Mitchell Mathis

Houston Advanced Research Centre (HARC)

What is the value of nature? Philosophers, ethicists, theologians, and a wide spectrum of social and even natural scientists have responded to this question with a variety of answers based on an equally varied set of frameworks and approaches. These responses are often categorized as either "anthropocentric," in which value is derived from some form of interaction with humans, or "biocentric," in which nature and the organisms of which it is comprised have intrinsic value apart from humans, and where humans are no more or less valuable than any other organism. The response by the field of economics falls within a specific anthropocentric approach known as "utilitarianism." From the perspective of the utilitarian approach, nature has value insofar as it yields benefits or satisfaction to humans. Thus, the notion of ecosystem services - that is, the wide array of processes, functions, and resources provided by the ecosystem that benefit humans - fits squarely within the utilitarian approach to value.8

Ecosystem services are closely linked with the existence of "natural capital," discussed in Section 4.5, in much the same way that interest income is linked to a financial asset. In either case, a given amount of the asset, sometimes generically referred to as "the stock," generates a certain flow of benefits, while increasing or decreasing the amount of the asset, which, in turn, changes that asset's capacity to generate benefits.

As the many beneficial functions provided by the ecosystem become better understood, and as the nonmarket benefits the ecosystem bestowed upon humans become more widely appreciated, significant research attention has begun to focus on the economic value associated with ecosystem services (Costanza et al., 1997; Daily, 1997).

As with markets, economics generally defines the benefits that nature provides in terms of goods and services. Some of these goods are inanimate, such as water, rock, oil, and minerals; others are the result of living ecosystems, often referred to collectively as "ecosystem services." These beneficial ecological functions include the provision of renewable natural resources such as fish and timber, as well as a host of other valuable services ranging from erosion and flood control, to pollination, to the mitigation of a wide range of pollutants, to the provision of scenic beauty. The flows of services provided by the ecosystem can be categorized into four types: (1) raw material used as production inputs, (2) life support, (3) recreational amenities and aesthetics, and (4) waste assimilation (Freeman, 1993). Many of the goods, and most of the services that nature provides, are conferred directly to their human beneficiaries by nature, without passing through markets.

8DeGroot et al. (2002) establish categories of ecosystem functions that yield ecosystem services. These include regulation of ecological and natural processes, habitat, production, and information.

Because markets for many, if not most, ecological benefits do not exist, no market prices exist to reflect their use or nonuse values. The absence of a price is not inherently undesirable; however, the lack of a price to indicate the economic value (or loss of value) of such ecological benefits makes it difficult to incorporate these benefits into planning and decision-making processes. Consequently, many of the valued natural resources and ecological services provided by nature "for free" are overlooked and are undervalued in both the private and public sectors.

Over the past half century, the field of economics has developed a rich and extensive literature that advances the theory and methodology of estimating values associated with the myriad unmarketed yet economically valuable benefits provided by nature. While the literature is vast, the number of approaches available to estimate the economic value of ecosystem services remains limited to only a handful, each with its own strengths and weaknesses (for comprehensive reviews, see Mitchell and Carson, 1989; Freeman, 1993; Smith, 2000; Mathis et al., 2003). These include replacement costs and avoided costs analysis, factor income analysis, hedonic pricing, contingent valuation, and travel costs analysis. A discussion of these approaches follows later in this section. Although there is often considerable debate about the methods used and the accuracy of the values derived, there is little doubt that the unpriced economic value of ecosystem services is enormous.9

6.2.5.1 Economic Value. Considerable confusion often exists regarding the terms "economic value," "market value," and "market price." Each of the terms refers to quite different concepts, but they are nonetheless often mistakenly used interchangeably. Thus, before moving forward with the discussion of the economic value of water to sustain the ecosystem, it is useful to discuss what is meant by the term "economic value." Economic theory contains a number of concepts pertaining to value. Some of the most fundamental of these notions are represented in Figure 6.17, which presents a simple depiction of a "market" in which the consumer and the producer interact to generate an equilibrium price, P*, and a quantity, Q*. This familiar graph contains a variety of important information regarding economic value, derived from certain characteristics of consumers and producers, and the relationship of these characteristics with the market.

Marginal Costs and Marginal Willingness to Pay. Consider first line segment AB, which maps out the consumer's "marginal willingness to pay" for each successive unit of the goods in question to form the "demand curve." Its downward slope reflects "decreasing marginal utility," that is, the notion that the value to the consumer of each successive unit of the goods decreases the more units of the goods the individual obtains. This line is also often referred to as the "marginal benefits" curve. Turning now to the producer (the firm), consider line segment CD. This line

9Costanza et al.'s work on "The value of the world's ecosystem services and natural capital" in 1997 sparked an array of debate over valuation methodology as well as its usefulness. Ecological Economics, April 1998, was dedicated primarily to the valuation of ecosystem services and a response to Costanza's article that had appeared in Nature.

Quantity

Figure 6.17. Framework of economic value.

represents the firm's "marginal costs," that is, the costs associated with producing each successive unit of the good. The marginal cost curve's upward slope reflects the idea that firms will utilize "low hanging fruit" first, and as more units of the goods are produced, accessing "fruit higher in the tree" increases the cost of production. The marginal cost curve is also the foundation of the familiar "supply" curve.

Market Price. When the consumer and producer come together with "mutual coincidence of wants" to form a market, the consumer will accept a price no higher than his willingness to pay, and producers will accept a price no lower than their cost of production (willingness to sell). The equilibrium market price P* occurs at the number of units Q* where the marginal benefits to the consumer equal the marginal costs to the producer. In other words, price simultaneously matches the consumer's willingness to pay and the producer's willingness to sell, thus "clearing the market"; that is, at (P*, Q*) there is no gap between marginal willingness to pay, marginal willingness to sell, and the market price. No trades for additional units of the goods will occur because the price exceeds the consumer's willingness to pay, and falls below the producer's marginal cost. It is important to recognize that the market price P* reflects only the value of the last unit Q* exchanged in the market, and this value is identical for both the consumer and the producer.

Because the market price increases or decreases according to changes in supply and demand - for example, a decrease in supply or increase in demand will both lead to a higher price - price is relied upon as an indicator of economic scarcity, and is sometimes even referred to as "scarcity value." The scarcer the goods, the higher the price, and vice versa.

Economic Surplus. For each unit exchanged in the market previous to Q*, a gap exists between the consumer's willingness to pay, the producer's marginal costs of production, and the market price at which those units were exchanged. The difference between the consumer's marginal willingness to pay curve and the producer's marginal cost curve for each successive unit of the goods is referred to as "marginal surplus" (or marginal net benefits). This marginal surplus is divided between the consumer and the producer. For each unit, the consumer surplus is the amount by which his willingness to pay exceeds the market price, while the producer surplus is the amount by which the market price exceeds the marginal cost. Total consumer surplus is found by summing up the marginal consumer surplus for each unit of the goods up to Q*, and is represented in Figure 6.17 by shaded triangle I. Similarly, total producer surplus is represented by shaded triangle II. Total surplus is the combination of both consumer and producer surplus, represented by both shaded triangles, and can be viewed as the total net benefits to society achieved by the production and consumption, sale and purchase, of Q* quantity of the goods. In the standard neoclassical economic model presented here, it is total surplus that is typically used as the representation of economic value. Total benefits, that is, economic value, are maximized at the point where marginal benefits (willingness to pay) are equal to marginal costs, and the market outcome is said to be "efficient" because no further trade can be made that increases these total benefits. The maximization of total benefits is one of the fundamental objectives of the economic decision-making process.

Observe that economic value, defined as total surplus, is not the same as market value. Market value is simply the producer's revenue - the number of units sold, Q*, multiplied by the price, P*. While market value includes the producer surplus, represented in Figure 6.17 by triangle II, it also includes the cost of producing Q*, represented by area III. Moreover, it does not include any surplus that accrued to the consumer (triangle I).

It is also important to distinguish between economic value and "economic impact." Economic impact is a broad concept often used to understand the "pros" and "cons" of changes associated with implementing a project or policy, in terms of the economic system that is affected. Analysis of economic impact can include changes in economic value, as described above, but economic impact is not the same as economic value. It typically includes estimates of "direct" effects (e.g. changes in direct revenues and income, changes in the number of jobs) and may also include estimates of secondary effects that result as direct effects work their way through the economic system. For example, a policy or project that yields direct negative impacts on the local fishing industry may also yield negative secondary impacts on the coastal community that provides the fishing industry with a variety of goods and services. When considering increases or decreases in income/revenue, a "multiplier" is often used to capture some of these secondary effects.

6.2.5.2 Approaches for Estimating the Economic Value of Ecosystem Services. As described above, to estimate the value of ecosystem services that pass through

Figure 6.18. Economic value of nonmarket ecosystem services.

markets, it is necessary to have information about both producers' marginal costs and the consumers' marginal willingness to pay.10 However, because most ecosystem services are nonmarket benefits conferred directly to the consumer, no human producer is necessary. Consequently, there is no marginal cost curve (in the traditional sense described previously) associated with nonmarket ecosystem services. Thus economic value depends only on consumers' willingness to pay for such services. Indeed, most of the approaches used to estimate the economic value of non-market ecosystem services are based on information about the willingness to pay for those particular services. In particular, economists seek to estimate the area under the willingness-to-pay (demand) curve, as a measure of total net benefits (see Fig. 6.18). Two important points are worth making here. First, consumers in this context include any entity that derives benefits from the ecosystem service, whether it is an individual or a firm. Secondly, willingness to pay does not imply that the beneficiaries of ecosystem services actually pay for them; in fact, in most cases we do not. Instead, it represents the value to consumer of the benefits they receive.

Estimating the economic value for nonmarket ecosystem services presents a unique challenge because no direct evidence of value can be observed in actual behavior. Thus, methods that seek to estimate economic value based on willingness to pay generally fall into one of two categories: those that use indirect evidence from observed actual economic behavior, and those that use direct evidence from hypothetical behavior.11

• Travel Cost (TC): Service demand may require travel, whose costs can reflect the implied value of the service; recreation areas attract distant visitors whose

10Producer costs include the costs of converting the ecosystem service into a marketable good, as well as bringing the good to market.

11More technically, these two approaches are respectively based on "revealed preferences" and "stated preferences."

value placed on that service may be at least what they were willing to pay to travel to it. Willingness to pay for the ecosystem service is revealed indirectly through actual expenses incurred during the trip.

• Hedonic Pricing (HP): Service demand may be reflected in the prices people will pay for associated goods; housing prices at beaches exceed prices of inland homes. Willingness to pay for the ecosystem services is revealed indirectly through the willingness to pay higher prices for property that receives a higher level of ecosystem services.

• Contingent Valuation (CV): Service demand may be elicited by posing hypothetical scenarios that involve some valuation of alternatives; people would be willing to pay for increased fish catch or deer bag. Willingness to pay is obtained directly from the consumer in response to a hypothetical context.

Another type of approach is based on estimating the costs of "replacing" the ecosystem service if that service were not available. This approach has two variations: avoidance cost and replacement cost.

• Avoided Cost (AC): Services allow society to avoid costs that would have been incurred in the absence of those services; flood control avoids property damages, or waste treatment by wetlands avoids health costs.

• Replacement Cost (RC): Services could be replaced with man-made systems; natural waste treatment can be replaced with costly treatment systems.

A third type of approach - referred to as the production or factor income method - recognizes the important role ecosystem services often play in the production of market goods. In particular, the ecosystem service is viewed as an intermediate production input. Thus, the ecosystem service contributes a certain portion of the final market good.

In addition to values derived from various utilitarian benefits of nature, that is, ecosystem services, economics can also incorporate concern for the survival or well-being of other species and various other aspects of nature, with which no direct benefits occur. Within the framework of economic value, such concerns are generally expressed as "nonuse" values, because the individual does not consume or otherwise directly benefit from the "good." Sources of nonuse values might include the existence of rare or diverse species of animals, unique natural environments, areas of pristine habitat, or even a way of life, such as family farms or indigenous villages. These values may seem less tangible because they derive from the satisfaction the individual obtains from knowing that such aspects of nature exist, and/or will continue to exist, without actually experiencing them at that moment. However, they can be an important component of nonmarket value associated with nature.12

12Nonuse values can be divided further into "existence," "bequest," and "option" values. Option values are motivated by the desire to preserve the option of the individual to enjoy the environmental benefit at some point in the future, even though the individual may not currently be doing so. Bequest values reflect the desire to leave an environmental legacy, that is, to preserve the option for others in the current

6.2.5.3 Value of Ecosystem Services and the Chemical Industry. Estimates of the value of ecosystem services are important information that can help to incorporate the benefits nature provides into a variety of decision-making processes. Two relatively well-known examples of how such estimates of economic value can be useful (discussed in greater detail elsewhere in this book) are costs -benefits analysis and environmental accounting. Thorough costs -benefits analysis should include estimates of changes in "intangible" nonmarket economic values, in terms of losses or gains associated with resulting ecological impacts and changes in ecological benefits. Economists widely recognize that the omission of nonmarket economic values can result in assessments of economic net benefits that are highly skewed and inaccurate.13 To implement environmental accounting, whether at the global, national, state, or local level, the need for estimates of economic value of both assets (natural capital) and flows of benefits (ecosystem services) is obvious.

With regard to the chemical industry in particular, certainly many basic production inputs to the chemical industry are derived from inanimate or living natural resources, and are often processed and exchanged as market goods. Thus, certain ecological services may be linked to the chemical industries through the market forces of supply and demand. In such cases, the market price provides important information about the economic value of these services, which is fundamentally important to decision-making processes throughout the industry. However, a variety of nonmarket, hence unpriced, ecosystem services are tied to the chemical industry either as beneficial inputs to the production process, or through negative ecological impacts as a result of byproducts of the production process or of the chemical product itself.

As with firms within any industry, chemical firms that are pursuing sustainable development goals must contend with two generally opposing forces: (1) the firms' drive to reduce costs and (2) the necessity, from a societal perspective, of incorporating important unpriced ecosystem costs and benefits into their decision-making process. Devoting the necessary resources toward understanding the value of ecosystems services, both those that provide benefits to the firm as well as those that are negatively impacted, is an important step. However, this must be carried out in tandem with another, and perhaps more difficult, step: to recognize and incorporate those values into the firms' internal decision-making process.

generation, and/or those in future generations to enjoy a given environmental benefit. Finally, existence value is based on the satisfaction derived from simply from knowing that a given element of nature exists.

13In general, the economic impacts of a change in the allocation of water will make some people better off and others worse off, and these losses and gains are not distributed equally across neighborhoods, cities, counties, regions, and states. It is therefore important to examine where the economic impacts of a project or policy occur. Although economic theory can contribute extensive insights regarding efficiency and the objective of maximizing total benefits, it provides relatively little guidance as to whether one distribution of losses and gains is better than another.

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