### Grant McDermott

Assistant Professor
Dept. of Economics
University of Oregon

# Putting a price on nature (I)

George Monbiot has produced another thought-provoking column this week. However, rather than take his fellow greens to task for their irrational and self-defeating opposition to nuclear power, his latest effort decries the UK Government's "well-intentioned" attempts to put a price on its natural heritage:

Last week, the Department for Environment, Food and Rural Affairs announced the results of its national ecosystem assessment, a massive exercise involving 500 experts. The assessment, it tells us, establishes "the true value of nature… for the very first time". If you thought the true value of nature was the wonder and delight it invoked, you're wrong. It turns out that it's a figure with a pound sign on the front.

[... The problem with the report] is that it delivers the natural world into the hands of those who would destroy it. Picture, for example, a planning enquiry for an opencast coalmine. The public benefits arising from the forests and meadows it will destroy have been costed at £1m per year. The income from opening the mine will be £10m per year. No further argument needs to be made. The coalmine's barrister, presenting these figures to the inquiry, has an indefeasible case: public objections have already been addressed by the pricing exercise; there is nothing more to be discussed.[...] Cost-benefit analysis is systematically rigged in favour of business.
Given that a large part of any environmental economist's job is about trying to "put a number" on nature, I obviously have some skin in this game. I'd therefore like to make a few comments that hopefully add context to the discussion. In particular, I hope to partly assuage George's fears and counter some mistaken views that he has regarding economic valuations of the environment.

All right. Let's have a look at the rationale and methodology that underpins environmental assessments from an economic perspective:

The area under discussion here is known as non-market valuation. It forms one of the more ambitious arms of environmental and resource economics, as it tries to understand the additional value of natural goods and services (i.e. beyond what is indicated by the explicit market price). While inherently difficult, the profession has developed a range of methods and tools that make things more tractable and, ultimately, realistic. This includes 1) hedonic pricing, 2) contingent valuation, 3) shadow price estimates, and several other approaches. Each method has its own particular short-comings (and strengths), but together they offer a reasonable framework towards understanding the value of nature in economic terms. Further, I should say that the purpose is to gain a sense of nature's value in terms of its direct contribution to our productive activities, as well as in situ (i.e. its natural state).

The important thing that I'm trying to convey here is that the methods used by environmental economists cater for both objective and subjective forms of valuation, and across multiple dimensions. For a more in-depth breakdown of non-market valuation methods, as well as a discussion of the broader policy implications, two good references are Harris, 1996 (specifically section 4.2) and Stavins, 2004.

My broader point is that, as much as they want to, environmentalists can't simply play the "nature is beyond valuation" card at their leisure. This only serves to seal off the debate and, whether we like or not, it is vital to understand what the monetary worth of something might be; even if that does not capture all of the value at stake. Indeed, I would say that economic valuation of the environment isn't meant to be the final word on the subject and one certainly shouldn't make that claim.[*]

An analogy: It may be scant comfort for a widow that she receives a life insurance policy in the event of her husband's death. She would presumably trade them instantly if she could. However, at least she does not have to want for material necessities or comforts in his absence.

To be sure, monetary valuation is an imperfect way of evaluating environmental trade-offs, but a vital one. For one thing, it provides a way to compare very different goods in terms of a common measurement unit (i.e. dollars and cents). Rather than the be-all-and-end-all, economic estimates of nature's monetary value are meant to serve as guides that can help to inform public (and private) opinion. Of equal importance is the fact that these estimates provide a figure for economic agents $$-$$ whether firms or individuals $$-$$ to benchmark against when it does come to paying for certain environmental goods. As an example, I have argued numerous times on this blog that water needs to be priced better (i.e. according to market forces) if we are going to use it more responsibly. Understanding how much a litre of water is "worth" to a power firm in producing a unit of electricity (because of cooling purposes), or a textile mill that produces cloth (for cleaning and spinning), provides the crucial foundation from which either of these can set about defining their subjective marginal values. And that is the first step towards establishing a price level that will ensure sustainable usage.

A final point on this issue $$-$$ and one where I think George is missing something very important $$-$$ is that valuation is not meant to be static or linear. It's simply not the case that (using George's example) a forest or meadow will be valued at a constant ratio of 1:10 against a potential coal mine into perpetuity. It all depends on what happens to the other forests and meadows around the country. In particular, as some forests are cut down, the value of all remaining forests will rise. This is the real beauty of the price mechanism: it adjusts with increasing scarcity. And, as I have written previously, accounting for such changes in the relative price of environmental goods provides one of the strongest economic arguments for decisive action against man-made climate change.

All of this is not to say that relative prices will necessarily and always adjust to reflect the true, intrinsic value of nature. Pure market transactions can impose a bias against conservation that is intrinsic, but easy to forget. My next post will try to flesh out this point in greater depth.

UPDATE: Part II is here.

[*] Having read through some of the UKNEA report, I think that it does err on the right side of this divide. The clumsy (though convenient) headline claims are tempered by the context provided in the actual research of the report.