Coastal Services Center

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Social Value versus Economic Impact: Measuring Equity and Efficiency in Environmental Policymaking

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Introduction

Figure 1. Overview of equity and efficiency in policymaking.

Coastal habitat restoration can result in additional wages or taxes earned resulting from an increase in tourism and fisheries harvest. The harvesting, marketing, and consumption of a natural resource generates income and jobs in other industries as the income earned from enhanced harvests ripples through the economy. Then secondary economic impacts occur as the businesses harvesting the natural resource buy products from local suppliers and purchase transportation and other services from local companies. In turn, those companies and their employees increase their local purchases. These economic impacts must be considered when weighing the benefits of an environmental action or policy.

But do these primary and secondary economic impacts capture the social value of a project to a region or is social value captured using other methods? Are both social benefits and economic impacts important, and how are they measured? This article tackles this question of social value versus economic impact, discusses how each is measured, and examines how both measures are needed to assess a proposed environmental action or policy in terms of both efficiency and equity.
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Efficiency versus Equity

Economics is concerned with the allocation of scarce resources among competing uses. There are two aspects to the allocation of scarce resources for achieving value: efficiency and equity.

Efficiency is concerned with producing the greatest total social value (as determined subjectively by individuals and as measured by economists either in markets or by using non-market methods) for the least possible social cost. Efficiency is achieved when all resources are in their most productive use (production efficiency), no mutually beneficial trades of goods and services are possible (exchange efficiency), and net value is maximized. No reallocation of resources or consumption can result in an increase in total value net of cost.

Equity is concerned with the relative distribution of value and resources among individuals and groups in society according to notions of fairness and justice and interpersonal comparisons of utility.

Both efficiency and equity matter to policy makers, so in the public policy arena, tradeoffs are frequently made between solutions involving more efficient uses of resources and those producing more equitable ones. Related to the notions of efficiency and equity is that of social welfare and a concept called Pareto efficiency, named for the Italian economist Vilfredo Pareto ( 1848-1923). If no reallocation of resources or trade of goods and service can be made that increases value to some individual without anyone else being made worse off, the situation is Pareto efficient. However, a Pareto-efficient solution may be seen as inequitable (not increasing social welfare) because of an unfair initial distribution of resources or some other reason, so Pareto-efficiency is a necessary but not sufficient condition for maximum social welfare. Economists use different types of analyses to measure efficiency and equity.
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Figure 2. The Exxon Valdez oil tanker during oil spill in Prince William Sound, Alaska (photo courtesy of the Exxon Valdez Oil Spill Trustee Council).

Social Benefits versus Economic Impact Analysis and Equity Analysis

Social benefits, often measured through benefit-cost analysis (BCA) and/or cost-effectiveness analysis (see Approaches for Conducting Analysis of Natural Resource Values), are concepts related to the efficiency of policies and actions. BCA and cost-effectiveness analysis are methods designed to help determine whether social value and social welfare is increased in a Pareto-efficiency sense by a given action. BCA, for example, estimates the increase in value to society (measured in markets or by non-market methods) produced by some action, such as restoration of a wetland, net of the costs necessary to achieve the restoration. As noted in the page on this Web site dealing with the methods for measuring natural resource values over time, the primary objective of BCA is to determine whether society as a whole would benefit as a result of implementing an environmental policy or action. To answer this question, BCA weighs the social benefits and costs of an environmental action and determines whether the gains outweigh the losses. BCA is, therefore, primarily concerned with determining the most economically efficient option.

Among the resources appearing on the cost side of the ledger are factors of production, such as the capital and labor, used in restoration activities. These factors of production are concerned with how much of the cost of restoration is paid to them in compensation, i.e., their “share” of the activity. Economic impact analysis thus is closely related to equity analysis. Economic impact analysis applied to, for example wetland restoration, measures the aggregate change in economic activity (measured by wages paid, jobs, value of sales, and other factors) associated with the restoration. This analysis often is done at the regional level to determine what the regional “share” of activity was. Economic impact analysis examines all economic activity in markets tied to a project and answers the questions of 1) how much economic activity (e.g., income, jobs, output) was generated in a region, 2) who, specifically, gains from implementing the plan, and 3) who are the expected losers from plan adoption and what is the magnitude of the gain or loss. The impact is approximately the sum of resource costs and producer surplus.

The difference between social welfare or economic efficiency on the one hand and economic activity on the other can be seen most clearly when society suffers a large loss as a result of an environmental or natural disaster, and then society undertakes a recovery program. To bring this point into perspective, consider the Exxon Valdez oil spill on Prince William Sound, Alaska (Figure 2). The spill itself clearly produced a large loss of economic wealth and environmental value, which is counted as a social welfare loss. (It also resulted in a large loss in economic activity related to fishing in particular, which is not in itself a welfare loss, but a resource savings.) The social welfare loss would be measured as the market value of the fish, recreation services, and non-market values associated with the damage, less the value of fuel, wages, boat depreciation and other resources no longer expended in pursuit of the damaged resources.

The restoration of Prince William Sound resources resulted in a cleaner environment and probably an improvement in social welfare relative to a situation with no cleaning up, but this return to a higher level of value would be measured in market value of restored resources and by extensive use of non-market methods. On the cost side, cleaning up the oil spill generated a great deal of economic activity in Alaska , including construction, maintenance, and environmental cleanup, not to mention economic research and legal fees (Figure 3). Society clearly did not benefit as a result of the spill. Society was worse off than if the spill had never happened, largely due to the lost recreational opportunities, long-term impact on the local fishery, reduced non-use values, and ecosystem damage; however, the economic impact on the Alaskan economy of the cleanup and restoration activities (which were basically a cost to society as a whole and necessary to restore some of the lost Prince William Sound environmental values) was positive.

Figure 3. Clean-up crew hosing down the oiled beach after the Exxon Valdez oil spill and picketers from the seafood processing industry protesting a shortage of work at Exxon Headquarters (photos courtesy of the Exxon Valdez Oil Spill Trustee Council).

The discussion up to this point begs the question: What matters to economists, economic activity or social benefits? The answer is that both have their role in policymaking. Benefit-cost analysis measures economic efficiency and changes in welfare by quantifying in dollars the advantages (benefits) and disadvantages (costs) associated with a particular policy or action. Economic impact analyses assess changes in total economic activity generated by a policy or action along with its distributional effects among competing groups. Both economic activity and social benefits are relevant and complement one another.

The information requirements of each method outlined in this article are quite similar. There are, in fact, economic models (general equilibrium models) that can be designed to simultaneously measure the impacts of an environmental policy or action included in all three forms of analysis. It is, therefore, essential to ensure consistency in the assumptions and data used to support each analysis. Each analysis should use the same scientific information and baseline assumptions regarding discount rates, time horizon, and elasticity assumptions, although elasticity assumptions may vary based on equity analysis subgroups. Because economic impact analysis and equity analysis examines a broader array of economic activity and extends the analysis to subpopulations, an additional set of assumptions is needed to support the complexity associated with those forms of analysis.
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Economic Impact Analysis (EIA)

In regional economics, industries with markets outside of the region are called basic industries, whereas those with markets within the region are called secondary or support industries (Scott 1984). The economic impact to basic industries is generally called the primary impact, whereas those accruing to support industries are called nonbasic or secondary impacts. Thus, when there is an increase in earnings or employment in basic industries, there is a resultant and predictable increase in secondary industries. The ratio of the activity’s total impact on the region’s economy and its impact on basic industries is known as the multiplier effect. For example, suppose that a coastal restoration program resulted in increased commercial harvesting of fish. The total economic impact of expanded fish harvesting, including the secondary economic impacts on local companies and employees, is a measure of economic activity levels, not social value. It measures the total spending created by the new economic activity but fails to capture the value of the consumer surplus associated with the harvested fish and the resource costs necessary to harvest the fish (labor capital, fuel and other materials, along with environmental effects).

The Unfunded Mandates Reform Act of 1995 and Executive Order 12866 require federal agencies to examine the economic impacts of regulatory actions. An EIA enables federal agencies to comply with these mandates by measuring how a change in a policy or market condition affects income, output, employment, or expenditures in a region or economic sector (Letson and Milon 2002). Further, it measures changes in economic activity across sectors of the economy (e.g., industries by standard industrial classification codes) to identify the winners and losers of an environmental policy or action and the magnitude of the win or loss. EIAs include both the direct impacts on the basic industries and the secondary effects on support industries, as well as the impact on local government in terms of expenditures and additional tax revenue.

An EIA differs significantly from a BCA in that it does not account for the value of what is given up to achieve the measured level of economic activity, nor does it measure the opportunity cost of the activity. For example, an economic impact analysis of sport fishing does not examine how the recreational fishermen would respond if a moratorium was imposed on the fishery. Would they go golfing or travel to other coastal areas to go bird watching? Or would they simply stay home? Furthermore, it places no economic value on the non-use values of environmental resources, such as the spiritual benefits obtained when viewing scenic sunsets or the existence benefits individuals enjoy just knowing that coastal areas exist.
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Florida Keys Tourism Example

An example that illustrates the use of EIA is the economic contribution of the Florida Keys to the tri-county area of Broward, Dade, and Monroe counties in South Florida (Figure 4; Letson and Milon 2002). An EIA conducted for the South Florida region used an input-output model called IMPLAN to estimate the impact of visitor spending on income, output, and jobs generated in both primary (direct spending) and secondary (indirect spending) industries.

This definition of the multiplier effect is taken from economic base theory as provided by Scott (1984).

Figure 4. The Florida Keys are a popular destination for tourists (photo courtesy of NOAA).

Figure 5 presents the findings of the South Florida EIA. This study found that visitors spent roughly $1.67 billion annually while visiting the Florida Keys. After subtracting $400 million in inputs purchased outside the study’s geographic area (e.g., souvenirs purchased outside the region and resold to tourists, beef shipped in from outside the region and served in restaurants), the $1.67 billion in expenditures generated $1.27 billion in direct output, $753.28 in direct income, and created 14,493 regional jobs. The indirect impact on secondary and support industries was estimated at $1.7 billion in output, $1.1 billion in income, and 13,329 additional jobs. The total economic contribution of the Florida Keys to the region’s economy was, thus, estimated at $2.94 billion in total output, $1.69 billion in total income, and 27,822 jobs created (Letson and Milon 2002). However, although useful to policy makers who care about the level of employment and income of their constituents, tax yields, and the like, such values do not measure the efficiency benefit of tourist activity. For example, a significant part of the $1.27  billion direct output and $1.7 billion indirect output in the example represents real costs of labor, capital, and raw materials that are normal costs of production, not social welfare or efficiency benefits. Society only gains welfare to the extent that these commitments of resources produce more value when committed to the tourism industry than they would in their next best use.
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Figure 5. Economic impact of visitor spending at Florida Keys in South Florida (Adapted from Letson and Milon 2002).

Equity Analysis

As noted in the previous section, EIAs fail to capture how much a society gains or loses from an environmental policy or action. EIAs do, however, give resource managers and policy makers a better understanding of the distribution of consequences across sectors. Economic impact measures, such as changes in employment and income among various socioeconomic groups, examine the effects of a policy or action in terms that are of direct interest to elected officials, resource managers, and interest groups. Thus, there is demand for EIAs.

Equity assessments examine the impact of a regulation, policy, or action on subpopulations. More specifically, equity analyses generally consider the effects of environmental policy on disadvantaged or vulnerable subgroups of the population, including individuals who are more physically vulnerable to environmental hazards, minority groups, economically disadvantaged groups, children, and small businesses. Equity analysis aids in the protection of these groups, which are not fully capable of protecting their own interests.

Equity analysis enables policy makers to examine the impacts of a regulation, policy, or action on the distribution of wealth within a region. When used together with BCA, equity assessments also enable an examination of the tradeoffs between economic efficiency and equity. This analysis arms the resource manager or policy maker with an important tool in examining an environmental policy or action according to a broader set of decision criteria.
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Conclusion

This article discussed the concepts of social value and economic impact and concludes that an EIA is a useful tool in determining the total impact of an environmental policy or action, including indirect impacts on secondary industries, on a region. However, since EIA fails to capture what is given up to generate the activity or what is forgone as a result of that activity, it measures only economic impact without considering its social value.

The primary goals of EIA and equity analysis should be considered complementary, rather than at odds with, the objectives of BCA. EIA and equity analysis used in conjunction with BCA allows resource managers and policy makers to examine the consequences of an environmental policy or action according to a broader set of criteria, and enables them to assess the tradeoffs between equity and efficiency when considering competing alternatives.
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References

Letson, D., and J. Milon. 2002. Florida Coastal Environmental Resources: A Guide to Economic Valuation and Impact Analysis. Florida Sea Grant College Program, University of Florida. Gainesville, FL.

Lipton, D., and others. 1995. Economic Valuation of Natural Resources –A Handbook for Coastal Resource Policymakers. NOAA Coastal Ocean Program Decision Analysis Series 5. NOAA Costal Ocean Office. Silver Spring, MD. Available at: http://www.mdsg.umd.edu/Extension/valuation/handbook.htm

Meyer, P.A., and others. 1995. Elwha River Restoration Project Economic Analysis: Final Technical Report. Presented to: The U.S. Bureau of Reclamation, The National Park Service, The Lower Elwha S'Klallam Tribe. Davis, California. Available at: http://www.nps.gov/olym/elwha/docs/econanaly.htm

Scott, M. 1984. A Fishery’s Guide to Understanding Secondary Economic Impacts of Northwest Salmon and Steelhead. Paper presented at Making Economic Information More Useful for Salmon and Steelhead Decision, a workshop sponsored by National Marine Fisheries Service, July 24-26, Seattle, Washington . NOAA Technical Memorandum NMFS F/NWR-8, National Marine Fisheries Service. Portland, Oregon.
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Additional Information Sources

*Some of the documents below are in Adobe portable document format (PDF) and requires Adobe Acrobat Reader.

Cole, R., and others. 1996. Linkages Between Environmental Outputs and Human Services. IWR Report 96-R-4. U.S. Army Corps of Engineers. Alexandria, VA. Available at: http://www.iwr.usace.army.mil/iwr/pdf/96r04.pdf

Environmental Protection Agency. 2000. Guidelines for Preparing Economic Analyses. EPA 240-R-00-003. Washington, D.C. Available at: http://yosemite.epa.gov/ee/epa/eed.nsf/webpages/Guidelines.html/$file/Guidelines.pdf

Harrington, K., and T. Feather. 1996. Evaluation of Environmental Investments Procedures: Overview Manual. IWR Report 96-R-30. U.S. Army Corps of Engineers. Alexandria, VA. Available at: http://www.iwr.usace.army.mil/iwr/pdf/96r30.pdf

Hartwick, J., and N. Olewiler. 1998. The Economics of Natural Resource Use. Addison Wesley Longman. New York, NY.

Higgins, M., and T. Ardito. "Rhode Island Restoration." [Web site]. Available: www.edc.uri.edu/restoration/index.htm

National Oceanic and Atmospheric Administration. 2000. Habitat Equivalency Analysis: An Overview. Damage Assessment and Restoration Program, National Oceanic and Atmospheric Administration. Silver Spring, MD. 23 pp. Available at: http://www.darp.noaa.gov/library/pdf/heaoverv.pdf
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