Valuation of Nature: An Economic Perspective

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Valuation of Nature An Economic Perspective

• Stephen J. Conroy, Ph.D.
• Professor of Economics

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I. How to Value an Asset?

• Simply put, an asset is something that you own
  that has value.
• This value may derive from some useful function
  or other aesthetic attribute that the asset
  possesses (e.g., gold has aesthetic as well as
  useful attributesas jewelry that never oxidizes
  in air or water.)
• There are two basic types of assets, those that
  generate cash flows over time (like stocks that
  pay dividends, most bonds, some real estate) and
  those that do not (e.g., gold, silver, some real
  estate). All assets may appreciate, remain
  constant, or depreciate in value over time.

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II. Value of the Firm

• Lets focus on one of these . . . stocks.
  However, since a share of stock grants the owner
  to a partial ownership of a firm, the value of a
  share of stock derives from the value of the firm
  itself.
• So, lets focus on deriving the value of a firm.
• How to estimate this value???
• Forecasting net income into future
• Determine appropriate discount rate

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II. Value of the Firm
Lets start by taking an example of valuing a
firm
Where P is profit, or net income, and k is the
appropriate discount rate. We can rewrite this
more compactly as
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II. Value of the Firm

• What measurable value (statistic) should this
  estimate compare to???
• If financial markets are robust . . . Then the
  Market capitalization (market cap) (No. of
  outstanding shares of stock) (Price per share)

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II. Value of the Firm

• What about a stock like ExxonMobil?
• ExxonMobil generates about 40 billion per year
  in net income (profits). How much is ExxonMobil
  worth?
• Yahoo Finance Quote from 2/15/12

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II. Value of the Firm

• Go to Excel Spreadsheet Example for Exxon Mobil
• Asset valuation in economics and finance takes on
  this basic construct, though with lots of
  different variations.

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III. Valuing Nature

• Now, lets apply the same approach to valuing
  nature. The natural capital in an ecosystem
  produces benefits to society. . .
• What are these benefits or profits in nature?
• Costanza et al. (1997) paper suggests a number of
  benefits or services from ecosystems (see p.
  254, Table 1)
• Gas, water, soil, fruit, habitat, recreation,
  cultural/aesthetic

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Costanza et al. 1997
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III. Valuing Nature

• How to value these services? (Is there a market
  for all of these services?)
• Costanza et al. (1997) provide a discussion of
  willingness to pay (WTP).
• If an ecosystem provides 50 in benefit to lumber
  companies and 70 in aesthetic value, then the
  total benefit is 120, but only 50 contributes
  to the monetary part of the economyor has an
  explicit value.

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Costanza et al. 1997
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III. Valuing Nature

• When Americans look at Haitians massive
  deforestation, we wonder about the Haitians
  rationality. Why would anyone do this?
• This is important in terms of policy
• If cutting down a tree is irrational then policy
  implication is simple education
• If it is rational, however, then policy is not so
  simple education plus

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III. Valuing Nature

• In the following simulation, I wish to create a
  model which demonstrates the conditions under
  which a rational economic human may choose to
  cut down a tree sooner, rather than later,
  leading ultimately to deforestation.
• Here, I will assume property rights are well
  defined and the individual owns the tree.
• The model may lead to important policy
  implications.

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IV. SimulationA Model

• Go to Excel Spreadsheet.
• Assume we have a mango tree that generates
  20/year in fruit.
• Assume the mango tree also generates an
  additional 5/year in water benefits (retention,
  purification/filtration
• Assume the mango tree could also be harvested as
  either lumber or charcoal. Say the lumber
  benefit is 1,000 but that means the tree will
  die.

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IV. SimulationA Model

• Assume the mango tree grows at a rate of 3 per
  year, thus increasing the fruit, water and
  board benefits in a similar manner. (This is
  the inflator in the model.)
• I present four different outcomes
• Harvest for wood/charcoal after year 1
• Harvest after year 10
• Harvest after year 20
• Harvest after year 30

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IV. SimulationScenario 1

• Scenario 1 The normal scenario is presented
  first.
• Reasonable (for U.S.) discount rate of 0.04
• Reasonable inflator of 0.03
• Somewhat-reasonable values for other amenities.
• Result highest value is from waiting for 30
  years to cut down tree

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IV. SimulationScenario 2

• Scenario 2 Now, what if agents are impatient
  (e.g., because they are hungry)
• Discount rate increases, say, to 0.50 (from 0.04)
• Everything else the same.
• Result highest value, by far, is to cut down
  the tree after just the first year! (683.33 vs.
  74.58 after 10 years 53.69 after 20 years
  53.20 after 30 years)

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IV. SimulationScenario 3

• Scenario 3 Now, assume that the price of boards
  (or charcoal) increases dramatically (e.g., due
  to scarcity of trees).
• Price of boards/charcoal triples to 3,000.
• Everything else the same as in Scenario 1.
• Result highest value is to cut down the tree
  after just the first year. (2,909 vs. 2,875
  after 10 years 2,840 after 20 years 2,809
  after 30 years)

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IV. SimulationScenario 4

• Scenario 4 Now, assume that the annual flow of
  benefits from the tree (mangos and water) has no
  (explicit or implicit) value.
• Price of mangos and water goes to zero.
• Everything else the same as in Scenario 1.
• Result highest value is to cut down the tree
  after just the first year. (962 vs. 881 after
  10 years 800 after 20 years 727 after 30
  years)

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V. Discussion

• The results of these simple simulations
  demonstrates thatunder certain
  conditionsrational economic agents would have an
  incentive to cut down trees after the first
  period, thus promoting deforestation.
• Thus, as despicable as it is, deforestation is
  not a completely ignorant or irrational act.
  Education alone will not necessarily solve the
  problem.

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V. Discussion

• Policy would need to be Education Plus.
• Programs designed to
• Decrease the discount rate of individuals
• Provide universal access to quality K-12
  education (increases opportunities and view of
  the world, especially for women)
• Reduce mortality and morbidity rates through
  improvements to healthcareparticularly low-cost,
  public health programs and clinics
• Improve economic opportunities (e.g.,
  microfinance).
• Improve access to credit
• Improve access to private and public pension
  programs

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V. Discussion

• Increase the perceived value of nonmonetary
  services (e.g. water in this model).
• Promote ecological education and information
  (e.g., watershed, biodiversity, gas emissions)
• Decrease the price of boards and charcoal.
• Subsidize natural gas distribution to reduce
  demand for charcoal
• Promote alternatives for cooking and building
  materials (solar ovens, natural gas pipelines,
  more efficient cooking appliances)

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V. Discussion

• Increase the price of services or benefits from
  forests
• Promote markets for mangos (also coffee, cacao,
  nuts, etc.)
• Promote free/fair trade to open up export markets

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Costanza et al. 1997
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Costanza et al. 1997