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Methods, Section 5
Damage Cost Avoided, Replacement Cost, and Substitute Cost Methods

Estimate economic values based on costs of avoided damages resulting from lost ecosystem services, costs of replacing ecosystem services, or costs of providing substitute services.

  1. Overview
  2. Why Use the Cost-Based Methods?
  3. Application of the Cost-Based Methods
  4. Summary of the Damage Cost Avoided and Replacement Cost Methods
  5. Applying the Damage Cost Avoided, Replacement Cost, and Substitute Cost Methods
  6. Advantages of the Damage Cost Avoided, Replacement Cost, and Substitute Cost Methods
  7. Issues and Limitations of the Damage Cost Avoided Method



Overview

The damage cost avoided, replacement cost, and substitute cost methods are related methods that estimate values of ecosystem services based on either the costs of avoiding damages due to lost services, the cost of replacing ecosystem services, or the cost of providing substitute services.  These methods do not provide strict measures of economic values, which are based on peoples’ willingness to pay for a product or service.  Instead, they assume that the costs of avoiding damages or replacing ecosystems or their services provide useful estimates of the value of these ecosystems or services.  This is based on the assumption that, if people incur costs to avoid damages caused by lost ecosystem services, or to replace the services of ecosystems, then those services must be worth at least what people paid to replace them.  Thus, the methods are most appropriately applied in cases where damage avoidance or replacement expenditures have actually been, or will actually be, made.
 

Some examples of cases where these methods might be applied include:

  • Valuing improved water quality by measuring the cost of controlling effluent emissions.
  • Valuing erosion protection services of a forest or wetland by measuring the cost of removing eroded sediment from downstream areas.
  • Valuing the water purification services of a wetland by measuring the cost of filtering and chemically treating water.
  • Valuing storm protection services of coastal wetlands by measuring the cost of building retaining walls.
  • Valuing fish habitat and nursery services by measuring the cost of fish breeding and stocking programs.


This section continues with some example applications of the cost-based methods, followed by a more complete technical description of the methods and their advantages and limitations.
 

Hypothetical Situation
An agency is considering restoring some degraded wetlands in order to improve their ability to protect the surrounding area from flooding.  The agency wants to value the benefits of improved flood protection.

Why Use the Cost-Based Methods?
This method was selected in this case because the agency is only interested in valuing the flood protection services of the wetlands, and they do not have a large budget available for a valuation study.  A cost-based method may be the easiest and least costly method to apply in this case.

Application of the Cost-Based Methods 

Step 1:
The first step is to conduct an ecological assessment of the flood protection services provided by the wetlands.  This assessment would determine the current level of flood protection, and the expected level of protection if the wetlands are fully restored. 

Step 2:
This step depends on the specific method chosen.  The Damage Cost Avoided method might be applied using two different approaches.  One approach is to use the information on flood protection obtained in the first step to estimate potential damages to property if flooding were to occur.  In this case, the researcher would estimate, in dollars, the probable damages to property if the wetlands are not restored.  A second approach would be to determine whether nearby property owners have spent money to protect their property from the possibility of flood damage, for example by purchasing additional insurance or by reinforcing their basements.  These avoidance expenditures would be summed over all affected properties to provide an estimate of the benefits from increased flood protection.  However, one would not expect the two approaches to produce the same estimate.  One might expect that, if avoidance costs are expected to be less than the possible damages, people would pay to avoid those damages.

The replacement cost method is applied by estimating the costs of replacing the affected ecosystem services.  In this case, flood protection services cannot be directly replaced, so this method would not be useful.  The substitute cost method is applied by estimating the costs of providing a substitute for the affected services.  For example, in this case a retaining wall or a levee might be built to protect nearby properties from flooding.  The researcher would thus estimate the cost of building and maintaining such a wall or levee.  The researcher must also determine whether people would be willing to accept the wall or levee in place of a restored wetland.
 

How Can the Results be Used?
The dollar values of the property damages avoided, or of providing substitute flood protection services provide an estimate of the flood protection benefits of restoring the wetlands, and can be compared to the restoration costs to determine whether it is worthwhile to restore the flood protection services of the wetlands.
 
 

Case Study Example of the Replacement Cost Method 

Case #1— Soil Erosion in Korea

The Situation
As relatively flat farmland in Korea is lost to urban growth and industrial development, farming has moved into the hilly upland areas.  Heavy soil erosion has occurred on these upland areas, due to inadequate soil management techniques and errors in field layout and construction. 

The Challenge
Resource managers needed to evaluate the benefits of proposed new soil management techniques.  These benefits include the benefits of retaining the soil and nutrients on the upland areas, and the benefits of protecting downslope areas from damage by the eroded soil. 
 

The Analysis
The replacement cost method was used, with the costs of physically recovering and replacing lost soil, nutrients, and water taken as a measure of minimum benefits from preventing erosion and the resulting soil, nutrient and water losses.  Researchers measured the cost of physically replacing lost soil, nutrients, and water in upland areas, and the cost of compensating for downstream losses. 

First, the researchers calculated the annual soil loss per hectare, nutrient loss/hectare, and water runoff/hectare.  Second, they calculated the expected losses, in terms of replacement costs, if the new management practices were not implemented. The cost of recovering and replacing eroded soil was estimated as W80,000 per hectare per year; the cost of fertilizer and spreading to replace lost nutrients was estimated as W31,200 per hectare per year; the cost of annual field maintenance and repair was estimated as W35,000 per hectare per year; the cost of damage to downstream fields in lost production (valued at market price) was estimated as  W30,000 per hectare per year; and the cost of supplemental irrigation to replace lost water was calculated as W92,000 per hectare per year.  Thus, the total cost of soil erosion under existing management is W268,200 per hectare per year.  The net present value  of the annual replacement of soil and nutrients with existing practices, using a 15 year time horizon, was calculated as W2,039,662.

Next, the researchers calculated costs with the new management techniques.  These costs included the cost of compensation payments, soil replacement, nutrient replacement, and mulching.  The net present value of the costs of new management techniques was estimated to be W1,076,742.

The Results
The researchers found that the cost of new management techniques is about half the replacement cost.  Thus, the proposed preventive steps are worth implementing.

 
 
Case #2 — Oil Spill Damages

 
The Situation
 
The Zoe Colocotroni was a ship that spilled oil off the coast of Puerto Rico. The case was taken to court to determine the monetary damages resulting from the spill’s effects on the local ecosystem.

 
The Analysis
 
The trustees used the replacement cost method to estimate monetary damages.  They first calculated the number of lower trophic organisms killed by the spill, and then added up the cost of purchasing these organisms from a scientific catalog.

The Results
 
The US Court of Appeals rejected the use of the replacement cost method in this case, because the trustees did not plan to actually purchase the organisms and restore them to the ocean.  In fact, by the time such a plan could have been carried out, the organisms would have restored themselves.  Thus, the Court determined that the costs of purchasing the organisms did not accurately measure the actual ecosystem damages.
 
 

Summary of the Damage Cost Avoided and Replacement Cost Methods 

The damage cost avoided, replacement cost, and substitute cost methods are related methods that estimate values of ecosystem services based on either the costs of avoiding damages due to lost services, the cost of replacing environmental assets, or the cost of providing substitute services. 

The damage cost avoided method uses either the value of property protected, or the cost of actions taken to avoid damages, as a measure of the benefits provided by an ecosystem.  For example, if a wetland protects adjacent property from flooding, the flood protection benefits may be estimated by the damages avoided if the flooding does not occur or by the expenditures property owners make to protect their property from flooding.

The replacement cost method uses the cost of replacing an ecosystem or its services as an estimate of the value of the ecosystem or its services. Similarly, the substitute cost method uses the cost of providing substitutes for an ecosystem or its services as an estimate of the value of the ecosystem or its services.  For example, the flood protection services of a wetland might be replaced by a retaining wall or levee. 

Because these methods are based on using costs to estimate benefits, it is important to note that they do not provide a technically correct measure of economic value, which is properly measured by the maximum amount of money or other goods that a person is willing to give up to have a particular good, less the actual cost of the good. Instead, they assume that the costs of avoiding damages or replacing natural assets or their services provide useful estimates of the value of these assets or services.  This is based on the assumption that, if people incur costs to avoid damages caused by lost ecosystem services, or to replace the services of ecosystems, then those services must be worth at least what people paid to replace them. This assumption may or may not be true.  However, in some cases it may be reasonable to make such assumptions, and measures of damage cost avoided or replacement cost are generally much easier to estimate than people’s willingness to pay for certain ecosystem services.  The methods are most appropriately applied in cases where damage avoidance or replacement expenditures have actually been, or will actually be, made.
 

Applying the Damage Cost Avoided, Replacement Cost, and Substitute Cost Methods 

These methods require the same initial step—assessing the environmental service(s) provided.  This involves specifying the relevant service(s), how they are provided, to whom they are provided, and the level(s) provided.  For example, in the case of flood protection, this would involve predictions of flooding occurrences and their levels, as well as the potential impacts on property.

The second step for the damage cost avoided method is to estimate the potential physical damage to property, either annually or over some discrete time period. The final step for the damage cost avoided method is to calculate either the dollar value of potential property damage, or the amount that people spend to avoid such damage.

The second step for the replacement or substitute cost method is to identify the least costly alternative means of providing the service(s).  The third step is to calculate the cost of the substitute or replacement service(s).  Finally, public demand for this alternative must be established.  This requires gathering evidence that the public would be willing to accept the substitute or replacement service(s) in place of the ecosystem service(s).
 

Advantages of the Damage Cost Avoided, Replacement Cost, and Substitute Cost Methods 

  • The methods may provide a rough indicator of economic value, subject to data constraints and the degree of similarity or substitutability between related goods.
  • It is easier to measure the costs of producing benefits than the benefits themselves, when goods, services, and benefits are non-marketed.  Thus, these approaches are less data- and resource-intensive.
  • Data or resource limitations may rule out valuation methods that estimate willingness to pay.
  • The methods provide surrogate measures of value that are as consistent as possible with the economic concept of use value, for services which may be difficult to value by other means.

Issues and Limitations

  • These approaches assume that expenditures to repair damages or to replace ecosystem services are valid measures of the benefits provided.  However, costs are usually not an accurate measure of benefits.
  • These methods do not consider social preferences for ecosystem services, or individuals’ behavior in the absence of those services.  Thus, they should be used as a last resort to value ecosystem services. 
  • The methods may be inconsistent because few environmental actions and regulations are based solely on benefit-cost comparisons, particularly at the national level.  Therefore, the cost of a protective action may actually exceed the benefits to society.  It is also likely that the cost of actions already taken to protect an ecological resource will underestimate the benefits of a new action to improve or protect the resource.
  • The replacement cost method requires information on the degree of substitution between the market good and the natural resource. Few environmental resources have such direct or indirect substitutes.  Substitute goods are unlikely to provide the same types of benefits as the natural resource, e.g., stocked salmon may not be valued as highly by anglers as wild salmon.
  • The goods or services being replaced probably represent only a portion of the full range of services provided by the natural resource.  Thus, the benefits of an action to protect or restore the ecological resource would be understated.
  • These approaches should be used only after a project has been implemented or if society has demonstrated their willingness-to-pay for the project in some other way (e.g., approved spending for the project).  Otherwise there is no indication that the value of the good or service provided by the ecological resource to the affected community greater than the estimated cost of the project.
  • Just because an ecosystem service is eliminated is no guarantee that the public would be willing to pay for the identified least cost alternative merely because it would supply the same benefit level as that service. Without evidence that the public would demand the alternative, this methodology is not an economically appropriate estimator of ecosystem service value.

 
 
     
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