3.8 Methods using cost as a proxy for value
Fundamental principle in economics is the distinction between benefits and costs.
In the context of ecosystem services:
- economic benefits reflect what is gained by increasing the amount of a given service relative to some baseline,
- while costs reflect what must be given up in order to achieve that increase.
Costs can provide information about benefits or value only under specific and limited conditions.
- First, there must be multiple ways to produce an equivalent amount and quality of the ecosystem service.
- Second, the value of the ecosystem service must be greater than or equal to the cost of producing the service via this alternative means, so that society would be better off paying for replacement rather than choosing to forego the ecosystem service.
Habitat equivalency analysis
Habitat Equivalency Analysis seeks to determine the restoration projects that would provide ecosystem or other related services (including capital investments such as boat docks) sufficient to compensate for a loss from a natural-resource injury (e.g., a hazardous waste release or spill).
In principle, to determine whether a set of projects provides sufficient compensation for a loss, Habitat Equivalency Analysis should determine the tradeoffs required to make the public whole using utility equivalents of the associated losses and gains – i.e., it should use a value-to-value approach. However, in practice Habitat Equivalency Analysisis often based on a service-to-service approach specified in biophysical equivalents rather than utility equivalents.
The price of tradable emissions permits under cap-and-trade systems will almost never meet the requirements for using cost as a proxy for value. The price of an emission permit in a well-functioning market will reflect the incremental cost of pollution abatement. This price does not reflect the value of pollution reduction unless one of two conditions is met:
- the number of permits is set optimally, so that the incremental cost of pollution equals the incremental benefit of pollution reduction; or
- there are significant purchases of permits for purposes of retiring rather than using the permit, which indicates the willingness-to-pay for pollution reduction by the purchaser.
