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Coastal Ecosystem Restoration
Environmental Economics
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Methods for Environmental Valuation
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Risk and Uncertainty in Environmental Restoration Programs
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Methods for Environmental Valuation

Approaches for Conducting Analysis of Natural Resource Values

Figure 1
Figure 1. Overview of approaches for conducting natural resource value analysis.

Introduction

The management of coastal areas requires the evaluation of policies concerning a broad spectrum of issues, ranging from the protection of fisheries to coral reef restoration. When implementing new actions to protect or restore aquatic ecosystems, coastal managers may need to determine whether society will be better off for having undertaken the policy or action. Due to data limitations, it may not always be fully possible to calculate societal benefits and costs of a given policy or action; however, the practice of explicitly weighing the benefits and costs of policies and actions, to the extent feasible, generally will lead to more informed decisions and better plans.

This page examines three approaches for measuring natural resource values over time, all of which are designed to inform decision-makers and assist in the technical evaluation of coastal management programs and actions: a) benefit-cost analysis, b) cost-effectiveness analysis, and c) incremental-cost analysis. The methods outlined here can be used to help select the most economically efficient restoration plan or action, measured both in terms of design and scale. The most economically efficient option, however, may not be the most politically acceptable, socially desirable, or environmentally beneficial. Therefore, these analytical methods represent important tools to policymakers, but are only part of the decision-making process.
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Benefit-Cost Analysis

Benefit-cost analysis (BCA) is an economic technique applied to public decision-making that attempts to quantify the advantages (benefits) and disadvantages (costs) associated with a particular policy or action. A BCA often requires the quantification of inputs and outputs in monetary terms, which are used to normalize and compare benefit and cost elements. In the end, the purpose of BCA is to compare benefits and costs to calculate benefit-cost ratios and net benefits. The primary objective of BCA is to determine whether society as a whole would benefit as a result of implementing a policy or action.

When completing a BCA, the results are largely driven by explicit assumptions, procedures and data used to support the analysis. This transparency enables consumers of public information to assess the accuracy of the conclusions drawn by the analysis easily. A well-executed BCA also reveals information and implications of policy actions that might otherwise not be considered. Finally, BCA allows for comparability between policy options. What otherwise would be an “apples” to “oranges” comparison between competing policy options turns into a comparison based on a single, easily comparable metric.

There are five primary steps in conducting a BCA: 1) define the policy or action, 2) describe and quantify the effects of a policy or action, 3) estimate social costs and benefits, 4) introduce a time horizon, discount benefits, and costs, and 5) compare benefits and costs. Each step is described below and is illustrated using an oyster restoration project similar to one examined in Lipton (Lipton and others 1995).
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Figure 2
Figure 2. Crassostrea ariakensis, a non-native oyster being considered for restoration in Chesapeake Bay Courtesy NOAA.

Step 1 – Define the policy or action. The first step is clearly to identify and describe the policy or action considered in the BCA. The accounting perspective of the BCA (e.g., social, private) and the boundaries of the project (e.g., national, regional, local) also must be specified. Define the objective of the project and describe how the project will meet the proposed objective. Additional elements involved in defining the policy or action include the timing of the action, location, and parties that are likely to be affected. Consider a proposed oyster restoration project involving the introduction of a non-native species of oysters (Crassostrea ariakensis) in an effort to revitalize oyster production in Chesapeake Bay (Figure 2). Oyster production in Chesapeake Bay has declined rapidly in recent years (from an average of 7 million bushels per year to less than a half-million bushels per year) due in part to the intrusion of Haplosphoridium nelsoni (MSX) and Perkinsus marinus (Derma), which are protozoan pathogens. Introducing the new species, which is resistant to MSX and Derma, could boost the local oyster harvest but could also introduce a nuisance species that could displace desirable native species.

An important step in a BCA is also defining the “without project” condition, which is critical to properly estimating benefits and costs. This is one of the most difficult tasks in a BCA and economic analysis. The “without project" condition implies certain assumptions about what would happen without the project. For example, would oysters continue to decline, stabilize, or recover, and, if so, at what rate (Figure 3)?

Figure 3
Figure 3. Oyster trends in Maryland since 1840 (adapted from Kennedy and Breisch 1981; updated by Maryland SeaGrant Extension).
Click to view this study
Figure 4. Study conducted by the National Research Council to evaluate the socioeconomic and ecological risks associated with non-native oyster introduction in Chesapeake Bay (NRC 2004).

Step 2 – Describe and quantify the effects of the policy or action. The second step effectively involves the identification of the timing and effect of input and output flows of the project. What kinds of effects should be included in the appraisal? The answer is all the direct costs and benefits of the project or action, as well as the indirect costs and benefits, including externalities, borne by third parties. Returning to the oyster restoration example, potential benefits could include increased income levels and employment, ecological benefits of reef-formation, water filtration by the oysters, and enhanced water quality. The costs of introducing C. ariakensis include disease introduction, monitoring, maintenance, and research costs. Other indirect costs include the risk of environmental injury, displacement of desirable native species, and other unforeseen ecological impacts. Many of these effects are straightforward, but the analyst may need to employ models and conduct additional scientific research to predict the environmental benefits and consequences of species introduction (Figure 4). Policy makers are also often keenly interested in nonmonetary metrics resulting from implementation of an environmental policy, such as the number of jobs created or lost, or how the policy could impact the number of recreational travelers who visit their district.
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Step 3 – Estimate Social Costs and Benefits. This step involves assigning economic values to the effects of the policy or action outlined in Step 2. The direct costs of action implementation are generally straightforward and based on previous experience with similar actions. The indirect costs and benefits of the program involve professional judgment on the part of the analyst and require the use of one or more of the valuation techniques described in the environmental valuation page of this website. Costs and benefits should be identified on an annual basis over the life of the project. In the oyster restoration example, this step involves assigning values to the aforementioned benefit and cost elements. The Office of Management and Budget Circular A-94 recommends presenting benefits and costs in real terms, adjusted to remove the effects of inflation (OMB 1992). Examples of some coastal restoration costs are presented in Table 1.

Table 1. Range of Costs for Coastal Habitat Restoration/Creation per Hectare (costs are 1997 US$) (Spurgeon 1998).
Cost
estimate 		Coral reefs Mangroves Seagrasses Salt marshes
Low 10,000 3,000 9,000 2,000
High 6,500,000 510,000 684,000 160,000

 

Step 4 – Introduce a Time Horizon, Discount Benefit, and Cost. The time horizon places a boundary on the time that costs and benefits are being examined. The length of the time horizon will depend on the nature of the policy or action undertaken. Naturally, BCA time horizons should be longer when project benefits and costs extend well into the future. Discount rates are used to compress a stream of benefits and costs into a single present value amount. Thus, present value is the sum of a stream of payments and/or receipts over time in the future, converted to the present using an interest rate. For example, a $100 benefit realized in the second year of a project would be considered worth $95 in present-value terms when a 5 percent discount rate is applied. Note that the beginning of the time horizon is not necessarily the first year in which costs are analyzed, but can be the time when the project is expected to be operational and producing benefits. To the extent that costs are incurred before the beginning of the time horizon, costs and any benefits accruing before the base year must be brought forward and inflated to base-year dollars. The oyster restoration project could entail a 20-year time horizon during which all benefit and cost elements would be quantified and potentially monetized. In turn, the annual values assigned to each benefit and cost element would be compressed based on the selected discount rate. Thus, $1,000 in ecological benefits associated with reef restoration realized in Year 10 would be valued less than $1,000 in project costs imposed in Year 1. Discount rates are discussed in more detail in the discounting and time preference page of this Web site.
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Step 5 – Compare Benefits and Costs. The final step is to compare the societal costs and benefits of the proposed policy or action. In a BCA, the present value of benefits is compared with the present value of costs to generate benefit-cost ratios (BCR) or net benefits estimates. A BCR > 1.0 (BCR = present value of benefits / present value of costs) or net present value of benefits > 0 (net present value of benefits = present value of benefits - present value of costs) demonstrates positive economic returns to society. Provided that the BCR is >1.0 or net present value of benefits > 0, the project is considered economically efficient. The greater the net present value of benefits, the greater the economic returns to society. As part of the overall oyster restoration effort in Chesapeake Bay, an evaluation of the net economic benefits of oyster reef restoration was conducted (Hicks and others, 2004). The study found that the use benefits to recreational anglers are a substantial percentage of the costs of reef restoration (estimated to be approximately $36,556 per hectare), whereas the non-use benefits are substantially higher than the costs of restoration.

For all the practical benefits of BCA, many argue on ethical grounds that the environment is a priceless good that defies economic valuation. Apart from this objection, there is the analytical problem that spiritual and intrinsic environmental values are difficult to monetize. BCA is also criticized because it fails adequately to capture the rights and needs of future generations and generally does not address equity implications of policy options. That is, who receives the benefits and bears the costs of a policy or action may be as important to decision-makers as the quantity of the benefits and costs. BCA is silent on this question unless separate BCA calculations are done for benefits and costs experienced by each group significantly affected by the policy or action.
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Figure 5 (a)
Figure 5 (b)
Figure 5. Tidal wetland construction for wastewater treatment, during and after construction Courtesy of U.S. Navy.

Cost-Effectiveness Analysis

Cost-effectiveness analysis (CEA) is a technique that is very similar to BCA. As its name implies, CEA compares the costs of alternative projects or regulations designed to achieve similar benefits. As an analytical tool, CEA is particularly useful when project benefits are not easily quantifiable, when research funds are limited, or when a specific policy goal is clearly targeted and policy options, or regulatory scenarios, are designed to meet the minimum requirements of the goal. For example, Hartwick and Olewiler in The Economics of Natural Resource Use demonstrate how CEA could be used to examine alternative options for reducing the contamination of groundwater by nitrates caused by the agricultural use of animal waste (Hartwick and Olewiler 1998). Assuming that the benefits associated with reducing these nitrates are not well known, the local government could consider three alternatives designed to meet a common set of minimum standards set forth in a waste-reduction program: a) truck animal waste out of district, b) reduce use of waste as fertilizer, and c) construct waste containers at each site. The present value costs associated with implementing the three options are assumed to be $228,800 (truck animal waste out of district), $227,900 (reduce use of waste as fertilizer), and $241,000 (construct waste containers at each site). In this example, the second option involving a reduction in animal waste as fertilizer would be selected as the most cost-effective approach for meeting the goals of the waste-reduction program.

One common application of CEA involves the examination of environmental damage linked to adverse human health conditions, particularly when the link between the environmental hazard and health impact is not clearly drawn because of a lack of scientific evidence, and the monetary benefits of the program, in terms of improved human health, are not readily measurable. Limited as it may be, CEA is an effective tool for judging the most efficient way to achieve a desirable environmental goal.
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CEA involves four main steps: 1) setting the goal, 2) identifying the alternatives, 3) performing cost analysis, and 4) selecting the least-cost alternative. Consider a community with a water supply that has been contaminated by dangerous parasites or chemicals. The community could follow the four-step procedure outlined below to address the issue.

Step 1- Set the goal. An appropriate goal would be to reduce the environmental impact of pollution on a biologically important estuary by a given (verifiable) amount.

Step 2 – Identify the alternatives. The community could identify a range of alternatives that make similar progress toward the goal outlined in Step 1, including restoring a coastal wetland for filtration purposes, expanding an existing sewage treatment facility, or building a series of upland barriers to retard runoff from feedlots (Figure 5).

Step 3 – Perform cost analysis. The costs of each scenario are analyzed for the three alternatives outlined in Step 2. The cost analysis is simple and straightforward, including all initial and recurrent costs over a defined period with the stream of costs discounted to a present value amount. A CEA approach often expresses costs in per-unit terms (e.g., cost per million gallons delivered).

Step 4 – Select the least-cost alternative. Once the costs associated with each scenario have been clearly specified, the least-cost method is chosen. This method is deemed to be the most efficient and effective solution to the community’s water supply dilemma.

The CEA approach also can be extended to examine the costs of projects at varying levels of output and determine the least-cost approach for different output levels. To illustrate this point, consider Table 2. For each level of acres of restored habitat identified in the restoration plan, a number of solutions are proposed. Total cost, total output, and average cost per acre are identified for each plan, including the no-action plan. The least-cost approach for each level of output is shaded in the table.

Table 2. Coastal Habitat Restoration – All Solutions (adapted from Orth, Robinson, and Hansen1998)

  Total Cost
($)		 Total Output
(acres) 		Average Cost
per Acre ($)
No Action Plan (no
restoration) 		0 0 --
Restoration Plan A 300,000 100 3,000
Restoration Plan B 350,000 100 3,500
Restoration Plan C 400,000 100 4,000
Restoration Plan D 640,000 200 3,200
Restoration Plan E 700,000 200 3,500
Restoration Plan F 800,000 200 4,000
Restoration Plan G 850,000 200 4,250
Restoration Plan H 1,200,000 300 4,000
Restoration Plan I 1,500,000 300 5,000
Restoration Plan J 2,100,000 300 7,000
Restoration Plan K 2,200,000 400 5,500
Restoration Plan L 2,600,000 400 6,500
Restoration Plan M 3,200,000 400

8,000

       

Incremental Cost Analysis

Incremental cost analysis examines how the costs associated with additional input change as output levels increase. Incremental cost analysis requires data to compute the change in cost (incremental cost) and output (incremental output) between each successively larger solution. Incremental cost analysis is used to differentiate between the least-cost alternatives to determine the most efficient level in terms of both output and cost. Thus, incremental cost analysis is necessary to determine the appropriate scale of the project. The information presented in Table 1 is graphically illustrated in Figure 6 to demonstrate that among the competing plans there are least-cost approaches and that those approaches vary in terms of the average cost per acre of restored habitat. Based on the output of Table 2 and Figure 6, the outcome of the CEA would suggest that Plans A, D, H and K, along with the no-action plan, should be considered for incremental cost analysis. Among these plans, Plan A could be implemented at the lowest average cost per acre (at $3,000 per acre), with the costs rising significantly as the scale of the project expands ($5,500 per acre for Plan K).

Figure 6
Figure 6. Total output and average cost of all plans.

Total and average cost information are valuable for screening alternatives and removing inefficient plans; incremental cost analysis is more useful for identifying a cost-effective output level. Returning to the example examined in Table 2, the incremental output and incremental cost of the most cost-effective plans at each level of output are presented in Table 3. In addition to the cost information previously presented, Table 3 also presents the incremental change in output, incremental change in cost, and the incremental cost per acre. These calculations can be used to help determine whether increasing the size of a restoration project is, in an informal sense, “worth it.”

Table 3. Incremental Output and Cost of Cost-Effective Plans

  Total Cost
($)		 Total
Output
(acres)		 Change in
Cost ($) 		Change
in Output
(acres) 		Incremental
Cost ($/acre) for
Added Acreage
No Action Plan (no
restoration) 		0 0 -- -- --
Restoration Plan A 300,000 100 300,000 100 3,000
Restoration Plan D 640,000 200 340,000 100 3,400
Restoration Plan H 1,200,000 300 560,000 100 5,600
Restoration Plan K 2,200,000 400 1,000,000 100 10,000
           

In Table 3, Plan A costs $300,000 more than the No Action Plan and would result in 100 acres being targeted for restoration. Thus, the incremental cost per acre is $3,000 ($300,000 / 100 acres). Restoration Plan D, in turn, costs $340,000 more than Plan A but doubles output at an incremental cost per acre of $3,400 ($340,000 / 100 acres). Expanding output to 300 acres would cost $5,600 per acre (for each of the additional 100 acres), whereas expanding output to 400 acres would cost $10,000 for each additional acre. The incremental cost and output information presented in Table 3, combined with an understanding of the importance of resource restoration and the total effects of each restoration plan, can be used to support better-informed decisions regarding the selection of restoration plans.
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Conclusion

The methods examined in this page (benefit-cost analysis, cost-effectiveness analysis, and incremental cost analysis) are used by natural resource managers to weigh the economic costs and benefits of a proposed policy or action and to select the most economically efficient action, both in terms of the design of the plan and the appropriate scale or level of output. It is important to note that the most economically efficient option may not be the most socially desirable, politically expedient, or ecologically beneficial. Thus, any method outlined on this page should be considered one, albeit important, tool used in the decision-making process.
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References

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

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

Hicks, R.L., T.C. Haab, and D. Lipton. 2004. The Economic Benefits of Oyster Restoration in the Chesapeake Bay. Final Report. Prepared for the Chesapeake Bay Foundation. Available at: http://rlhick.people.wm.edu/Working_Papers/Oyster%20Restoration%20Final%20Report%20May%2011%202004.pdf

Kennedy, V.S. and L.L. Breisch. 1981. Maryland's Oysters: Research and Management. Maryland Sea Grant College. College Park, MD. Available at: http://www.mdsg.umd.edu/oysters/research/mdoysters.html

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 Coastal Ocean Office. Silver Spring, MD. Available at: http://www.mdsg.umd.edu/Extension/valuation/handbook.htm

NRC (National Research Council). 2004. Non-native Oysters in the Chesapeake Bay. National Academies Press. Washington D.C. Available at: http://www.nap.edu/books/0309090520/html/

OMB (Office of Management and Budget). 1992. Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Program. OMB Circular A-94. Washington, D.C. Available at: http://www.whitehouse.gov/omb/circulars/a094/a094.pdf

Orth, K., R. Robinson, and W. Hansen. 1998. Making More Informed Decisions in Your Watershed When Dollars Aren’t Enough. U.S. Army Corps of Engineers, Institute for Water Resources. IWR Report 98-R-1. Alexandria, VA. Available at: http://www.iwr.usace.army.mil/iwr/pdf/98r1.pdf

Spurgeon, J. 1998. "The socio-economic costs and benefits of coastal habitat rehabilitation and creation." Marine Pollution Bulletin. Volume 37, Number 8. Pages 373 to 382.

Additional Information Sources

Arrow, K., and others. 1996. Benefit-Cost Analysis in Environmental, Health, and Safety Regulation: A Statement of Principles. American Enterprise Institute, The Annapolis Center and Resources for the Future. Washington, D.C. Available at: http://www.aei-brookings.org/admin/authorpdfs/page.php?id=203

Kopp, R., A. Krupnick, and M. Toman. 1997. Cost-Benefit Analysis and Regulatory Reform: An Assessment of the Science and the Art. Resources for the Future. Washington, D.C. Available at: http://www.rff.org/rff/Documents/RFF-DP-97-19.pdf

Turner, R., D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf. Hemel Hempstead, UK.
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