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p. 66 of 74 BACK | NEXT I. Introduction II. Background III. The Economic Rationale of A Project IV. Macroeconomic and Sectoral Context V. An Integrated Approach To Economic Analysis VI. Identification and Quantification of Costs and Benefits VII. Valuation of Economic Costs and Benefits VIII. Large Projects, Linkages, and National Affordability IX. Least-Cost and Cost-Effective Analysis X. Investment Criteria: Economic Viability XI. Discount Rate XII. Uncertainty: Sensitivity and Risk Analysis XIII. Sustainability of Project Effects XIV. Distribution of Project Effects XV. Projects and Policies XVI. Appendices Appendix 1: Key Questions For The Economic Analysis of Projects Appendix 2: Project Economic Rationale: Market and Nonmarket Failures Appendix 3: The Project Framework Appendix 4: Identification and Measurement of Consumer Surplus Appendix 5: Treatment of Working Capital Appendix 6: Depletion Premium Appendix 7: The Use of Constant Prices In The Economic Analysis of Projects Appendix 8: General Methodology For Building Up Project Statements Appendix 9: Economic Evaluation of Project Output and Input Appendix 10: Economic Price of Traded Goods and Services Appendix 11: Valuation of Nontraded Outputs and Inputs Appendix 12: Shadow Wage Rate and The Shadow Water Rate Factor Appendix 13: The Economic Price of Land Appendix 14: Treatment of Resettlement Components of Projects Appendix 15: Calculating Economic Prices At The Domestic Market Price Or World Market Price Levels Appendix 16: Estimating The Shadow Exchange Rate Factor and The Standard (Or Average) Conversion Factor Appendix 17: Example of An Economic Rate of Return: An Irrigation Rehabilitation Project Appendix 18: Effect On Net Foreign Exchange and Budget Flows: An Example Appendix 19: Least-Cost Analysis and Choosing Between Alternatives Appendix 20: Estimating The Economic Opportunity Cost of Capital Appendix 21: The Treatment of Uncertainty In The Economic Analysis of Projects: Sensitivity and Risk Analysis Appendix 22: User Charges, Cost Recovery, and Demand Management: An Example For Piped Water Appendix 23: Financial Returns To Project Participants: An Illustration Appendix 24: Economic Evaluation of Environmental Impacts Appendix 25: Distribution of Project Effects Appendix 26: Impact On Poverty Reduction Appendix 27: Difference Between Economic and Financial Prices Appendix 28: Use of Economic Prices In Measuring Effective Protection Appendix 29: Exchange Rate Issues In Project Analysis XVII. Others

Guidelines for the Economic Analysis of Projects : XVI. Appendices

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Appendix 24 : Economic Valuation of Environmental Impacts

I. Background

1. The methodology of integrating the costs and benefits of environmental changes in economic analysis is still evolving. Therefore, such valuation should be carried out for large or environmentally sensitive projects for which the Bank requires an environmental impact assessment (EIA).¹

2. The environment is increasingly being treated as a form of natural capital resource and therefore damaging or using the environment is in a sense similar to the use of any other form of capital. Some parts of this capital, for example, the ozone layer, cannot be replaced or substituted with manufactured capital. Valuation of these resources in the context of projects or programs is thus fundamental to the notion of sustainable development.

3. Three important conceptual problems need to be addressed at the outset. First, it is necessary to choose a technique for valuing the environmental impact of the project. Second, for all types of project it is necessary to define the boundary of the analysis. Since most environmental impacts include externalities, how far to expand economic analysis is an important issue. For example, in dealing with the impact of waste water, boundaries for downstream effects need to be agreed upon; should it include the area affected immediately or go beyond to account for impacts on irrigation, fishing, and drinking water far away and often beyond the national boundaries. Third, it is also necessary to define an appropriate time horizon. A number of impacts are immediate or within the life of the assets of the project under consideration, whereas there are effects also beyond the project life. For those cases where impacts go beyond the project life, an extended analysis covering the time period for the environmental impact can be attempted, or, alternatively, the concept of capitalized value of net benefits at the end of the project life can be included, a form of salvage value.

4. The net present value (NPV) of a project is an appropriate criterion to compare the without and with project environmental impacts. Any time, discounting criteria will depend on the choice of the discount rate, which could reflect the opportunity cost of capital or the social rate of time preference. Only one discount rate should be used for any single economic analysis. However, for the Bank discount rate of 10 to 12 percent many long-term environmental impacts tend to become insignificant. Where environmental impacts may extend beyond the life of other project effects, the environmental impact analysis can be combined with a sensitivity analysis for the discount rate, based on a lower rate. If, from the societys point of view, individuals overconsume environmental resources in the present, the discount rate based on societys time preference would be lower than market-based discount rates. In such circumstances, NPVs for without and with environmental impact values can be examined at alternative discount rates.

II. Initial Screening Process

5. Environmental impact assessments provide the basic information on the physical impacts of different types of stressors as a result of undertaking a project. Using this information, a four-step screening is envisaged as given in Figure 1 to identify major impacts that require quantification. Many potential impacts may not be possible to translate into quantitative terms because of either insufficient data or uncertainty attached to these impacts. A detailed qualitative assessment should be provided in these cases. Following the screening process, it is expected that a list of environmental impacts that require further analysis and quantification, is prepared.

III. Types of Environmental Impacts

6. Different types of environmental stressors impact on different aspects of the environment. Table 1 provides an illustration of major stressors, the potential impact on the air, water, and land, and in three other areas: human health, human welfare, and environmental resources. The human health effects include both mortality and morbidity impacts; for example, environmental changes can be associated with death or increased probability of death, or a higher incidence of illnesses like cancer, malaria, or respiratory disease. Human welfare impacts include damage to property, visual or noise impairment, traffic congestion, changes in soil productivity, changed patterns of recreational uses, loss of homeland, forced relocation, and effects on cultural or religious beliefs. The final category of impacts are on environmental resources, for example, on coastal areas, freshwater ecosystems, biodiversity, and global systems.

Table 1. Taxonomy for Evaluating Potential Impacts of Environmental Stressors

Click to enlarge table

IV. The General Approach to Valuation

7. Environmental impacts can have both use and nonuse values. Use values can be further divided into direct use value, such as natural parks where individuals are willing to pay for the use; indirect use value where these benefits are derived from ecosystem functions such as mangroves; and option value where individuals are willing to pay for avoiding irreversible change. There are a number of primary valuation methods that are used to value environmental impacts. Table 2 provides a summary of these methods and their underlying basis. Two distinct approaches are used for valuation: objective valuation approaches and subjective valuation approaches. In the first approach, damage functions based on technical relationships between environmental stressors and the degree of physical damage are estimated. In the second approach, assessments are made of possible damage expressed or revealed in market behavior. When these values cannot be assessed from direct behavior, surveys are used, such as in contingent valuation methods to assess willingness to pay from a representative sample of people and organizations.

V. The Benefit Transfer Approach

8. The primary research on project specific conditions is resource intensive and requires a long lead time. Given the data, time, and budget considerations, an alternative method to value environmental impacts in projects is suggestedthe benefit transfer approach. The benefit transfer approach essentially uses the primary research data generated elsewhere for valuing impacts after adapting such values to the economic valuation of a given project. If the analysis based on this approach affects the project decision, more site specific information could be gathered, and primary research carried out, wherever feasible, to validate the analysis.

9. The approach to valuing environmental impacts using benefit transfer involves three major steps. The first step is to select the appropriate literature given in look-up tables to find reference values and major assumptions regarding the valuation and country conditions. A sample look-up table is presented in Table 3. The evaluator needs to select the most appropriate literature from these tables and a range of values that have been derived from primary research carried out in other country conditions.

10. The second step is to adjust these values to the location-specific conditions. It is often found that this step involves a lot of subjectivity. It is important to correct for differences between assumptions, such as income, level of human development, wages, cost of time, or price levels, since most primary research studies are carried out in the developed countries. EIAs normally provide information on the baseline conditions. For example, the findings of primary research on the health-related impact of vehicular pollution in urban areas in the United States, when used in the context of other cities like Bangkok, can result in an underestimate if used directly to value environmental impact. It is prudent to document the actual adjustments made from the reference values to project specific conditions and the underlying logic. Finally, using an appropriate range rather than one unique number represents the uncertainties of benefit transfer.

11. The third and final step is to set these values in the context of the economic analysis framework; values need to be adjusted to economic prices to make these values consistent with other values used for the economic analysis of the project. In particular, environmental costs and benefits need to be expressed using the same numeraire as for the project economic analysis. Where the economic analysis uses the world price numeraire, and environmental effects are valued in domestic market prices, the environmental costs and benefits will have to be revalued using a specific or the standard conversion factor.

* = in 1990 US dollar.
WTP = willingness to pay

VI. Conclusions

12. There are a number of important issues that need to be kept in view while valuing environmental impacts. First, most primary research is carried out in developed countries and until data and information based on primary research in developing country conditions are available, recorded values can only provide an approximate range. Second, there is a great deal of uncertainty attached to these values. Therefore, the analysis should be carried out in the context of dealing with uncertainty facing the project. Third, for projects with possible large environmental impacts, additional resources should be devoted for data collection and validation of primary research data. Finally, the evaluator will need to explicitly state omissions and subjective judgments in a transparent manner for an informed decision.

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¹ This appendix is based on the Economic Valuation of Environmental Impacts: A Workbook, 1996, Office of the Environment and Social Development, Asian Development Bank.

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