the idea of a potential Pareto improvement and often goes by the name of the Kaldor-Hicks compensation test.

The test of efficiency to be used in practical decision making is the following compensation test:

• Kaldor-Hicks compensation test: a situation A is an improvement over B if the gains are greater than the losses, so that the gainers could compensate the losers and still be better off.

Cost benefit Analysis (CBA) is, then, presented as providing a mechanism for showing that a project passes this compensation test. The idea is that it gives one a tool for policy making that does not require comparisons in the levels of utility of different affected parties. We choose that project which produces the highest number of gains over losses.

2 questions:

Is there a good case for rejecting interpersonal comparisons of well-being?

Is the compensation test a good basis for policy making?

Initial sceptical remark:
The compensation principle is either redundant - if the compensation is actually paid then there is a real Pareto improvement and hence no need for the test - or unjustified - it is no consolation to losers, who might include the worst off members of society, to be told that it would be possible to compensate them even though there is no actual intention to do so. (A. Sen 1987 p.33)

II. Extending prices to environmental goods.

1. The absence of markets in environmental goods

(clean air, rare species, landscapes etc.). Preferences for environmental goods are not revealed in market prices. For neo-classical economics this is the source of our environmental problems: "The explanation of environmental problems as due to the nonexistence of markets is...an insight of purely neoclassical origin." (K. Arrow 'Limited Knowledge and Economic Analysis' )

Palos Verdis Blue (World's rarest butterfly)

2. Extending prices: For neo-classical economist the solution is to ensure preferences for environmental goods are revealed in market prices.

i. Bring environmental goods into actual markets though an extension of tradable property rights to environmental goods.

ii. Construct prices for environmental goods by ascertaining what individuals would pay for them were there a market.

• Hedonic pricing: Inference from some proxy good in the market such a property values an estimate a price for environmental goods
• Travel-cost: Inference from costs incurred by individuals to use an environmental amenity to estimate a values
• Contingent valuation: By asking individuals how much they would be willing to pay for a good or accept in compensation for its loss in a hypothetical market.

Monetary values can then enter into a cost-benefit analysis for any proposed projects.

III. Critics of economic valuation I: the constituency of policy

1. Basic problem: future generations and non-humans cannot express a willingness to pay for a good.

2. Response: indirect inclusion

Three values expressed in willingness to pay

a. Actual use value of good to the agent
b. Option value – the potential value of an environmental good to agents as opposed to its actual use. Preserving a system as a resource
c. Existence value – value placed on a good regardless of any actual or potential use the good may have. Eg. value placed on whales simply for their existence.

Total economic value = Actual use value + option value + existence value

3. Reply to response: Is indirect vicarious inclusion adequate?

a. Representation of non-humans and future generations is precarious. Their interests count only to the extent that current generations’ preferences include them. Only if current generations have the preferences they ought to have will they be included. – See 4 below.

Question

Can any account of environmental decision making avoid this problem?

If you can think of an example do post it to the discussion site.

b. Representation is inadequate:
i. preferences of future generations and non-humans will often be outweighed by preferences for current satisfaction.
ii. Problem of discounting (see next block for more on this)

IV. Critics of economic valuation II: the reason blindness of monetary valuation

1. Intensity of preference vs. reasons or grounds for a preference

Monetary valuation treats all preferences as on a par save in the 'intensity' with which they are held. It is blind to the reasons and arguments that individuals have for or against different proposals. Standardly, environmentalists appeal to features of the site on which a development is to take place, to its aesthetic merits, its landscape qualities, to its value as a habitat, to the variety of species it holds, to its value as a place, its history and so on. Cost benefit analysis is blind to such reasons. The strength or weakness of the intensity of a preference count, but the strength or weakness of the reasons for a preference do not. Preferences grounded in aesthetic, scientific or historical judgements about the site are treated as on a par with preferences for a particular flavour of ice-cream. They are priced and weighed with the others. Cost benefit analysis provides policy without debate.

2. Consumer preferences vs. citizen preferences (Sagoff)

Monetary valuations treat the preferences an individual has a citizen as being of the same kind as that she has as a consumer, assuming that both can be measured an individual’s willingness to pay. To do so, Sagoff claims, is to make a category mistake, confusing desires or wants with beliefs or judgements. The public ‘preferences’ an individual expresses as a citizen, are statements of belief about the good of the community which can be true or false and which are open to reasoned argument. What matters in pubic debate is not the intensity with which beliefs are held but the persuasiveness of the reasons for them. As such they cannot be captured by an individual’s willingness to pay which merely expresses the intensity of individual’s desires for particular goods that satisfy private interests. Environmental goods and bads need to answer to public democratic debate, not to mechanisms borrowed from market.

Question

How powerful is the objection that cost-benefit analysis is reason-blind?

Do think this through by creating some examples that you think would pursuade someone else that CBA is reason-blind and that that is a problem.