PhD Qualifying Exam: Methods (Question 4)

What insights can economic analysis of alternate environmental management policies (regulatory, incentive-based, and voluntary) provide for the watershed planning process?

Economic analysis of alternative environmental policies is designed to facilitate decision making for improved social welfare. A watershed planning process, similar to other areas of public decision-making, can draw from economic theory to identify appropriate courses of action. While the ultimate goal of economic analysis is to improve social welfare, there are specific contexts in which economic analysis is particularly useful.

To reallocate resources for efficiency improvements
Economic analysis helps identify inefficient resource use, and potentially can propose different allocations to improve total social welfare. Improved allocation of resources is essential in order to meet human needs and wants. Furthermore, the scarcity of our global resources, which can be contrasted with growth in human populations, makes efficiency essential to maintain or improve human welfare. As mentioned earlier, a driving principle in economics is the ideal of Pareto Optimality whereby we seek to improve the welfare of at least some individuals without decreasing the welfare of others. Frequently this is obtained through the exchange of goods and services that exploit our different individual preferences in order to create transactions that benefit all parties involved.

Many environmental problems are concrete manifestations of inefficient resource allocations. Economics can clarify that the pollution generates undesirable costs that should be averted so that resources can be used elsewhere. Therefore when a lake is polluted, or drinking water supplies are contaminated, economic arguments in favor of environmental remediation are not merely acts of kindness, but rather driven by arguments against the inefficiency of pollution.

In some circles, especially in the realm of critical theory, efficiency has been criticized for obtaining dogma status or for trampling on concerns of equity, rights, or diversity (Scott, Rawls, Young). While the goal of efficiency does not justify ignoring other social issues, neither should we dismiss efficiency improvements as a worthwhile social goal.

To establish appropriate rules of exchange
Economic analysis can help assess how different norms of exchange, rules, or institutional frameworks may yield different outcomes. Existing resource allocations (land, capital) as well as the existing institutions that govern resource exchange (regulatory, incentive-based, and voluntary) are the products of historical struggle (Costanza, Ostrom, Schneider). Often, the arrangements we have inherited are deemed inappropriate on either efficiency or equity grounds. In these cases, economic analysis is essential for evaluating the impacts of various institutional arrangements that contextualize production and distribution.

In a watershed planning process, there is usually considerable debate about what the rules of engagement should be. Under which circumstances should society give private firms the right to pollute? How should pollution be managed? How should public agencies intervene? And what are the rights of pollution victims? These are not easy questions to answer since society must live with some degree of resource use and pollution. Few would argue for a zero pollution society since that would imply a rejection of all technology and contemporary goods. However if we accept some level of resource use and pollution, the question then becomes, how much? What is the appropriate level of pollution? To answer these questions, we must: (a) understand social preferences and (b) then establish appropriate rules of exchange, norms, or institutions, in order to bring us closer to our social preferences.

Therefore, economic analysis can help establish the appropriate rules of engagement between actors in a watershed, and can estimate the different outcomes that are likely to occur under different scenarios (regulatory, incentive-based, and voluntary). When existing norms of engagement are inappropriate, economic analysis can provide institutional innovation to devise new rules that may lead to better outcomes. In recent years, economists have been exploring institutional arrangements that combine command-and-control policies with incentive-based mechanisms. For example, the cap-and-trade system for carbon emissions, involves a command-and-control cap, followed by a trading system among polluters in order to maximize pollution reduction at the lowest possible cost. This is an example of the institutional innovation generated by economists that can be useful for improving social welfare.

To compare of alternative courses of action
Ideas are always competing for attention and the chance to be implemented. In the face of this competition, any decision making processes must be able to evaluate the competing alternatives in order to make sound choices. Economics provides analytical tools, both conceptual and quantitative, that facilitate this comparison of alternatives.

When evaluating alternative courses of action, it is useful to have a common unit or metric for comparison. The field of economics proposes that we evaluate alternatives based on the social utility generated from each option. This social utility is quantified and monetized into a common unit of exchange. While this process of monetization is controversial, it still provides a starting point for assessment.

Most choices involve trade-offs. If we want recreation areas for hikes and picnics, we may need to forgo urban development for low income housing. If we want clean water supplies free of carcinogenic compounds, we may need to contribute additional greenhouse gases to the atmosphere. Economic analysis clarifies these tradeoffs. It helps us balance competing demands and helps us chose the policies that most closely approximate social preferences.

Cost-benefit analysis is one way to weigh these competing interests. When costs and benefits are distributed unevenly throughout society, economic analysis can help identify the winners and losers, and potentially quantify the magnitude of these gains and losses. This information, while always incomplete, is essential information for making decisions about alternatives.

Economic analysis can also help uncover new alternatives that watershed managers did not consider at the outset. I hope this is the case with my own dissertation whereby conducting an analysis on the watershed scale and by integrating economic knowledge with our understanding of ecosystems, I will be able to identify new courses of action that can improve environmental quality and reduce water treatment costs.

Finally, economic analysis can help us avoid making costly mistakes. It has been asserted that decision making without analysis can lead to systematic bias and error (Costanza). Errors can be costly, either to us directly or for future generations. Incorrect valuations or expectations about the future may constrain future choices, or limit the resources available to us tomorrow. Economic analysis helps us study these future scenarios, although this sort of analysis is by no means exclusive to the realm of economics.

Thus economics provides a common language in which to evaluate alternatives. And while this common language is not perfect, it is a starting point upon which to make systematic evaluations of proposed strategies for moving forward.

Methods for estimating social preferences
Economics also provides methods to ascertain social preferences. In watershed planning processes, these methods are especially useful since many of the goods and services related to watershed planning are not valued by markets. In these cases, economics offers methods for estimating how society values these goods and services. Common methods in environmental economics include: hedonic valuations, that decompose the value of marketed goods into various components in order to extract the additional value of a non-marketed good; contingent valuation studies that directly inquire into individuals willingness to pay for a non-marketed good or service, and travel cost studies, which measure the expenses travelers pay to visit areas of biological value or natural beauty in order to ascertain how much they value these sites.

Here I have described only four ways in which economic analysis contributes to watershed planning. Yet all of these insights from economics: (1) the improvement of resource allocation for efficiency; (2) the establishment of appropriate rules of engagement; (3) comparing alternative courses of action; and (4) methods for estimating social preferences; are designed to improve decision making and social welfare. These contributions, while limited in many respects, nevertheless can help clarify the complex and competing demands associated with watershed management.