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Cost-Benefit Analysis and the Environment

Further Developments and Policy Use

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This book explores recent developments in environmental cost-benefit analysis (CBA). This is defined as the application of CBA to projects or policies that have the deliberate aim of environmental improvement or are actions that affect, in some way, the natural environment as an indirect consequence. It builds on the previous OECD book by David Pearce et al. (2006), which took as its starting point that a number of developments in CBA, taken together, altered the way in which many economists would argue CBA should be carried out and that this was particularly so in the context of policies and projects with significant environmental impacts.

It is a primary objective of the current book not only to assess more recent advances in CBA theory but also to identify how specific developments illustrate key thematic narratives with implications for practical use of environmental CBA in policy formulation and appraisal of investment projects.

Perhaps the most significant development is the contribution of climate economics in its response to the challenge of appraising policy actions to mitigate (or adapt to) climate change. Work in this area has increased the focus on how to value costs and benefits that occur far into the future, particularly by showing how conventional procedures for establishing the social discount rate become highly problematic in this intergenerational context and what new approaches might be needed. The contribution of climate economics has also entailed thinking further about uncertainty in CBA, especially where uncertain outcomes might be associated with large (and adverse) impacts.

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Quasi-option value

Another aspect of uncertainty is quasi-option value (QOV) where the notion of precaution is made more formal. Again the starting point here is that costs and benefits are almost never known with certainty. But the insight in QOV is that uncertainty can be reduced in some situations by gathering information. Any decision made now which commits resources or generates costs that cannot subsequently recovered or reversed is an irreversible decision. In this context of both uncertainty and irreversibility it may pay to delay making a decision to commit resources. The value of the information gained from that delay is the QOV. This chapter explains how QOV arises, what it adds to the approaches outlined in and addresses some of the terminological issues that have arisen in the literature. The concept of QOV can make a significant difference to decision-making especially as it serves as a reminder that such decisions should be based on maximum feasible information about the costs and benefits involved, and that includes “knowing that we do not (currently) know”. If this ignorance cannot be resolved then there is nothing to be gained by delay. But if further information can resolve it, then delay can improve the quality of the decision. How large is this gain is an empirical question.

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