3
Assessing Benefits and Costs of Corps Projects

FEDERAL WATER RESOURCES PLANNING AND EVALUATION

Benefit-cost evaluations have been part of Corps of Engineers planning studies since the early twentieth century. As discussed in Chapter 2, the Corps began standardizing its more routine economic procedures in the 1920s, providing estimates of project benefits and costs. Growing budgets related to Flood Control Acts in 1917 and 1928 (the latter in connection with the exceptional Mississippi River floods of 1927) created pressures for greater accountability. In 1927, Congress directed the Corps to study all major U.S. river basins in terms of navigation, hydropower, irrigation, and flood control project prospects. Over the ensuing decade, the Corps produced a mass of documents entitled “308 reports” (named after the U.S. House of Representatives document that mandated the studies), in which the agency relied on some quantification of benefits and costs to impose discipline upon its growing programs.

The Flood Control Act of 1936 mandated formal benefit-cost analysis (BCA) within Corps planning studies. One observer has referred to the act as “… one of the heroic efforts of the United States Congress to control its own bad habits” (Porter, 1996). The act states:

[…] the federal government should improve or participate in the improvement of navigable waters or their tributaries, including watersheds thereof, for flood control purposes if the benefits to whomsoever they accrue are in excess of the estimated costs, and if the lives and social security of people are notherwise adversely affected.

Following passage of the 1936 act, several policy and planning milestones have affected ways in which benefits and costs are calculated within Corps planning studies. Examples of key subsequent federal and Corps water resources planning guidance documents regarding benefit and cost calculations include a 1952 document (Circular A-47) from the



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Analytical Methods and Approaches for Water Resources Project Planning 3 Assessing Benefits and Costs of Corps Projects FEDERAL WATER RESOURCES PLANNING AND EVALUATION Benefit-cost evaluations have been part of Corps of Engineers planning studies since the early twentieth century. As discussed in Chapter 2, the Corps began standardizing its more routine economic procedures in the 1920s, providing estimates of project benefits and costs. Growing budgets related to Flood Control Acts in 1917 and 1928 (the latter in connection with the exceptional Mississippi River floods of 1927) created pressures for greater accountability. In 1927, Congress directed the Corps to study all major U.S. river basins in terms of navigation, hydropower, irrigation, and flood control project prospects. Over the ensuing decade, the Corps produced a mass of documents entitled “308 reports” (named after the U.S. House of Representatives document that mandated the studies), in which the agency relied on some quantification of benefits and costs to impose discipline upon its growing programs. The Flood Control Act of 1936 mandated formal benefit-cost analysis (BCA) within Corps planning studies. One observer has referred to the act as “… one of the heroic efforts of the United States Congress to control its own bad habits” (Porter, 1996). The act states: […] the federal government should improve or participate in the improvement of navigable waters or their tributaries, including watersheds thereof, for flood control purposes if the benefits to whomsoever they accrue are in excess of the estimated costs, and if the lives and social security of people are notherwise adversely affected. Following passage of the 1936 act, several policy and planning milestones have affected ways in which benefits and costs are calculated within Corps planning studies. Examples of key subsequent federal and Corps water resources planning guidance documents regarding benefit and cost calculations include a 1952 document (Circular A-47) from the

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Analytical Methods and Approaches for Water Resources Project Planning Bureau of the Budget; the 1958 report, Proposed Practices for Economic Analysis of River Basin Projects” (known familiarly as “the Green Book”), issued by a subcommittee of the Federal Interagency River Basin Committee; Senate Document 971, approved by President Kennedy in May 1962; and the 1973 Principles and Standards (P&S) and the 1983 Principles and Guidelines (P&G), both issued by the federal Water Resources Council (WRC, 1973; 1983). Although the methods and criteria for evaluating benefits and costs in Corps studies have changed substantially over the years, BCA has played a central role in prioritizing water project proposals throughout the agency’s history and remains the key decision criterion in Corps planning studies. The following section reviews the use of benefit-cost analysis in Corps water resources project planning studies. BENEFIT-COST ANALYSIS IN WATER PROJECT PLANNING Benefit-cost analysis is well-established in theory and practice. Water resources planning and research has had important influences on the field of benefit-cost analysis (e.g., Eckstein, 1958; Krutilla and Eckstein, 1958; Maass et al., 1962; Mazmanian and Nienaber, 1979), and there is a broad literature regarding BCA theories and methods for water project evaluation (e.g., Brent, 1998; Garrod and Willis, 1999; Hanley and Spash, 1993; Zerbe and Dively, 1994). Presidential Executive Orders 12,291 (1981) and 12,866 (1993) require benefit-cost analysis of all major executive regulatory proposals that affect human health and the environment. As mentioned, benefit-cost analysis remains the most important criterion in Corps planning studies (USACE, 2000). Benefit-cost analysis is a method for organizing information to support decisions. By imposing discipline and uniformity on the collection, interpretation, and presentation of information, BCA provides a systematic means of assessment, enabling comparisons among projects. It aims to separate acceptable from unacceptable projects (based on objective criteria) to ensure that resources are invested wisely. A secondary role of BCA is to prioritize project alternatives. Examples of decision criteria used in connection with benefit-cost analysis include (1) maximizing the ratio of 1   The document was entitled Policies, Standards, and Procedures in the Formulation, Evaluation, and Review of Plans for Use and Development of Water and Related Land Resources.

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Analytical Methods and Approaches for Water Resources Project Planning benefits to costs, (2) maximizing net benefits, and (3) identifying all alternatives for which the benefits exceed the costs. A strict decision rule based solely upon BCA, however, is problematic because the multiple objectives of government agencies like the Corps are not easily reduced to simple criteria. Nevertheless, BCA provides critical information against which public goals can be calibrated and individual projects scrutinized. Measuring Benefits and Costs In making choices about how to spend their income and other resources, people make trade-off decisions. Generally speaking, the more something is valued by an individual, the more will a person be willing to give up for it. The concept of willingness-to-pay (WTP) as a measure of economic value (benefits) flows from this precept. WTP is a measure of the amount one would be willing to give up in exchange for the good or service being valued. It is the most that one would be willing to forgo, whether or not one actually pays for the good.2 Several characteristics of WTP as a measure of value are worth emphasizing.3 First, it is based entirely on human preferences. There is no innate feature of a good or service, such as its energy content, its biomass, or its vulnerability to extinction, that measures its value, although these characteristics often influence human preferences. Second, WTP is not limited to goods exchanged in markets. To the extent that people care about goods and services that are not traded in markets, such as environmental quality or an endangered species, they will be willing to give up other goods and services to protect them. The valuing of environmental goods is thus consistent with the valuing of goods traded in regular markets, because both applications involve the use of resources to achieve something of value to people. Third, although willingness to pay is typically gauged in monetary units (such as dollars), the concept itself has little to do with money. The key notion is that the value of obtaining something can be measured by how many other goods and services a 2   To the extent that the price of a good is less than this WTP, consumers enjoy a “consumer surplus”—a value over and above their actual payment. 3   A related concept of value is willingness to accept (WTA). This is a measure of the minimum amount of other goods and services or money an individual would be willing to accept in exchange for giving up a good or service. Although WTP is used in this discussion for simplicity, the concepts apply equally to WTA.

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Analytical Methods and Approaches for Water Resources Project Planning person is willing to do without. The use of money as the unit of measure is convenient but not essential—it simply allows goods and services to be valued by the same measure. The cost side of BCA involves the full opportunity cost of a project (OMB, 2000), which represents what society gives up to obtain project benefits. This includes both direct financial costs and indirect benefits forgone associated with a project. For example, the full opportunity cost of a project might include construction costs, administrative costs, the value of lost environmental benefits, and the economic value of discomfort or inconvenience suffered as a consequence, such as waterway traffic delays during construction. Benefit-Cost Analysis in Decision Making In a seminal 1996 essay, 11 prominent economists framed appropriate roles for benefit-cost analyses in environmental and health policy making (Arrow et al., 1996), stating (see also Box 3-1): Benefit-costanalysis can play a very important role in legislative and regulatory policy debates on improving the environment, health, and safety. It can help illustrate the tradeoffs that are inherent in public policymaking as well as make those tradeoffs more transparent. It can also help agencies set regulatory priorities. Benefit-cost analysis should be used to help decisionmakers reach a decision. Contrary to the views of some, benefit-cost analysis is neither necessary nor sufficient for designing sensible public policy. If properly done, it can be very helpful to agencies in the decisionmaking process. Benefit-cost analysis should be required for all major regulatory decisions, but agency heads should not be bound by a strict benefit-cost test. Instead, they should be required to consider available benefit-cost analyses and to justify the reasons for their decision in the event that the expected costs of a regulation far exceed the expected benefits. Agencies should be encouraged to use economic analysis to help set regulatory priorities. Economic analyses prepared in support of particularly important decisions should be subjected to peer review both inside and outside government.

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Analytical Methods and Approaches for Water Resources Project Planning BOX 3-1 Principles for Appropriate Use of Benefit-Cost Analysis Arrow et al. (1996) recommended that all benefits and costs of a project should be identified; those that can reliably be monetized should be, uncertainty in the benefits and costs should be calculated and reported, and distributional consequences (who gains and who loses) should be addressed and reported. By providing this information, not only the final users of BCA will know the best estimates of the net benefits of the project, but they also will have a good understanding of who pays for it and who benefits from it. The principles of benefit-cost analysis they identified are as follows: BCA is a useful way of comparing the favorable and unfavorable effects of proposed policies. Decision makers should not be precluded from considering the economic costs and benefits of different policies. BCA should be required for all major regulatory decisions. Although agencies should be required to conduct BCA for major decisions and explain why they have selected action for which reliable evidence indicates that expected benefits are significantly less than expected costs, those agencies should not be bound by strict benefit-cost tests. Benefits and costs of proposed policies should be quantified wherever possible. Best estimates should be presented along with a description of uncertainties. The more external review regulatory analyses receive, the better are they likely to be. A core set of economic assumptions should be used in calculating benefits and costs. Although BCA should focus primarily on the overall relation between benefits and costs, a good analysis will also identify important distributional consequences. SOURCE: Arrow et al. (1996).

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Analytical Methods and Approaches for Water Resources Project Planning Reasons for rejecting a strict benefit-cost test as a decision rule for ranking investment priorities include the following: (1) there may be important equity considerations in the distribution of costs and benefits that are not addressed by maximizing the difference between total benefits and total costs, (2) benefit and cost estimates may contain significant uncertainties, and (3) it may not be possible to use money as a measure of all relevant costs and benefits (e.g., biodiversity, ethical issues). Consistent with these principles, many economists and planners agree that benefit-cost analysis is an important means for informing public policy decisions, but that it should not be used as a strict decision rule. That is, benefit-cost analysis can be used to identify whether an action increases aggregate well-being, which is its traditional role. Yet benefit-cost analysis could also provide information regarding the distribution of benefits and costs, the robustness of benefit and cost estimates in the face of future uncertainties, and whether nonmonetized factors are important. When BCA is used as a strict decision criterion, however, the richness of these multiple considerations is lost. Benefit-cost analysis is most appropriately employed mainly as a method to inform and support decisions, not as a precise decision rule. Pursuant to the 1936 Flood Control Act, however, the Corps is required to use benefit-cost analysis as a strict decision rule in recommending projects to Congress. This reflects a view that BCA assessment is a specific, strict decision rule, which is inconsistent with principles of “best practice” in modern economics and inconsistent with the principles identified by the Arrow et al. group (1996). Nonmarket Goods and Services Many of the goods and services delivered by water resources project are not exchanged in markets. Examples of nonmarket goods and services include some recreational opportunities (e.g., swimming in a lake or river), ecosystem services (e.g. genetic diversity; waste assimilation capacity), and reduced risk of injury or death. Methods exist for including nonmarket goods in benefit-cost analysis (Bateman et al., 2002; Bjornstad and Kahn, 1996; Champ et al., 2003; Freeman, 1994; Haab and McConnell, 2002; Kopp et al., 1997; Randall, 1999; Smith, 1996), but there are methodological challenges associated with consistently valuing them. The value of environmental goods and services has been the subject

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Analytical Methods and Approaches for Water Resources Project Planning of numerous studies.4 Methods used to obtain quantitative values can be divided into two categories: (1) revealed preferences and (2) stated preferences. Revealed preferences are methods that infer willingness to pay from related market behavior. An example of a revealed preference study is an estimate of the WTP for clean air by comparing real estate prices in more- and less-polluted regions of a city. Similarly, the WTP for more abundant fish populations can be derived from the demand for recreational fishing trips. The unifying theme of revealed preferences is that data on market behavior are used to calculate the value of associated environmental goods. Stated preferences are methods that elicit WTP directly from individuals through surveys, interviews, or simulated exercises. Begun in the 1960s, stated preference methods have become increasingly popular and today constitute a large literature within the environmental economics field. Much of the appeal of these methods stems from their flexibility. Stated preference methods can be applied to any good or service, at any place or time, including hypothetical goods such as a new recreational opportunity or restoration of a degraded ecosystem. They may also be the only practical approach for some categories of benefits and costs. Corps guidance recognizes the utility of both revealed and stated preference methods for planning studies (USACE, 2000) and uses them for some categories of benefits. For example, the Corps often uses unit day values, estimated through benefits transfer, to represent the economic value of environment or natural resources, and the Corps publishes unit day values for use in valuing recreational impacts of its projects.5 These approaches estimate WTP for project or resource use outcomes using goods or services other than the ones for which the values are initially needed. As an example of the benefits transfer method, assume that a proposed project is being considered that would eliminate fishing in a Louisiana estuary. Rather than conducting a new study of the estuary, an existing stated or revealed preference study on recreational fishing in a Texas estuary could be consulted. Suppose the Texas study found that on average, an angler was willing to pay $25 per day for a fishing outing. If the study is sound and the resulting value is within 4   Braden and Kolstad (1991), Freeman (1993), and Herriges and Kling (1999) provide overviews of methods of nonmarket valuation. Anderson and Kobrin (2002) review the use of benefit cost analyses within the U.S. Environmental Protection Agency’s programs. 5   For example, effective in March 2002, Corps guidance provides for general recreation values ranging from $2.90 to $8.69 per day and specialized recreation values from $11.46 to 34.41 per day (USACE, 2002). A point system for identifying the quality of the recreational experience allows analysts to select values within these ranges.

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Analytical Methods and Approaches for Water Resources Project Planning the range of the Corps’ published values for this experience, it might then be “transferred” or applied to the Louisiana project. The number of angling days lost to the Louisiana estuary could then be estimated and multiplied by $25 to yield an estimate of the lost value of the recreational angling. There is an underlying assumption that Texas anglers and Louisiana anglers value estuarine fishing the same way. Some nonmarket goods and services do not have to be consumed or experienced in order to be valued. For example, some people may value the existence of whales in the sea although they may never see a whale or consume whale-based products. Such “non-use” values can be difficult to accurately measure, as it is difficult to determine how many people will have positive non-use values for a particular good. It has also been argued that such goods might take on symbolic value—valued not so much for themselves but for a broader concern for environmental protection or species conservation that they represent.6 Nonetheless, there is little debate that non-use values are a legitimate, conceptual component of environmental benefits and should be included in calculations of overall project, regulatory, or programmatic benefits. Benefit-Cost Analysis in Other Agencies and Organizations Despite the challenges of valuing environmental goods and services, the Office of Management and Budget (OMB) places enough confidence in established methods to have authorized carefully-constructed valuation studies as important elements of rule-makings (OMB, 2000; 2003; see Appendix C). These guidelines are applicable to all executive-level agencies.7 The U.S. Environmental Protection Agency (EPA) and the National Oceanic and Atmospheric Administration (NOAA) are mandated to address environmental issues and problems; their experience with valuation is thus relevant to the Corps’ ecosystem restoration efforts. In 2000, the EPA issued Guidelines for Preparing Economic Analyses, which serves to guide BCA applications for EPA’s environmental regulations and programs (similar to the Corps Planning Guidance Notebook). The EPA guidelines reflect an awareness of the challenges of measuring and monetizing benefits and costs of environmental 6   This is sometimes called the “warm glow” effect in the environmental economics literature. 7   Both revealed and stated preference methods have also been used by various federal and state agencies in litigation to recover damages for environmental impacts.

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Analytical Methods and Approaches for Water Resources Project Planning goods and services. Nevertheless, its guidelines state that “to the extent feasible and warranted by their contribution to the results, as many of the effects of a policy as possible should be monetized. This enhances the value of the conclusions to policy makers weighing the many, often disparate consequences of different policy options and alternatives” (EPA, 2000, p. 176). Within the NOAA, environmental valuation has been an important method for implementing provisions of the Oil Pollution Act that require compensation for environmental damages due to oil spills. In the process of assessing losses associated with natural resources damages, NOAA requires monetary compensation for non-use (often referred to as “passive losses”), a decision that has withstood legal challenge.8 Nonmarket valuation is also practiced by some international organizations, such as the World Bank, which requires benefit-cost studies of proposed investments (see Box 3-2). In comparison to other federal environmental and natural resources management agencies (e.g., EPA, NOAA), the Corps has made less use of environmental valuation techniques in its benefit-cost analyses. This may have been appropriate in an earlier era when Corps authorities and U.S. federal laws only tangentially addressed environmental goals. Today, however, ecosystem planning and restoration are major and growing foci of the Corps work program. The Corps’ largest restoration projects involve years of planning and evaluation and expenditures of billions of dollars. In this context, current Corps guidance concerning the use of environmental valuation techniques is out of date. Carefully used, these techniques can improve the Corps’ planning and evaluation capabilities. The Corps Institute for Water Resources has led agency efforts in supplementing its guidance in this analytical realm (Stakhiv et al., 2003).9 8   General Electric Co. v. U.S. Dep't of Commerce, Nat'l Oceanic & Atmospheric Admin., 128 F.3d 767 (D.C. Cir. 1977). 9   Although it acknowledges the presence of estimation methods suitable for valuing some ecological services, the Corps is guarded in its assessment of the usefulness of these methods: …considerable technical obstacles, both scientific and economic, stand in the way of comprehensive monetary accounting of restoration project benefits. Scientific obstacles relate to problems in tracing the links between restoration actions and service outcomes underlying all possible routes to human benefits. Economic obstacles relate to methodological limitations for measuring nonmarket benefits of service outcomes that affect the quality of human life in ways that have no close connection to the use of market goods. Together, the scientific and economic obstacles to comprehensive valuation of restoration outputs impede use of a net benefits criterion for justifying restoration projects (Stakhiv et al., 2003).

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Analytical Methods and Approaches for Water Resources Project Planning BOX 3-2 Environment and BCA at the World Bank The World Bank makes nearly $20 billion in project and program loans annually to nations around the world, approximately ten times the level of Corps of Engineers investment activities. The Bank organizes most of its activities around a “project cycle” that includes both ex ante and ex post evaluations. The Bank’s appraisals distinguish “financial” costs and benefits—those that accrue as cash flows to or from the project sponsor—from “economic” costs and benefits that are experienced by all other entities. BCA is accepted within the Bank not only as a systematic way to evaluate proposed investments, but also as a decision criterion, and over the years, Bank economists have made important contributions to the literature on benefit-cost analysis. The World Bank’s guidelines for BCA include the following approach to valuing environmental services: environmental externalities are identified as part of the environmental assessment, quantified where possible, and included in the economic analysis as project costs (e.g., decreased fish catch, or increased illness) or benefits (e.g., reduction in pollution of coastal areas). After monetary values are assigned to costs and benefits, they are entered into the cash flow tables like other costs and benefits (World Bank, 1996). Environmental appraisals are the responsibility of the borrower and are required for all projects expected to have a major environmental impact. The appraisal “predicts and assesses the project’s likely positive and negative impacts, in quantitative terms to the extent possible,” while the required analysis of project alternatives “quantifies the environmental impacts to the extent possible, and attaches economic values where feasible” (World Bank, 1999). In practice, however, environmental costs are generally not monetized for Bank projects. Recently, some experimental appraisals with environmental monetization have been conducted. For example, the 1999 appraisal of a $3.7 billion oil development and pipeline project in Cameroon and Chad explicitly included a comprehensive net present value of all environmental and social costs—and estimated them at less than $20 million against $1.8 billion in economic benefits. However, although some costs were monetized (e.g., value of lost agricultural and grazing use, loss of edible game harvested in forests), others were merely mentioned (World Bank, 2000). SOURCES: World Bank (1996, 1999, 2000) and http://www.essochad.com/Chad/Files/Chad/EAESU1.pdf.

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Analytical Methods and Approaches for Water Resources Project Planning Implementation of these techniques by the Corps will require approval from the OMB, or revision of the P&G, or both. Nonmarket valuation of environmental goods and services will always be subject to some degree of uncertainty. This should not be a reason to disregard its usefulness in benefit-cost analysis, however. Almost all methods used to evaluate benefits and costs, whether traditional market-based approaches based on engineering studies or international trade studies of projected port usage, are subject to uncertainty. Although nonmarket valuation methods do contain uncertainties and represent substantial analytical challenges, the same could have been said of today’s “traditional” methods when they were in early stages of development. These methods were improved over time through repeated applications and refinements. The growing importance of environmental evaluations and projects within the Corps suggests that the relevance and potential usefulness of nonmarket valuation methods will continue to grow. The Corps should thus continue its efforts in improving the scope, reliability, and applicability of valuation methods (an ongoing National Research Council study on the valuation of goods and services within aquatic ecosystems, cosponsored by the Corps and due for publication in 2004, should be useful to the agency). Given the extensive use of benefit-cost analysis within the federal government, the Corps would also be well-served by cooperating with other federal resource management agencies, notably EPA, NOAA, and the Departments of Agriculture and Interior, to coordinate and support research to improve BCA methods and applications. The Office of Management and Budget should support such cooperative efforts. STATE OF CORPS PRACTICE: CURRENT ECONOMICS APPROACHES The Corps Planning Guidance Notebook (USACE, 2000; see Box 3-3) establishes standards according to which all projects should be scrutinized. These principles of analysis are accepted by many economists and policy analysts, although they do contain some unusual features. Efficiency The economic notion of efficiency refers to the degree to which the marginal costs of an action or policy equal its marginal benefits. Meas-

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Analytical Methods and Approaches for Water Resources Project Planning Defining and Valuing Benefits Definitions Environmental restoration is an important concept to the Corps, to ecological scientists, and to many interest groups and citizens. The concept gained in importance and prominence during the 1990s, and its definition and applications evolved during that decade (see Box 3-5). The field of ecosystem restoration is supported by an increasingly rich theoretical base, but there has been limited experience and limited evaluation of results to date. Establishing an operational definition of this broad concept that is consistent with and complementary to existing BOX 3-5 Evolution of the term “Restoration” Restoration: returning an ecosystem to a close approximation of its condition prior to disturbance (NRC, 1992). Rehabilitation: modifying selected sections of riverine systems to a pre-determined structure and function (Gore and Shields, 1995). Naturalization: shifting some characteristics of the regulated system closer to a natural pattern while maintaining or enhancing economic and social uses of the system (Rhoads and Herricks, 1996). Normalization: the standard established from what is possible in a natural-cultural context as opposed to pristine conditions, which are difficult, if not impossible, to define or achieve (Stanford et al., 1996). Restoration: returning a site to a condition similar to the one that existed before it was altered, along with its predisturbance functions and related physical, chemical, and biological characteristics. The goal is to establish a site that is self-regulating and integrated within its landscape, rather than to reestablish an aboriginal condition that can be impossible to define and/or restore (Middleton, 1999). Restoration: the process of assisting the “recovery” of an ecosystem that has been degraded, damaged, or destroyed … interact with contiguous ecosystems including cultural (SER, 2002).

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Analytical Methods and Approaches for Water Resources Project Planning guidance and programs is a challenge for an action-oriented agency such as the Corps. Although there is not an agency-wide, standard definition of restoration, definitions that are used are generally consistent with contemporary literature on the topic. For example, according to internal Corps guidance: Civil works ecosystem restoration initiatives attempt to accomplish a return of natural areas or ecosystems to a close approximation of their condition prior to disturbance, or to a less degraded, more natural conditions. In some instances a return to pre-disturbance conditions may not be feasible. However, partial restoration may be possible, with significant and valuable improvement made to degraded ecological resources. The needs for improving or re-establishing both the structural components and the functions of the natural area should be examined. The goal is to partially or fully restore the attributes of naturalistic, functioning and self-regulating systems (USACE, 1999b). Although consistent with scientific literature on the topic, such definitions do not provide specific guidance for Corps planners. As a result, the Corps may find it difficult to define its limits and strengths within the broad realm of ecological restoration. For example, ecological restoration could include changes in dam operations, reintroduction of native species, changes in water quality, changes in land use, and the creation of new wetlands. Many of these issues were addressed in a National Research Council report (NRC, 2002a) that examined the scientific, as well as organizational, challenges facing the Corps in its efforts to balance a variety of uses and mandates on the Missouri River, which include the protection of endangered species (Box 3-6). That report also pointed out the need for Congress to review and address the multitude of laws and guidance that it has issued pertaining to management of the Missouri River dam and reservoir system. Valuation Techniques As subjects for economic analysis, ecological restoration projects share some similarities with other Corps projects, as they entail an initial investment, various subsequent expenditures, and a stream of benefits valued by humans. Some characteristics common to most ecological restorations, however, should be stressed lest they be

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Analytical Methods and Approaches for Water Resources Project Planning BOX 3-6 The Corps and Missouri River Management The Corps of Engineers constructed and operates six mainstem dams on the Missouri River. Those dams are the heart of North America’s largest reservoir storage system and exert considerable control on the river’s hydrology. Constructed to enhance Missouri River navigation and reduce flood damage, the dams have also altered the dynamics of the river’s hydrologic and geomorphic systems, which has contributed to the declining condition of the river-floodplain ecosystem. The Corps’ main document guiding system operations is the Missouri River Mainstem System Reservoir System Regulation Manual, or the “Master Manual” (USACE, 1979). The first Master Manual was issued in 1960. In response to a severe drought across much of the basin in the late 1980s, the Corps initiated a process of revising the Master Manual, a process that was not yet completed when this report went to press. Operations of the system represent a delicate and controversial balancing act for the Corps, because originally authorized purposes of the system and subsequent environmental laws may pull the agency in different directions. As General David Fastabend, Commanding General of the Corps’ Northwestern Division explained to the U.S. House of Representatives, “Our guidance is sometimes contradictory and the resolution of those contradictions is extremely problematic” (Fastabend, 2002). In 1999, the U.S. EPA and the Corps requested the National Research Council to convene a committee to provide advice on Missouri River ecosystem science. There have been some efforts aimed at enhancing the Missouri’s environmental benefits, but as the NRC committee noted in its 2002 report, “Degradation of the natural Missouri River ecosystem is clear and is continuing” (NRC, 2002). That report also pointed to the key factors that must be addressed in order to effect restoration: “Degradation of the Missouri River ecosystem will continue unless some portion of the hydrologic and geomorphic processes that sustained the pre-regulation Missouri River and floodplain ecosystem are restored—including flow pulses that emulate the natural hydrograph, and cut-and-fill alluviation associated with river meandering” (NRC, 2002a).

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Analytical Methods and Approaches for Water Resources Project Planning neglected in the analysis. First, ecological restoration tends to involve multiple benefits from a single complex natural entity. For example, a restored wetland can simultaneously reduce downstream flooding, trap sediment, purify water, produce hunting and fishing opportunities, provide attractive scenery, and support endangered species. Most, although not all, of these benefits are nonmarket benefits, so their value must be calculated by revealed or stated preferences, rather than by market prices. Also, some benefits may be consumed by people as existence values rather than use values, and geographically, it may be difficult to delineate precisely where each benefit is enjoyed. Second, the benefits are produced by natural systems, and the complexities of these systems confound precise forecasts. According to guidelines issued by the Society for Ecological Restoration (SER, 2000, p. 7), “no two intact ecosystems are ever identical … (and) no restored ecosystem at a project site can ever be identical to any single reference”. (Box 3-6 lists attributes of restored ecosystems, according to the SER). These values are thus distinct, although from an economic point of view, there may be reasonable substitutes for specific habitats when it comes to producing specific benefit flows of value to people and societies. Moreover, ecosystems change and develop over time and may still function despite natural or human perturbations. This makes them different from most engineering investments, in which there is a mechanistic relation between a fixed piece of capital and a stream of benefits. Third, ecologists view “restoration” not as a particular state, but rather as “attempts to return an ecosystem to its historic trajectory” (SER, 2002). The idea of trajectory implies that an ecosystem may require years to (re)gain its ability to produce a full array of benefits. Ecosystem restoration could thus be disadvantaged in benefit discounting, compared to structural approaches that generate ecological benefits more quickly, or even to simplified, constructed ecosystems such as wetlands populated with nonnative, rapidly growing species. If a natural ecosystem provides distinctive services that are more highly valued than an artificial environment, a proper accounting of service flows and their values may outweigh timing issues (Box 3-5). In giving fair analytic treatment to a restored system, it is essential to consider the range of trade-offs between benefits. For example, nonnative species may quickly control and help manage runoff in wetlands, but as a result, the wetland may never regain its previous state of wildlife values. Discounting Most Corps projects have design lives of many dec-

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Analytical Methods and Approaches for Water Resources Project Planning ades. To permit comparison of benefits and costs accruing at different times, a means of normalizing benefits over time is required. Normalizing benefit and cost streams also permits comparisons between projects with different life cycles. Benefit-cost analysis uses discounting procedures to normalize financial outcomes over time. The logic is that resources are productive and time is valuable. In the marketplace, the interest rate signals the marginal productivity of financial resources and the marginal willingness of individuals to defer consumption to some future date. Implicitly, benefits obtained sooner are worth more than those same benefits realized later, a difference reflected by the amount of interest that can be earned in the interim. Future benefits and costs can be normalized to present benefits and costs by discounting at the rate of interest. Although discounting is well established in its treatment of financial resources,12 the Corps is reluctant to apply discounting to physical resources yielding streams of benefits over time, such as habitat or the members of an endangered species. The Planning Guidance Notebook (USACE, 2000, Sec. E-36c (1), p. E-154) states that “ecosystem restoration outputs are not discounted, but should be computed on an average annual basis, taking into consideration that the outputs achieved are likely to vary over time.”13 Temporal considerations are relevant to all productive resources, however, whether the services yielded can be monetized by standard means (e.g., flood damage reductions) or not (e.g., enjoyment of a scenic vista). It does not seem wise to reject the potential value for discounting out of hand simply because the units being discounted are physical rather than financial. The Corps may wish to reevaluate its cost effectiveness and incremental cost analysis to help address these issues. 12   The issues surrounding discounting are important for the Corps. There is an extensive literature on the theory of discounting (e.g., Lind et al., 1982). At the same time, the Corps must follow the guidance issued by the Office of Management and Budget. 13   Stakhiv et al. (2003, p. 92) also address the challenge of discounting.

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Analytical Methods and Approaches for Water Resources Project Planning OTHER ISSUES The Challenges of Forecasting: “With” and “Without-Project” Forecasts Perhaps the single most difficult methodological challenge facing project analysts is forecasting future conditions. The value of many Corps proposals often hinges on the size and scope of future economic activity. Deepening a harbor or navigation channel is often worthwhile only if shipping costs are reduced or if the amount of commerce increases enough to more than offset the costs associated with dredging. However, future cost savings and commodity flows will depend not only deepening the harbor, but also on future competition from other nations and ports, technological or regulatory changes affecting competing modes of transport, energy costs, economic growth rates, and other factors. Modest changes in some of these factors can have marked effects on the economic development benefits of a navigation project. Similarly, the forecasting of future environmental conditions is confounded by the roles of extreme events, human influences, and uncertainty regarding long-term environmental changes and variability. In July 2002, the Corps issued a new policy precluding the use of “locally developed planning models which cannot withstand national level scrutiny” (Griffin, 2002). According to the policy declaration, The Corps Institute for Water Resources will validate Corps economic forecasting models through an independent expert review process. Although this is a step in the right direction, it falls short of the practices by other federal agencies that have instituted more routine review processes that entail a greater degree of independence. The U.S. Department of Agriculture (USDA), for example, supports the Food and Agricultural Policy Research Institute at the University of Missouri, and the National Science Foundation (NSF) supports the National Center for Atmospheric Research in Boulder, Colorado. Both of these institutions develop and manage complex models that are used extensively by their respective sponsoring agency, as well as by other agencies. The Corps Engineering Research and Development Center (ERDC) and Institute for Water Resources, for example, have produced many highly regarded engineering and scientific models and reports. Corps models and reports, however, have not regularly been subjected to fully independent reviews by experts from outside the agency. Such independent reviews are becoming

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Analytical Methods and Approaches for Water Resources Project Planning an increasingly important component of the credibility of federal agencies and other bodies. External Expertise The relationships that some other federal agencies have with external experts ensure that relevant modeling capabilities are available to the agencies, that expertise accumulates, and that research and studies are subjected to the scrutiny of external experts (see also the report from the 216 study panel on peer review methods; NRC, 2002). Analyses in Corps planning studies today are highly sophisticated, suggesting that the Corps would benefit from the advice of experts outside the agency. Moreover, the Corps is often subjected to strong national- and local-level pressures in its more controversial and complex studies. Given the complexities and pressures that surround the Corps’ larger and more costly planning studies, there is the need to involve independent experts to ensure that its plans and projects are technically sound, as well as to ensure a higher degree of credibility. Other federal agencies also routinely engage outside experts to develop and improve analytical tools. For example, the long-range timber supply and demand models used by the U.S. Forest Service were developed with university economists and have been the subject of numerous peer-reviewed articles. The Corps has engaged independent experts at its research centers at the Institute for Water Resources and the Engineering Research and Development Center; however, the use of independent expertise has been less common in the Corps of Engineers than in some other agencies. Experts can be used to conduct many aspects of the planning studies or at least to serve on advisory bodies charged with ensuring that defensible methods and assumptions are used. They can also be called upon to recommend planning approaches, techniques, and tools and to assist operating staff in their use. Routine use of external experts and carefully-reviewed planning methods will better enable the Corps to defend its studies. The agency is today keen on enhancing the credibility of its planning studies, and in many cases, there is no substitute for the credibility that attends independent, expert review. Increased participation of external experts may also help the Corps contend with a long-term decline in the size of its planning staff that is likely to be compounded by impending retirements. Finally, systematic peer review of Corps planning studies would help ensure that the methods used represent best practices, that assumptions are reasonable and justifiable, and

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Analytical Methods and Approaches for Water Resources Project Planning that plausible options for achieving national goals are not being over-looked. Scaling Analysis to Project Importance and Cost A reasonable principle of policy or project analysis is that the intensity and cost of a study should be commensurate with the scale and cost of the proposal. Apart from the general exhortation in the introduction to the PGN to “be guided by common sense in applying the policies and procedures contained herein” (USACE, 2000, p. 2-1), this principle is explicitly stated only in Appendix F dealing with the Continuing Authorities Program ((USACE, 2000, Sec. F-3b): Level of Detail. District staff will use common sense and professional judgment to perform the appropriate level of detail of analyses to produce a quality project in a reasonable time and at a reasonable cost. Simplified evaluation procedures may be adopted for low risk/low cost projects and when the consequences of failure are minimal and do not pose a threat to human life or safety. This reasonable policy should be applied more generally to Corps planning studies. Reporting Results of Economic Analyses Analytical results should be understandable to reviewers, to stakeholder groups, and to policy makers. Reports of analyses will be most understandable if they clearly state the assumptions used and models and data sources employed. At present, however, results from Corps planning studies tend to be presented in multiple, thick documents, and even the most diligent reader is challenged to identify the study’s main assumptions and models employed, key environmental issues, primary costs and benefits, relevant risks and uncertainties, and so on. The evolution of environmental impact statements (EISs) done under the National Environmental Policy Act of 1969 offers useful lessons. After a chaotic period during the 1970s in which EISs became ever larger and more unreadable, reforms instituted by the Council on Environmental Quality in the early 1980s led to shorter, more consistent, and more us-

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Analytical Methods and Approaches for Water Resources Project Planning able documents, even for very large and complex projects. There is no reason the Corps cannot do the same. A short summary document should become a standard of Corps planning studies. COMMENTARY Economic concepts and analyses have a long history and tradition in the planning of Corps of Engineers projects, and economic concepts and considerations are at the foundation of the Principles and Guidelines and most of the Corps’ investment and operational decisions. A review of the treatment of economics in Corps planning is thus in a sense a review of the agency’s decision-making paradigms. Although economic concepts such as benefits and costs are clearly important in water resources management decisions, there is a danger in relying too heavily on monetized values and analytical methods to arrive at a final decision. In Corps planning studies, the benefit-cost ratio, arrived at through analytical methods prescribed in the Principles and Guidelines and the Planning Guidance Notebook, is the ultimate criterion. This, however, is an improper use of benefit-cost analysis because it places an undue burden on analytical processes to determine the best water planning or management decision. Today, stakeholder groups call for a greater voice in water resources decision making, many important costs and benefits from Corps projects defy monetization and inclusion in the benefit-cost calculus, and political influences and preferences have always played important roles in water project construction and operations. Benefit-cost analysis clearly yields important information and should continue to be a standard in Corps planning studies. In fact, benefit-cost analyses in Corps planning studies should be strengthened by using accepted methods and external review procedures. However, a single measure, such as achieving the highest benefit-cost ratio, should not serve as the ultimate decision criterion. Implicit within the current planning process is an assumption that sound water management decisions are based primarily on monetized values derived by analytical methods, but in reality this is clearly not the case. Other important social, environmental, and even political considerations should be recognized explicitly in the decisionmaking process. The Principles and Guidelines defines an analytical gauntlet that often requires years of experience to negotiate. Some degree of standardized procedures and guidelines is important to ensure consistency and efficiency, but the current P&G planning process may be inhibiting the

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Analytical Methods and Approaches for Water Resources Project Planning exploration of more creative and comprehensive water management approaches. Moreover, planning guidance, models, and analytical methods developed since the 1983 approval of the P&G have not proven highly effective at helping resolve conflicts and differences between agencies, policies, or interest groups. The Corps of Engineers is not the only federal agency with problems related to overly detailed bureaucratic procedures, as pointed out in the 2003 Volcker Report: “Too often, as well, federal employees depart before their time in frustration over the strangling organizational and procedural complexity of contemporary government decision making. For too many, even their best efforts to be responsive and creative end up in organizational oblivion” (NCPS, 2003). A review of economics methods in the Corps’ primary planning guidance shows that these are not fully consistent with procedures used by other federal agencies and organizations. For example, the Corps is not allowed to count “damages avoided” as a benefit in relocating structures from floodplains, while in FEMA guidelines, damages avoided from relocations constitute a benefit. NOAA enlists “blue ribbon” expert panels and forges one set of valuation techniques and approaches, while the Corps adopts a different set. The USDA and the NSF have long-standing and vigorous external review programs, while the Corps has almost no tradition of routinely enlisting external experts in its planning studies. It appears that these agencies, despite many overlapping mission areas, nonetheless operate largely independently of one another. More vigorous efforts by the administration and the Congress to coordinate activities and responsibilities across federal water-related agencies would thus be useful. Such coordination would help the Corps and other agencies better understand each other’s responsibilities, and could ensure that relevant, contemporary economics and other principles are being applied consistently across federal agencies. Another point reinforcing the need for independent expert input relates to the fact that Corps staff positions are funded by individual studies or projects. This means that staff must charge their time to an active study or project, rather than being accounted for as general overhead. In addition, Corps district-level planning is conducted by staff members who live and work in the region under study and who may have personal relationships with the sponsor. Familiarity with the region and the sponsors may improve communication and a study team’s sensitivity and appreciation for the priorities and values at hand, but it can also result in the Corps being placed in the position of acting as silent advocate rather

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Analytical Methods and Approaches for Water Resources Project Planning than independent analyst. The motivation for the Corps to seek to please a local sponsor does not imply that this behavior is somehow improper, but rather speaks to the human nature of not wanting to disappoint colleagues and sponsors. Periodic, independent review can help ensure that these human tendencies are not affecting a study’s engineering, economic, and scientific analyses. In addition to weighing the input of independent experts, the Corps has for many years sought the advice of interested organizations and individuals in its planning studies and projects. Although the Corps has lengthy experience in working with “stakeholders” in its projects, finding an appropriate balance among diverse perspectives and values presents a substantial management challenge. Chapter 4 reviews the Corps’ efforts to enhance stakeholder participation in its planning studies.