Water Resource Economics C H A P T E R E E V A L U A T I O N O F W A T E R D E V E L O P M E N T P R O J E C T S

Transcription

1 Water Resource Economics C H A P T E R E E V A L U A T I O N O F W A T E R D E V E L O P M E N T P R O J E C T S

2 Text Reader, based on Griffin (2006),

3 Organization 1. The nature of water development projects 2. Cost-benefit analysis 3. Finding the empirical values 4. Funding of projects

4 Objectives 1. To understand the need for project evaluation. 2. To describe and replicate various measures to evaluate projects, including costbenefit analysis. 3. To understand the drawbacks of these measures. 4. Apply cost-benefit analysis to simple cases. 5. Apply an economic perspective on the scope and application of cost-benefit analysis.

5 Introduction This chapter covers the economics of water development projects, such as large infrastructural constructions including dams, desalination, and development or upgrading of irrigation systems. These examples illustrate that such projects are generally large in their scope and they are almost always aimed at supplymanagement, rather than demand-management. The size of many water development projects implies the involvement of large budgets. The standard tool to evaluate the proper use of these budgets is cost-benefit analysis (CBA), which values and compares all costs and benefits of a proposed project over its lifetime. CBA does not only inform about the value of the project, but can also be used to compare the project to any possible alternative uses of the budget.

6 Water development trajectories

7 Project benefits and costs A water development project can induce costs and benefits in various domains: 1. (beneficial or adverse) effects on the economy 2. effects on water supply to current water users 3. effects on water supply to future water users (e.g. in case of a groundwater project), and 4. effects on the environment. Costs can usually be quantified in monetary terms, but this does not hold for all types of benefits. For example, environmental benefits are notoriously difficult to monetize. Nevertheless, a large set of valuation methods is available, e.g.: 1. Hedonic pricing 2. Contingent valuation 3. Travel cost method, etc.nowadays

8 Project benefits and costs Valuation methods decompose the value of an environmental quality into: 1. various use-values (i.e. value of recreation and fishing) 2. Various non-use values (i.e. existence value and bequest value), Often applied in context of watershed services

9 Evaluating benefits and costs What analytic techniques should be used to determine if a specific project is among the efficient package of water management policies? Cost-benefit analysis (CBA) is the widely used standard for project evaluation. One practical reason is that CBA was pushed by governments in the US and Europe to evaluate large water development projects.

10 Evaluating benefits and costs Two drawbacks. 1. Monetary valuation may not be possible for one of many reasons. If so, benefits can be assessed by qualitative descriptions, e.g. using indicators. 2. Social goals are hard to include in a CBA, because CBA focuses on aggregate efficiency (recall Chapter A). When a project aims to increase water supply to poor communities at the cost of hydropower development, the proposed project may be inefficient (in aggregate terms) but very successful with respect to the project goals.

11 CBA input The input required to do a CBA is an inventorisation of all monetized costs and benefits over the project lifetime. Such input can be dipslayed in a matrix where costs and benefits are displayed for each period of the project. Future costs are discounted to their present value using the discount factor d, because of time preference and economic growth (which causes the marginal utility of additional consumption in the future to decline). This factor normally corresponds to either: 1. the costs of borrowing funds, or 2. a mandated social discount rate (usually in the range of 5% to 9%). The present value PV of a benefit B t occurring in year t is then discounted as follows: PV(B)=B t /(1+d) t e.g. d=0.05 corresponds to a 5% discount rate.

12 A CBA spreadsheet

13 Cost categories Major costs categories are the costs for: 1. planning and design 2. land purchases 3. salaries and wages 4. materials and equipment 5. borrowing costs (interest) 6. environmental losses Main benefits categories are the benefits of: 1. increased water supply 2. enhancements to recreation 3. flood control 4. Hydropower 5. Navigation 6. water quality

14 Measures obtained from CBA Three separate measures are usually obtained from CBA to aid decision making: 1. Net Present Value (NPV): This is obtained by subtracting the discounted costs and negative effects from the discounted benefits. A negative NPV suggests that the project should be rejected because society would be worse off. 2. Benefit-cost ratio: This is derived by dividing the discounted costs by the discounted benefits. A value greater than 1 would indicate a useful project. 3. Internal rate of return (IRR): The average rate of return on investment costs over the life of the project.

15 Output of a CBA The output of a CBA analysis is a comparison of benefits and costs over the lifetime of a project. One attractive measure that can be obtained from a CBA is the net present value (NPV). There are two important issues to consider: 1. A positive NPV does not imply that the project is efficient. There may be an alternative project for the same budget that has a higher NPV. Hence, opportunity costs should be accounted for. 2. When a project replaces an existing project (e.g. in the case of a dam that replaces an old reservoir for water supply for irrigation), then the costs of the previous project (e.g. maintenance costs) can be double-counted.

16 Valuing a cost increase

17 Valuing a diminished good

18 Growth-driven demand shifts

19 Project financing Project financing relevant to project evaluation. Who is funding? Are project beneficiaries contributing? If so, how? Project expenses linked to specific project purposes? (in case of multi-purpose projects) Contributions are usually in the form of one-time lump-sum contributions or (temporary) increases in water charges, in addition to government contributions which are funded by the government budget for the specific purpose of the project.