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Valuing Ground Water: Economic Concepts and Approaches 3— A Framework for the Valuation of Ground Water This chapter provides a conceptual framework for valuing ground water resources that in turn provides a basis for evaluating the trade-offs that occur whenever there are competing uses for the ground water resources. For example, continued use of ground water as an input into agricultural production implies that less ground water is available for municipal purposes. The ''correct" or economically efficient allocation of a scarce resource such as ground water among competing uses depends in part on how the service flows are valued from each use of the resource. The framework proposed in this chapter is based on an overall economic valuation approach that integrates the hydrological and physical components of the valuation problem. More specifically, the framework links changes in the physical characteristics (quantity and quality) of ground water resources to changes in the level of services or uses of the resources and finally, to how society values the changes in the services or uses. It is in establishing the connections among the changes in quantity/quality of ground water and the changes in service flows that collaboration among researchers (e.g., engineers, hydrogeologists, and economists) is most essential. How society values the changes in service flows or uses is primarily an economic valuation problem; its outcome is influenced by institutions and individual tastes and preferences. The steps involved in developing this integrative framework, delineated in the following sections, highlight the needed input from both economics as well as other relevant disciplines. Variations of this interdisciplinary framework have been utilized for the valuation of other resources or resource-related assets, including agricultural land resources, air quality, recreational resources, and wet-
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Valuing Ground Water: Economic Concepts and Approaches lands. Boyle and Bergstrom (1994) proposed a similar framework for measuring the economic benefits of ground water in a report prepared for the U.S. Environmental Protection Agency. While the impetus for Boyle and Bergstrom's report was the need to incorporate the value of ground water resources when conducting regulatory impact analyses, the framework they developed and the variation of that framework outlined here are applicable to other policies and programs that affect ground water resources. SOME PRELIMINARIES Ground Water as a Natural Asset Ground water can be considered a natural asset. The value of such an asset resides in its ability to create flows of services over time. As discussed in Chapter 1, there are two broad categories of resource services provided by ground water: extractive and in situ . The relationships among these are illustrated in the schematic diagram shown in Figure 3.1. In each time period depicted in Figure 3.1, a ground water stock provides each of the services and is subjected to various influences that affect its quality. Of course extraction and/or addition of water today affects the quantity and quality of stocks tomorrow, and it is critical to incorporate this intertemporal element into the analysis of the valuation problem. Intertemporal issues are related to each of these service flows, and understanding them is fundamental to understanding the overall valuation problem. The Concept of Total Economic Value The total economic value (TEV) of ground water is a summation of its values across all of its uses. Sources of values have been classified into use values (sometimes called direct use values) and nonuse values (also known as passive use values, existence values). The use values arise from the direct use of a good or asset by consuming it or its services. For ground water, these would include consumption of drinking water and other municipal or commercial uses. Nonuse values arise irrespective of such direct use. Thus in the economist's jargon the total economic value of a given resource asset includes the summation of its use and nonuse values across all service flows. The notion of total economic value is fundamental to ground water valuation and should enter into management decisions regarding use of water resources. Valuation is a useful tool if the values can help inform decision-makers. The relevant issue is how the TEV of ground water will change when a policy or management decision is implemented. Prices are often used as a proxy for values. In settings where goods or services (for example, eggs and haircuts) are traded through markets, prices are a good proxy for the value of the last, or the marginal, unit that is traded. As more
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Valuing Ground Water: Economic Concepts and Approaches FIGURE 3.1 Ground water services. and more units are traded, the marginal value continues to decrease, as represented by a negatively sloped demand curve for the good in question. But the total value, represented by the area under the demand curve out to the quantity demanded increases. Several important points about value have particular relevance to ground water valuation. Values are specified at an individual level, and defining a social value for ground water requires aggregating individual values. There are many possible ways to weight individuals in forming such aggregates, including using unweighted dollar-for-dollar sums. Assigning equal weights across all individuals (i.e., a dollar-for-dollar summation) is a common procedure in benefit-cost analyses of public policies. Use of such a procedure assumes that the current or existing distribution of incomes is socially acceptable. All values derive ulti-
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Valuing Ground Water: Economic Concepts and Approaches mately from services to consumers, whether these services are consumed directly or through produced goods. In this way ground water, ecosystems, and other environmental resources generate value either directly or indirectly. Economic valuation methods have concentrated on techniques for assessing particular pieces of the total value puzzle. The easier pieces to value are those associated with identifiable uses such as agriculture, municipal water supply, and other commercial or industrial uses. The examples in Chapter 6 illustrate the noncomprehensive approach to valuing a ground water resource, where the focus has been primarily on valuing ground water resources in their direct use purposes. Finally, there are no restrictions on why someone values a good. Economic values are anthropocentric notions and are based on situations of choice. The mechanism of choice might be a market or a negotiated explicit or implicit contract or a public referendum. Because this valuation is based on human choices, it does rule out some of what concerns some ecologists and environmentalists who believe that nature inherently has "rights." Therefore the concept of economic valuation does have some limitations in discourse about natural resource policy where the "rights" of nonhuman entities are given significant weight compared to human use values. Nonuse values are more controversial than use values when it comes to measuring and validating them. Some of the techniques presented in Chapter 4 suggest ways to quantify the nonuse values as part of measuring the total economic value. The issue of how to model and measure nonuse values cannot be totally separated from the measurement of use values. And as Freeman (1993b: 161-162) indicates: economic theory gives unambiguous guidance only on defining total values as compensating income changes for changes in a resource. The question of whether non-use values, however defined, are positive takes on meaning only after some decision has been made about what use values measure, since non-use values are simply total value minus whatever has been called use value… Ultimately we want to be able to measure total value. Any distinction between use and non-use values is itself useful only if it helps in the task of measuring total value. Although there is no a priori agreement on when nonuse values are likely to be significant, economists often suggest that one factor would be whether the resource in question is sufficiently unique, has no close substitutes, and has a low price elasticity of demand. In certain locations ground water could satisfy these requirements, particularly if it is valued as a source of "pristine" water. Even in situations where the ground water by itself does not produce much in the way of nonuse value, it may contribute to habitat for endangered species, which has significant nonuse value. In such a case, the derived value of the ground water will include this value as well.
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Valuing Ground Water: Economic Concepts and Approaches Institutions and Decisions The value of ground water, that is, its ability to produce valuable service flows to people, is increased when any given amount of water is allocated efficiently across potential water uses. Water is efficiently allocated when the increment to value that could be obtained from using a little more water in any one way (called the marginal value of water in that use) is the same across all uses of water. To understand this concept, assume that such a balance does not exist. For example, suppose that one use (say, an industrial process) could generate $100 in incremental value if a little more water is used there, while another use (say, agricultural production) would lose only $50 in value if a little water is removed from that use. Then transferring a unit of water from the agriculture to the industrial use increases the total value of water services by $50. Any inefficiencies in the allocation of ground water across uses or quality will lower the value of the ground water. Poor quality will also reduce its value to users. The value of ground water, then, is intimately tied to institutions that govern how it is allocated (or misallocated) and protected in the current period, through time, and according to its quality. That is why, in Figure 3.1, institutions are depicted as a set of overarching influences that govern the value of ground water. One possible institution for allocating ground water is a set of private water markets. Economists have shown that if these markets are organized in a particular fashion, then the allocation of water among uses will be efficient. Of course the conditions underlying this result would be difficult to meet. Instead of a market system, there presently exists a complex web of water resource institutions that vary from jurisdiction to jurisdiction. These institutions are described in more detail in Chapter 5. The analysis of how these institutions promote or mitigate inefficient water allocations is an important but difficult task that is beyond the scope of this committee's investigation. The total value of ground water is increased if it is efficiently allocated. Identifying this efficient allocation depends on measuring the incremental value of water in alternative uses and the incremental value of improvements in water quality. When there are large gaps between these incremental values across uses, then economic well-being is enhanced by altering the allocation. If the incremental costs and benefits of changing water quality are greatly different, then economic well-being is enhanced by improving water quality or perhaps by allowing a lower level of water quality for some uses. Consider first the allocation decision. In Figure 3.2 the horizontal axis shows the quantity of water that can be allocated to either of two uses: in-stream flows, which provide ecological services; or landscaping, which provides aesthetic values that can also be considered a part of ecological services. At the right edge of the diagram, at point Q, all water is allocated to in-stream flows, and none goes to landscaping. The vertical axis measures incremental values. The line
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Valuing Ground Water: Economic Concepts and Approaches FIGURE 3.2 Allocation decisions. sloping downward to the right depicts the additional value one could obtain from having more water for landscaping. It is initially very high, since some plants and trees and degree of green is highly valued, but as more and more water is used in this fashion, the additional value that can be obtained falls. Similarly, the incremental value for ecological services is initially very high, since some water in streams sustains basic biological functions, but it, too, falls as more water is allocated to this purpose. The efficient allocation of ground water balances incremental values across the two uses. This is shown at a point qe in Figure 3.2. At point q1, more water should be allocated to landscaping, while at point q2, stream flows should be increased. Currently, there is minimal information on the value of ground water in many of its alternative uses. Much has been written regarding municipal, agricultural, and industrial uses and the inefficient institutions that artificially depress the value of ground water in agricultural uses in the American West. The idea is that there are large gaps between incremental values of water across these uses. Although extractive uses have been widely studied, almost nothing is known
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Valuing Ground Water: Economic Concepts and Approaches FIGURE 3.3 Quality decisions. about in situ ground water services and their values. Even the incremental value of many municipal water uses, such as landscaping, is not well understood. Consider now the quality decision. Figure 3.3 on quality decisions shows a diagram similar to the last one but with a different interpretation. Suppose a remediation decision is to be made. The horizontal axis shows the degree of contamination of a ground water stock, with increasing contamination to the right. The contaminated stock is at quality Q. Improving ground water quality via treatment is, as explained in Chapter 2, a costly process. The incremental costs are shown as moving upward to the left. Information is available about the cost of alternative technologies for cleaning up ground water; for example, a recent NRC report, Alternatives for Ground Water Cleanup (NRC, 1994), is directed to this issue. However, this information does not address whether or how much to remediate or treat. The decision process requires value information. The relevant value is the incremental value of enhanced water quality, shown by the line increasing to the right in Figure 3.3. The efficient quality decision lies at quality level qe. Treatment levels between Q and qe such as q2 (Figure 3.3) represent less than eco-
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Valuing Ground Water: Economic Concepts and Approaches nomically optimal treatment since the benefits from additional treatment outweigh the costs. If water is left untreated (point Q), gains from treatment outweigh costs up to a quality level qe. Treatment to achieve qualities greater than that at qe (as, for example, to q1) is excessive since benefits are outweighed by the costs. These simple examples depict how valuation measures can be used in decision-making. Obviously, these are highly stylized. In practice these nice smooth curves do not exist, and there are lumpy, nonincremental decisions to reach. But the basic point remains. The valuation framework described later in this chapter is of interest not in its own right as an academic exercise but rather as part of a decision-making process. One set of relevant decisions involves ground water management decisions within a given institutional structure. Values can also be used for institutional reform, to reduce systematic inefficiencies. A major question concerns the availability of value information for use in decision-making. When assets and their services are exchanged in organized markets, there is an observable link between the asset's value and the values of the services that the asset provides (Kopp and Smith, 1993). For example, the current value of a commercial building (an asset) can be determined in the real estate market. Its value can also be appraised by examining the present discounted value of the stream of net incomes realized over time (as a result of annual rentals), plus any residual value. If the building is damaged, the value of the asset is reduced precisely because the present discounted value of the stream of net rental incomes is reduced. In this case the existence of organized markets provides information on how society values the asset. In the case of ground water, however, other nonmarket institutions govern its use. Neither the asset nor its services are traded on well-organized markets. Thus, no ready source of information automatically provides a connection from service values to asset values that would be similar to the information the market provides. The valuation process that managers and policy-makers undertake should, in theory, be similar to the valuation process the market provides. One needs to know the time stream of services ground water supplies, and the values that society places on these services. These values are not straightforward for two reasons. First, there are many services for which information on individual values is not readily obtained. For example, because ecological services fall outside of markets, they call for specialized valuation techniques. Second, values are defined and measured at the individual level. The difficulty comes in deciding how these should be aggregated across people. Because services exist across time, an appropriate discount rate must be used to determine the present value of this stream of annual service values. This is rather like the problem of adding up values across people: now we need a way to add up value across people alive at different points in time. The market rate of interest serves as an approach for money assets, but things are not quite so simple
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Valuing Ground Water: Economic Concepts and Approaches for natural assets provided through public institutions. This is a complex question tied to issues of intergenerational equity. The next step in the process is creating a link between the management decision to be implemented and the resulting changes in the time path of services the ground water stock will provide. Considerations must go beyond mere description of the services already used in one state of the world; they must also involve predictions of future services. Allocation over Time and Discounting The provision of benefits or services over time requires that consumers and other users "trade off" benefits (or costs) in one period, such as the present, against benefits in a different time period. In other words, consumers/users of the resource must balance the desire for current consumption against a desire for consumption in the future. All else being equal, people would rather consume a unit of a good today rather than wait to consume it in the future, say in a year's time. Having a unit of income today is worth more than having the same unit of income a year in the future. As indicated earlier, ground water is considered to be a common limited resource that can be used at different rates over time. Water managers must be concerned with the preferences society has for using that limited resource and the manner in which the ground water will be mined under alternative institutional arrangements. Both of these concerns lead to notions of intertemporal use and discounting. The traditional criterion used to address the problem of use rates over time is to compare the net benefits (benefits minus the costs) received in one period with the net benefits received in another period. The concept that allows for making this comparison is called present value, which explicitly incorporates the time value of money. The present value of a onetime net benefit received a year from now is computed as where r is the appropriate interest rate. This process of calculating present value is known as discounting, and r is referred to as the discount rate. Using the notion of discounting, we can determine an economically efficient allocation of a resource over time: an allocation of a resource across n periods is efficient if it maximizes the present value of net benefits that could be received from all possible ways of allocating the resource over the n periods. For water managers, the challenge is to balance the current and subsequent uses of the ground water stocks by maximizing the present value of the net benefits derived from the limited resource. Knowing the total economic value of the ground water is crucial for determining the net benefits.
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Valuing Ground Water: Economic Concepts and Approaches Scarcity imposes an opportunity cost, which economists refer to as a marginal user cost. Greater use of the resource today diminishes future opportunities for use, so the marginal user cost is the present value of these foregone opportunities. Using ground water for watering lawns and agricultural purposes may not be appropriate under conditions where drinking water supplies to future generations are denied but may be wholly appropriate in situations with sufficient supplies of water. Failure to take higher scarcity value of water into account will lead to extra costs to society by imposing extra scarcity on the future. Conversely, overconservation in areas with sufficient supplies will impose additional costs on society today. Allocation of the ground water resource over time is affected by the discount rate. The higher the discount rate, the greater the amount of the resource that will be allocated to the earlier periods. Higher discount rates skew consumption and use toward the present because they give less weight to future net benefits. The methodology for choosing an appropriate discount rate is a matter of continuing debate: "after a lot of time trying to discover an unassailable definition of the social rate of discount, economists are beginning to decide that a totally satisfactory definition does not exist" (Page, 1977). The proper rate depends, in part, on the context of the decision being analyzed (Lind, 1990) but the role of the discount rate is to ensure that scarce resources are allocated efficiently over time. Issues of whether resources are allocated fairly over time are different, albeit important, issues. In Sustaining Our Water Resources (NRC, 1993a), Brown Weiss notes that: "… the withdrawal of ground water in excess of recharge rates to supply potable drinking water or rapid withdrawal of water from nonrechargeable aquifers, will cause conflicts between immediate satisfaction of needs and long-term maintenance of the resources." Brown Weiss notes further that in these cases "means need to be developed to reconcile intergenerational concerns with the demands of the living generation." Issues of whether allocations over time are fair are difficult to address through the selection of a discount rate. Recent literature has raised questions about the applicability of cost-benefit analysis as currently practiced to deal with intergenerational issues. Smith (1988) suggests that many resource problems we face today, including depletion of ground water resources, "stretch the conceptual basis for benefit-cost analysis well beyond the bounds for what it was intended—a single generation borrowing from itself." Page (1988) suggest a fundamental change in how economists evaluate allocation issues that span many generations. In his view the question is not simply one of selecting the appropriate rate of discount, but of basing policy decisions on an intergenerational social choice rule, according to what society considers "fair." In his earlier writings, Page (1977) argues for preserving the opportunities for future generations as a common sense minimal notion of intergenerational justice. Preserving these opportunities is critical in settings where there are irreversibilities and a large degree of uncertainty with respect to both the size of the resource stock and the future
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Valuing Ground Water: Economic Concepts and Approaches demands on the resource. These issues of fairness are distinct from issues of allocative efficiency and, in general, selection of discount rates should be guided by considerations of efficiency while issues of fairness should be resolved in other ways. Role of Economic Uncertainty Economic uncertainties occur at both micro and macro scales. The value of a particular ground water supply that supports an extractive use may be influenced by events at local, regional, national, or international levels. For example, the prices of water-intensive commodities such as cotton or copper are affected by price supports and international markets. Changes in commodity prices affect the value of the ground water used to produce those commodities. Farm policies also have an impact on ground water use. Economic uncertainty is commonly related to lack of data with which to predict human behavior across time and space. Economic uncertainties relative to nonmarket goods and services are even more substantial, because outside of a market there is no documentation of monetary value. Various techniques have been developed to estimate monetary value, but certain values may remain hidden, and there are multiple sources of error in these techniques as well. These techniques and their flaws are discussed in greater detail in Chapter 4. Externalities and Ground Water The valuation of ground water involves considerations of external effects inflicted upon ground water, such as the ecosystem side effects incurred when ground water is extracted or contaminated, and the effects that ground water extraction decisions have on ground water availability and cost. The decisions of any number of consumers and firms may alter ground water quality in unintended ways. Some of these result from point sources of pollution, where a known, identified source is contributing to the problem. We can, at least in principle, measure the quantity of emissions from point sources. Standard approaches for controlling these problems are available, as will be discussed below. Nonpoint source pollution is generated from farms, residences, and urban runoff—a diffuse set of sources such that measurement of emissions from any single source is impractical. Ground water contributes services to the aquatic ecosystem that individual extractors are not likely to take into account. Contamination of an aquifer may lead to surface water contamination, and depletion may change wetlands, affect water tables, cause land subsidence, and so on. A host of effects greatly complicate the valuation problem; additional examples are in Chapter 2. Certain externalities arise when one firm's pumping causes other firms' situations to change. These open access resource problems have basically two
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Valuing Ground Water: Economic Concepts and Approaches types of effects. First, pumping may decrease pressure in the aquifer, implying that the total amount of ground water available to all users is reduced. Second, an increase in pumping today increases the pumping costs for all users. SERVICES PROVIDED BY GROUND WATER This section offers a brief overview of the different services that ground water resources typically provide (see also Tables 1.4 and 1.5). It also discusses information required to establish the values of such services and how they are affected by changes in ground water policy and/or management. Extractive Uses Extraction in excess of net recharge in the current period, as depicted in Figure 3.1 by arrow A, will reduce ground water stocks in the future. Water managers need information to assess how the cost of extraction and distribution is altered by changes in ground water stocks and hydrogeological information to assess how given pumping rates will alter the pressure head in the future. Of course the influence of pumping on future stocks and their quality is a complex issue of hydrogeology and chemistry, since recharge rates, the quality of the recharged water, and aquifer capacity all are involved. The extractive services consist of municipal, agricultural, and industrial uses of water. Clearly, the efficient allocation of water to alternative uses requires information on relative values in these uses. The municipal uses include direct human consumption, for which strict quality criteria must be met, and a host of other uses with lesser demands on water quality, such as street cleaning, washing cars, and water used for landscaping private residences, parks, and golf courses. Deciding how to value changes in the quantity or price of water for these municipal uses is fairly difficult. Data exist with which to value water for total household use, but how do people value green lawns relative to other uses? Are watered fairways on public golf courses of high or low priority? Further, the supply of water is one issue, the reliability of this supply another. Many ground water development projects are in fact directed to the latter, thus policy-makers need to give attention to valuing changes in the reliability of the water supply along with valuing changes in the quantity of water supplied period by period. Of greater methodological difficulty is understanding how quality changes alter value, particularly if deteriorated conditions preclude future uses requiring higher quality standards. What demands are placed on water quality by alternative uses? Economists have devoted considerable attention to determining the value of protecting the quality of drinking water from various contaminants. This research is not without controversy, and the committee addresses some of the issues below. But experts also disagree on the health implications of ground
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Valuing Ground Water: Economic Concepts and Approaches water contamination, and the public's perception of the state of this knowledge is even more variable. Agricultural and industrial uses have a wide variety of water-quality needs attached to them, and the relevant issue is the cost of supplying a sufficient quantity of ground water of suitable quality. The values are fairly straightforward to measure conceptually: the use of ground water contributes to the making of products, and the incremental contribution of water to the value of production measures ground water value in these uses. But of course policy-makers need information from various sources to undergird these measurements. In particular, industrial process engineers or agricultural production specialists might help determine how water quality and quantity changes will affect production. Alternatively, water managers might employ a statistical approach. Arrow B in Figure 3.1 involves interaction between economic and engineering information and, regarding human uses, may involve input from psychometricians (a person skilled in the administration and interpretation of psychological tests), and health experts, as well. It should also be noted that ground water extraction can be influenced by return flows and their associated quantity and quality. Naturally, this depends on the uses to which ground water is put and on a host of biological, chemical, and hydrological factors. Thus several types of information are needed to elucidate Arrow C in Figure 3.1; such information could be based on input from hydrologists, chemists, soil scientists, and so on. Further, ground water is subject to pollution from waste disposal and efforts to mitigate such effects. These influences, represented by Arrows D and E in Figure 3.1, are the province of all the current work on ground water contamination, fate and transport of pollutants, movement of pollution within aquifers, effectiveness of alternative remediation or containment efforts, and so on. Ground water systems are interrelated with surface water systems. Therefore, in the taxonomy defined in this report (see Table 1.3), ecological services are a subcategory of in situ services. Understanding of the linkages among ground water resources, wetlands, and lake and stream levels is a complex task for hydrologists, geologists, and aquatic biologists. This information is needed to determine the magnitudes of effects depicted by Arrow F in Figure 3.1. Surface water provides a number of ecological functions, including filtering and processing of pollutants and providing habitat for a wide variety of species, both directly aquatic and terrestrial. The importance of chemists and ecologists is self-evident. Establishing the connections indicated by Arrows F and G in Figure 3.1 is thus a multidisciplinary task. Ground water contributes notably to many surface water services (see Table 1.5), notably, recreational services. Water in parks makes them more valuable, and swimming, fishing, boating, bird-watching, and a host of other activities either require water or are enhanced by it. There are a variety of methods for measuring recreational values.
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Valuing Ground Water: Economic Concepts and Approaches In Situ Services The mere presence of ground water in an aquifer provides a number of services referred to as in situ services. First, to some extent, waste products can be added to ground water and their potentially harmful impacts can be mitigated. This assimilative capacity can be thought of in terms of reductions in the cost of other forms of waste disposal or treatment. Obviously, chemists and biologists would determine the capacity of ground water to provide these services (Arrow F in Figure 3.1), and economists and engineers would determine the cost savings implied (Arrow G). Second, ground water provides structure to the geologic environment. If ground water is extracted, subsidence can occur. The degree to which this happens in any given circumstance is the province of geologists and geotechnical engineers. Civil engineers can assess resulting effects on buildings and infrastructure by direct damage or flooding. The primary economic measure of loss is the dollar value of damage in lost property value or replacement cost for infrastructure. To the extent that the exact degree of subsidence and associated damage is uncertain for given amounts of extraction, economists must assist in analyzing plans for ground water extraction (Tsur and Zemel, 1995). Very similar to subsidence is the role of ground water stocks in coastal areas in avoiding salt water intrusion. At low levels of stock, reduced hydraulic pressure can allow salt water to invade a coastal aquifer. The extent to which this might happen and at what level of stock is uncertain, but hydrogeologists or engineers can supply some information. The loss in services of ground water is then a matter of the resultant changes in the salinity of ground water. Tsur and Zemel (1995) offer an economic analysis of optimal response to uncertainties in this area. Ground water also provides a buffer, or insurance service, when managed conjunctively with surface water stocks. Since surface water supplies can fluctuate, ground water acts as important insurance to smooth overall supplies. In times of low surface supply, ground water can be extracted relatively more heavily to augment total supply, and in times of abundant surface supply ground water extractions can fall, allowing the stock to replenish by recharge. Tsur and Graham-Tomasi (1991) have found that this buffer value can be significant. In one example, buffer value constituted 84 percent of the total value of the ground water stock, meaning that if this value were ignored, ground water would be seriously undervalued. THE CONCEPTUAL FRAMEWORK This section summarizes the steps involved in an economic analysis of ground water value, noting both the limitations of economic techniques and the inherent uncertainties associated with this task.
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Valuing Ground Water: Economic Concepts and Approaches Measuring ''Values" Any empirical analysis requires that some preliminary decisions be made regarding the scope of the research. For the ground water valuation problem, this means deciding what value to quantify. The economic concept of value, introduced earlier in this chapter, is the cornerstone of this conceptual framework and is grounded in neoclassical welfare economics. The basic premises of welfare economics are that all economic activity is aimed at increasing the welfare of the individuals in society and that individuals are the best judges of their own welfare. Each individual's welfare depends upon the consumption of private goods and services as well as the consumption of goods and services provided by the government and the consumption of nonmarket goods and services. The latter might include service flows from resources, such as opportunities for outdoor recreation, maintaining wildlife habitat, and visual amenities. Thus it follows that the basis for deriving measures of the economic value of changes in a natural resource, such as ground water, is its effect on human welfare. The economic theory for measuring changes in human welfare was initially developed for goods and services exchanged in private commodity markets, using observed prices and quantities. Over the past few decades, the theory of measuring economic values has been extended to include nonmarket goods and services. The basis for extending the theory to goods and services that are not traded through private markets is that individuals do substitute among markets as well as use nonmarket goods and services, and this process of substituting reveals something about the values placed on these goods. The value measures are commonly expressed in terms of willingness to pay (WTP) or willingness to accept (WTA) compensation, either of which can be defined in terms of the quantities of a good an individual is willing to substitute for the good or service being valued or in terms of monetary units. (See Freeman, 1993a for a complete discussion of WTP and WTA measures.) The approaches to measuring values discussed in Chapter 4 are attempts to measure either WTP or WTA, when the ground water service flows are not purchased in perfectly functioning markets and have public good characteristics. A Simple Conceptual Model Although measuring values involves the use of techniques based on economics, these values must be determined in conjunction with knowledge from other disciplines. For example, estimates of the value of a ground water aquifer in sustaining wildlife habitat must incorporate knowledge of the ecological and hydrological links among the water level of the aquifer, recharge, and the exploited fish and animal species. Estimates of the value of ground water as a source of municipal water depends upon the availability of substitutes, recharge, and other information that water scientists can supply. Lack of knowledge con-
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Valuing Ground Water: Economic Concepts and Approaches cerning these physical, biological, and/or hydrological relationships is a major limitation to obtaining valid empirical estimates of value of the ground water resource. The conceptual framework presented herein is an attempt to (1) emphasize the importance of economics in valuing ground water resources and (2) make clear that the economic technique and resulting values depend on the underlying relationships that determine the quantity and quality of ground water service flows. The economic values of the service flows from an aquifer can be viewed as the outcome of three sets of functional relationships; these are functional representations of the flow diagram (Figure 3.1). The first relates some measure of ground water quality/quantity sensitivity to the human interventions that affect it, the second relates the use of the ground water resource and the quality/quantity of the resource, and the third relationship describes government policies and a management plan (Figure 3.4). The first relationship can be represented as (1) where S(t) represents a quantifiable measure of the ground water resource (a combination of quality and stock of water), A(t) represents actions taken by people, such as extraction pollution events and remediation, and z represents some random uncontrolled disturbances such as hydrologic events related to net recharge of the aquifer. This relationship shows how the future state of the ground water resource depends on its current state and what is done to it in the meantime. This relationship summarizes a set of purely physical outcomes. The second functional relationship can be written as (2) where A(t) is as defined above, representing the set of human activities. G(t) represents a set of governmental policies or management plans. Y represents other background variables, such as the costs of inputs into the production process including labor, capital, and materials that also depend on S, income levels, population, etc. and I(t) is a set of institutional factors that show how decisions are reached and actions taken. This second relationship can be viewed as a decision function that maps the milieu within which ground water decisions are made (government policies, prices of goods and services, income levels, population, the ground water resource, and institutions) into actions (pumping rates, remediation, waste disposal). This shows how changes in any of these factors will alter how ground water is used. The third set of functional relationships gives the economic value as a function of the uses or service flows. The first relationship in this set shows how the dollar values of the services provided by ground water in any given period depend on those flows and other variables. First, regarding the extractive values, B. (3a)
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Valuing Ground Water: Economic Concepts and Approaches FIGURE 3.4 Conceptual framework for ground water valuation. which shows that the extractive benefits in the current period depend on the actions taken, the status of the ground water stock, background variables, institutions, and random events, such as rainfall. Second, regarding in situ services, the benefits achieved are given by (3b) This shows that benefits from in situ services are determined by the status of the ground water stock, background variables, institutions, and random events such as salt water intrusion or subsidence events as well as fluctuations in rainfall. The TEV of the ground water's services in the current period is the sum of the extractive and in situ values. Thus, we have (3c)
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Valuing Ground Water: Economic Concepts and Approaches And finally, the value of the ground water stock itself, specified as the present value of the benefits conferred by the service flows that the stock generates can be addressed. Discounting issues and the valuation of the ground water asset will be further discussed in Chapter 4. Here, it can be noted that The importance of the discount rate is obvious here. The set of relationships represented by equations 1 and 2 above are noneconomic in nature and involve a variety of physical, biological, and hydrological processes. The set of relationships represented by equations 3 above depict the integration of the physical and economic sciences. Economists must work closely with other scientists, for an essential input to valuation of in situ and ecological services is the magnitude of those service flows. The three stages in Figure 3.4 correspond to the three sets of relationships discussed above. Stage 1 involves an assessment of the current quantity and quality of the ground water resources in a particular area and an assessment of how events or circumstances might alter the baseline quantity and quality. This alteration could come about through underlying economic and social forces, such as increased population, or arise from some explicit decision, such as a change in management or policy or institutional structures. This stage represents a crucial input in estimating the economic value of the stock and makes explicit the role of natural sciences in the valuation process. The second stage maps changes in ground water resources into changes in the service flows from the use of the resource. Stage 3 represents the formal economic analysis, equivalent to the third set of relationships. This third stage quantifies the value of services and how these values are affected by changes in service flows. Each of the stages in Figure 3.4 requires in-depth research and is accompanied by its own levels of uncertainty. The uncertainty with respect to the estimates of the biophysical impacts on the quantity or quality of the resource will be carried through the valuation process and will be compounded by the uncertainties in the economic valuation methods. For example, the National Research Council's Ground Water Vulnerability Assessment (NRC, 1993b) attests to the importance as well as the difficulties and uncertainties present in current vulnerability assessment methods available to predict changes in the quality and quantity of ground water resources. The conceptual framework involves the research of economists, building upon the hydrological and biophysical analyses that preceded it. The uncertainties and challenges associated with economic valuation techniques as they pertain to valuing ground water assets are discussed in Chapter 4. The hydrological,
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Valuing Ground Water: Economic Concepts and Approaches physical, and biological principles relevant to the economic valuation procedures were discussed in Chapter 2. As Boyle and Bergstrom (1994) indicate, "Economic valuation of ground water therefore requires that progress be made on two fronts: establishing formal linkages between ground water policies and changes in the biophysical condition of ground water and developing these linkages in a manner that allows for the estimation of policy-relevant economic values." While each of the stages in Figure 3.4 can be associated with specific disciplines, one cannot overemphasize the need for interactions and cooperation among economists, other scientists, and water managers to value ground water resources. Relationship to Benefit-Cost Analysis The framework proposed in this chapter for valuing ground water could just as well be termed a framework for measuring the economic benefits of ground water. Information obtained from an analysis of the benefits of ground water would be used in a full fledged benefit-cost analysis (BCA) of regulatory actions or management decisions affecting ground water quantity and quality. Benefit-cost analysis has had a long history relating to water resources. The U.S. Bureau of Reclamation and the U.S. Army Corps of Engineers initially developed BCA to evaluate surface water investments. The overall objective was to provide a picture of the costs and gains associated with investments in surface water development projects. In more recent years, BCA has been applied to environmental and resource regulations. (For details see Kneese, 1984.) In these applications BCA should not be used as a simple decision rule but rather as a framework and a set of procedures to help organize available information and evaluate trade-offs. Viewed in this way, the framework proposed in this chapter is an approach to quantifying the benefits of current and proposed management practices affecting ground water. If this information were to be used in a decision-making framework, it would need to be matched with information on the costs of alternative management strategies. RECOMMENDATIONS As noted earlier, some knowledge of a resource's TEV is vital to the work of water managers, and in the development of policies dealing with allocation of ground water and surface water resources. For many purposes, the full TEV need not be measured, but in all cases where a substantial portion of the TEV will be altered by a decision or policy, that portion should be measured. Policy-makers must recognize the role of the discount rate in ensur-
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Valuing Ground Water: Economic Concepts and Approaches ing the efficient allocation of resources over time. As such, the discount rate should reflect the opportunity cost of financing ground water projects. Issues of equity or fairness should be addressed directly and not through adjustments to the discount rate. An interdisciplinary approach, such as the conceptual model presented in Chapter 3, is useful in conducting a ground water value assessment. The approach should incorporate knowledge from the economic, hydrologic, health and other social, biological, and physical sciences. Every assessment should be site specific and integrate information on water demands with information on recharge and other hydrologic concerns, and to the extent possible, should reflect the uncertainties in both the economic estimates of the demand for ground water and in the hydrologic and biophysical relationships. There are many research needs related to natural resource valuation concepts and methods. Research is needed to: determine the general circumstances under which nonuse values are likely to be significant; provide a clearer understanding of how changes in water quality alter value; and, develop better methodologies for linking ground water policy and changes in the biophysical properties of aquifers. Such research must be multidisciplinary. REFERENCES Boyle, K. J., and J. C. Bergstrom. 1994. A framework for measuring the economic benefits of ground water. Department of Agricultural and Resource Economics Staff Paper. Orono: University of Maine. Freeman, A. M. III. 1993a. The Measurement of Environmental and Resource Values: Theory and Methods. Washington, D.C.: Resources for the Future. Freeman, A. M. III. 1993b. Non-use values in natural resource damage assessments. Pp. 161-162 in Valuing Natural Assets, the Economics of Natural Resource Damage Assessment, Kopp and Smith, eds. Washington, D.C.: Resources for the Future. Kneese, A. V. 1984. Measuring the Benefits of Clean Air and Water. Washington, D.C.: Resources for the Future. Kopp, R. J., and V. K. Smith, eds. 1993. Valuing Natural Assets, The Economics of Natural Resources Damage Assessment: Washington, D.C.: Resources for the Future. Lind, R. C. 1990. Reassessing the government's discount rate policy in light of new theory and data in a world with a high degree of capital mobility. Journal of Environmental Economics and Management 18(2):S8-S28. National Research Council. 1993a. Sustaining Our Water Resources. Washington, D.C.: National Academy Press. National Research Council. 1993b. Ground Water Vulnerability Assessment. Washington, D.C.: National Academy Press. National Research Council. 1994. Alternatives for Ground Water Cleanup. Washington, D.C.: National Academy Press.
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Valuing Ground Water: Economic Concepts and Approaches Page, T. 1977. Conservation and Economic Efficiency. Baltimore, Md.: Johns Hopkins University Press. Page, T. 1988. Intergenerational equity and the social rate of discount. Pp. 71-89 In Environmental Resources and Applied Welfare Economics: Essays in Honour of John V. Krutilla, V. K. Smith, ed. Baltimore: Resources for the Future Press. Smith, V. K., ed. 1988. Environmental Resources and Applied Welfare Economics: Essays in Honour of John V. Krutilla. Baltimore: Resources for the Future Press . Tsur, Y., and T. Graham-Tomasi. 1991. The buffer value of ground water with stochastic surface water supplies. Journal of Environmental Economics and Management 21: 201-224. Tsur, Y., and A. Zemel. 1995. Uncertainty and irreversibility in ground water resource management. Journal of Environmental Economics and Management 29(2):149.
Representative terms from entire chapter: