Quantifying the Wealth of Nature

Can Ecosystem Valuation Create Markets?

By Tim Fitzgerald

To many, the terms ecosystem services and ecosystem valuation sound obscure and complex. But for a growing number of economists, government officials, and financiers, quantifying the benefits of clear-running streams, standing forests, and other natural processes is an idea whose time has come. The Economist (2005) recently devoted a cover story to the challenges of putting a proper value on ecological services. Last year the World Bank and the National Research Council both issued reports on assessing nature's services. These efforts followed on the heels of the international Millennium Ecosystem Assessment, which enjoyed international support.

Once the value of nature is calculated, it might seem a short step to create markets for ecological functions. In March, the influential banks ABN Amro and Citigroup threw their weight behind efforts to create environmental markets of the sort pioneered by the Katoomba Ecosystem Marketplace.

Don't bet on such projects just yet. Expanding existing benefit-cost analysis to include the impacts of ecological functions will improve policy analysis. But it is tragically over optimistic to think that accounting for the economic value of ecosystems will create markets to preserve them.

What Are Ecosystem Services?

Ecosystem services are the flows that humans capture from natural resources (excluding non-renewables). Timber production benefits humans, and is thus part of a forest's ecosystem service stream. However, the term also includes those services provided to people if the forest is not harvested, such as watershed regulation or wildlife habitat.

Harvesting some of the timber might change the amount and quality of water that flows through the forest, or the amount and type of wildlife habitat. Ecosystem valuation provides a framework for bringing these potential changes to light and quantifying their impact on humans. Most importantly, it identifies those changes in monetary units so that they can be compared to timber benefits. In other words, ecosystem valuation is an extension of cost benefit analysis, the traditional means of economic valuation of non-market goods.

The flood plain of Nigeria's Hadejia river system offers a good example of how ecosystem valuation can improve policy analysis. The first large dam in the watershed was built by the Nigerian government in 1974. Further dams were proposed, most controversially the Kafin Zaki. Its construction would have cut off the source of water recharge for wetlands that provide drinking and irrigation water to downstream households. A simple cost-benefit analysis would consider only the potential irrigation benefits against the cost of pouring concrete.

When the costs and benefits of downstream ecological services were also considered, it became evident that the costs of reduced groundwater to downstream households exceeded the potential (upstream) benefits of the diversion project.1 Although the future of Kafin Zaki is unclear, construction halted in 1994 and has yet to resume.

From a societal point of view, using ecosystem valuation to consider the impacts on downstream groundwater led to a better decision. As scientific understanding of how ecosystems operate (understanding hydrology in the case of the Hadejia) improves, this process of valuation will improve.

Such progress is in stark contrast to earlier attempts at ecosystem valuation. Robert Costanza et al. (1997) published an article in the prominent journal Nature that attempted to estimate the economic value of the natural world. They summed the estimated value of ecosystem services such as erosion control, nutrient cycling, pollination, and waste treatment across a variety of biomes: forests, grassland, and wetlands, for example. The mean value for the entire world was $33 trillion per year.2 This created a stir in the popular media, especially since $33 trillion exceeded the value of global economic output.

Although aggregate values are impressive and grab headlines, they do not help policy analysis. It was observed at the time that the primary motivation for the paper may have been political rather than economic (Toman 1998). It is marginal values that matter. Recent ecosystem valuation preserves this perspective. Indeed, in Nigeria, it was the additional dam, the Kafin Zaki, that had costs far outweighing benefits.

Can We Create Markets?

The success of ecosystem valuation should not be confused with the potential for markets. Without a defined and defensible property right in the ecosystem service, markets will not work. Thus, the Economist's enthusiastic claims that such market protection is imminent should be carefully scrutinized.

To illustrate the potential for markets, the magazine presented a story about the Panama Canal. The canal, now owned by the government of Panama, requires a large amount of fresh water to operate the locks, 52 million gallons per ship passage. This water comes from the surrounding mountains.

The availability of this water is threatened. Much of the government-owned land bordering the canal has been cleared of natural vegetation, mostly by logging, slash-and-burn agriculture, and cattle grazing. Without the forest cover, water reaches the canal in periodic floods instead of a steady stream. During periods of drought the number of daily passages has been limited by the lack of fresh water to operate the locks (Dean 2005).

Runoff from the denuded mountainsides also carries unwelcome nutrients and sediment to the canal. As a result, expensive dredging is necessary. Valuing ecosystem services suggests that a standing forest would enhance human welfare.

Although the Panamanian government owns the canal and surrounding watershed, it is unable or unwilling to reforest the watershed or effectively exclude maverick loggers and others who deforest the mountains. We might expect a private solution to correct this government failure. The Economist describes a British firm, ForestRe, that is considering replanting some of the forest in return for payments by the shipping companies, who have a genuine interest in keeping the canal open.

This is a marvelous idea, but unfortunately it won't work. The problem is that the shipping firms would be spending money on trees they do not own and cannot protect. If the government (and owner of the canal) is not going to protect the forest, a better market solution might be for these companies to invest in their own production and distribution networks including travel around Cape Horn. No firm or individual will make an investment without some confidence in a return.

Ecosystem valuation has arrived as a policy analysis tool, as the recent flurry of activity demonstrates. However, jumping to the conclusion that being able to accurately value ecosystems will engender markets for them is premature. Property rights are absolutely necessary to any market, and notably absent from most natural processes.

NOTES

  1. This project has been discussed in Acharya and Barbier (2002) and related papers.
  2. Pimentel et al. (1997) was a concurrent and similar study that was also received critically by the economics community.
  3. The Panamanian government is currently negotiating with the World Bank for reforestation funds.

REFERENCES
Acharya, Gayatri, and Edward Barbier. 2002. Using Domestic Water Analysis to Value Groundwater in the Hadejia-Jama'are Flood Plain, Northern Nigeria.
American Journal of Agricultural Economics 84(2): 415-26.

Costanza, Robert, et al. 1997. The Value of the World's Ecosystem Services and Natural Capital. Nature, May 15, 253-60.

Dean, Cornelia. 2005. To Save Its Canal, Panama Fights for its Forests. New York Times. May 24.

Economist. 2005. Are You Being Served? April 23-29, 76-78.

Pimentel, David, et al. 1997. Economic and Environmental Benefits of Biodiversity. BioScience 47(11): 747-57.

Toman, Michael. 1998. Why Not to Calculate the Value of the World's Ecosystem Services and Natural Capital. Ecological Economics 25: 61-65.

Topics: 
Type: 
Media Source: 
Tim Fitzgerald is an assistant professor of economics at Montana State University and was a 2012 PERC Lone Mountain Fellow. His paper "Frackonomics: Some Economics of Hydraulic Fracturing" was recently published in the Case Western Reserve Law Review. 
Read More > More Articles by Tim Fitzgerald >