Contingent Valuation Method

Definition of Contingent Valuation Methods (CVM):

A Stated Preference Approach technique for valuing ecosystems or environmental resources that elicits expressions of value from respondents for specified increases or decreases in the quantity or quality of an environmental good or service, under the hypothetical situation that it would be available for purchase or sale. This yields their willing to pay (WTP) for the quality of quality of the good or service under question, or willingness to accept compensation (WTA) for its loss. Because the elicited WTP values are contingent upon the market described to the respondents, this approach came to be called the contingent valuation method.

This is the common definition for Contingent Valuation Methods (CVM), other definitions can be discussed in the article

Introduction

The CVM should be modelled after a political market, notably in a referendum format. In other words, respondents should be asked how they would vote (favour or against) upon a described marine environmental protection program, taking into account that its approval would imply the payment of a tax. For each if the protection program refers to the introduction of a ballast water treatment complex in European harbours one could model the WTP question as follows: “If the total tax amount to be paid for the water treatment complex was 30 Euro per year for the next 2 years, and thus keeping European coast free from exotic algae and the beaches free from algae foams, how would you vote on the introduction this tax?” Bearing in mind the answer of the respondents to this question and the use of appropriated econometric tools, economists are able assess the individual demand for environmental quality and thus quantify in monetary terms the underlying welfare changes. The typical CVM survey consists of three sections.

The first section is characterized by the description of the environmental change as conveyed by the policy formulation and the description of the contingent market. The policy formulation involves describing the availability (or quality) of the environmental commodity in both the ‘reference state’ (usually the status quo) and ‘target state’ (usually depicting the policy action). Since all monetary transactions occur in a social context, it is also crucial to define the contingent market - most of the time rather unfamiliar to the respondents - by stating to the respondent both the rules specifying the conditions that would lead to policy implementation as well the payment to be exacted from the respondent’s household in the event of policy implementation.

The second section is where the respondent is asked to state her monetary valuation for the described policy formulation. This part is the core of the questionnaire. The major objective of this section is to obtain a monetary measure of the maximum Willingness to Pay that the individual consumers are willing to pay for the described environmental policy action.

The third section of the CVM instrument is a set of questions that collect socio-demographic information about the respondents. The answers to these questions help to better characterise the respondent’s profile and are used to understand the respondent’s stated WTP responses. The third section finishes with follow-up questions. The follow-up questions are answered by the interviewers. The goal is to assess whether the respondents have (well) understood the CVM survey in general, and the valuation question in particular see A brief history of contingent valuation for more details on the practice of this method.

Today, the CVM is one of the most used techniques for valuation of environmental benefits, widely used by academic institutions as well as by governmental agencies as a crucial tool in cost-benefit analysis and damage cost assessment (see NOAA Panel for more technical details on how to construct an efficient survey). This is partly due to the advantages of CVM compared to other valuation methods. First, the CVM method gives immediately a monetary assessment of respondents’ preferences. Second, the CVM method is the only valuation technique that is capable of shedding light on the monetary valuation of the non-use values, i.e., the benefit value component of the environmental commodity that is not directly associated with its direct use or consumption. These values are characterized by having no behavioural market trace. Therefore, economists cannot glean information about these values relying on market-based valuation approaches. For environmental resources such as the protection of natural parks or biodiversity sensitive areas, which play an important role in guaranteeing the protection of local wildlife diversity, the non-use value component may account for the major part of the conservation benefits. Ignoring such values will be responsible for a systematic bias in the estimation (an underestimation) of the total economic value of the related environment. Third, CVM brings with it the advantage that environmental quality changes may be valued even if they have not yet occurred (ex ante valuation). This implies that the CVM can be a useful advisory tool for policy decision-making. Furthermore, the constructed nature of the CVM method permits to value environmental changes even if they have not yet occurred. Therefore, CVM offers a greater potential scope and flexibility than the revealed preference methods since it is possible to specify different states of nature (policy scenarios) that may even lie outside the current institutional arrangements or levels of provision.

A brief history of contingent valuation

The first CVM published reference dates from 1947. We refer to the Ciriacy-Wantrup^[1] article published in the Journal of Farms Economics. The study focuses on the valuation of the economic effects of preventing soil erosion. The author suggested that one way to obtain information on the demand for these favourable effects would be to ask directly the individuals how much they would be willing to pay for successive increments. However, no empirical valuation was attempted. However, the first CVM design and implementation only occurred two decades later when Robert Davis assessed the economic value of the recreational possibilities of the Maine Woods by exploring the survey technique (Davis 1963^[2]). Davis simulated a market behaviour situation by putting the interviewer in the “position of a seller who elicits the highest possible bid from the users of the services being offered”.

Since these early beginnings, the CVM has been used to measure benefits of a wide range of environmental goods including recreation, amenity value, scenery, forests, wetlands, wildlife, air and water quality. More recently, there has been a trend to conduct CVM studies not only to value environmental goods, but also to investigate the various methodological issues involved in the valuation exercise, including the study of the impact of consumer’s attitudes, motivations on CVM estimates. Furthermore, throughout these decades, the CVM has gone through several phases, emerging from the academy into the rough and tumble of the outside world. Strong development stimulus was given by the Reagan Executive Order 12291, introduced in 1981; the re-interpretation of CERCLA, in 1989; the Exxon Valdez damage assessment, in 1992, and, more recently, the NOAA panel^[3].

The Reagan Executive Order

The Reagan Executive Order 12291, introduced in 1981, constitutes a strong stimulus for the development of the monetary valuation methods of environmental commodities. In concrete terms, the Executive Order stipulated that all federal regulations on environmental policy should be submitted to a cost-benefit analysis. All regulations, including both the promulgation of new regulations and the review of the existing ones, would only be carried out if a positive present value for the society could be achieved. Therefore, the social benefits had to be monetized. The flexibility and generality of CVM’s application was the main reason why this valuation method received most of the EPA’s “demands” in the monetary assessment of the social costs and benefits associated with the new regulations on environmental policy. Thus, the appearance of Executive Order 12291 had a major impact in the development of the CVM. Furthermore, the District of Columbia Court of Appeals re-interpretation in 1989 of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (USDI 1989) expressed not only the legitimacy of non-use values as a component of the total resource value, but also granted equal standing to stated and revealed preferences evaluation techniques. Such a governmental decision was responsible for the expansion of the CVM beyond the academic world, now fully recognized as a fair, conventional method to shed light on the economic value of environmental quality, corner stone of an efficient, well accepted policy design.

Exxon Valdez oil spill

Another important benchmark in the history of the CVM is the massive oil spill due to the grounding of the oil tanker Exxon Valdez in the Prince William Sound in the Northern part of the Gulf of Alaska on March 24, 1989. This oil spill was the largest oil spill from a tanker in US history: more than 1,300 kilometres of coastline were affected and almost 23,000 birds were killed. After the oil spill, the State of Alaska commissioned various studies to identify the physical damage to the natural resources. The follow-up economic damage assessment studies also take into account, in addition to water purification costs, economic losses such as the decrease in revenue from recreation and fisheries. Moreover, the State of Alaska appointed an interdisciplinary group of researchers to design and implement a national CVM study to measure the loss of non - use values to US citizens as a result of the oil spill. This study was coordinated by Richard Carson and constitutes one of the major contingent valuation applications and represents an important methodological reference for all contingent valuation researchers' work. The loss of non - use values resulting from the Exxon Valdez oil spill was estimated at 2,8 billion dollars.

However, and anticipating these high financial consequences, Exxon commissioned a group of researchers to verify whether non - use values could be accurately measured by means of CVM. The main argument of critics of CVM is that this method is not capable of resulting in valid and reliable monetary measures of non-use values. Hausman’s well-know argument “is some number better than no number”^[4] fully expresses the scepticism toward the CVM method. Therefore, according to Hausman, assessments of lost non-use values by means of the CVM method should not be used in court. In order to address Hausman’s critique, the National Oceanic and Atmospheric Administration set a group of experts in order to evaluate the reliability of the use of CVM in the natural resource damage assessments.

The National Oceanic and Atmospheric Administration Panel

A panel of experts, with the Nobel Laureates Kenneth Arrow and Robert Solow as chairmen, provided advice to the National Oceanic and Atmospheric Administration, (NOAA) on the following question: “is the contingent valuation method capable of providing estimates of lost non - use or existence values that are reliable enough to be used in the natural resource damage assessments?” The final advice of the NOAA panel may be summarised by the following sentence:

"... the Panel concludes that well conducted CVM studies can produce estimates reliable enough to be the starting point of a judicial process of damage assessment, including lost passive values." ^[5]

This conclusion cheered all researchers who wish to use the contingent valuation. However, the Panel was rather prudent with its conclusion and qualified such a statement by establishing a set of guidelines, recommended to all future CVM applications, concerning the design and execution of the survey instrument. The six most important guidelines, also well known as the six pillars of the NOAA, are summarised as follows:

CVM should rely on face-to-face interviews rather than telephone interviews, and whenever this is not possible (specially because of the high costs associated with the personal interviews) telephone interviews are preferable to mail surveys;
CVM should elicit the respondent’s WTP to prevent a future incident rather than WTA (Willingness to Accept) for an incident already occurred;
CVM should use a dichotomous choice referendum elicitation format, i.e., the respondents should be asked how they would vote (favour or against) upon a described environmental quality change. The main reason for the dichotomous choice is that such a take-it-or-leave-it survey valuation question is more likely to reflect real daily world market decisions which individuals are confronted with. Moreover, the dichotomous choice referendum reveals itself to be less vulnerable to strategic bidding behaviour than, for example, the open ended elicitation format;
CVM should contain an accurate and understandable description of the program or policy under consideration and the associated environmental benefits in each of the two scenarios, i.e., with and without the policy. Interdisciplinary work with other research areas, namely the biological sciences, is recommended;
CVM should include reminders of the substitutes for the commodity in question as well as its budget. In a context where the respondents are being asked how they would vote on a financial contribution to protect a natural area, the respondents should be reminded of the existence of the other areas that exist. Moreover the respondent should be reminded that such contribution would reduce the amount of money that he or she has available to spend on other things. The major idea here is to make such a (hypothetical) valuation exercise resemble as closely as possible an actual market transaction;
CVM experiments should include a follow-up section at the end of the questionnaire to be sure if the respondents understood (or not) the choice that they were asked to make.

References

↑ Ciriacy-Wantrup (1947) “Capital Returns from Soil Conservation Practices”, Journal of Farms Economics, 29, 1180-1190.
↑ DAVIS, Robert K. (1963)"The Value of Outdoor Recreation: An Economic Study of the Maine Woods" Ph.D. dissertation. Harvard University
↑ NOAA – National Oceanic and Atmospheric Administration (1993) “Report of the NOAA Panel on Contingent Valuation”, Federal Register, Vol 58, no. 10, US, 4601-4614.
↑ Diamon, P.A.; Hausman, J.A. (1994) Contingent Valuation: Is Some Number better than No Number? The Journal of Economic Perspectives, Vol. 8, No. 4. (Autumn, 1994), pp. 45-64.
↑ NOAA, Federal Register, Vol. 58, No. 10, page 4610

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