Spot the Bias

'Tis a bug life. I'm just not in the equation

Many an environmental policy has floundered after being subjected to a cost-and-benefit analysis. The important question, as Philip E. Graves points out, is whether such rejections are founded on proper science.

In a recent paper he explores the sources of bias in the methods used to evaluate environmental policy in the United States, an exercise that has direct application to environmental policy-making in other countries.

After a careful, wide-ranging analysis, he finds that environmental valuation as practiced today is biased against the environment, leading to a predisposition against acceptance of environmental projects. Powerful special interests are aligned against certain environmental goods.

Furthermore, non-use values such as preservation and existence are poorly captured by the methods currently in widespread use. The methods of economics tend to concentrate exclusively on use values, while some environmental amenities will actually have a higher value to society collectively if preserved.

But this is not all. The most commonly used damage estimation methodologies (sum of specific damages, usually shortened to SSD, and the hedonic method) as typically conducted understate damage. The latter, for instance, resorts to expert legal testimony and regulatory practices that refer to either property value or wages, despite long-standing knowledge that compensation for environmental amenities and disamenities generally occurs in both the land and labour markets.

SSD, in turn, among other things tends to omit health and other effects, such as material damage, scenery and so on, while emphasising acute damages rather than chronic damages, which are more difficult to study.

Moreover, while each of the previous valuation methods has specific flaws leading to undervaluation, there is a quite fundamentally different view of “damage perceptions” under the two approaches. The SSD implicitly assumes zero damage perception; were this not the case rational people would engage in averting behavior to avoid those damages, averting behavior that is ignored in this approach.

The hedonic methodology, in turn, implicitly makes a polar opposite assumption about damage perception—not only are damages from pollution assumed to be perfectly perceived under this approach, but households are also assumed to perfectly perceive the spatial variation in pollution. The underlying assumptions about perception of damages are inconsistent across these approaches, suggesting the likelihood that entirely different damage categories are being picked up in the two approaches.

In sum, Mr Graves makes a strong case for applying both methods, adding the benefits of a properly conducted hedonic analysis to the benefits obtained from the sum of the SSD approach. While acknowledging that some double-counting may occur in this process, he expects it to offset the biases within each methodology that lead to an understatement of environmental values.

Philip Graves: Benefit-Cost Analysis of Environmental Projects: A Plethora of Systematic Biases, CESifo Working Paper No. 3144

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