Valuation of Nature: An Economic Perspective

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Valuation of Nature: An Valuation of Nature: An Economic PerspectiveEconomic Perspective

Stephen J. Conroy, Ph.D.Stephen J. Conroy, Ph.D.

Professor of EconomicsProfessor of Economics

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I. How to Value an Asset?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 attributes—as 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 FirmII. Value of the Firm

Let’s focus on one of these . . . stocks. Let’s focus on one of these . . . stocks. However, since a share of stock grants the However, since a share of stock grants the owner to a partial ownership of a firm, the owner to a partial ownership of a firm, the value of a share of stock derives from the value of a share of stock derives from the value of the firm itself. value of the firm itself.

So, let’s focus on deriving the value of a firm.So, let’s focus on deriving the value of a firm. How to estimate this value???How to estimate this value???

Forecasting net income into futureForecasting net income into future Determine appropriate discount rateDetermine appropriate discount rate

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nn

kkkkV

1.....

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Where is profit, or net income, and k is the appropriate discount rate. We can rewrite this more compactly as:

1 1t

tt

kV

Let’s start by taking an example of valuing a firm:

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What measurable value (“statistic”) should What measurable value (“statistic”) should this estimate compare to???this estimate compare to??? If financial markets are “robust” . . . Then the If financial markets are “robust” . . . Then the

Market capitalization (“market cap”) {(No. of Market capitalization (“market cap”) {(No. of outstanding shares of stock) * (Price per outstanding shares of stock) * (Price per share)}share)}

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What about a stock like ExxonMobil?What about a stock like ExxonMobil? ExxonMobil generates about $40 billion ExxonMobil generates about $40 billion

per year in net income (profits). How per year in net income (profits). How much is ExxonMobil worth?much is ExxonMobil worth?

Yahoo Finance Quote from 2/15/12:Yahoo Finance Quote from 2/15/12:

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Go to Excel Spreadsheet Example for Go to Excel Spreadsheet Example for Exxon MobilExxon Mobil

Asset valuation in economics and finance Asset valuation in economics and finance takes on this basic construct, though with takes on this basic construct, though with lots of different variations.lots of different variations.

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III. Valuing NatureIII. Valuing Nature

Now, let’s apply the same approach to Now, let’s apply the same approach to valuing nature. The “natural capital” in an valuing nature. The “natural capital” in an ecosystem produces benefits to society. . . ecosystem produces benefits to society. . .

What are these benefits or “profits” in What are these benefits or “profits” in nature?nature? Costanza et al. (1997) paper suggests a Costanza et al. (1997) paper suggests a

number of benefits or “services” from number of benefits or “services” from ecosystems (see p. 254, Table 1)ecosystems (see p. 254, Table 1)• Gas, water, soil, fruit, habitat, recreation, Gas, water, soil, fruit, habitat, recreation,

cultural/aestheticcultural/aesthetic99

Costanza et al. 1997


How to value these services? (Is there a How to value these services? (Is there a market for all of these services?)market for all of these services?)

Costanza et al. (1997) provide a Costanza et al. (1997) provide a discussion of willingness to pay (WTP).discussion of willingness to pay (WTP).

If an ecosystem provides $50 in benefit to If an ecosystem provides $50 in benefit to lumber companies and $70 in aesthetic lumber companies and $70 in aesthetic value, then the total benefit is $120, but value, then the total benefit is $120, but only $50 contributes to the monetary part only $50 contributes to the monetary part of the economy—or has an explicit value.of the economy—or has an explicit value.

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When Americans look at Haitians’ massive When Americans look at Haitians’ massive deforestation, we wonder about the deforestation, we wonder about the Haitians’ rationality. Why would anyone Haitians’ rationality. Why would anyone do this?do this?

This is important in terms of policy:This is important in terms of policy: If cutting down a tree is irrational then policy If cutting down a tree is irrational then policy

implication is simple: implication is simple: “education”“education” If it is rational, however, then policy is not so If it is rational, however, then policy is not so

simple: simple: “education plus” “education plus”

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In the following simulation, I wish to create a In the following simulation, I wish to create a model which demonstrates the conditions model which demonstrates the conditions under which a rational “economic human” under which a rational “economic human” may choose to cut down a tree sooner, rather may choose to cut down a tree sooner, rather than later, leading ultimately to deforestation.than later, leading ultimately to deforestation.

Here, I will assume property rights are well Here, I will assume property rights are well defined and the individual owns the tree.defined and the individual owns the tree.

The model may lead to important policy The model may lead to important policy implications.implications.

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IV. Simulation—A ModelIV. Simulation—A Model

Go to Excel Spreadsheet.Go to Excel Spreadsheet. Assume we have a mango tree that generates Assume we have a mango tree that generates

$20/year in fruit.$20/year in fruit. Assume the mango tree also generates an Assume the mango tree also generates an

additional $5/year in water benefits (retention, additional $5/year in water benefits (retention, purification/filtrationpurification/filtration

Assume the mango tree could also be Assume the mango tree could also be harvested as either lumber or charcoal. Say the harvested as either lumber or charcoal. Say the lumber benefit is $1,000 but that means the tree lumber benefit is $1,000 but that means the tree will die.will die.

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IV. Simulation—A ModelIV. Simulation—A Model

Assume the mango tree grows at a rate of Assume the mango tree grows at a rate of 3% per year, thus increasing the fruit, water 3% per year, thus increasing the fruit, water and “board” benefits in a similar manner. and “board” benefits in a similar manner. (This is the “inflator” in the model.)(This is the “inflator” in the model.)

I present four different outcomes:I present four different outcomes:1.1. Harvest for wood/charcoal after year 1Harvest for wood/charcoal after year 1

2.2. Harvest after year 10Harvest after year 10



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IV. Simulation—Scenario 1IV. Simulation—Scenario 1

Scenario 1: The “normal” scenario is Scenario 1: The “normal” scenario is presented first. presented first.

Reasonable (for U.S.) discount rate of 0.04Reasonable (for U.S.) discount rate of 0.04 Reasonable inflator of 0.03Reasonable inflator of 0.03 Somewhat-reasonable values for other Somewhat-reasonable values for other

amenities.amenities. Result: highest value is from waiting for 30 Result: highest value is from waiting for 30

years to cut down treeyears to cut down tree

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Scenario 2: Now, what if agents are Scenario 2: Now, what if agents are impatient (e.g., because they are hungry)impatient (e.g., because they are hungry)

Discount rate increases, say, to 0.50 (from Discount rate increases, say, to 0.50 (from 0.04)0.04)

Everything else the same.Everything else the same. Result: highest value, by far, is to cut down Result: highest value, by far, is to cut down

the tree after just the first year! ($683.33 vs. the tree after just the first year! ($683.33 vs. $74.58 after 10 years; $53.69 after 20 $74.58 after 10 years; $53.69 after 20 years; $53.20 after 30 years)years; $53.20 after 30 years)

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Scenario 3: Now, assume that the price of Scenario 3: Now, assume that the price of boards (or charcoal) increases dramatically boards (or charcoal) increases dramatically (e.g., due to scarcity of trees).(e.g., due to scarcity of trees).

Price of boards/charcoal triples to $3,000.Price of boards/charcoal triples to $3,000. Everything else the same as in Scenario 1.Everything else the same as in Scenario 1. Result: highest value is to cut down the Result: highest value is to cut down the

tree after just the first year. ($2,909 vs. tree after just the first year. ($2,909 vs. $2,875 after 10 years; $2,840 after 20 $2,875 after 10 years; $2,840 after 20 years; $2,809 after 30 years)years; $2,809 after 30 years)

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Scenario 4: Now, assume that the annual Scenario 4: Now, assume that the annual flow of benefits from the tree (mangos and flow of benefits from the tree (mangos and water) has no (explicit or implicit) value.water) has no (explicit or implicit) value.

Price of mangos and water goes to zero.Price of mangos and water goes to zero. Everything else the same as in Scenario 1.Everything else the same as in Scenario 1. Result: highest value is to cut down the Result: highest value is to cut down the

tree after just the first year. ($962 vs. $881 tree after just the first year. ($962 vs. $881 after 10 years; $800 after 20 years; $727 after 10 years; $800 after 20 years; $727 after 30 years)after 30 years)

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V. DiscussionV. Discussion

The results of these simple simulations The results of these simple simulations demonstrates that—under certain conditionsdemonstrates that—under certain conditions—rational economic agents would have an —rational economic agents would have an incentive to cut down trees after the first incentive to cut down trees after the first period, thus promoting deforestation.period, thus promoting deforestation.

Thus, as despicable as it is, deforestation is Thus, as despicable as it is, deforestation is not a completely “ignorant” or irrational act. not a completely “ignorant” or irrational act. Education alone will not necessarily solve Education alone will not necessarily solve the problem.the problem.

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V. DiscussionV. Discussion Policy would need to be “Policy would need to be “Education PlusEducation Plus.” .” Programs designed to:Programs designed to:

1.1. Decrease the discount rate of individuals:Decrease the discount rate of individuals:a)a) Provide universal access to quality K-12 education Provide universal access to quality K-12 education

(increases opportunities and view of the world, especially (increases opportunities and view of the world, especially for women)for women)

b)b) Reduce mortality and morbidity rates through improvements Reduce mortality and morbidity rates through improvements to healthcare—particularly low-cost, public health programs to healthcare—particularly low-cost, public health programs and clinicsand clinics

c)c) Improve economic opportunities (e.g., microfinance).Improve economic opportunities (e.g., microfinance).

d)d) Improve access to creditImprove access to credit

e)e) Improve access to private and public pension programsImprove access to private and public pension programs

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V. DiscussionV. Discussion2.2. Increase the perceived value of nonmonetary Increase the perceived value of nonmonetary

services (e.g. “water” in this model).services (e.g. “water” in this model).a)a) Promote ecological education and information (e.g., Promote ecological education and information (e.g.,

watershed, biodiversity, gas emissions)watershed, biodiversity, gas emissions)

3.3. Decrease the price of boards and charcoal.Decrease the price of boards and charcoal.a)a) Subsidize natural gas distribution to reduce demand Subsidize natural gas distribution to reduce demand

for charcoalfor charcoal

b)b) Promote alternatives for cooking and building Promote alternatives for cooking and building materials (solar ovens, natural gas pipelines, more materials (solar ovens, natural gas pipelines, more efficient cooking appliances)efficient cooking appliances)

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V. DiscussionV. Discussion

4.4. Increase the price of services or benefits Increase the price of services or benefits from forestsfrom forests

a)a) Promote markets for “mangos” (also coffee, Promote markets for “mangos” (also coffee, cacao, nuts, etc.)cacao, nuts, etc.)

b)b) Promote free/fair trade to open up export Promote free/fair trade to open up export marketsmarkets

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Valuation of Nature: An Economic Perspective