Challenges in Economic Evaluation of Environmental Impacts

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Evaluation Issues

Proper evaluation of environmental impacts requires that a number of conceptual issues be carefully considered. These include the correct understanding of environmental cost, choice of valuation technique, setting the time horizon, assessing distributional impacts and inter temporal issues, and evaluating risk, uncertainty, and ethical considerations. These are discussed in the chapter’s first section and the last section concentrates on anthropocentric element in the economic evaluation of environmental impacts.

Environmental Cost

Environmental externality costs from a productive or consumptive process can be identified as the cost resulting from the provision of a resource, which can be passed on to a third party. These costs are not incorporated into the price of productive or consumptive resource, and can cause damages to human health, human life, materials and ecosystems. For clarification, it should be noted that this cost is not equivalent to the cost to the government or the cost associated with meeting social obligations in production or consumption of the resource (e.g., compliance with environmental standards resettlement, etc.). Although there could be a similarity, environmental cost is different from the well-known dead weight loss due to interventions in any market. The environmental cost is a form of social cost due to the non-existence of markets, while dead weight loss is due to intervention in the proper functioning of a market.

Environmental externality costs can occur despite complying with all national rules and regulations. Therefore, meeting environmental Challenges in Economic Evaluation of Environmental Impacts standards does not mean that there is no unaccounted environmental cost. The cost of compliance is likely to be included as part of the base cost—hence is treated as a financial cost. There should be no confusion between the two types of costs. Environmental externality cost can be defined as a social cost and it is not reflected in resource prices. Although this cost decreases as a function of improved technology, studies have shown that it still amount to a significant proportion of current resource prices.

Taking the energy sector as an example, it is the general practice in many countries to set electricity regulations and standards to select demand and supply-side least-cost options. Often, when utilities develop their least cost plans, these approaches do not consider the social cost or cost of environmental externalities. There is a possibility to include cost of regulated externalities. However, not all emissions are regulated, and in such cases, prices reflected in the market are inefficiently low and quantities sold in the market are inefficiently high. If the externality is to be positive, the price and quantity relationships work in opposite directions. Therefore, the basis of internalizing environmental externalities is an attempt to recapture some of the unpriced externalities to the resource prices.