Conservation Reconsidered, The Economics of Natural Environments, and Our Understanding of Environmental Preferences

Nicholas FloresDepartment of Economics

University of Colorado, Boulder

April 28, 2002

Prepared in Honor of RFF at 50 Years

1I am also cognizant of the fact that many readers may never have read this work or that it has been a long time since.

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1. Introduction

This paper is written in honor of the 50th Anniversary of Resources For the Future. In the paper,

I discuss work from the Natural Environments Program at Resources for the Future and its impact on

how economists view economic preferences for the environment. Of this work, I focus on two highly

influential publications, Conservation Reconsidered, Krutilla (1967), and The Economics of Natural

Environments, Krutilla and Fisher (1975). While the powerful ideas presented in Conservation

Reconsidered and The Economics of Natural Environments certainly represent the intellectual core for

the Natural Environments Program at Resources for the Future beginning in the mid 1960's, the ideas

transcend this program and continue to deeply influence today’s intellectual core for the field of

environmental economics. This work was instrumental in setting much of the environmental economics

research agenda for the past thirty-five years, a feat worthy of celebration.

Conservation Reconsidered and The Economics of Natural Environments contain many distinct

ideas, concepts, and illustrative examples that proved instrumental in shaping economic thinking about

environmental preferences and the practice of economic analysis. One approach to considering the

impact of this work would be to take each concept separately. However these ideas combine in a very

special way. Taken together, the ideas put forth by the authors advocate a new approach to the economic

analysis of environmental problems. In hoping to retain some of this spirit, I first provide a fairly

unadulterated overview of Conservation Reconsidered in Section 2 and The Economics of Natural

Environments in Section 3.1 In Section 4, I discuss the theoretical and conceptual work that followed

directly from these ideas while in Section 5, I discuss issues of benefit measurement. Finally in Section

5, I offer some comments on contemporary research topics that also follow from the ideas of

Conservation Reconsidered and The Economics of Natural Environments.

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2. Challenging Conventional Thinking: Conservation Reconsidered

In 1967, preserved natural environments were essentially worthless according to conventional

economic analysis. In his highly influential book Water-Resource Development: The Economics of

Project Evaluation, Eckstein (1958) states [pg. 41], “recreation must be judged on other criteria, for the

use of benefit-cost analysis for them not only is invalid, but casts general doubt and suspicion on

procedures which can effectively serve a high purpose where they are appropriate.” The service flows

provided by the natural world were relegated to the category of intangibles and simply did not play a

meaningful role in economic analysis.

Against this backdrop, vast tracts of public lands and natural rivers managed by Federal agencies

such as the U.S. Forest Service and the Bureau of Land Management were designated for multiple uses.

These uses included mineral, oil, and natural gas extraction; hydroelectric power development of rivers;

a host of recreational activities; and habitat for plants, animals, fish etc. Often, development for

extractive uses or hydroelectric power was clearly incompatible with other uses. Extractive development

often resulted in the complete elimination of recreational opportunities, destruction of viable wildlife

habitat, significant and negative visual impacts. Conventional economic benefit-cost analysis, when

properly applied, could screen out projects that were financially unsound. However conventional

analysis, by the zero value assumption for service flows from the preserved environment, could not

weigh in on the decision of whether the benefits of financially sound extractive development exceed the

forgone opportunity cost of the flows resulting from a preserved environment. Thus for truly difficult

decisions between incompatible and competing uses, economics was effectively irrelevant. Conservation

Reconsidered challenges conventional thinking of its time by providing economic reasoning why this

situation should be corrected if economics is to aid in the resolution of these problems. The ideas used

in arguing against conventional practice were instrumental in helping economists define the very

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meaning of preferences for the environment.

2.1. Asymmetric Technical Change and Irreversible Development of Unique Areas

Technical change and irreversible development figure prominently in Conservation

Reconsidered. Krutilla calls on the work of Barnett and Morse (1963) who analyze historical resource

trends and find declining real prices for exhaustible natural resources. According to Barnett and Morse,

declining prices are the result of technological progress sufficient to compensate for the depletion of

higher quality resource stocks. Krutilla reasons that while technology continues to lessen dependence

on the resources extracted in the development of natural areas, it is not capable of reproducing these

natural areas once destroyed or altered by development. In this sense, technical change is asymmetric

while development is irreversible.

Krutilla then asks the reader to consider a unique area, such as the Grand Canyon, when thinking

about irreversible development. The Grand Canyon is an excellent example of a resource that is truly

unique, has few viable substitutes, and for which it is easy to imagine that development for some use

such as hydroelectric power production will be, for practical purposes, irreversible. While uniqueness

certainly helps drive home the ideas, Krutilla notes [fn. 5], “Uniqueness need not be absolute for the

following arguments to hold. It may be, like Dupuit’s bridge, a good with no adequate substitutes in the

“natural” market area of its principal clientele, while possibly being replicated in other market areas to

which the clientele in question has no access for all practical purposes.” The discussion of asymmetric

technical change and irreversible development of a relatively unique area set the stage for reasoning that

development benefits over time are likely to be falling relative to the benefits of preservation.

2.2. Static Considerations: Option Demand and Existence Value

The reasoning for rethinking the approach to conservation provided in Conservation

Reconsidered draws both on static and dynamic considerations. From a static perspective, Krutilla

2Consumer surplus is a measure of the benefits of consuming a particular good. Mathematically this measure canbe represented as the area beneath the demand curve for the good and above the price. By the time of ConservationReconsidered, consumer surplus usually referred to the area underneath a compensated demand curve, the type of demandassociated with the consumer problem of minimizing expenditure subject to a specified level of utility.

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argues that conventional economic analysis overlooks the values associated with potentially large

segments of the population affected by the decision over whether or not to preserve a natural

environment. To begin, natural environments are extremely important to many people and in fact present

a form of endowment or income. To take away some natural wonder may not be captured by [pg. 779]

“a comparison of the total area under the demand curve on one hand and market receipts on the other.”

To emphasize this point, Krutilla introduces the [fn. 7] “spiritual descendants of John Muir” as one group

for whom natural environments occupy a special place in the hierarchy of endowments. For these

spiritual descendants of Muir, transformation from a natural state to a developed state may result in what

amounts to a considerable loss of endowment which would not be captured through demand analysis.

As another means of arguing for a different analytical perspective of preservation, Krutilla calls

on notion of option demand. In his 1964 paper in the Quarterly Journal of Economics, Weisbrod (1964)

provides several examples in which current non-users may be willing to pay for the option of using the

service when demand is uncertain. Weisbrod’s examples include the option of visiting Sequoia National

Forest, the option to go to the hospital, and the option to use public transportation. Thus even though

someone may not be a user, they may still value the service and most importantly this value will not be

reflected through current consumer surplus.2

In relation to preservation of natural environments, Kruitlla notes that option demand is one

reason why people may value the preservation of a natural environment and raises several instances when

this is likely to matter. First, he brings up the need to preserve genetic diversity for those times when

society may need genetic material that is lost in domesticated strains. The demand for earlier, more

primal, genetic material is uncertain, but will only be available if some of the genetic stock is preserved.

3It is also worth noting that recreation is not mentioned whatsoever in relation to option demand.

4This is the classic coordination problem that derails bargaining solutions such as those presented in Coase (1960).

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Second, he notes that many botanical species used for medicinal purposes may potentially yield useful

compounds even though their usefulness is not yet recognized. Again we have uncertain but potentially

highly-valued demand. Third, he raises the possibility that option demand may have a sentimental basis

and in turn [pg. 781] “persons who obtain satisfaction from mere knowledge that part of wilderness North

American remains even though they would be appalled by the prospect of being exposed to it.” It is

important to note that these examples are new types of option demand. Weisbrod’s examples deal with

goods for which some people currently use the resource. For the Conservation Reconsidered examples

of option demand, there are no current demands to observe.3

In winding up the discussion of static considerations, Krutilla poses the question, “If a genuine

value for retaining an option in these respects exists, why has not a market developed?” In response to

this question Krutilla provides several reasons why market solutions such as the Nature Conservancy are

imperfect. First with regards to scientific research, the risks to a single investor are very high. Second,

the returns to those individuals who take on this risk may not be fully appropriable. Finally, preservation

of truly unique natural landscapes, scenic wonders, and endangered species often involves large tracts

of lands and represents a significant public goods problem involving geographically dispersed

individuals.4 Before turning to a discussion of dynamic considerations, it is worth noting that the

concerns raised under static considerations also occur across time. Conservation Reconsidered appears

to classify these particular issues as static because they are important in the current period, regardless of

how relative values for preservation and development change over time.

2.3. Dynamic Considerations: Learning-by-doing

With regard to dynamic considerations, Conservation Reconsidered draws on a quote from

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Davidson et al. (1966) in which they note that demand for water-based recreation depends upon the

availability of facilities. Once facilities are in place, demand increases over time as people partake in

learning-by-doing. Conservation Reconsidered raises this same issue in relation to the preservation of

natural areas. A generation of car campers begets a generation of backpackers. A generation of

backpackers begets a generation interested in more primitive recreation. This line of reasoning paints

a picture of increasing and changing demands. In particular, over time the demand for natural landscapes

in aggregate continues to increase. The most important message implicit in this reasoning is that today’s

demand may be a very poor predictor of tomorrow’s demand. If one finds this reasoning compelling,

then conventional analysis in its most advanced form in 1967 was far off of the mark even when the static

considerations raised above were not operable. Looking forward Krutilla notes [pg. 782] “[t]hese are

important considerations for research, results of which will have significant policy implications.”

2.4. Dynamic Considerations: Bequest

In order to extend dynamic considerations in a more comprehensive fashion than simply

considering recreation demand, Conservation Reconsiders returns to asymmetric technological change.

Technology is diminishing our reliance on the natural resource base and when properly applied,

facilitates extraction with much less environmental impact. Overall we can inexpensively substitute away

from disrupting natural areas that may be highly valued for the reasons outlined above, recreation,

scientific research, etc. In contrast [pg. 783], “[i]t is improbable that technology will advance to the point

at which the grand geomorphic wonders could be replicated, or extinct species resurrected.” As

technology advances and demand for preserved natural environments increases, we have a fundamental

asymmetry that has significant implications. In particular, “[n]atural environments will represent

irreplaceable assets of appreciating value with the passage of time” [p. 783]. According to Krutilla,

technological advances and increasing demand for preserved natural environments work in the same

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direction with regard to preservation. The static implication of these dynamic considerations is that

preserved natural environments should be considered a high-yield asset to leave for future generations.

If people concerned with bequests for future generations want to maximize value, then [pg. 784] “the

appropriate mix of opportunities to enjoy amenities experienced directly from association with the natural

environment along with readily producible goods.” Thus if we care about future generations, our

children, their children etc., then we, who decide how much of the natural environment is preserved

today for tomorrow, should consider leaving behind some of this irreplaceable and appreciating asset.

2.5. Implications for Economic Analysis

With regard to the general implications for economic analysis, Conservation Reconsidered

describes the problem as follows [pg. 785].

Accordingly, our problem is akin to the dynamic programing problemwhich requires a present action (which may violate conventional benefit-cost criteria) to be compatible with the attainment of future states ofaffairs. But we know little about the value that the instrumentalvariables may take. We have virtually no knowledge about the possiblemagnitude of option demand. And we still have much to learn about thedeterminants of the growth in demand for outdoor recreation and thequalitative significance of the asymmetry in the implications oftechnological advances for producing industrial goods on the one handand natural environments on the other. Obviously, a great deal ofresearch in these areas is necessary before we can hope to apply formaldecision criteria comparable to current benefit-cost criteria.

Conservation Reconsidered suggests several ways that in 1967, benefit-cost analysis of decisions

involving the preservation or development of natural environments was well off of the mark. The

prescriptions offered for remedy are limited to pursing research to better understand the issues raised in

the paper and to adopt a conservative approach to decisions that involve conservation.

3. Further Development and Application: The Economics of Natural Environments

Conservation Reconsidered provides the conceptual reasoning for the need to rethink economic

preferences for the preservation of natural areas. Furthermore, Conservation Reconsidered identifies key

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issues that form a blueprint for the Natural Environments Program. All of this is accomplished without

a single equation or model. Though rich in economic reasoning, concepts and research issues,

Conservation Reconsidered provides little analytical detail or concrete examples. The Economics of

Natural Environments was first published in 1975, eight years after Conservation Reconsidered and

offers refinement and extension of many of the concepts as well as examples. As the authors admit in

the preface, the “work represents a “first generation” effort to incorporate the noncommercial, or

amenity, resources of natural environments into the body of economic theory and application.” These

extensions and examples draw on the substantial work of many members associated with the Natural

Environments Program and in this sense represents a progress report on the Program’s research agenda.

3.1. Conceptual and Theoretical Refinements

The first half of The Economics of Natural Environments provides analytical detail that was

lacking in Conservation Reconsidered. First, the book addresses the issues of externalities, property

rights, and valuation of resources on public lands. An important distinction is made between private

property resources and common property resources. The uses of public lands can take on varying

degrees of privateness and publicness. At one extreme, mineral extraction associated with patented

claims on public lands are clearly private property resources. At the other extreme we have non-use

considerations of in the form of option demand associated that are clearly common property resources.

In between we have recreation which can be considered a private property resource if access is strictly

regulated or a common property resource with all of its associated problems, Scott (1955),when open

access is allowed. Given the continuum of private property resources to common property resources

associated with public lands, the authors chose a conceptual/theoretical model of externalities over a

classic model of public goods. Drawing on work by Cicchetti and Smith (1970), the authors present a

model of jointness in supply that handles these goods which span the private to common property

5Recall the endowment issue raised in Conservation Reconsidered and the example of the spiritual descendants ofJohn Muir.

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continuum. Two distinct types of externalities are identified, those occurring between groups such as

between mineral extractors/recreationists and those occurring withing groups such as congestion

externalities between recreationists. While externalities between groups are implicit in Conservation

Reconsidered, congestion externalities between recreationists are not.

The authors provide detailed reasoning against the relevance of the bargaining model of

environmental valuation, Coase (1960). In particular, they note that endowment effects may be

significant on account of the fact that the benefits from a preserved natural environment may constitute

a significant portion of income for the recreationist or conservationists.5 Furthermore, the potentially

large numbers of recreationists/conservationists would violate the conditions of negligible transaction

costs necessary for Coase’s bargaining model to apply. Citing the work of Mishan (1971) and Page

(1973), the authors advocate assigning property rights to the constructive (preservation) use as opposed

to the destructive use (development).

With regard to irreversibility, the authors provide two models. The authors first present a

dynamic programming model in which the objective is to maximize the present value integral of

development benefits and preservation benefits in the choice of the control variable, development

investment. Development benefits are increasing and concave in the scale of development while

preservation benefits are decreasing and convex in the scale of development. Development investment

equals the instantaneous change in the scale of the development; development is subject to an

irreversibility constraint. In addition to depending on the scale of development, the benefit functions

themselves change with time. This feature captures the change in relative benefits associated with

asymmetric technical change reducing dependency on natural resource products and increasing scarcity

of preserved areas. Thus it is assumed that development benefits are decreasing at an exponential rate

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over time while preservation benefits are increasing over time. The overall result of this model is that

given irreversible development, it may be optimal to initially incur negative benefits by not developing

in exchange for the relatively higher preservation benefits that will accrue later. Of course merely

focusing on the initial period’s benefits and costs without consideration of the relative dynamics of the

system will miss this optimal choice.

The second model of irreversibility is a two-period model from Arrow and Fisher (1974) in

which development or preservation is an option in the first period. The benefits of development and the

benefits of preservation for the first period are known with certainty while the benefits of development

and the benefits of preservation for the second period are uncertain but the distribution of the uncertainty

is known. The weighting of the benefit functions are linear, reflecting risk neutral preferences for

benefits. If complete development is not undertaken in the first period, including preservation, additional

development can be undertaken in the second period. The key to this model is the fact that in the second

period, the uncertainty is resolved in time to make a completely informed second period development

decision. If this second period uncertainty were not resolved, then we would have the standard problem

of choosing development based on today’s relative benefits and our expectations of tomorrow’s relative

benefits which is essentially a one-time decision. Instead we have the option of waiting for more

information. There are two main implications of this model. First, the expected value of this model is

greater than the expected value when the second period option is unavailable. Hence we have a “quasi-

option value” associated with this option. Second, according to Arrow and Fisher (1974) [p. 317], “if

we are uncertain about the pay-off to investment in development, we should err on the side of under

investment, rather than overinvestment, since development is irreversible.” This result is significant

because the “option value” associated with option demand, defined as the difference between what an

uncertain demander would pay to retain the option of using the resource and the expected consumer

6The authors define the discount rate as where the discount factor is given by using a continuous time model.

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surplus of use, is positive or negative depending on risk aversion, Cicchetti and Freeman (1971). Risk

aversion is a sufficient condition for option value to be positive. The Arrow and Fisher result implies

a positive “quasi-option” value, even under risk neutrality. Krutilla and Fisher’s primary conclusion

regarding quasi-option value is that a more conservative approach, thinking beyond exclusive

consideration of today’s expectation of benefits and costs, should adopted in situations when additional

information about relative benefits is forthcoming in the future and development is irreversible.

In addition to these two models of irreversible development, the authors provide commentary on

the appropriate choice of discount rate for present value calculations. They conclude that a single

discount rate should be applied to benefits of preservation as well as benefits of development.6 Though

they leave open the door to applying a lower discount rate that falls below the market rate of interest,

they essentially come down in favor of conducting sensitivity analysis in the choice of discount rate.

3.2. Illustrative Analyses

The Economics of Natural Environments provides five illustrative analyses demonstrating the

implications of incorporating the benefits from preservation alternatives. The first analysis considers

two alternative hydroelectric generation projects proposed for the Hells Canyon reach of the Snake River,

the High Mountain Sheep project and the Low Mountain Sheep-Pleasant Valley Complex project. The

authors argue that Hells Canyon qualifies as a truly unique resource for which few viable substitutes

exist. Either hydroelectric development project would significantly alter the environment and would

essentially be irreversible.

The analysis first considers the economic benefits of the projects without any regard to

environmental costs and then develops estimates of recreation values associated with preservation.

Technological progress and increasing recreation benefits are central to the analysis. Technological

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progress is inferred from the energy literature while recreation benefits are inferred from recent trends

in recreational demand for the area as well as population growth. Without any regard to environmental

costs associated with forgone recreation, the analysis finds negative net present value for the Low

Mountain Sheep-Pleasant Valley Complex and positive net present value for the High Mountain Sheep

project. Based on the positive net present value estimate for the High Mountain Sheep project, the

analysis then derives the amount of initial year’s benefit that would result in the same net present value

benefits as the High Mountain Sheep project subject to an assumed benefit growth rate. From the

inferred initial year’s benefit, the analysis then centers around the question of whether this current year’s

benefits can be justified? Using modest estimates of the value of visitor days, the authors conclude that

an economic case can be made for preserving Hells Canyon as opposed to moving forward with the High

Mountain Sheep Project. The conclusion rests on the temporally declining development benefits and

temporally increasing recreation benefits.

The second illustrative analysis presented in The Economics of Natural Environments deals with

the decision of whether to develop an area in Idaho adjacent to the White Cloud Peaks for molybdenum

mining. The White Cloud Peaks form a self-contained pocket mountain range which distinguishes the

peaks from surrounding mountains. The area surrounding the White Cloud Peaks supports a remarkable

variety of large animals as well as a highly productive fishery. Additionally, the area provides rangeland

for wildlife and livestock. Overall, the area offers the potential for mining, recreation, and rangeland,

all of which are considered in the analysis. With regard to recreation, the study considers different levels

of recreational facilities development and associated demand given development. Using results from

Cicchetti and Smith (1973), the analysis infers benefit estimates of recreation. With regard to livestock

grazing, the study analyzes the benefits of improved range management. Finally the analysis provides

a discussion of the price of molybdenum and concludes that given the current excess capacity in

7For this analysis, The Economics of Natural Environments cites an early version of Cicchetti et al. (1976) that waspresented at the Econometric Society Meetings in Toronto, 1972.

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molybdenum mining, mineral resource development in the area is not warranted. Though the analysis

is very preliminary, it presents a comprehensive analysis that considers multiple estimates of services

associated with preservation.

The third analysis presented in The Economics of Natural Environments, involves prospective

development of a natural area in the Mineral King Valley of California as a ski area.7 The analysis

estimates aggregate demand for ski trips in California and then develops consumer surplus estimates for

the proposed ski area in Mineral King Valley. The analysis uses an assumption of perfect substitutability

between the proposed ski area and an existing ski area. The proposed ski area thus differs only by price.

Though these estimates are static in nature, the analysis represents a state-of-the-art analysis of current

benefits of a Mineral King Valley ski area.

The fourth analysis summarizes work of Brown and Hammack (1972) who employ an optimal

control approach in determining the number of ponds and the amount of waterfowl bagged in an area that

would maximize the net present value of duck hunting. The net value of duck hunting is the value of

hunting less the cost of providing ponds. The relationship between the value of hunting and the amount

of waterfowl bagged is estimated through a contingent valuation survey of hunters that asks them for

their maximum willingness to pay to hunt based on varying bag rates. The analysis assumes that ponds

are reproducible and so irreversibility is not an issue; demand does not change over time. Though the

study does not involve the irreversibility/uniqueness issues or relatively changing values raised in

Conservation Reconsidered, it does represent a detailed analysis of preservation issue by specifically

linking preservation to utility.

The fifth and final analysis presented in The Economics of Natural Areas considers the economic

benefits of delivering Alaskan North Slope oil to market by alternative routes. The primary proposal was

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to build a Trans-Alaska pipeline from the Prudhoe Bay on Alaska’s North Slope to Valdez, Alaska and

then by ship oil out of Prince William Sound. Environmental objections to this first alternative included

the disruption sensitive areas by extraction activities, construction of the pipeline across almost 400 miles

of sensitive permafrost, and shipping of oil out of Prince William Sound which creates risks from oil

spills ship waste in the area. Another alternative believed to be less environmentally damaging was to

build a pipeline across Canada going through Edmonton and then onto Chicago. The analysis does not

specifically address the environmental costs of the proposals, though there are significant differences in

anticipated environmental damage. The highlights of the analysis are the careful consideration of the

alternatives’ relative capital outlays and relative market considerations that result from oil being

delivered into different markets. The conclusion of the analysis is that given that North Slope oil

production, the Trans-Alaska pipeline was inferior to the alternative based on market-based economic

considerations.

3.3. A Call to Action: Five Main Themes

Before moving onto specific work avenues of research inspired by the ideas in Conservation

Reconsidered and The Economics of Natural Environments, I want to reflect on the main themes of

which I find five. First, the work strongly argues that benefits of non-development alternatives need to

be considered in benefit-cost analysis. This stands in stark contrast to conventional analysis of the time.

To this end, the illustrative examples provided in The Economics of Natural Environments attempt to

incorporate non-development benefits for many different alternative uses. Second, economic analysis

needs to consider how benefits of development are likely to change relative to the benefits of

preservation. The illustrative examples that specifically address this second issue/principle do not

“assume” rates of change, rather they infer these rates of change from historical data. Third, irreversible

development of unique areas entails special considerations. In addition to stressing consideration of

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preservation benefits relative to development benefits, the authors advocate a “conservative” approach

that includes special designation of public lands as wilderness. Fourth, there may exist people who are

currently non-users, but hold option values or quasi-option values that may not be captured by standard

consumer surplus measures. In this regard it is important to recognize that all discussions of option value

in Conservation Reconsidered and The Economics of Natural Environments do not include recreation.

Fifth, preservation/development analysis needs to carefully consider the demand dynamic in relation to

the supply of preserved areas (with irreversibility considerations). Demand for preserved areas for

recreational use is likely to change due to increasing population and more importantly, learning-by-

doing. This change will result in more recreationists per capita and more recreationists seeking remote

wilderness experiences.

In advancing these ideas, Conservation Reconsidered and the Economics of Natural

Environments issued a challenge to the economics profession. Move economic thinking about

environmental preservation beyond the status quo. There are benefits associated with natural

environments and they have a rightful place in economic analysis if the analysis is going to be true to its

purpose. The rest of the paper explores the professional response to this challenge.

4. Conceptual and Theoretical Developments

Conservation Reconsidered and The Economics of Natural Environments make the case for the

need for economists to seriously consider the implications of incorporating preservation benefits into

economic analysis. The prospect of incorporating preservation benefits, and particularly the many

concepts advanced in Conservation Reconsidered and The Economics of Natural Environments, created

the need for a theoretical framework and subsequent refinement of these bold new ideas. These ideas

presented several theoretical challenges. First, the ideas were not explicitly grounded in a theoretical

model linking consumer utility to environmental preservation in a meaningful way. Second, though the

8The concept of recreational demand modeling through travel cost is typically traced back to an unpublished letterfrom Harold Hotelling to the Director of the National Park in 1947.

9In keeping with the times, I am referring to values associated with non-use as passive-use values. This terminologywas introduced in a 1989 U.S. Federal Court of Appeals decision in Ohio v. U.S. Department of Interior.

10Early examples of this model are Rothbarth (1941) for the theory of rationed private goods and Samuelson (1954)in his classic on the theory of public goods. This particular model is adapted from Carson et al. (1999).

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travel cost method had already been proposed by Hotelling8 and further developed by Clawson (1959),

a clearer link between differing levels of environmental quality needed to be established. Third, the

notion of passive-use values needed further development.9 A considerable amount of research effort has

been applied along these lines. I turn to these theoretical and conceptual issues in advance of my

discussion of the measurement because they frame many of the issues that were addressed in the

literature on developing techniques for measuring preservation values in general.

4.1. Basic Model of Environmental Valuation

The workhorse model of this area of research is a model of rationing in which policy goods such

as preserved areas and public goods are considered rationed.10 A consumer’s utility is defined

over a vector of market goods X and a vector of policy variables Q. The vector of policy variables

includes things such as environmental quality, state of preservation, etc. The vector X includes all goods

in the consumer’s choice set including things such as trips to use a park or natural area as well as other

market goods. The policy variables in Q are not in the consumer’s choice set and can be viewed as

rationed; the levels of policy variables are common across consumers. For example, preservation of an

area is a feature that is common across all consumers even if they face different travel costs to get to the

area or even if they do not have access to the area. The consumer faces a budget constraint requiring that

the purchase of market goods at the current vector of prices P be bounded above by income y, .

The optimal choice of X results in a vector of ordinary demand functions that depend on prices of market

goods, the policy variables, and income, . Utility evaluated at the optimal market

11I use the compensating variation to avoid the ambiguities associated with the terms willingness to pay andwillingness to accept.

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demands gives us an indirect utility function, that represents the maximum obtainable utility

given prices, policy variables, and income .

Now suppose we are considering a change in the policy variables from to . There are

two common ways of defining the value for this change, Kaldor (1939), Hicks (1939), and Hicks (1943).

The first measure of value is compensating variation which is an adjustment in income after the policy

change that exactly ensures utility under the new policy is matched with the initial utility level,

. If the change in policy variables is a change the consumer likes,

then compensating variation is positive and can be interpreted as willingness to pay for the new policy.

If the change in policy is something the consumer does not like, then the measure is negative and can be

interpreted as willingness to accept compensation for giving up the original, more preferred policy.11 A

second measure of value is equivalent variation which uses the post change utility as the reference utility.

Income adjustments are made under the initial policy that adjust utility exactly to utility obtained under

the new policy, . Compensating variation is subtracted from income

while equivalent variation is added which results in the measures being the same sign for the same

change, though they will typically be different in size. These same measures can be applied for general

changes in prices, policies, and income. For example and

.

The selection of welfare measure should depend upon the assumed property rights. For example

the property rights discussion in The Economics of Natural Environments suggests that if the policy

change is to develop a natural area, then the property rights should be assigned to the preserved state,

a constructive versus destructive approach. In this case, the new policy is less preferred to consumers

and the reference utility level is the utility provided by the preserved state under the initial policy. Hence

12If an income change from to accompanies the change in prices and policies, an income adjustment is added,.

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we would use compensating variation which could be interpreted as willingness to accept compensation

for the development of the area.

An expenditure function approach facilitates a more convenient , yet analytically equivalent way

to represent these welfare measures. The dual problem to utility maximization is to minimize the level

of expenditures, subject to a given level of utility where prices and policies are given. The optimal

choice of X results in the Hicksian or compensated demands which will depend on prices, policies, and

the level of utility, . The expenditure function is simply expenditures evaluated

at the optimal levels, which in turn represents the amount of income

necessary to exactly achieve utility level U facing prices P and policies Q. For a generic change in prices

and policies from to , compensating variation can be represented as a difference in

expenditures, where is

the level of utility obtained before the change occurs.12

Our primary problem in non-market valuation is to determine the compensating variation for a

policy change from to exclusive of any changes in prices or income. Using the expenditure

function representation, . Compensating variation is often

referred to as the “total value” measure for the policy.

4.2. Weak Complementarity and Non-Market Valuation

Suppose that our policy is simply a change in the first policy variable q1 and we wish to derive

the compensating variation measure. Using the expenditure function, the only argument that changes

is q1. is the vector left after removing the first element of Q.

20

Now consider the trick of adding and subtracting two different terms that allow us to introduce

an arbitrary price change along with this quantity change. Because I am adding and subtracting terms,

I have not changed the size of the welfare measure.

The second and fourth terms are the original terms while the other four terms taken together are

the “zero” terms. Note the way that I have arranged terms. The first line is the value of the price change

at the new level of q1. The second line is the negative of the value of the price change at the initial level

of q1. Finally the last line is the value of the change in q1 at the new price level.

Suppose that the Hicksian demand for market good one (x1)depends upon the level of q1 in a

marginally positive way, i.e. the Hicksian demand curve shifts out as q1 increases. Further suppose that

if consumption of this market good is zero, the marginal value for the change in q1 is zero. Maler (1974)

referred to this situation as weak complementarity. Now turning back to the way compensating variation

is written above, suppose that the change in price was from the original price level to the price that

chokes off demand for this weakly complementary good. I will designate this choke price as .

By definition, demand for our weakly complementary good is zero at . By weak

complementarity, the last line equals zero since if the good is not consumed the marginal value is zero

21

which implies the difference in expenditures is also zero. Now our compensating variation is simply the

change in total consumer surplus for the weakly complementary good. By Shepard’s lemma, the value

for a price change is simply the area under the Hicksian demand curve between the respective prices,

basic consumer surplus.

Weak complementarity is appealing since if satisfied, valuing the change in q1 can potentially

be accomplished by valuing the change in consumer surplus from the weakly complementary good.

Figure 1 graphically depicts compensating surplus for this weakly complementary good.

This result is extremely important because it establishes a clear link between demand and the

22

level of environmental quality. Weak complementarity also provides conditions that facilitate recovering

Hicksian demands, needed to derive compensating variation, from ordinary demand estimates. The

problem with this technique is that weak complementarity must be assumed and this assumption is

unverifiable. If the assumption is incorrect, the last line of the price/quantity decomposition is no longer

zero and so compensating variation will be under-estimated by the change in total consumer surplus

depicted in Figure 1.

4.3. Defining Passive-Use Value Via Price/Quantity Decomposition

Some authors, e.g. McConnell (1983) and Freeman (1993), use the price/quantity decomposition

as a way of defining passive use value. The changes in Hicksian consumer surplus represented by the

price change terms are considered use value while the last term is considered passive use value.

A problem with defining passive use value in this way is that the decomposition is not unique

since we could write out a decomposition for any good that has a Hicksian demand with a finite choke

price. Despite this potential problem, this decomposition has proved to be incredibly important in a

practical sense. Consider the problem for recreationists portrayed in Conservation Reconsidered in

which the policy is to develop an area which essentially eliminates the site. Though the decomposition

may still not be unique, the eliminated site is an obvious candidate. The first integral which measures

consumer surplus after the site is eliminated will equal zero since without the site there is no consumer

surplus. The measure will simply consist of current consumer surplus plus the value of the change in

23

policy at the choke price. According to the definition, we have an obvious measure of the loss of use

value plus a residual. The decomposition provides a measure that will under estimate total value in the

sense that for increases in q1, the use value component defined by this decomposition is positive and less

than total value (willingness to pay); for decreases the use value component defined is negative and

greater than total value (willingness to accept).

Bohm (1977) and Gallagher and Smith (1985) suggest defining passive-use values as the value

an individual holds for a change in policy given that access is denied. As Carson et al. (1999) point out,

this definition may be problematic since non-users may value preservation differently depending whether

or not access is denied. For example some current non-users may value preservation of an area for the

provision of habitat and would prefer no access to hikers while other non-users feel that preservation

should be on account of recreation for others. Access is basically a policy in an of itself and so defining

passive-use by access is not neutral.

4.4. Defining Passive Use Without Obvious Demand

For a recreational user of a natural area, there is hope of estimating some value through change

in consumer surplus from demand. However there may be hopeless cases such as the class of problems

that Freeman (1979) presents in which utility takes the form where is

increasing and quasi-concave in X and the function T is increasing in both elements. Values motivated

exclusively by existence considerations would be a good candidate for this form of preferences. This

class of utility is separable in X and Q and so the marginal rate of substitution between any two market

goods are independent of Q which implies that ordinary demands are independent of Q. In this case,

there will be no obvious demand for which to consider measuring a change in consumer surplus resulting

from the change in Q. We cannot think about a use value portion since observed demands will not

provide insight into the Hicksian demands. The Hicksian demand will still depend on Q since utility

13McConnell (1983) also considers this form of preferences.

24

depends on Q.

Another possibility suggested by Hanemann (1988) and Hanemann (1995) applies when utility

takes the form where g is quasi-concave in both of its arguments and T is

increasing in both of its arguments.13 Hanemann suggests defining the passive-use value component by

the value associated with changing only the separable portion of Q and then defining the use value

component as the remainder of compensating variation where .

This definition provides a unique components and a decomposition such that CV = PUV + UV.

The idea behind this decomposition is that there may be a portion for which value through demand

consumer surplus is measurable, yet still there might be a component that cannot be recovered. It is

worth noting that given this functional form, one still may not be able to recover all of the UV from

market demand data. Thus we may have a further decomposition of UV into a measured and unmeasured

component, a prospect that makes this definition less appealing.

4.5. Operational Definition of Passive-Use Value

Carson et al. (1999) and Maler et al. (1994) offer a different approach to defining passive use

value that is based on practical considerations rather than a theoretical decomposition. The following

definition is taken from Carson et al. (1999).

Definition: Passive-use values are those portions of total value that are unobtainable usingindirect measurement techniques which rely on observable market behavior.

This definition captures the essence of the earlier decompositions, but creates a dichotomy based on what

14Much of this discussion is drawn from Flores (2002).

25

can and cannot be measured using market behavior. To date, welfare economic theory has been unable

to deliver a clear definition of passive-use value. All of the definitions discussed above ultimately come

down to defining passive-use value as a form of residual that cannot be picked up from observable data.

Some may view the inability to develop a bullet-proof theoretical definition of passive-use value as

problematic for the concept. However as Kopp (1992) points out, passive-use considerations satisfy the

conditions for pure public goods. In the case of any pure public good, a precise notion of value is

similarly hard to pin down if value inferred from observable behavior is the anchor. Observable behavior

will not facilitate estimating the benefits of national defense any better than it will facilitate estimating

the benefits of preservation for those who value the mere existence. Both problems are classic public

goods problems.

4.6. Altruism as a Source of Passive Use Value

Conservation Reconsidered includes bequests on account of the desire to leave one’s heirs a

portfolio of appreciating asset as one motive for people to value preservation. Bequests are direct

evidence of caring for one’s heirs which directly relates to the standard definition for altruism: regard

for and devotion to the interests of others. The same intuition that suggest bequests as a motive generally

applies to altruism. Hence altruism is often included as a motivation for passive-use value and has been

investigated considerably in the public goods literature. There are two pure types of altruism discussed

in this literature, non-paternalistic and paternalistic.14 Non-paternalistic altruism refers to the situation

where a given individual, the altruist, values the welfare of another, the beneficiary. In contrast,

paternalistic altruism refers to the situation where the altruist values the beneficiary’s consumption of

a particular merit good, irrespective of the beneficiary’s preferences. Theoretical investigations of pure

paternalistic altruism for merit goods conclude that the altruistic value enjoyed by the altruist is simply

15This model is an extension of the model in Becker (1974).

16See Jones-Lee (1991), Johansson (1992), Jones-Lee (1992), Johansson (1994), Johannesson et al. (1996), Lazoet al. (1997), and McConnell (1997).

26

part of the altruist’s demand for the public good and additional value is correctly attributable on account

of altruism.

Standard models of non-paternalistic altruism include the beneficiary’s utility as an argument in

the altruist’s utility function, , along with demand for own private goods and

own enjoyment of the public good.15 With regard to non-paternalistic altruism, Bergstrom (1982) proved

that a necessary condition for a Pareto optimum with non-paternalistic altruism is for the optimum to also

be classified as a Pareto optimum based only on selfish considerations. Thus optimal provision of public

goods ultimately depends upon selfish preferences. Based on Bergstrom’s result, many authors have

further concluded that non-paternalistic altruism can and should also be ignored for the generic, discrete

changes encountered in benefit-cost analysis.16

In Flores (2002), I provide an analysis of generic changes in public goods under non-paternalistic

altruism. The analysis explicitly allows for preference interdependence between public goods and

income distribution between the altruist and one or more beneficiaries. This work shows that in some

cases, a benefit-cost test that is based only on selfish preferences may reject a good project where good

projects are defined as those for which there exists some arrangement of payments that will cover costs

while leaving no one worse off, that is an actual Pareto improvement. The analysis does not contradict

Bergstrom (1982), but does indicate that Bergstrom’s reasoning does not generally apply to benefit-cost

analysis as once believed. The results are obtained by recognizing that the altruist’s marginal value for

a change in the beneficiary’s utility will depend upon the level of public goods. With changes in the

levels of public goods, the altruist and the beneficiary may both be better off if the altruist buys

additional public goods on behalf of the beneficiary-even if the beneficiary may not choose to do so

27

based on his own preferences! This analysis has implication for passive-use value in that it establishes

that as in the case of paternalistic altruism, non-paternalistic altruism can also be a real source of

additional value for a change in public goods. The analysis also indicates that values are not independent

of the distribution of costs.

4.7. Uncertainty as a Source of Passive Use Value

Carson et al. (1999) note that Conservation Reconsidered’s strength in convincing at least some

economists that some people may hold passive-use values is the careful selection of the examples

discussed in Section 2. These examples are cast under the general rubric of option demand Weisbrod

(1964). Like Conservation Reconsidered, Weisbrod relies on good examples to carry his ideas. The

option demand examples of Weisbrod are clearly cases of uncertain, yet potentially observable demand.

However, the option demand examples in Conservation Reconsidered relate to things for which demand

is not currently observable for anyone. Recall the examples: benefits from existence, benefits from

leaving bequests in the form of preserved public lands, and benefits from preserving areas that may hold

genetic/medicinal compounds that may later prove beneficial. In Weisbrod’s examples, demands from

current users at least provide insight into the realized benefits of use. However in the cases such as those

given in Conservation Reconsidered where there are not any current demands to observe, there is no

potential for even estimating current realized benefits.

Even though the option demand portrayed in the Weisbrod examples facilitate estimation of

realized benefits, the fact that demand is uncertain raises the prospect that option demand benefits may

differ from realized benefits. Let us consider a simple stylized model of uncertain consumer demand in

order to establish the practical importance of the notion of expected consumer surplus. Suppose that with

probability p a consumer demands a good and gets realized consumer surplus from consumption of D

and with probability 1 - p the consumer does not demand the good and consumer surplus equals zero.

28

The expected surplus for this consumer is pD. Now assume there are N - 1 other uncertain demanders

with the same probability of demand p and realized consumer surplus D. Total expected realized

consumer surplus is simply NpD. Our best estimate of p will be the proportion of those who used the

resource, Nu/N. Looking back at the total expected consumer surplus, our best estimate of total expected

consumer surplus will simply be the total realized consumer surplus, . To derive this estimate, we

do not even need to know the total number of people with uncertain demand, N, or the probability of

demand, only the number of people who demanded the good and the best estimate of their consumer

surplus. The simplicity of this example suggests an intuitive appeal of thinking about the benefits of

option demand relative to consumer surplus which is exactly the issue that the option value literature

considered.

The option value literature is spirited and colorful. In a comment on Weisbrod’s concept of

option demand, Long (1967) states “The point of this note is to show that option value is the

unrecognized son of that old goat, consumer surplus.” Commenting on Long’s paper, Lindsay (1967)

states “Long achieved his aim [of stripping away the legitimacy of option demand] by setting up a

conceptual experiment where option could not possibly exist. Testing for it and finding it lacking, he

thereby sentenced Weisbrod to wear the “scarlet letter.” This note is intended to restore his good name.”

Lindsay then goes onto argue that the benefit of option demand exceeds expected consumer surplus. And

so the stage is set. Conservation Reconsidered’s use of the term option value certainly piqued additional

research interest in the relationship between option demand and expected consumer surplus. Researchers

from the Natural Environments Program are among the main contributors. As Freeman (1984b) notes,

“A lot of ink has been spilled on the option value question since Weisbrod’s (1964) original article.”

The simple model above was presented to suggest why expected consumer’s surplus effectively

became the benchmark of comparison. I want to adapt some of the earlier conceptual development to

29

uncertainty. Recall the indirect utility function from above, . Uncertainty could come in

many different forms such as price uncertainty, environmental quality uncertainty, income uncertainty

or even preference uncertainty due to things like weather or a child getting sick, etc. The

policy/environmental quality vector is partitioned into where the first element is a policy

taking binary values or not . The policy is assumed to be known with certainty.

According to the notation that I adopt, everything else could be uncertain, but does not necessarily have

to be uncertain. Let s stand for the realized state of the world. An adaptation of indirect utility in state

s is given by . This notation allows for potential price uncertainty,

environmental quality uncertainty, income uncertainty and preference uncertainty. Of course any of these

things can apply separately or in total. Expected consumer surplus with is given as follows.

Expectation is with respect to the probability law associated with the random state s. In the

option value literature, this space is typically discrete. Under a discrete state space with say i states, each

variable that is a function of s could potentially take i different values. I am not assuming an sort of

continuity in s for these variables, only that s maps these variables into potentially different values across

the states. Now suppose we want to express the total value for the policy using a compensating variation

type of value; this value is referred to as option price (OP). For example suppose that the policy is to

preserve an area for recreation as opposed to developing the area for extraction.

Option price is the state independent payment independent that equates expected utility. Using

the preservation example, option price can be interpreted as the ex ante willingness to pay for

17Note the assignment of property rights goes to the “destructive” use in this case.

30

preservation.17 Under a scenario in which a consumer cares about the area only through consumption

of recreation trips, then in any realized state, consumer surplus for demand will equal equivalent

variation.

Consumer surplus is written as a function of the state, CS(s), because conceivably this could

differ in each state. Expected consumer surplus is just the expectation of consumer surplus across the

states.

The primary research question in this literature is whether option price exceeds consumer surplus,

as suggested by Weisbrod (1964), or is option price less than or equal to expected consumer surplus?

The term “option value” is defined as the difference between option price and expected consumer

surplus.

Many papers addressed the question of whether option price exceeds expected consumer surplus.

In comments on Lindsay (1967), Cicchetti and Freeman (1971) conclude that for a demand uncertain

consumer, option value is positive when preferences are concave in income. In the same issue of the

Journal of Quarterly Economics Byerlee (1971) finds that option value can be positive, negative, or zero;

in Byerlee’s model, preferences are convex over the good demanded and income and the utility function

is concave in good demanded for all values of income. Schmalensee (1972) shows that option value may

18As pointed out by Freeman (1993), Anderson J.R. (1981) and Bishop (1982) also provide analyses to the contraryof the findings of Cicchetti and Freeman (1971).

19Parallel results were derived in the case of supply uncertainty. See for example Smith (1985) and Plummer (1986).

31

be positive, negative, or zero even in the case of risk aversion considered by Cicchetti and Freeman

(1971).18 The issue that had been overlooked by Cicchetti and Freeman (1971) is that it is not risk

aversion that really drives the issue, but the relative marginal utilities for income in the states of demand

and no demand. The overall conclusion with regard to demand uncertainty is that generally option value

may be positive, negative, or zero.19

Graham (1981) notes that [pg. 722] “option price may be regarded as a “second best” measure

of benefit appropriate to situations in which 1) actual financing involves sure collection from individuals,

and 2) secondary contingent claims markets are not available.” Here secondary contingent claims refer

to markets for efficiently allocating risks, e.g. insurance contracts. Most instances of preservation of

public natural environments satisfy these two conditions. Thus according to Graham, option price is the

correct welfare measure. Smith (1987) notes that option price and expected consumer surplus are

respectively ex ante and ex post measures of value and so option value is a mixture of two different

valuation perspectives. Smith goes onto suggest that if use/non-use benefit taxonomies are to be

meaningful, then the same valuation perspective needs to be used in defining the divisions. Accepting

an ex ante valuation perspective, the option value literature does not suggest a definitive bias from using

expected consumer surplus as the best approximation in those cases in which the sole expected utility

benefit is associated only with uncertain use. In cases where expected utility is positively influenced by

the preservation of the good, expected consumer surplus approximated by total estimated consumer

surplus from realized demand will be the wrong measure for the same reason that consumer surplus is

the wrong measure of total value in a certain/complete information valuation perspective is wrong.

4.8. Uncertainty, Quasi-Option Value, and Irreversibilities

20For example the inability to value environmental preservation from observable behavior has equally clearimplications in a temporal setting.

21Henry explicitly assumes an all or nothing first period development level while the Arrow/Fisher model of linearbenefits always results in a corner solution of all or nothing development.

32

The concepts discussed above are essentially cast in a “timeless” setting in the sense that the

temporal nature of preservation decisions is not explicitly considered, though much of the reasoning

applies to temporal settings.20 In a “timeless” setting, irreversibility, which plays a prominent role in the

reasoning in Conservation Reconsidered and The Economics of Natural Environments, has no real

meaning. The option value literature explicitly addresses the issue of valuation under conditions of

uncertainty, but with an overly simplistic information structure. In particular, it is likely that as time

progresses, more information regarding future benefits is likely to become available. The quasi-option

literature basically addresses the question, how does the prospect of forthcoming information impact

today’s development decision relative to ignoring this prospect?

The pioneering work in this area is Arrow and Fisher (1974), Henry (1974), and Henry (1974).

As noted in Section 3 above, Arrow and Fisher’s conclusion from their work is that when the prospect

of forthcoming information is incorporated into today’s decision, less irreversible development should

take place relative to when the forthcoming information is ignored. The benefit of this flexibility is

quasi-option value. The conclusions are weak in the sense that today’s development incorporating the

prospect of forthcoming information is less than or equal to first period development when the prospect

is ignored. Thus the results do not suggest that development should not occur, rather that accounting for

the information structure may lead to less irreversible development and definitely no more development.

Hanemann (1989) points out that there is a caveat to these results. The Arrow/Fisher and Henry

models result in all or nothing decisions.21 It is easily imaginable that one decision alternative is

developing part of an area while preserving the rest. Development in the affected area would still be

irreversible, but the decision is no longer “all or nothing.” Epstein (1980) develops a general model that

22In Epstein’s model additional information about period 2 benefits still arrives in time for the period 2 decision, butuncertainty regarding second period benefits is not fully resolved, though it could be as a special case.

23Hanemann (1989) provides a special case of Epstein’s model that allows partial development but uncertainty iscompletely resolved in the second period, basically the Arrow/Fisher model with partial development. Hanemann concludesthere may be instances where the less development sufficiency conditions are not satisfied and hence there may be moredevelopment. In my reading of Epstein’s conditions, I do not agree with Haneman’s conclusion. I believe Epstein’s highwaysand farms example encompasses Hanemann’s model and Epstein establishes the less development sufficiency conditions..

33

allows partial development and varying information structure22 and provides a sufficiency theorem. The

sufficiency theorem provides conditions that imply when less irreversible investment will occur relative

to ignoring the forthcoming information and the theorem also provides conditions when more

development will occur. When neither of these two sufficiency conditions are satisfied, relative

development cannot be generally determined. Epstein’s model applies to a larger set of decisions than

those considered in the early environmental quasi-option value literature, e.g. savings/consumption,

timing of capital orders, along with preservation/development. Epstein provides an example of a

farmer’s decision to pave over part of his farm for a highway that is identical to the Arrow/Fisher model

with the exceptions that second period development benefits are no longer required to be linear and

second period uncertainty need not be completely resolved. In the example, Epstein shows that the less

development sufficiency conditions are satisfied and thus less development should take place given the

prospect of additional information.23 These models all suggest that when the prospect of additional

information is forthcoming, less development should take place relative to when this information is

ignored. In these cases, quasi-option value is greater than or equal to zero. These results suggest that

the intuition from Conservation Reconsidered is on the mark.

All of the quasi-option value models discussed so far have the common feature that forthcoming

information is independent of the first period development decision. Miller and Lad (1984) present a

model in which forthcoming information depends on the level of first period development. In particular

they note [pg. 168], “preservation action informs us about different variables than does development

24Resource and Energy Economics, Vol. 22, No. 3.

34

action.” Thus information gains from developing or not developing could either weaken or strengthen

the earlier conclusions of the need for a more conservative approach to development when information

is forthcoming. In cases of pro-active information, quasi-option value may be negative or positive.

Interest in irreversible investment continues due to applications in the financial theory of options. A

recent issue24 of Resource and Energy Economics is dedicated to irreversibility in economics. In the

edition, Fisher (2000) shows the equivalence between the option value theory developed for the

preservation problem and the theory developed for financial options by Pindyck (1991), Dixit (1992),

and Dixit and Pindyck (1994).

Quasi-option value in relation to public resources is essentially a planner’s problem as opposed

to a consumer’s problem, Freeman (1993)[ pg. 264]. In fact, the value associated with quasi-option value

exists independently of the accuracy of today’s estimate of current and future benefits. In this sense

quasi-option value should not be considered a value that may be missed, rather it should be viewed as

an opportunity missed if the prospect of future information is simply disregarded by the planner. The

Economics of Natural Resources advocates a conservative approach, meaning irreversible decisions

require more thoughtful consideration than simply predicting tomorrow’s benefits simply using estimates

of today’s benefits.

4.9. Irreversibility and Uniqueness

Partial development can easily have a large impact on the rest of an area that remains in a natural

state. For example a small, unfortunately placed strip mine can have a serious visual impact on an area

such as the Grand Canyon, Yellowstone National Park, or any other natural area. Some people would

consider this an example of reversible development while others find them irreversible. The Hells

Canyon analysis found in The Economics of Natural Environments is drawn from Fisher et al. (1972).

25Cummings and Norton readily concede that species loss is indeed irreversible.

26The non-profit organization American Rivers lists 80 dams on the list of dams removed in 1999 through 2001.

35

In a comment on this analysis, Cummings and Norton (1974) “find a basic problem in the F-K-C [Fisher,

Krutilla, Cicchetti] paper which results from their nebulous and somewhat inconsistent distinction

between preservation (P) and development (D) options, and the relationship to these to irreversible

investments.” Cummings and Norton argue that development can entail a range of alternatives from

camping and other recreation facilities to hydroelectric power development. They argue that even in

cases as extreme as hydroelectric power development, development is technically reversible and that

future generations will be more capable of paying higher costs for reversing earlier development

projects.25

Cummings and Norton make some very good points and viewed from an historical perspective

they certainly appear to have some merit. For one, many small dams are being removed while other

dams around the country may come down if their benefits cannot be justified.26 There is also the matter

of providing replacement habitat for areas that are developed. Though still in its relative infancy, created

wetlands are emerging in mitigation banking programs across the country. Though these efforts certainly

have detractors, they suggest that technological development may not be as asymmetric as suggested in

Conservation Reconsidered and The Economics of Natural Environments. This is not to say that these

technological innovations will satisfy everyone. Some people are purists and will find “engineered”

natural areas greatly inferior substitutes for those provided by nature.

Similarly, uniqueness is a relative term. Loss of the last nesting pair of bald eagles in Boulder

County, Colorado may not raise much concern nationwide when there are many other nesting pairs in

Colorado. However for Boulder County residents, loss of the last nesting pair of bald eagles represents

a unique loss. Since I am do not take regular birding trips, it is unlikely that my value for preserving bald

36

eagles would be revealed through techniques that rely on observed behavior. Cicchetti and Wilde (1992)

claim that the passive-use values alluded to in Conservation Reconsidered only apply to cases of

irreversible decisions affecting unique and irreplaceable resources. However the notion of passive-use

values is applicable to most instances of a resource that provides benefits that fall toward the pure public

good end of the private/public goods spectrum. The case for passive-use values is most easily made in

the case of irreversible development of unique and irreplaceable resources, but it need not be a necessary

case.

5. Measuring Preferences for the Environment

In this section I discuss some of the research related to the issues raised in Conservation

Reconsidered and The Economics of Natural Environments that involve measuring preferences. The

literature in this area is too vast to cover in detail. I limit my discussion to the work that I feel most

relevant to the research agenda advocated by Krutilla and his colleagues in the Natural Environments

Program.

5.1. Recreational Demand

The call to arms in Conservation Reconsidered and The Economics of Natural Environments

proved to be extremely influential in the development of techniques for measuring economic preferences

for the environment. The overall agenda calls for measurement and inclusion of preservation benefits

in general. Because recreational benefits are such obvious candidates for consideration, they were the

focus of much early work. There are some very clear areas of research in recreation benefits

measurement that came out of the Natural Environments Program, the first one being the study of

recreational congestion and economic welfare. In considering optimal supply of public lands and

potentially designated uses, congestion is an extremely important factor.

27Further development of the theory, econometrics, and application is found in Cicchetti and Smith (1976).

28The Mineral King Valley example in The Economics of Natural Environments is drawn from an earlier versionof Cicchetti et al. (1976).

37

The first detailed study of congestion was conducted by Natural Environment Program

researchers, Cicchetti and Smith (1973).27 In their study, Cicchetti and Smith gathered visitor addresses

from entry records for the Spanish Peaks Primitive Area in Montana. Visitors were mailed a survey sent

on behalf of the Wilderness Society. In the survey, visitors were provided different congestion scenarios

and asked to state the highest price they would pay per day under these conditions of congestion.

Additionally, visitors were asked information regarding travel costs and other related expenses from their

actual visit to the Spanish Peaks and demographic information, e.g. education, gender, and age. From

this information and a theoretical/conceptual model linking congestion to utility and choices, Cicchetti

and Smith infer the relationship between recreation benefits and various types of congestion. Cicchetti

and Smith’s study is pioneering work for the economics of recreational congestion. Examples of authors

who later draw on this work include McConnell and Duff (1976), Freeman and Haveman (1977),

McConnell (1977), Walsh et al. (1983), McConnell and Sutinen (1984), and McConnell (1988).

Further work that can clearly be linked to the Natural Environments Program is in the area of

household production analysis of environmental goods and multi-site recreational demand modeling.

Cicchetti et al. (1976) provide what I believe is the earliest environmental application of the household

production framework of Becker (1965) in their analysis of recreational demand and welfare analysis

of the Mineral King Valley ski area.28 Related work is found in Feenberg and Mills (1980) and Bockstael

and Kling (1988). Cicchetti et al. (1976) use aggregate trip data while paying careful attention to the

importance of measuring potential of site substitution. Their work, along with that of Burt and Brewer

(1971), greatly influenced the development of individual-level, multi-site recreational demand models

29For examples see the work of Morey (1981) and Kling (1989).

30Davis (1963) is typically credited with the first application of the contingent valuation method in his study ofhunting in the Maine woods.

31For a discussion and analysis see Kling (1989) and Smith (1993).

38

which now dominates the recreational demand literature and applications.29

The travel cost method of Clawson (1959) and the theoretical refinement of Maler (1974) provide

a clear avenue for estimating recreation benefits from trip demand. However in many cases, trip demand

data is either completely lacking or when available, there is often not enough environmental quality

variation to estimate the effect of environmental quality. Given that survey research is often needed to

collect basic trip demand data, a natural avenue of extension is to ask questions about maximum

willingness to pay to recreate under hypothetical scenarios of quality. This type of questioning is one

type of the technique is now referred to as the contingent valuation method. Davis (1963) uses this

approach as do Cicchetti and Smith (1973), Brown and Hammack, Brown and Hammack (1973), and

Brown and Hammack (1974).

In The Economics of Natural Environments, Krutilla and Fisher comment on Brown and

Hammack’s use of contingent valuation [pg. 224], “Although it is true that economists (at least these

economists) generally prefer the method of indirectly estimating demand and value, as developed and

applied in chapter 8, because of its reliance on observed behavior rather than responses to hypothetical

questions, there are good grounds for choosing the Davis technique [contingent valuation] in this case.”30

Krutilla and Fisher focus on the practical difficulties of collecting sufficient data to adequately model

demand in this particular case. Information on substitute sites is difficult to come by, particularly since

there are so many ponds in the prairie region that Brown and Hammack study. The problem of site

substitution continues to plague recreational demand modeling31 and makes contingent valuation an

attractive alternative for inferring recreational benefits and many applications followed suit. This type

32Robust analysis from trimmed and weighted data sets resulted in higher correlations, 0.88 and 0.92 respectively.

39

of survey approach facilitates estimating both contingent valuation estimates and revealed preference

estimates from travel cost, making possible comparisons of these two types of estimates.

In relation to estimates derived from revealed preference technqiues, how does contingent

valuation measure up? In work with several colleagues, Carson et al. (1996), we sought out as many

studies as we could find that provide estimates from both revealed preference methods, those for which

value estimates are derived from observed behavior, and contingent valuation. For each pair of

estimates, we calculated the ratio of the contingent valuation estimate to the revealed preference estimate.

In all we found 83 studies that provide 616 different comparisons. The mean of these ratios is 0.89 with

a 95% confidence interval for the mean ratio [0.81, 0.96]; the median ratio is 0.75. These statistics

indicate that for these studies, contingent valuation tends to, on average, provide smaller estimates than

their revealed preference counterparts. The correlation between the contingent valuation estimate and

the revealed preference estimate is 0.78.32 We conclude from our analysis that contingent valuation

produced estimates that are remarkably consistent with their revealed preference counterparts, at least

for the goods analyzed in these studies. Obviously contingent valuation analysis need not be limited to

recreation and it was not. As Mitchell and Carson (1989) note, early applications of contingent valuation

include improved water quality, decreased mortality risk from a nuclear power plant accident, toxic waste

dumps, visual and health benefits from improved air quality, just to name a few. Many of these

applications estimate values for some non-users and so there was an increasing trend to measure passive-

use values with contingent valuation. This move presented a methodological challenge for contingent

valuation.

5.2. Measuring Passive-Use Value with Contingent Valuation

In contrast to recreation surveys, designing contingent valuation surveys to estimate passive-use

33In using a survey-based approach, it is just as important to survey those who do not value the good as it is to surveythose who do.

34Researchers also worked at drawing more explicit links between contingent valuation choices and economic theory.Notable examples in the are estimation are Hanemann (1984), Cameron (1988), and Hanemann and Kanninen (1999). Inexplaining potential disparities between willingness to pay and willingness to accept compensation estimates see Hanemann(1991) and Hanemann (2000).

35For example see the edited book Cummings et al. (1986).

40

value for the general population is considerably more difficult. The population as a whole may not be

familiar with the issue at hand, or particularly interested.33 Relative to a population of recreationists,

sample selection problems loom much larger for passive-use studies. Lack of familiarity implies

considerably more attention needs to be given to effectively communicating the issues, including the way

in which values are elicited.

For these reasons, contingent valuation evolved. Smith (2000) refers to early contingent

valuation as the “experimental stage” in which survey protocol took a back seat to questions of how to

ask the valuation questions; interviews were often conducted by graduate students and survey

instruments were not always tested before taken into the field. Contingent valuation evolved to a method

that as Smith states, “adhered to the conventions of professional survey research. ..” Smith (2000) credits

the Randall et al. (1974) study of air quality improvements in the Four Corners area of the south-western

U.S. as “the first serious, professionally administered, population survey to collect CV responses.” After

the Randall et al. (1974) study and the continued adoption of higher and higher survey research

standards, the technique gained official acceptance.34 A significant event was the 1979 Water Resources

Council listing of contingent valuation as one of acceptable techniques for determining project benefits,

along with travel cost and the unit day value method. Contingent valuation was coming of age in the

1980's with the number of applications rising each year. To the credit of contingent valuation researchers

and the rest of the economics profession, contingent valuation quality standards were constantly being

discussed and updated.35

41

After a decade of research dedicated to contingent valuation research, Mitchell and Carson

(1989) published their treatise on contingent valuation which to this day is the most comprehensive

treatment of contingent valuation. In their book, Mitchell and Carson covered issues including the

economic theory of public goods, survey design and sampling, respondent strategic behavior, potential

measurement biases, and standards for assessing the validity and reliability of contingent valuation

studies. Mitchell and Carson end on an optimistic note [pg. 295], “Contingent valuation shows promise

as a powerful and versatile tool for measuring the economic benefits of the provision of nonmarketed

goods.” The most promising aspect of contingent valuation according to Mitchell and Carson is the

ability to capture “total value” which distinguishes it from all revealed preference techniques. Given the

rapidly increasing use of contingent valuation and the rising interest in non-market valuation techniques

by 1989, the issues raised in Conservation Reconsidered were clearly being addressed.

A significant event for contingent valuation and the economics of passive-use value occurred a

little after midnight on March 24, 1989 when the Exxon Valdez oil tanker ran aground on Bligh Reef

spilling approximately 11 million gallons of oil. This event was significant because a team of

researchers, including Mitchell and Carson, conducted a passive-use value study to estimate damages

from the spill Carson et al. (1992) for the State of Alaska. This application catapulted contingent

valuation and passive-use values into a storm of controversy. As the passive-use value study was being

conducted, the Exxon Corporation and the American Petroleum Institute (API) became very interested

in funding research on contingent valuation. Many of the researchers funded by the Exxon/API research

program are among the most prominent economists in the world and so significant weight came with

their reputations.

This research focuses on a variety of theoretical and empirical issues involving contingent

valuation measurement of passive-use values. A symposium on contingent valuation was held in

36The conference proceedings are collected in Hausman (1993).

37Implicit in this argument is that if motivations are not economic, then the values elicited are not economic.

42

Washington in April of 1992 in which researchers presented their results.36 The main conclusions from

this research is summarized by Diamond and Hausman (1994). Diamond and Hausman conclude that

contingent valuation is a “deeply flawed methodology for measuring nonuse values, one that does not

estimate what its proponents claim to be estimating.” In support of their conclusion Diamond and

Hausman make several claims. First, economic motivations are not driving people’s answers to

contingent valuation questions.37 Second, contingent values do not vary sufficiently across the

population as we would expect of economic values, particularly income. Third, contingent values suffer

from the problem of embedding. Embedding is the phenomenon that if we program A alone, value

program B alone, and then value programs A and B together, the sum of the programs valued alone

exceed the value of the two programs. Fourth, contingent values differ according to the way the public

is asked to pay for the good (payment vehicle). Fifth, since contingent valuation is motivated by

altruistic considerations, double-counting of benefits is likely. Sixth, respondents are not sufficiently

familiar with the commodities they are asked to value and do not have well-defined economic

preferences.

Many of these issues are answered, at least to some extent, in contemporary research. First with

regard to motivations, Hanemann (1994) notes that economic theory has nothing to say about motivations

and provides several quotes including this one from Becker’s Nobel lecture, “[I]ndividuals maximize

welfare as they conceive it, whether they be selfish, altruistic, loyal, spiteful, or masochistic.” On the

issue of income, Flores and Carson (1997) show that even if a public good is a luxury good in demand

(a 1% increase in income results in a greater than 1% increase in demand), it need not have a luxury

value ( a 1% increase in income results in a greater than 1% increase in value). Diamond and Hausman

43

compare income elasticity estimates of willingness to pay from contingent valuation studies with income

elasticity estimates of charitable contributions. The former involves the value of rationed public goods

while the latter involves demand for services from charities. On the issue of embedding, Hoehn and

Randall (1989) provide a theoretical justification for this phenomenon and Carson et al. (1998) provide

the sufficient conditions on preferences that imply an embedding effect. Thus embedding can certainly

be an economic phenomenon regardless of measurement issues. The implications of altruism are

somewhat, but not completely settled. My work on altruism discussed earlier from Flores (2002)

establishes that altruism can generate additional values, but the distribution of costs plays an important

role. My conclusion is that if costs to others are specific, then contingent valuation should not double-

count benefits. The issue of familiarity is taken up in Hanemann (1994) and Carson et al. (1999).

In response to the Exxon Valdez spill, Congress passed the Oil Pollution Act of 1990. The Act’s

designated trustee, the National Oceanic and Atmospheric Administration (NOAA), appointed a

prestigious panel to make a recommendation of contingent valuation in 1992, the high point of this

debate. The panel was jointly chaired by economists Kenneth Arrow and Robert Solow; other members

were economists Paul Portney, Edward Leamer, Roy Radner, and survey research expert Howard

Schuman. The panel evaluated many comments and testimony from interested parties on both sides of

the issue. Their report published in the Federal Register, Arrow et al. (1993), concludes “that contingent

valuation studies can produce estimates reliable enough to be the starting point for a judicial or

administrative determination of natural resource damages-including lost passive-use value [pg. 4610].”

Additionally the panel provides a list of “maladies” that if present would deem a study unreliable. These

maladies are high non-response rates to the survey or valuation question, inadequate responsiveness of

estimates to the scope of the environmental insult, lack of understanding of the task by survey

respondents, lack of belief in the full restoration scenario, and yes/no votes on hypothetical referendum

44

that are not followed up or explained by making reference to the cost and/or value of the program. As

Smith (2000) points out, these stringent guidelines significantly increase the price of a reliable

contingent valuation study, to the extent of pricing contingent valuation out of the market, and that only

one study to date, Carson et al. (1994) meets these guidelines. This is not to say that contingent

valuation applications have stopped. A recent review and bibliography of contingent valuation studies

by Carson (forthcoming 2002), lists over 5500 contingent valuation studies from over 100 countries. The

following graph from Carson’s shows the number of studies per year. Much of this growth in contingent

valuation studies is overseas.

YEAR

CO

UN

T

1960 1970 1980 1990 20000

100

200

300

400

500

Contingent Valuation Literature by Year

Though the panel’s recommendation effectively endorses contingent valuation with qualifications,

it would be naive to ignore the long term damage inflicted by such a high profile debate. Contingent

valuation detractors effectively exposed the technique’s Achilles heel of hypothetical choices. In contrast

to applications to recreation benefits, there is no revealed preference basis of comparison for contingent

estimates of passive-use values. Validity and reliability must be judged by good practice along the lines

38For examples see the work presented in Groves et al. (1987) .

39Central to their framework is the distinction between consequential and inconsequential questions. There is noeconomic theory of hypothetical question for which there are no consequences. However if a question has potential, perhapseven uncertain consequences, economic theory can help analyze incentive compatibility.

40Related empirical work by that tests for differences in the distribution of values due to mechanism finds that

45

of those outlined by Mitchell and Carson (1989) and Arrow et al. (1993). Most of the profession is

relatively ignorant of the details of the debate or even the panel’s recommendation. However phases such

as“ask a silly question and get a silly answer” resound with a profession that has a strong revealed

preference tradition. This impression is strong and will likely last for some time. The impression makes

contingent valuation/passive use values an unattractive area of research for younger researches which

undoubtedly will impede progress on understanding and measuring passive use value.

5.3. Contingent Valuation and Incentives

The professional scrutiny of contingent valuation has forced contingent valuation researchers to

face important issues head on. In particular the issue of incentive compatibility, truthful response to

valuation questions, has come to the forefront. Economic theory has struggled with the issue of incentive

compatibility in actual choices. One of the central questions from this literature is what types of

mechanisms elicits truthful responses38, thus avoiding the problem of strategic misrepresentation identified

by Samuelson (1954). Carson et al. (1999) develop a conceptual model of incentives with regard to

responding to hypothetical questions and apply results from the mechanism design literature to evaluate

contingent valuation questions.39 Drawing on the work of Gibbard (1973) and Satterthwaite (1975), they

find that the current practice standard of asking contingent valuation questions as a “take-it or leave-it”

binary option cast in a referendum framework is the best approach, as suggested by Arrow et al. (1993).40

Rigorous investigation like this is needed if contingent valuation is to be restored in the profession.

5.4. Attribute-Based Choice Methods

Attribute-based choice methods, also referred to as choice-based conjoint analysis, are quickly

41Relevant citations are Adamowicz et al. (1998) and Adamowicz et al. (1999).

42For a discussion of this issue see Flores and Thacher (2002).

46

gaining ground on contingent valuation as a means of estimating non-market values, including passive-use

values.41 This approach which has been widely applied in the marketing literature, also uses hypothetical

choices to model preferences. Contingent valuation studies typically attempt to value the population

distribution of values for one particular project. In contrast, attribute-based choice studies focus on

measuring the marginal utility of different attributes within a random utility framework. Study

participants make choices over alternatives that vary by attribute levels and typically study participants

answer several of these choice questions. This approach is appealing because it provides information that

can be used to evaluate a range of projects. For example in natural resource damage assessments, this

technique can value the loss from an injury while also providing insight into the value of compensatory

resources. Though cost may or may not be included as an attribute, exclusion of cost from the analysis

precludes benefit-cost considerations.42 This approach appears promising for continuing the advancement

of non-market valuation research, including applications to measure passive-use value. However because

attribute-based choice modeling is a stated preference approach, the same issues facing contingent

valuation will have to be addressed, especially for applications involving passive-use value.

6. Looking Forward

John Krutilla and his colleagues in the Natural Environments Program at Resources for the Future

were instrumental in determining much of the environmental economics research agenda for the last

thirty-five years. In my opinion, their quest (and ours) is all about ensuring that economic analysis is, to

paraphrase Otto Eckstein, “capable of serving the high purpose for which it is intended.” Given the work

of the last thirty-five years, I conclude that the ideas from Conservation Reconsidered and The Economics

of Natural Environments, won out in the intellectual struggle. Benefits from preserving the environment

43Examples of this approach are Sieg et al. (2000) for housing markets and air quality and Walsh (2001) for housingmarkets and open space.

47

having gained explicit recognition by the courts and in economic analysis; these benefits are far from the

category of intangibles. But there is still much important work to be done. Continuing in the spirit of

Conservation Reconsidered and The Economics of Natural Environments I turn to some research areas

that I feel are important for the continued advance of economists’ understanding of environmental

preferences.

The dynamics of recreational demand still deserves further attention. Citizens of the west cannot

help but notice that many people west on account of a desire to pursue more serious recreation, a trend

that is placing considerable pressure on the environment. The optimal supply of preservation and they

types of access permitted across recreation type, e.g. car camping, backpacking, wilderness experience,

is an area that has not been sufficiently explored. Recreational congestion and urban sprawl are

equilibrium outcomes involving people with heterogeneous preferences. Casting these problems,

theoretically and empirically, in a general equilibrium/sorting framework is likely to produce real insights

into the optimal supply problem.43

Temporal modeling at the individual level needs to be further developed and better micro data is

likely to facilitate this line of research. At least for some types of recreation, yesterday’s choices strongly

influence today’s choices. Temporally aggregated models miss these influences as do independent choice

models. What are the implications of temporal persistence and temporal substitution for economic

analysis? Are current welfare economic concepts capturing the essence of these temporal problems? Can

we gain insights into learning-by-doing through a temporal modeling approach?

Passive-use values are looming larger than ever in contemporary debates such as the decision to

drill or not drill the Alaska National Wildlife Refuge (ANWR) or whether to embark on a serious effort

to reduce carbon dioxide emissions. Both of these issues involve passive-use value considerations and

48

learning-by-doing. Have we recognized the full extent of these two issues in the problem? An important

change that is taking place is the ability for citizens to coordinate through the Internet and email. This

coordination is effectively lowering costs of acquiring information and most importantly letting citizens

voice their preferences for environmental public policy. Electronic action groups that send out alerts and

facilitate contact with elected representatives and agencies are managing to mobilize millions of people.

There is certainly information about environmental preferences in these messages, but how can

economists help interpret?

Stated-preference techniques have been applied primarily to value the environment. I believe that

applications to general public goods, especially local public goods will provide new insights. In the case

of local public goods there is the possibility of linking stated choices with voting. Good work in this area

will buy credibility from the general profession regarding public goods preference modeling and passsive-

use values. Environmental economists are the experts who are up to this task.

As I mentioned in discussing irreversibility, replacement and compensatory environmental

resources are quickly becoming a part of public policy. Private and quasi-public mitigation banks and

restoration projects are springing up all over the country while the efficacy of this approach is being

seriously debated by ecologists. Here we have issues of quasi-option value regarding genetic diversity

and long-run sustainability mingled with public preferences over manufactured versus naturally occurring

ecosystems layered on top of the flexibility that these programs offer. These projects may entail

considerable ecological risk. Is irreversibility a dead issue? Do existing concepts and techniques capture

the essential features of this problem?

49

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