Valuation of externalities for sustainable development

Andrea Ricci
Istituto di Studi per l’Integrazione dei Sistemi

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:

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.

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:

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).