Andrea Ricci
Istituto di Studi per l’Integrazione dei Sistemi
Roma
Italy

Extended abstract

Relevance of externality valuation

Externalities are changes of welfare generated by a given activity without being reflected in market prices. A cost (benefit) is considered external when it is not paid (enjoyed) by those who have generated it. Externality valuation provides major contributions to the formulation of sustainable development policies:

• on the one hand, supply side policies (infrastructure, products and services in general) require that the relative merits of alternative options be assessed and compared on an equitable basis. These policies can therefore directly benefit from: i) the availability of an extended accounting framework for Cost Benefit Analyses (CBA), where all social costs (i.e. both internal and external) are considered in a consistent and homogeneous manner, and ii) the subsequent possibility of comparing alternative investment options (e.g. through the assessment of differential values)
• on the other hand, externalities, if not internalised, introduce market distortions that should be corrected through regulatory and other (e.g. pricing) interventions. Demand side policies (regulation, pricing and taxation) should therefore systematically avail themselves of an accurate estimation of the absolute value of externalities in order to define the optimal terms and conditions of:
  1. mitigation/abatement measures, and
  2. measures for the internalisation of externalities.

Abundant research has been carried out in the area of externality valuation over the past decades, notably through the EU funded ExternE series. It has produced a significant body of knowledge both in methodological terms and for what concerns factual evidence supporting the integration of external cost accounting into policy decisions. However, several important aspects are yet uncovered, or insufficiently known.

• Sector-wise, two main areas have been so far investigated in detail, i.e., energy conversion and transport. Additional research is needed to define comparable externality accounting frameworks for agriculture, industry and the services sector, and, more generally, for land-use and water-use policies. There are several dimensions requiring in-depth investigation in this respect. The level of applicability of the existing accounting frameworks to new and different sectors must be assessed, whereby burdens, impacts, receptors, and the physical mechanisms linking them may vary considerably from one sector to another; additional knowledge must therefore be gained on the nature of burdens, the associated impact chains (exposure-response functions), and the monetary valuation of such impacts.
• Similarly, externality research has concentrated primarily on a limited - though crucial - set of external costs, i.e. those associated to the emission of air polluting substances, to accidents, to global warming and, concerning transport, to congestion. Noise pollution has been extensively investigated, but the current body of knowledge is still insufficient, while other externalities are altogether largely under-documented, such as e.g. visual intrusion, community severance, water and soil pollution, odours. Additional research, both theoretical and empirical (e.g., through ad hoc case studies) is needed.
• Moreover, energy and transport externalities are primarily negative (external costs). In dealing with agriculture, as well as with land and water use in general, the issue of multi-functionality arises, whereby any given policy entails both external costs and benefits, pointing at the need for an accounting framework that must be capable of integrating and balancing them accordingly. Well-established approaches such as, in particular, the IPA (Impact Pathway Approach), developed within ExternE and subsequently widely adopted worldwide, must be checked against their potential ability to account for external benefits, and to do so within a coherent valuation framework.
• Finally, and most importantly, the methodological approaches developed for externality valuation assume that the starting point of the analysis is a given technology, or a set of alternative technological options. What is then calculated is the monetary value of the full set of impacts generated by those technologies. In the wider framework of land and water use planning, the focus is on the formulation of integrated policies for the sustainable use of land/water, rather than on the ranking of a pre-specified set of alternative technological options. This calls for a shift in the overall approach to external cost valuation, whereby the accounting framework must then allow policies (rather than individual technologies) to be evaluated. To a large extent, policies can be defined as the combination of individual decisions, each directly or indirectly linked to a choice in the selection or/and in the use of technologies.

Policy formulation and target setting: an integrated approach

Pure CBA (Cost Benefit Analyses), such as those associated to the use of externalities’ accounting frameworks, are often criticised for not taking into due account social and political priorities that do not lend themselves to immediate and reliable quantification. Critics contend that the economic theory often fails to capture the true value of social, environmental, and other resources, whereby a given policy may be identified as maximising efficiency from the economic viewpoint, while failing to ensure the attainment of higher-level objectives, such as, for instance, the preservation of the ecosystem, the fight against long-term deterioration of natural assets, global warming, etc.

Responding to such legitimate criticisms calls for a complementary approach, whereby policies should be formulated with the primary objective of guaranteeing the attainment of sustainability targets, which in turn are geared to the intrinsic characteristics of the ecosystem, and of natural assets in general. This leads to the introduction of the well-known notion of thresholds, which can identify the maximum level of pressure (social, environmental) that a given system can absorb without facing irreversible collapse (the point of no return). While such an approach is conceptually recognised as interesting and policy-relevant, much progress remains to be made in order to establish a consistent and robust methodological body for the quantitative assessment of thresholds characterising natural assets such as agricultural land, coastal zones, seawaters and marine systems, and ecosystems in general.

In fact, the two research streams outlined above (i.e. externality accounting and threshold assessment) are often seen as reflecting parallel, and at times even conflicting approaches to policy formulation, while they should in fact be considered as complementary, and their integration accordingly pursued:

• in the CBA, externality-based approach, policies and technologies are ranked according to their economic performance: impacts are valued in monetary terms, and the overall economic performance is expressed by the final balance between total social costs and total social benefits.
• in the threshold approach, policies and technologies are ranked according to their relative performance in ensuring the compliance with minimum requirements (the threshold values).

Combining the two approaches amounts to devising a method whereby one of the two approaches is selected, and the other is included as a constraint in the ranking process.

For instance, alternative uses of land can be analysed in terms of their social external costs, along the entire IPA chain, leading to the monetary valuation of costs and benefits of a given land use option. In parallel, thresholds can be calculated to assess the carrying capacity of land in terms of absorption of specific negative impacts associated e.g. to the growing of specific crops, or to recreational use, etc.

The final ranking can be established by combining the two approaches: either by introducing the threshold constraint to refine the ranking established through externality analysis, or vice-versa.

In fact, several methodological options can contribute towards the integration of the two approaches, with particular reference to Input/Output Accounting (IOA), Strategic Environmental Assessment (SEA) and Multicriteria analysis, and combinations thereof. Concerning IOA, promising developments can be expected from the extension of the traditional IO structure so as to include the analysis of the interchanges between economic sectors and natural assets, thus allowing the capture of impacts that are usually unaccounted for (externalities).