Author : Nilanjan Ghosh

Expert Speak India Matters
Published on Jul 08, 2021
Pricing Nature: Between normative concerns and positive theories

“Cecil Graham: What is a cynic?

Lord Darlington: A man who knows the price of everything, and the value of nothing.

Cecil Graham: And a sentimentalist, my dear Darlington, is a man who sees an absurd value in everything and doesn’t know the market price of any single thing.”

― Oscar Wilde, Lady Windermere's Fan

Nothing else has witnessed a bigger conflict between “cynicism” and “sentimentalism” (in ways delineated in the above lines by Oscar Wilde) than the concern of valuing nature and natural ecosystems. Many view valuing ecosystem services (or the services provided by the natural ecosystem to the human community organically) as the single-most important contribution to the extensive body of work in the discipline of Ecological Economics. Nothing can be far from the truth! Despite valuation exercises getting the limelight, especially due to their importance in policy making, Ecological Economics has transended the bounds posed by neoclassical economic assumptions mooted in positive theory and reductionism, challenges them, adjudges the working of institutions from both positive and normative perspectives, and is justifiably classified as a discipline contributing to the heterodox economic thinking. In the process, it has emerged as a maverick field, often not really thought of as “real economics”, rather as an amalgam of sociology, anthropology, history, politics, and, at times, based on ideological constructs of political thoughts and normative principles of ethics. Unfortunately, the normative concerns and ideological constructs promoted by Ecological Economics lurk somewhere in the backdrop and is most often veiled by the prominence of “positive economics” as can be witnessed by the deluge of studies on valuation of ecosystem services.

Those who advocate the innumerable benefits of valuation of ecosystem services for helping decision-making and its broader implications for a decision support system for policy formulation, essentially base their arguments on the following points. Firstly, such values help human societies understand the critical importance of the ecosystem to them. Secondly, valuation of ecosystem services provides a basis for prioritising investments to meet conservation goals. Thirdly, monetary values associated with nature help understand the trade-offs between conservation and development. In many cases, infrastructures that are meant to augment development goals destroy the natural ecosystems, thereby, inhibiting their abilities to provide ecosystem services. Valuation helps in understanding these losses to the human community in monetary terms. Fourthly, to deal with compensation policies properly, the economic value of the harm so caused due to losses in ecosystem services needs to be assessed to obtain the extent of the negative externalities. Valuation helps this process. Fifthly, valuation helps investment (infrastructure development) decisions that might otherwise ignore the effects on the environment. Sixthly, valuation helps design efficient management mechanisms (economic instruments, controls, etc.) and institutions (PES).

Nature is indifferent to monetary metrics; unlike economic goods, it does not respond to market prices. Rather, the flow of the ecosystem services continues in forms of gas regulation, waste treatment, climate control, biological control, water regulation, pollination, food production, soil formation, nutrient cycling, and other functions, irrespective of what the market prices are.

Increasingly, larger numbers in the policymaking machineries across the world (and more so in the developing world) are getting convinced that such valuation exercises are omnipotent despite the assumptions that they are offshoots of epistemological and methodological perspectives. Arild Vatn and Daniel Bormley in their 1994 paper “Choices without Prices without Apologies” have talked about the serious problems making assumptions on the values of environmental goods and services, which compresses various informations about the attributes of the resource under consideration. Vatn and Bromley’s contentions emerged, however, more from a methodological perspective, as during the 1990s, most studies were conducted with a stated preference approach, more popularly, the Contingent Valuation Method (CVM). Here, respondents were asked the price that they were willing to pay for an improvement in ambient air or water quality or for the existence of a particular ecosystem.

Significant strands of literature (one may find a survey here) have already pointed to the drawbacks of the CVM that are largely methodological in nature from the perspective of inefficiencies of valuation exercises and estimates. These various biases in the CVM estimates emerge as: a) Strategic biases arising from respondents’ intentional misrepresentation of values; b) hypothetical biases as the respondents are not involved in real market transactions; c) Scope biases emerging from stated values not varying proportionally with the quantum and quality of the ecosystem services under consideration; d) frame biases resulting from the bias of the interviewer or the instrument; and e) mismatch between the WTA (Willingness to Accept) and WTP (Willingness to Pay) disparity at a particular point in the hypothetical demand function.

The contention in this essay goes one step ahead of this critique against CVM. While CVM might give unjustified and biased estimates as these are not based on a human being’s real behaviours in markets, even functioning markets for environmental resources or ecosystem services are not able to discover efficient prices that can compress adequate information about the utility of such goods and services. The emergence and failure of carbon markets bear ample testimony to this. The moot objective with which carbon markets were conceptualised was reducing carbon emissions, and not what it finally stood for: A hub of speculation in its derivative segment for sheer money making. The fundamental idea was that such markets will help realise the price of the cabon credit that will reflect on the cost of emission of an extra unit of carbon. In that sense, the overarching objective of the carbon market is to help the realisation of efficient prices that would reflect on the one hand, the scarcity value of ecosystem service (i.e., carbon stocking and annual sequestration), and on the other hand, the associated social marginal cost of carbon emission.

There is no harm in reiterating that the interactive dynamics of the demand-supply forces leads to price discovery in the markets. Now, the concern is that whether the markets are efficient enough to compress complete information in the prices. In 1970, Geoge Akerlof has shown the world how incomplete product information leads to the problem of “adverse selection” in the markets. For efficienct prices  to be discovered, there is a need for the consumer to be  aware of the “utility” of the commodity.

It is important to make human society understand and appreciate the values of ecosystem services so that the market phenomenon can reflect that. Else, we stay where we are: Environmental markets will keep on failing.

The situation is, however, a bit difficult for environmental resource or the ecosystem service as a commodity. For the environmental market, information is the missing element. In the process, the very assumption that prices are reflecting on the social cost and the scarcity value of offset mechanisms is invalid for carbon markets. As such, even the body of literature on natural sciences has not yet deciphered the range of ecosystem services that nature provides to humans. With the existing knowledge deficit about the range of negative impacts from trans-boundary air or water pollution, it is not possible for market prices of pollution to reflect the true scarcity value.

Rather, the prices here are more contingent upon the prevailing macroeconomic conditions than the actual supply-demand dynamics. The best example happens to be that of the Certified Emission Reduction (CER) markets. After the 2007–08 financial meltdown, the Certified Emission Reduction (CER) prices diminished, as the demand for CER declined due to a decline in industrial activities. Had the CER prices reflected on the scarcity value of carbon sequestration, the inherent implication is that the value of the damage caused by release of an extra unit of carbon has diminished. That is definitely impossible! Pollution causes the same damage during a recession, as it does during times of prosperity, and mangrove ecosystem sequesters carbon with the same intensity during recession, as it does during economic boom.

Nature is indifferent to the monetary metrics, unlike economic goods: It does not respond to market prices! Rather, the flow of the ecosystem services continues in forms of gas regulation, waste treatment, climate control, biological control, water regulation, pollination, food production, soil formation, nutrient cycling, and other functions, irrespective of what the market prices are.

This means the “values”and “prices” are divorced from each other. With an inelastic supply phenomenon, the prices in most environmental markets are demand determined. Yet, the demand function is formed out of minuscule information about the utility of the resource or the service. And, here emerges the duel between the “cynic” and the “sentimentalist” in Lady Windermere’s Fan: This can also be construed as an epistemological contest between positive theory (of prices discovered in markets) and normative concerns (of environmental conservation). Unfortunately, the crucial problem of this divergence cannot be wholly resolved, but may be done partially if two conditions get satisfied. First, better valuation techniques need to emerge to make humanity understand the actual cost of pollution or depleting ecosystem services. On the carbon sequestration benefit estimation, some progress has been made with value estimations being made on the basis of social cost of carbon, rather than considering the market prices of carbon credits. Second, it is important to make human society understand and appreciate the values of the ecosystem services so that the market phenomenon can reflect that. Else, we stay where we are: Environmental markets will keep on failing, being torn between the two extreme ideological constructs of “cynicism” and “sentimentalism”.

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Nilanjan Ghosh

Nilanjan Ghosh

Dr. Nilanjan Ghosh is a Director at the Observer Research Foundation (ORF), India. In that capacity, he heads two centres at the Foundation, namely, the ...

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