Chapter 8
Frameworks for the Economic Appraisal of Environmental Projects:
Cost-Benefit Analysis and Others
Chapter Summary
This chapter dealt with the economic appraisal of environmental projects. The key issues addressed
in this chapter are: (i) the welfare economics foundation of the standard cost-benefit analysis (CBA),
(ii) the choice of the discount factor and the associated problem of intergenerational equity, (iii)
other alternative methods for the appraisal of environmental projects that are used either to
supplement or, under certain circumstances, replace the conventional CBA (such as the
precautionary principle, environmental impact analysis, environmental risk assessment and risk
management, environmental justice, and so on).
Review and Discussion Questions
1. What is cost-benefit analysis (CBA)? It is said that CBA is used to evaluate ‘public projects’.
Provide three examples of public projects that are related to the environment. How does your
textbook conceptually define a project? Does it make sense to you? Explain.
2. Cost-benefit analysis is said to belong in branch of economics known as welfare economics. Use
Google to learn more about welfare economics. Having done this, do you see why CBS, by its
very nature, requires making ’value-judgment’? Does this fact in itself make CBA to be less of
science although it may still have a significant practical value? Explain.
3. As discussed on page 152 of your textbook, the theoretical foundation of cost-benefit analysis is
based on what is known as the principle of ‘potential Pareto improvement’. Do you understand
this principle and its implication on equity, that is, income distribution? Make sure you do so. By
the way, who is Pareto? Use Google to learn more about him!
4. Why is the principle stated by ‘actual Pareto improvement’ considered to be irrelevant? Explain.
5. Make sure you have a good understanding of the net present value (NPV) formula presented on
page 153 of your textbook. What are the four key variables in this formula? When this formula is
applies for decision making purpose (i.e., to either accept or reject a project), do you see how
the NPV is conceptually related to ‘potential Pareto improvement’? Make sure you do so.
6. The discount factor, r, one of the parameters in the NPV formula, plays an important role in the
valuation of environmental projects; make sure you have a good understanding of this concept
as presented in Exhibit 8.2, page 153 of your textbook. After reading Exhibit 8.2, do you
understand why a positive discount rate, r, would suggest putting less weight on the value of the
net benefit in the future relative to present, hence, discounting the future? Make sure you
understand this within the context of the NPV formula.
7. Your textbook discusses at some length the difference in private and public project appraisal,
that is, capital budgeting and cost-benefit analysis, respectively. Both of these project appraisal
methods use the net present value formula. However, they differ in some significant ways on
how the following three issues are addressed: (1) The estimation of benefits; (2) the estimation
© 2014 Ahmed Hussen
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of costs; (3) the choice discount rate. Make sure you have a good grasp of the salient issues
discussed in your textbook, that is, Section 8.3. In particular make sure you have a good
understanding of the following key concepts: social benefit versus private benefit, social cost
versus private cost, the problem of double counting costs, the real effect versus the inflationary
(secondary) effect of price changes, and private versus social discount rate.
Make sure you understand the discussion in Exhibit 8.4. This exhibit contains a theoretical
explanation of why the choice of discount rate matters and does this within the context of the
NPV formula. This is very helpful for a clear understanding of the implication of the choice of
discount rate on the wellbeing of future generation, that is, intergenerational equity.
The discount rate should be zero for environmental projects where the benefits are expected to
be realized way into the future, say one hundred years or more. Defend this statement using
policy measures that are designed to slow global warming.
The discount rate should be zero for energy projects, such as nuclear electric power plants,
where the high environmental costs are expected to be realized way into the future, that is, at
the end of the project period. Defend.
A critic of CBA may say this: What is the point of dwelling into the philosophically loaded
argument of intergenerational equity when we still have, as shown in Chapter 7, a long way to
go in addressing the practical problems of estimating the costs (i.e. environmental damages)
and/or benefits (i.e. environmental conservation). We should stop pretending to use a full blown
cost-benefit analysis and instead use cost-effectiveness analysis (CEA). What is costeffectiveness analysis? How does it differ from CBA? Do you agree the position taken by the
above type of criticism of CBA? Discuss.
In recent years, the precautionary principle has been heralded as a very practical method of
assessing environmental projects that are associated with potential irreversible damages (such
as loss of species biodiversity) and uncertainty. It is claimed that this method of project
assessment depends on ‘prudence’ instead of efficiency. What exactly does this mean? Do you
think the precautionary principle will have a wide application in the evaluation of environmental
projects? What are some of the challenges you foresee in using the precautionary principles as a
policy guide to long-term environmental concerns? Discuss.
Caring for future generations should not come at the expense of the present poor. Would this be
considered an argument (observation) made on account of environmental justice? Why or why
not? Answer this question by using a real world example.
‘Export of hazardous electronic waste from the United States to a developing country like
Taiwan is reprehensible and immoral’. Would this be considered an observation made on
account of environmental justice? Explain.
What does consideration of environmental justice say about the use of cost-benefit analysis in
the evaluation of environmental projects? Be specific.
The Rawlsian Justice is used to advocate for intergenerational fairness. What does
intergenerational fairness mean in this context? How is it related to CBA? Explain.
What actually is involved in environmental impact analysis (EIA)? It is said that EIAs do not make
any attempt to directly impute social values on the impacts identified as relevant for evaluating
the project, hence it is far removed from CBA. Should this make EIA less important as a project
evaluation tool? Explain.
© 2014 Ahmed Hussen
18. Environmental risk assessment and risk management involve the science and politics,
respectively, of environmental regulation. Equal consideration of both of these elements is
needed in formulating and implementing an effective environmental policy. Discuss.
© 2014 Ahmed Hussen