ROYAL VETERINARY AND AGRICULTURAL UNIVERSITY
Department of Economics and Natural Resources
Rolighedsvej 23
DK-1958 Frederiksberg C
Phone +45 35 28 22 80
Fax +45 35 28 22 95
[email protected]
Date: 17 August 2003
Cost-benefit analysis of wetland restoration∗
Alex Dubgaard
INTRODUCTION
Restoration of floodplains in river valleys has acquired a prominent position in the environmental
policies of many European countries. There are several reasons for this: much of the biodiversity
lost in European countries is connected with wetlands and riparian areas, restored wetlands are able
to reduce nutrient and other kinds of pollution, natural wetlands offer recreational opportunities, and
last but not least restored rivers and floodplains provide flood protection, which is of increasing
importance in several European countries. The magnitude and social significance of these benefits
will vary depending on the type of restoration, the size of the area, and the geographical location.
Likewise, the costs of restoration depend on the level of ambitions regarding the magnitude and
multitude of benefits and the alternative use value of the land. In other words, when selecting areas
for nature restoration decision makers are confronted with the questions: how can generically different benefits be measured in comparable terms and how should different levels of restoration costs
be weighed against benefits? Economic valuation methods and cost-benefit analysis (CBA) provide
an opportunity to guide policymaking. The main objective of this paper is to illustrate the application of CBA within the field of river restoration. The Skjern River restoration project in Denmark is
used as empirical example of how a CBA can be conducted in this context.
PROJECT APPRAISAL
Because of the public good or common property characteristics of most environmental resources
market forces cannot be relied on to guide them to their most desirable uses. Neither will market
forces reveal prices that reflect their true social values. It is the failure of the market system to allocate and price environmental resources correctly that creates the need for economic evaluation and
policy appraisal to guide decision making. The primary purpose of economic appraisal work is to
assist decision makers in allocating limited public funds/resources to their best social use.
Since 1983 legislation has directed U.S. federal agencies to assess the costs, benefits, and economic
impacts of their rules. Economic methods – such as cost efficiency and cost-benefit analysis - are an
integrated part of environmental policy evaluation and regulatory planning (see U.S. EPA, 2000). In
the UK the Treasury Green Book on appraisal and evaluation techniques states that all new policies,
programmes and projects should be subject to comprehensive economic assessment to help develop
a value for money solution (U.K. Treasury, 2003). A similar approach is taken in the Netherlands
where the Ministry of Transport, Public Works and Water Management has published a manual
∗
Paper to be presented at the conference: Towards Natural Flood Reduction Strategies. International Conference under
the auspices of the European Union’s 5th Framework Programme, Warsaw, 8-10 September, 2003.
promoting the use of cost-benefit analysis to assess the impacts of large infrastructure projects (see
Brouwer et al, 2001). In some cases the driving force behind the adoption economic appraisal
methods would be the demands by international support programmes and financial institutions.
Also, EU membership places demands on member states and prospective members regarding environmental efficiency assessments. For example, the EU water policy directive requires that member
states take account of the principle of recovery of the costs of water services, including environmental and resource costs. Environmental costs comprise the value of water resources for the conservation of habitats and species directly depending on water (see EU, 2000).
The focus of this paper is on the appraisal of programmes and projects when the overall policy objectives have been decided at the national or supranational level. Implementation of policy measures
typically leaves room for choices between feasible alternatives. The purpose of appraisal work is to
help ensuring that public funds are spent on the measures that provide the greatest benefits to society. Several economic techniques are available for the appraisal of the feasible options open to decision makers. The most relevant environmental valuation and assessment methods will be presented
in the following.
Economic appraisal techniques
Let us take as an example a public programme aiming at reducing phosphorous pollution in lakes
and other water bodies to a specific ambient concentration level. Several options are available for
the realization of this target, e.g.: removal of (more) phosphorous at waste water treatment plants,
better fertilizer management in agriculture, establishment of buffer zones along water courses, and
restoration of floodplains. The decision problem is then to identify the most advantageous alternative from a societal perspective. Here it is helpful to look at the concepts effectiveness, costefficiency, and optimality:
1) Effectiveness means that a target is met, i.e. the pre-specified reduction in ambient phosphorous pollution is achieved;
2) Cost-efficiency means that the target is met at the lowest social costs possible;
3) Optimality means that the resources used yield benefits at or above the level obtainable in
their best alternative use.
Thus, 1 is a feasible solution, which meets the target, but with no regard to possible lower cost alternatives. Both 2 and 3 take costs into account, but only 3 weighs benefits against costs to assess
the social “profitability” of the undertaking.
Cost-efficiency analysis (CEA) is the relevant method if only cost minimization is required and the
environmental target is measurable on a uni-dimensional scale – for example the ambient concentration of phosphorous in a water body. A CEA then seeks the option where the targeted ambient
concentration is realized at minimum social costs. In other words, economic efficiency is measured
against a single objective: the reduction in phosphorous pollution. This means that a CEA will fail
to identify the full social value associated with options yielding multiple benefits, unless the different environmental effects can be converted to uni-dimensional physical units. But environmental
effects are not in general physically or biologically commensurate. In the phosphorous reduction
example above the different measures produce joint benefits to a varying degree. Removal of phosphorous from wastewater would only contribute to the primary target; better manure management
would also reduce nitrate pollution of groundwater; whereas restoration of floodplains in upstream
areas could yield biological benefits and flood protection in addition to phosphorous reduction.
2
Cost-benefit analysis (CBA) is the method of choice when the objective is to assess the optimality
of policies or projects.1 For example, a CBA would investigate if a given pollution reduction is advantageous for society when the benefits are weighed against the costs. The basic notion is that the
social benefits must be at least as great as the social cost. If that condition is not met, the money or
resources could have been better spent for other social purposes. If the reduction target is prespecified politically the optimality test may be of academic interest only. However, as indicated in
the phosphorous pollution example above the additional benefits from different reduction measures
may vary significantly. This brings CBA back in focus as a technique, which can potentially identify the option providing most value for money when all relevant benefits are considered. Thus, a
social CBA should incorporate all relevant benefits and cost items, i.e. market goods as well as nonmarket goods in terms of environmental services. Summing up the benefits and collating them with
the costs require a common measuring unit. For most practical purposes this means that environmental effects must be quantified in terms of money. Over the last 3-4 decades a number of economic valuation methods have been developed for this purpose. A brief summary of these methods
is given below.
Valuation and pricing methods
Human use (direct or indirect) of the ecosystem’s services implies that these must be considered
economic values. The essential value categories are:
ƒ
Value as a factor of production (farm land, fish stocks, etc.)
ƒ
Ecosystem services (flood risk reduction, retention of nutrients, etc.)
ƒ
Consumptive outdoor recreation values (hunting, angling)
ƒ
Non-consumptive outdoor recreation values (hiking, boating, wildlife observation, etc.)
ƒ
Non-use value which individuals place on the mere existence of biological diversity.
A large number of these services are non-market benefits. The economic value must be uncovered
by measuring people’s (hypothetical) willingness to pay for the benefits in question. There are different theoretical approaches to monetization of non-market goods; preference based and nonpreference based, respectively. Economic valuation as such is based on preference revelation. Individuals’ willingness to pay for environmental benefits can be interpreted as trade-off ratios between
the non-market services and market goods. The approaches to economic valuation can be divided
into the following classifications: indirect methods based on market information such as property
values or expenditure on related goods, and direct methods based on stated willingness to pay expressed through questionnaires.
The most important indirect methods are the Travel Cost method and the Hedonic Pricing method.
The Travel Cost method has been used extensively to value site-specific recreation benefits, utilizing differences in visitors' costs of travelling to a specific site as a basis for estimating a demand
function. Hedonic Pricing models utilize the fact that environmental characteristics – such as landscape amenities, the proximity to recreational areas, air quality, etc. – influences the value for resi1
A theoretical and methodological introduction to CBA in an environmental context can be found in Johansson (1993).
See also U.K. Treasury (2003), U.K. DEFRA (1999), and U.S. EPA (2000). A book forthcoming at Edward Elgar Publishing will present a number of CBAs on flood mitigation and other water resource management cases (see Brouwer
and Pearce).
3
dential properties. The Contingent Valuation Method (CVM) is the most important among the direct valuation techniques. CVM stipulates a scenario for the preservation or production of a nonmarket good. Having explained the characteristic of the good, the rules of provision, access, method
of payment, etc., respondents are asked to state their willingness to pay for the good in question.
Indirect valuation methods are revealed preference approaches based on the complementarity between the use of environmental services and certain market goods. Non-use value is attributed to
preferences, which are separate from the use of market goods. As a result, revealed preference
methods cannot estimate non-use values. The contingent valuation method, on the other hand, sets
up hypothetical markets for the procurement of environmental services. In principle this means that
contingent valuation can capture use as well as non-use values.
There are also a number of non-preference based methods available for monetizing non-market
benefits. These methods can be described as pricing. One such approach is pricing via the costs of
alternatives or replacement costs. An example is the costs of sewage treatment as an alternative to
the retention of nitrogen and phosphorus on a restored floodplain. Pricing methods are usually
somewhat easier to apply than actual valuation methods. But the monetary estimates obtained are
not necessarily in agreement with the value concepts of welfare economics. However, in the absence of valuation studies, pricing may often be considered an acceptable alternative. It is beyond
the scope of this paper to go into details about the merits and problems associated with the respective valuation and pricing methods. A detailed description of valuation and pricing techniques can
be found in Garrod & Willis (1999).
Transfer of benefit-estimates
Conducting economic valuation by state-of-the-art criteria is both time-consuming and expensive.
This has lead to an increasing interest in reusing the results of previously conducted valuation studies – commonly referred to as benefit transfer.2 Benefit transfer implies that valuation estimates or
valuation functions from a research area (i.e. an area, in which a valuation study has been conducted) are transferred to a project area (i.e. an area, where one wishes to assess a project, prior to
an actual implementation). Preferably policy-analyses should be based on data collected through
primary research. However, it seems possible to get a fair impression of the magnitude of environmental benefits through benefit transfer. In the absence of primary valuation data benefit transfer is
endorsed as an acceptable solution by the British and American environmental authorities, among
others (see U.S. EPA, 2000 and U.K. Treasury, 2000). Benefit transfer was used extensively in the
cost-benefit analysis of the Skjern River restoration project, which will be presented in the following.
THE SKJERN RIVER RESTORATION PROJECT
During the past couple of decades much emphasis has been placed on nature restoration in Denmark. Restoration of natural floodplains in river valleys has a prominent position in this programme. This is due to the fact that much of the biodiversity lost in Denmark is connected with
wetlands and riparian areas. In addition, restored wetlands will often be able to reduce nitrogen and
phosphorus pollution and provide new recreational opportunities. The main objective of this chapter
is to illustrate the application of CBA in a specific area of river restoration. It is not possible go into
details with methodological issues and data collection. A more detailed description of the Skjern
River CBA will be available in Dubgaard et al. (forthcoming).
2
Benefit transfer techniques and applications are described and assessed in Desvousges et al. (1992) and Brouwer
(2000).
4
Outline of the Skjern River project
The primary purpose of the Skjern River project is to re-establish a large coherent nature conservation area with good conditions of life for the fauna and flora connected with wetlands. The location
of the area is presented in Figure 1.
Figure1. Location of the Skjern River Project Area
The Skjern River has a catchment area of 2,500 km2 and a length of 95 km. The river discharges
into the Rinkøbing Fjord - a shallow 300 km2 costal lagoon, which is connected with the North Sea
by a floodgate. The Skjern River delta and Ringkøbing Fjord have been designated as an international bird protection area for wading birds and as an EU habitat area. The river system is home to a
number of red-listed species in Denmark. Before the 1960s the Skjern River floodplain was managed as extensively grazed meadows and hayfields. During the 1960s the lower 20 km of the river
were straightened and diked. Pumping stations were established and 4,000 ha of meadows were
drained and converted to arable land. In 1987 the Danish Parliament decided to initiate studies of
restoration possibilities. Restoration of the river was decided in the late 1990s and completed by
mid-2003.
Of the 4,000 ha reclaimed in the 1960s 2,200 ha were included in the project. The entire project
comprises the following initiatives (Danish Forest and Nature Agency, 1998):
ƒ
ƒ
ƒ
ƒ
ƒ
The lower 19 km of channelled river have been turned into a 26 km meandering course.
The River has been laid out with several outflows to the Fjord, which, in time, will create a
delta of app. 220 ha.
Creation of a lake of approximately 160 ha.
Re-establishment of the contact between the River and riparian areas by permitting periodical floods on land within the project area.
Transfer of 1,550 ha of arable land to extensive grazing.
The flora of riparian areas and the River will become more diversified and the area will become
increasingly attractive to breeding birds as well as amphibian and reptile species. Improved water
quality and the re-establishment of spawning grounds will have a positive effect on the salmon and
trout populations in the River system. The Skjern River discharges into the Rinkøbing Fjord, which
is considerably affected by excessive loads of nutrients. The project will significantly reduce nutrient emissions to the Fjord due to the retention of nitrogen and phosphorous in the wetlands of the
river valley. Finally, the project will increase the possibilities for outdoor recreation such as hiking
and biking, boating, camping, studies of flora and fauna, angling and hunting.
5
The Skjern River cost-benefit analysis
The use and non-use value categories outlined previously are all incorporated in the CBA. Society
is defined as the state of Denmark. Transfer payments within the national boundaries are disregarded while transfers/subsidies from the EU are included in the analysis as benefits. The national
delineation of society also means that project benefits experienced by foreigners, for example tourist, should be excluded from the CBA. The same holds for global benefits in the form of reduced
greenhouse gas emissions, unless such emissions are eligible for inclusion in Denmark’s reductions
obligations under the Kyoto agreement. Cost and benefits are recorded in Table 1. The price level is
the year 2000 where one Danish Crown (DKK) equalled about €0.13 and US $0.12. Environmental
benefits and land rent forgone are service and cost flows that in most cases can be expected to continue in perpetuity. In table 1 these flows have been transformed into present values. Calculation of
costs and benefits is outlined below. The present values mentioned in the text have been calculated
at a 3 per cent discount rate over an infinite time horizon – unless otherwise explained.
Project costs and land re-allocations
Costs associated with surveying, designing and construction work amounted to app. 149 million
DKK. In addition 27 million DKK have been allocated to nature monitoring, information and nature
education programmes. The European Union has contributed about 32 million DKK to the implementation of the project. As noted above, trans-boundary transfer payments are treated as benefits.
After deduction of the EU subsidy net direct project costs amount to app. 144 million DKK.
Approximately 1,750 of the 2,200 project hectares were arable land until the restoration of the
River. As a result of the project they have been converted to nature areas or extensive grazing. The
change in land use represents a resource cost in terms of land rent forgone. The calculated land rent
per ha/year is 1,450 DKK for sandy soils, 2,015 DKK for sandy loam, and 2,580 DKK for loam and
humus soils. Implementation of the project means that 1,550 ha will be used for extensive grazing
(without fertilization or use of pesticides). Based on costs and revenues from similar pasture activities (young stock from the dairy herd) land rent from grazing was estimated at 170 DKK/ha/year.
This means, that grazing will recover – depending on the quality of land – between 5 and 10% of
the land rent forgone by giving up arable farming. Prior to the project draining and arable farming
had resulted in soil settling in some areas due to oxidation of organic soil and mechanical compression. In the long run this leads to marginalisation of arable land. When land becomes marginalized,
land rent is usually assumed to be zero. But this is not necessarily the case under the present acreage
payment scheme of the EU, which involves an obligation to set land aside. Assuming that the alternative is set aside of sandy soils outside the project area, the rental value of marginalized land was
estimated at 1,450 DKK.
The net costs of land use change are calculated as the present value of the land rent forgone minus
the present value of the land rent from extensive grazing. It consists of two main components: (1)
the discounted flow of land rents from arable land over an infinite time horizon and (2) the discounted value of land rents from (subsidised) set-aside land. It was tentatively assumed that in the
absence of the project, set aside payments to marginalized land would have continued for another
20 years. Capitalized costs associated with land use changes amount to approximately 76 million
DKK.
Estimation of benefits
Substantial benefits are derived from improved possibilities for outdoor recreation, hunting and
angling, together with the non-use value expected to be present as a result of an increase in the
6
area’s biodiversity. It was beyond the scope of the project to conduct primary valuation analyses to
identify these values. Instead value estimates were transferred from other studies. Value estimates
of the more straightforward benefit components – such as nutrient retention – were based on the
costs of alternatives or replacement costs approach.
Cost savings and rents
The project had a number of effects, which can be measured in terms of market goods, primarily
cost savings or returns from production activities (see COWI, 1998). The restoration of the Skjern
River provides flood protection by allowing rising water levels to spread in the width. This affects
approximately 30 houses positively. The present value of this benefit amounts to about 1 million
DKK. A fish farm in the project area was closed to stop emissions of organic material, which would
otherwise have ended up in the adjacent Ringkøbing Fjord. The capitalized net benefits (value of
reduced pollution minus loss of resource rent) have been estimated at 3.9 million DKK. The net
benefits from the closure of the fish farm and reduced flooding risk are entered in Table 1 under the
heading Miscellaneous cost savings.
Conversion of the arable land in the project area means that pumping water out of the area is no
longer required. The saved pumping costs, amounting to app. 12 million DKK in present value, are
considered a project benefit. In connection with the project about 1000 ha of farmland (outside the
project area) were reallocated between farms. This shortened the overall distance from the farms to
the fields. The resulting savings on transport, estimated at 30 million DKK, are included in the CBA
as a project benefit. It is expected that 300-400 ha of reedbeds will develop in the project area. The
present value of net returns from reed harvesting is estimated at 10 million DKK. Larger populations of migrating and resting birds will increase hunting values in the project area and adjacent
land. Based on expert opinion and compensations paid for hunting bans on meadowland elsewhere,
it was estimated that the rental value of hunting will increase by approximately 0.5 million
DKK/year. This is equivalent to a present value of 15 million DKK.
Nutrient and metal reduction
The project will lead to a considerable reduction of the emissions of nitrogen, phosphorus and
ochre. This is due to reduced leaching from the converted arable area and more significantly the recreation of the natural ecology and hydrology of the floodplain, which will restore the natural ability of the soil to filter nutrients and other particles. The benefits from reduced water pollution in the
project area as such are incorporated in the value estimates of improved recreational opportunities,
biodiversity, etc. The additional value of nutrient reductions is a spill over effect from the project in
the sense that it alleviates the pollution pressure on the adjacent Ringkøbing Fjord. According to the
Ministry of the Environment and Energy (2001) the Skjern River project is expected to reduce nitrogen emissions by a total of 211 tons annually, which is equivalent to 220 kg N per ha. The annual
retention of phosphorus in the project area is expected to be 14.5 tons, or approximately 6 kg P per
ha.
The economic value of the emission reductions due to the project can be measured via the costs of
alternatives approach – in this case the costs of extra sewage treatment or the establishment of wetlands elsewhere. Analyses show that establishing wet meadows is one of the cheapest alternatives
(see DIAFE, 2000 and Gren et al., 1997). Choosing creation of wet meadows as the relevant alternative the unit value of nitrogen reduction can be calculated at app. 8 DKK per kg N. At this price
the present value of nitrogen reduction due to the Skjern River project equals 57 million DKK.
What phosphorus is concerned, it is assumed that the ratio between nitrogen and phosphorous re-
7
ductions is the same in the Skjern River project as it would be in alternative wet meadow projects.
Accordingly, the benefits from phosphorous reduction are covered by the cost estimates of alternative wetland creation above.
Drained pyritiferous soil strata are leaking ferrous substances (ochre), which precipitate into
streams and fjords. It was estimated that the Skjern river project will lead to an annual reduction of
ochre emission of 635 tons. Alternative ochre treatment costs are estimated at 1.97 DKK per kg
ochre (COWI, 1998). This amounts a present value of app. 41 million DKK.
Effects on greenhouse gas emissions
The increased water level in the project area is expected to affect the emission of several greenhouse gasses. It was estimated that the net result is an annual CO2 reduction of approximately 15
thousand tons (COWI, 1998). A change in Denmark’s greenhouse gas emissions has a negligible
effect on the damages associated with global warming. Therefore, when measured at the national
level, the CO2 effect can only be considered a social benefit if it can be included in Denmark’s CO2
reduction obligations – according to the Kyoto protocol. A Danish Government report expects a
CO2 quota price in the area of 90 DKK per ton (see Ministry of Finance, 2003). At this price level
the value of CO2 reductions from the Skjern River project would amount to a capitalized value of
45 million. However, under the present standards it is probably not possible enter such reductions in
a country’s CO2 account. Consequently, the effect on CO2 emissions is not included in the present
cost-benefit analysis.
Angling benefits
The restoration of the river is expected to improve angling opportunities considerably – not only
along the restored part of the River, but also in the remaining parts of the River system. Of particular importance is the expected improvement in fishing for salmon and sea trout. The valuation of
improved angling opportunities is based on a transfer of benefit-estimates from Toivonen et al.
(2000). This investigation used various formats of the contingent valuation method to evaluate willingness to pay for access to angling in the Nordic countries. One of the scenarios estimated willingness to pay for access to a river with an above average chance of catching salmon. Danish anglers’
willingness to pay for this scenario lies in the interval 550–921 DKK/year per angler. Based on information from local anglers’ unions, it was estimated that some 5,000 anglers are currently using
the Skjern River system (COWI, 1998). It is likely that a larger number of anglers will use the area
after the completion of the project. However, estimating such an increase is surrounded by large
uncertainties. Assuming that the present 5,000 anglers will be willing to pay an extra 550–921 DKK
per year, the value of angling will increase by 2.8–4.6 million DKK annually. This amounts to present values between 93 and 153 million DKK. In the present cost-benefit assessment the lower
bound is used as a conservative estimate of the total economic benefits from angling.
Non-consumptive outdoor recreation
Outdoor recreation played a minor role prior to the project apart from consumptive uses in the form
of angling and hunting. The size and character of the newly created area allows for several types of
outdoor recreation activities in the form of hiking, boating, bird watching etc. Consumer surplus
associated with outdoor recreation was estimated with the help of benefit transfer. As a point of
departure, it was assumed that the Skjern River area will obtain a status similar to that of other nature areas of national significance, e.g. the landscape Mols Bjerge situated in eastern Jutland. Willingness to pay for access to outdoor recreation in Mols Bjerge was investigated in a previous study
(see Dubgaard, 1996). Based on this study it was estimated that average willingness to pay for ac-
8
cess to the Skjern River area will be in the area of 40 DKK per visit. Expected visitation was approximated on the basis of visit registrations in the Mols Bjerge area and locations in western Jutland resembling the Skjern River Valley with respect to recreational characteristics. An annual
number of visits in the order of 90,000 seem to be a reasonable (cautious) estimate for the Skjern
River Valley. Combining this figure with the willingness to pay estimate renders a recreational
benefit equal to 3.6 million DKK per year, which is equivalent to a present value of 120 million
DKK.
Non-use value of biodiversity
Krutilla (1967) pointed out that individuals’ may place a value on the mere existence of biological
variety and its widespread distribution. Numerous empirical investigations have established that
people are willing to pay for the preservation of species they do not expect to be able to observe or
make use of otherwise (se e.g. Loomis and White, 1996). It was assumed that this also holds for
most people in Denmark. The existence value of enhanced biodiversity was estimated with the help
of benefit transfer from a valuation study of nature protection and restoration in the Pevensey Levels in England (see Willis et al., 1996). The Pevensey Levels projects aims at ensuring and reestablishing the biodiversity of wet meadowlands with biological characteristics nearly identical to
those of the Skjern River project. Using the contingent valuation method willingness to pay for the
project was elicited from a representative sample of the population in Great Britain. The existence
value of biodiversity enhancement was approximated by non-users’ willingness to pay for the project.
While the two nature restoration projects are comparable with respect to biological characteristics
there is some difference in size. The Skjern River project area equals 2,200 ha, whereas the size of
the Pevensey Levels is 3,500 ha. To adjust for the difference in area size estimated willingness to
pay was calculated per hectare. The greatest benefit transfer problem, however, is the difference of
scale concerning the size of the populations of the two countries. To solve this scale problem the
benefit estimate per ha was divided by the number of households in Great Britain. The existence
value of biodiversity enhancement in the Skjern River area was then calculated by multiplying the
unit values from the Pevensey Levels area with the number of hectares in the project area and the
number of households in Denmark. According to these calculations, the non-use value associated
with the Skjern River project amounts to 2.7 million DKK annually – or a present value equal to 86
million DKK.
Results of the cost-benefit analysis
The calculated costs and benefits are assembled in Table 1, which shows 3 scenarios using discount
rates of 3%, 5% and 7%. The project is considered socially advantageous if the sum of discounted
consequences (benefits and costs) is positive. The Skjern River project turns out to be clearly beneficial for society at a discount rate of 3% where the present value of net benefits amounts to 228
million DKK. The project is still beneficial at 5% with a net present value of 67 million DKK. At a
7% discount rate the project provides a net present value close to zero. Thus, the magnitude of the
discount rate is essential to the outcome of the CBA. This is not surprising since a sizeable part of
the costs are incurred in the initial stages while the flow of benefits is expected to continue in
perpetuity. These are the usual characteristics of nature restoration projects.
Unfortunately, no agreement exists on which discount rate can be considered the most relevant in
social cost-benefit analyses. A group of economic analysts from agencies under the Danish Ministry
of the Environment recommend a social discount rate of 3% in social cost-benefit analysis (Møller
9
et al., 2000, p. 140). This recommendation is based on an estimate of consumers’ time preference
rate measured as the real rate of interest (after tax) in the capital market during the 1990s. However,
the Ministry of Finance (1999) recommends a social discount rate within the range of 6–7%. In the
USA there is a similar discrepancy between the recommendations of the environmental and financial authorities (see U.S. EPA, 2000 and U.S. OMB, 2000). The U.K. Treasury’s recommended
social discount rate used to be 6%. However, this has been reduced to 3% in the recent Green Book
from the Treasury on appraisal and evaluation (see U.K. Treasury, 2003).
Discount rate
Project costs
Operation and maintenance
Forgone land rent
Total costs
3%
143.7
17.0
75.8
236.5
5%
143.0
14.9
52.5
210.4
7%
142.2
14.7
41.3
198.2
Saved pumping costs
Better land allocation
Miscellaneous cost savings
Reed production
Reduction of nitrogen and phosphorus
Reduction of ochre
Improved hunting opportunities
Improved fishing opportunities
Outdoor recreation
Non-use value of biodiversity
Total benefits
12.1
29.7
5.0
10.1
56.7
40.5
15.3
89.0
120.1
85.9
464.2
7.4
19.4
2.4
5.0
34.0
27.0
9.0
52.4
70.7
50.6
277.6
5.4
15.2
1.3
3.0
24.3
21.3
6.3
36.7
49.6
35.5
198.6
228
67
-1
Net present value
Table 1: Cost-benefit results of the Skjern River project
CONCLUSIONS
In addition to the disagreements about the relevant social discount rate we have the uncertainties
associated with valuation of non-market environmental benefits. These uncertainties and disagreements mean that the results of a cost-benefit analysis should not be considered the final answer. The
usefulness of monetized benefit and cost estimates lies in their ability to reduce complex clusters of
effects to single-valued commensurate magnitudes. Viewed in this light benefit-cost analysis does
not dictate choices; nor does it replace the ultimate authority and responsibility of decision makers.
Rather, one should regard economic valuation and cost-benefit analysis as experiments testing the
robustness of a project to alternative assumptions concerning the magnitude of costs and benefits,
and the various social demands with respect to the return on invested capital. From this perspective
the outlined CBA indicates that the social efficiency of the Skjern River project is quite robust. In
the international economic literature arguments can be found for high as well as low discount rates.
When it comes to long-term environmental effects, however, there seems to be a tendency to prefer
low discount rates, i.e. approximately 3%. The results of the present CBA show that only when the
discount rate exceeds 7% the project fails the present value test. It must be concluded, therefore,
that the resources, which have been allocated to the Skjern River project, have been put to good use
from a social point of view.
10
REFERENCES
Brouwer, R. (2000): Environmental Value Transfer: State of the art and future prospects, Ecological
Economics, 32:137-152.
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