Monetization of impacts

Monetisation of impacts

by USTUTT (Alexandra Kuhn, Peter Bickel and Rainer Friedrich)

Purpose of monetising health impacts and quantifying health damage costs

Human activities cause damages and impose risks on human beings, ecosystems and materials. For instance, a power plant when producing electricity may emit pollutants that are transported in the atmosphere and then when inhaled can create a health risk or after deposition can disturb ecosystems. In order to be able to assess and compare the damages (often referred to as “external effects”) with each other and with costs, it is advantageous to transform them into a common unit; the choice of a monetary unit here has advantages described later. Often the damages of an activity are quantified using the concept of external costs. External costs are costs that are not included in the market price of the goods and services being produced, i.e. a cost not borne by those who create it. Defining scenarios we use the avoided external costs of one scenario compared to the external costs of the other as a measure of the benefits of this scenario.

There are several purposes for monetising health impacts and quantifying health damage costs.

• When investment decisions are made, e.g. about which power plant technology to use or where to site a power plant, it is evident that it would be of interest for society to take environmental and health impacts into account and include the external effects into the decision process. To support the decision process, the social costs of the investment alternatives, i.e. the sum of internal and external costs, can then be compared. If decisions are to be taken now, but the consequences of the decisions reach decades into the future, the possible future costs have to be estimated. The same principle is valid for ranking of alternative policies.
• In a similar way external cost estimates are useful for carrying out technology assessments, and thus to find out the principal weaknesses and strengths of a technology and to be able to assess the overall performance and usefulness of a technology; this would for example help to answer questions about whether and where the technology would need further improvement, and whether subsidising it or supporting further research might be justified.
• A third very important field of application is the performance of cost-benefit- analyses for policies and measures that reduce environmental and health impacts. Policies and measures for reducing environmental pollution generally imply additional costs for industry and consumers. Thus it is important for the acceptance of the measure to show that the benefits, for example reduced health risks, outweigh or justify the costs. The benefit can be expressed as avoided damage costs. To calculate these it is necessary to create two scenarios: a baseline scenario, which describes a development without the implementation of the measure or policy and a scenario including it. Then the impacts occurring for the two scenarios are calculated. The difference of the impacts is monetised; this gives the avoided damage costs or benefits (provided that the impacts of the scenario with the measure are lower than for the baseline scenario). These benefits can then be compared with the costs. If benefits are larger than costs, the policy or measure is beneficial for society’s welfare.
• Another area of application is the assessment of health and environmental impacts occurring in a region due to activities of different economic branches, in short green accounting. For example one could monetise the health effects occurring due to emissions of different pollutants, and can then rank different source categories, economic sectors or pollutants according to their health impacts, compare health effects in different countries or imposed from one country to another or to compare health effects of different years to find out whether the situation is improving.
• Quantifying external costs can also be used for internalising them, i.e. that the polluter has to pay for the pollution and the effects that he caused. This will lead to including the external costs into the market prices ("getting the prices right").

Why do we use monetary values?

The applications mentioned in the first section above all have something in common: having calculated different impacts (risks, damage) on receptors (e.g. adverse health effects) or indicators that indicate to what extent objectives are fulfilled, it is necessary to compare these impacts with each other and with costs. To compare technologies or assess policies, it has to be found out whether one set of impacts and costs is better or worse than another set. This is not straightforward, as the different impacts have different units, so they cannot be added directly. How can we compare, e.g. 10 cough days with one case of bladder cancer? So, before being able to add and compare impacts, it is necessary to transform them into a common unit.

There are different possibilities for a common unit. Why do we use monetary values?

1. All the applications mentioned in the first section imply that there are different effects and impacts that somehow have to be weighted relative to others to get an overall assessment of whether one basket of impacts is better or worse than another. The first requirement to a decision support methodology is that this assessment or weighting of impacts is as far as possible carried out using quantitative figures and procedures. The reason is that only quantitative algorithms ensure the necessary transparency and reproducibility of results.
2. The use of monetary values as common unit into which impacts are transformed has a number of advantages. First, units are conceivable. The importance of an impact in monetary units, say €10,000, can be directly and intuitively grasped, as one can compare it with the utility of the goods and services that one could buy with this amount. Whereas an amount of, say 120 utility points, does not say anything about the importance of the impact. Secondly, monetary values are transferable from one application to another. This is because monetary units are defined independently of the assessment process. So if a monetary valuation of the risk to get a certain disease, e.g. bronchitis, has been found, this value can – with some caution and adjustment – then be used in a further analysis, where this disease occurs, without having to carry out a new survey on its monetary value. Thirdly, the applications mentioned in the first section at some stage require the use of monetary units. So in order to compare costs with utility, it is necessary to convert utility into monetary units. It would of course also be possible to convert costs into some measure of utility like ecopoints, but this is obviously less useful due to the first reason mentioned.
3. Having determined monetary values for impacts, e.g. adverse health effects, it is possible to conduct cost benefit analyses because now the costs and the benefits can be measured on the same scale.

It may seem quite insensitive to allocate monetary values to impacts like health effects or the extinction of species. But preferences in society exist anyhow and monetising impacts just reflects those preferences for certain activities and decisions compared to other activities and decision.

Methods for monetisation

How is it possible to get a measure for the relative importance of impacts and thus for the weighting factors or algorithms needed? As no natural law exists that somehow weighs impacts with different units, the logical possibility is to measure the preferences of the population. This can be done with a number of methods, e.g. by asking for or observing the willingness to pay to avoid a certain impact. The only alternative would be to measure the preferences of elected representatives of the population, with the argument that representatives are or can be better informed than the public. However, these representatives change, so that benefit transfer is difficult or not possible. Furthermore experience with multi-attribute utility analysis shows that decision makers are often not willing to expose their preference structure, possibly because they fear that they lose influence on their decisions. Although it is also possible to use revealed preferences of decision makers for example, the preferred way is to directly measure preferences of the population.

Methods for monetisation can be grouped in

• goods with a market price and
• non-market goods.

Either is it possible to determine the

• willingness to pay a certain amount to avoid a certain impact, or the
• willingness to accept which presents the amount of money one would demand as compensation for accepting a certain impact.

Methods for deriving monetary values for market price goods:

• Market prices (only for goods traded on markets! e.g. crops, timber)

For non-market goods (public goods, human health risks):

• Indirect evaluation methods
  • Hedonic pricing (wage differences due to risks, price changes of houses or rents due to difference in air pollution or noise; prices of commodities contain implicitly the willingness to pay for the no-market goods)
  • Travel cost method (number of trips to areas, e.g. recreation areas with certain features as a function of expenses including travel time)
  • Averting behaviour method / prevention costs - costs of products paid to reduce risks or damage (purchase of a safety equipment, e.g. airbags in cars, installation of water filtering systems)
• Direct evaluation methods
  • Contingent valuation, contingent ranking (interviews to find out the changes in behaviour, e.g. number of trips, if a feature, e.g. environmental quality, of a good changes)
  • Participatory approaches
  • Surveys asking public decision-makers for their preferences (corresponds to multi-attribute utility analysis)

Alternative approaches for weighting different impacts (e.g. use of multi-attribute utility analysis) are possible; however they have to be justified well.

Contingent valuation method - CVM

The method used mostly for quantifying health effects is the contingent valuation methods which uses surveys to ask for the willingness to pay. To get useful results in these surveys, impacts should be described and explained as well as possible before measuring preferences. Given that it would be not feasible to ask the whole population, it seems sufficient to ask a representative sample of the population. Thus, the assessment of impacts is based on the (measured) preferences of the affected well-informed population. To be able to get meaningful results, the interviewed persons have to understand the change of utility that occurs due to the impact to be assessed. This implies that it is important to value damages, not pressures or effects. For instance, it is not useful to ask for the willingness to pay to avoid an amount of emissions, say 5 tonnes of NO_x, as no one – at least without further information or knowledge – can judge the severity of this or the damage or loss of utility caused by this emission. On the other hand, if somebody is asked for an assessment of a concrete health risk, e.g. a cough day, he can compare this impact with other impacts and changes of utility that he experiences. The advantage of the CVM compared to indirect valuation techniques is that it can be applied for all types of goods, i.e. also for goods where no market data or behaviour in the past can be found.

Comparison of WTA and WTP

	Willingness to accept	Willingness to pay
Environmental improvement	Which minimum amount of money would you claim if the improvement does not take place?	Which maximum amount of money would you be willing to pay for the improvement?
Environmental impairment	Which minimum amount of money would you claim for an impairment?	Which maximum amount of money are you willing to pay for the impairment not to happen?

Health impacts: Components of Welfare (from a presentation by Alistair Hunt at a Heimtsa Meeting )

1. Resource costs i.e. medical costs

2. Opportunity costs i.e. the cost in terms of lost productivity (work time loss (or performing at less than full capacity)) and the opportunity cost of leisure (leisure time loss) including non-paid work.

1 + 2 = Cost-of-illness

3. Dis-utility i.e. other social and economic costs including any restrictions on or reduced enjoyment of desired leisure activities, discomfort or inconvenience (pain or suffering), anxiety about the future, and concern and inconvenience to family members and others.

1 + 2 + 3 = Willingness to pay (WTP)

Site and time dependency of emissions

An important aspect is that damage costs depend on the time and site of the emission. For instance, if air pollutants are released in a densely populated area, the health of more people is at risk than for a site where equal amounts of pollutants are emitted but in a less densely populated area. Noise in a city at night is more annoying than a similar noise level outside the city during the day. The decision support methodology should thus be capable of calculating site and time dependent damage costs. Only a detailed bottom-up calculation allows a close appreciation of such site, time and technology dependence.

Discounting

The willingness to pay of people is dependent on the time. If one could avoid an asthma attack tomorrow one would pay more than if one could avoid it in 10 years time. Therefore the values must be discounted if one looks into the future.

Evaluation of health risks

Critical arguments often brought forward against monetisation include that basic human rights are not to be subjected to physical harm by other people. Another argument is that people would value a certain human life infinitively high. But in reality people weigh costs and benefits of investments into safety equipment carefully and a trade-off between health risks and income is found in day-to-day decisions. Furthermore what is to be evaluated are changes in ex-ante risks, not ex-post risks such as the deaths of known individuals.

See also a presentation held at the Kuopio workshop by Alex Kuhn from USTUTT. The original presentation slides can be found here