Marginal Oportunity 1987

8/12/2019 Marginal Oportunity 1987

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MARGINAL OPPORTUNITY COST AS A PLANNING CONCEPTIN NATURAL RESOURCE MANAGEMENTDavid Pearce and Anil MarkandyaDepartment of EconomicsUniversity College LondonGower St., London WCIE 6BTUnited Kingdom

AbstractRenewable resources are being used in non-sustainable waysin many countries in the world. The costs of non-sustainabilityneed to be enumerated and valued in order to establish thedesirability or otherwise of such development paths. Theappropriate concept is marginal opportunity cost (MOC), a measureof the social costs of resource depletion. This concept is set in thecontext of models of the development process which stress therelationship between environment and development as a"coevolutionary" one rather than one of trading off material gainagainst environmental quality. Measures of MOC need to reflectthe often intricate physical and ecological interlinkages withinecosystems, allowing for, e. g., the relationship betweendeforestation, soil erosion, streamflow and sedimentation. In turn,

MOC comprises direct costs of resource use, the externalitiesarising from ecological interlinkage, and a user cost componentwhich arises because of non-sustainable resource use. Formulatedin this way, MOC has implications for shadow pricing exercises,national accounting, and for the choice of sector and geographicalarea for project appraisal.I. Introduction

There is now a widespread appreciation that the economic fortunes ofmany developing countries are inextricably bound up with the state of theirnatural environments. In particular, serious concern is being expressed at the d_eefacto treatment of the primary renewable resources--soil, water and forestbiomass--as exhaustible resources, to be "mined" and depleted to the point ofactual or potential nonrenewability. The features underlying his concern are:

IThe views expressed in this paper are those of the authors, and shouldnot be attributed to the World Bank, to its affiliated organizations, or to anyindividual acting on their behalf. The authors wish to acknowledge assistancefrom the World Bank and the U ~ ESRC for earlier work on which this paper isbased.

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(a) exploitation giving rise to irreversibilityphenomena, notably desertifieation,such that the option to rebuild the stock to some policy-determined level isremoved; (b) the complex interlinkages in the ecological systems which containrenewable resources, such that the costs of depletion of one resource aremagnified through the interdependent systems; (c) the speed at which theseeffects occur; and (d) the immediate and future cost in terms of human misery,overwhelmingly among the rural poor, that arises because of resourcedegradation. Quantified descriptions now abound as do the pleas to takeconstructive action, viz., World Resources Institute [35], Repetto [25, 26],Bartelmus [3], Holdgate Il l] , Warlord [3 l], and Pearee [20].The costs of natural resource degradation (NRD) show up in two generalways. First, there is a direct dependence effect. Whereasdeveloped economieshave roundabout technologies in which the relationship between final productand natural resources is often obscure and complex, developing countries tend tohave household and agriculture sectors in which this roundaboutness is absent orsmall. Examples are the direct reliance on woodfuels (fuelwood and charcoal),rivers and lakes as sources of water for all uses, and even wildlife for food. Asillustrations, only 24% of the rural sector in Africa had house connections towater supplies in 1983, although this was a marked increase on the 10.8% figurefor 1970. Connections to urban households in Africa increased in number overthe same period, but as a percentage of the urban population, the figure fellfrom 63.5% to 59.6% (World Health Organization [34]). Traditional fuels(woodfuels and other biomass) as a percentage of total primary energy supply isabove 90% in Nepal, Malawi and Tanzania, and between 70 and 80% in Guinea-Bissau, Ethiopia, Sudan, Paraguay and Niger (authors' calculations from WorldBank UNDP Energy Assessments). The very existence of subsistence agricultureunderlines the direct dependence on soil fertility, rainfall, and natural ormanaged irrigation water. The depletion of these renewable resources is thuslikely to have detrimental effects on the populations reliant upon them.Second, the development process itself will be affected perhaps moreindirectly by NRD. Development is best indicated by a vector whose componentsinclude real incomes per head, health, education and other basic needs. NRDaffects a number of components of development via direct dependence, as withwaterborne diseases. It also affects more traditional indicators of change suchas per capita real incomes, especially if these are (properly) construed insustainable terms. That is, resource depletion may well yield temporary shortgains in real income in the same way as anyone can borrow from a capital fund,but continued depletion is likely to result in medium to long run income losses,depending, as we shall see, on the view taken about the dynamics of thedevelopment process. Examples of losses include depreciation in forest stocksdue to non-sustainable logging practices [27]; hydroelectricity osses due to damsedimentation arising, in part, from non-sustainable forest clearance foragriculture and woodfuels [29, 20]; crop losses due to diversion of naturalferti lizers--livestock dung and crop residues--to use as fuels in the face ofwoodfuels shortages. In short, the renewable resource base of the economy

ceases to be a dispensable input to the development process and must beviewed, instead, as both a condition of and an integral part of development.Complex issues arise about the optimal size of that renewable resource stock andwe have addressed them elsewhere [24]. What is not in question, however, is thata number of countries have depleted critical renewable stocks to extremely highrisk levels when measured in terms of development potential. This overall

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D A V I D P E A R C E A N D A N I L M A R K A N D Y A

m e s s a g e i s r e e e n t b u t n o w f a m i l ia r ( s e e , f o r e x a m p l e , I ~3 3, ]) .I n t h i s p a p e r w e s h o w h o w t h e t o o l s o f a n al y s i s t h a t a r e a l r e a d y f a m i l ia r

t o n a t u r al r e s o u r c e e c o n o m i s t s c a n b e u s e d t o el i c it c e r t a i n f e at u r e s o f t h e N R Dp r o c e s s w h i c h b o t h ( a) a s s i s t i n e x p l a in i n g t h a t p r o c e s s , a n d ( b) p o i n t t o w a r d sp o l i c y m e a s u r e s d e s i g n e d t o c o r r e c t it. T h e e o n c e p t w e u s e t o i n v e s ti g a t e t h e s ea s p e c t s o f N R D i s m a r g i n a l o p p o r tu n i t y c o s t . I n c a l c u l at i n g m a r g i n a lo p p o r t u n i t y c o s t , w e s e e k a m e a s u r e o f t h e t r u e c o s t o f a n a c t i o n o r p o l i e y w h i c hd e p l e te s a u n i t o f a r e n e w a b l e r e s o u r ce . T h e r e l e v a n t c o n t e x t i s o n e i n w h i c ht h a t r e s o u r c e i s d e p l e t ed i n s u e h a w a y t h a t t h e n at u r a l re g e n e ra t i v e p r o c e s sd o e s n o t e n s u e , i . e. , t h e r e s o u r ce i s s u b j e c t t o n o n - s us t a i n a bl e m a n a g e m e n tp r a c t i ce . S i n c e t h e c o n c e p t i s n o d i f f e r en t t o t h e m o r e f a m i l i ar o n e o f s o c i a le g s t , b u t i n t h e c o n t e x t o f n a t u r al r e s o u r c es b e i n g c o n s u m e d o n a n u n su s t a i na b l eb a s i s , i t m a y b e a r g u e d t h a t it i s n o t h i n g n e w . I n t e r m s o f t h e f a m il i a r i ty o fc o n c e pt s , w e a c c e p t t h a t o b s e r va t i o n -- a t l e a s t a s fa r a s e c o n o m i s t s a r ec o n c e r n e d - - b u t a r g u e t h a t i t i s s u g g e s ti v e a n d t h o u g ht - o r g a ni s l n g i n s e v e r ali n t e r es t i n g w a y s . I n p a r t i cu l a r , w e s h a l l a r g u e t h a t i t t e l ls u s s o m e t h i n g a b o u t ( i)t h e s o c i a l p r i c i ng o f n a t u r a l r e s o u r c e s i n d e v e l o p i n g e c o n o m i e s , ( ii ) t h e s p a t i a ld i m e n s i o n s o f p r o j e c t i n v e s t m e n t a p p r a i s a l , a n d ( ii i ) t h e i n t e r t e m p o r a ld i m e n s i o n s o f t h e N R D p r o c e ss . T o s e t t h e s c e n e f u r t h e r, w e b r i e f l y c o n s i de rt h e n a t u r e o f t h e l in k s b e t w e e n e c o n o m i e s a n d t h e i r n a t ur a l e n vi r o n m e n t s , a n dt h e e m e r g i n g m o d e l s o f d e v e l o p m e n t w h i c h f o cu s o n t h e r e n e w a b l e r e s o u r e eb a s e .If. E c o n o m y - E c o l o g y L i n k a g e s

S i n c e K e n n e t h B o u l d i ng ' s s e m i n a l s p a e e sh i p e a r t h e s s a y [4 ] , t h e r e h a sb e e n g e n e r a l b u t n ot u n iv e rs a l a w a r e n e s s t h a t th e l i ne a r e c o n o m y o f e c o n o m i ct e x t b o o k s i s a m i sl e a d i ng a b s t r a c t i o n . L i n e a r e c o n o m i e s c o n s i s t o f p r o d u c t i o na n d c o n s u m p t i o n s e ct o rs , w i t h t h e p r o c e s s o f m a x i m i s i n g t h e s o c i a l u t il i ty o fc o n s u m p t i o n b e i n g c o n s t ra i ne d o n ly b y t h e ra t e a t w h i c h r e s o u r c es e a n b et r a n s f o r m e d i n t o p r o d u e t i on a n d c o n s u m p t i o n . B o u l d i n g o b s e r v e d t ha t t h e l a w so f c o n s e r v a t i o n o f m a s s l i n k t h e n a t u r a l r e s o u r c e b a s e , w h i c h f e e d s t h ep r o d u e t i o n s e c t o r, t o t h e e m i s s i o n o f w a s t e s i n t o t h e r e c e iv i n g n a t u r ale n v i r o n m e n t s . S i n c e t h e e n v i r o n m e n t s t h e m s e l v e s h a v e li m i t e d ( t h o u gh va r i a b le )w a s t e a s s i m il a t i v e c a p a c i t ie s , c o n s t ra i n t s ( b e y o n d t h e l i m i t a ti o n s s e t b y t i m e a n ds o c i a l o r g a n is a t i o n ) e x i s t o n t h e r a t e o f r e s o u r c e t r a n s f o r m a t i o n ( a d d i ti o n a l t ot h o s e in c o n v e n t i on a l e c o n o m i c m o d el s ), a n d o n t h e t i m e p e r i od o v e r w h i c h s u e ht r a n s f o r m a t i o n s c a n t a k e pl a c e . T h e c o n s t r a i nt s e t b y t h e r e l a t io n s h i p b e t w e e nw a s t e e m i s s i o n s a n d e n v i r o n m e n t a l a s s i m i la t i v e c a p a c i t y i s t h e a n a l o g u e o f r u l e sf o r t h e s u s t a in a b l e u s e o f r e n e w a b l e r e s o u r c e s , n a m e l y t h a t h a r v e st r a t e ss h o ul d n o t e x c e e d n a tu r a l o r m a n a g e d y i e ld s . T h e l i ne a r e c o n o m y i s r e p l a c e dw i t h o n e i n w h i c h n o t j u s t f lo w s o f f l n a n e e a r e c i r c u l a r , b u t s o a l s o a r e t h e f l o w so f m a t e r i al s a n d e n er g y . M o r e o v e r , t h e s e t w o l a y e r s o f t h e s y s t e m i n t e r a ct :e c o n o m i e a n d e c ol o g ic a l s y s t e m s a r e n o t s e pa r a te .

B o u l d i n g f u r t h e r a e k n o w l e d g e d t h e e c o n o m i c i m p o r t a n e e o f e c ol o gi c alc y c l e s f a m i l i a r t o a n y l i f e s c i e nt i s t - -e . g . , e a r b o n c y c l e s , h y d r o l o g i c e y e l e s a n dn u t r i e nt c y c l e s . H i s f o c u s w a s p l a n e t e a r t h a s a g l o ba l e c o s y s t e m , b u t o t h e r sh a v e s h o w n h o w t h e p r in e ip l e s a p pl y t o r eg i on a l a n d n a ti o na l e c o n o m i c s y s t e m s( K n e e s e , A y r e s a n d d ' A r g e [1 3 ], H a f k a m p [ 10 ]. I n t h e d e v e l o p i ng e c o n o m yc o n t e x t F i g u r e 1 p r ov i de s a st y li s e d s u m m a r y o f s o m e o f t h e m a i n e c o n o m ye c o s y s t e m l i n k a ge s a s t h e y r e l a t e t o r e n e w a b l e r e s o u r c e s . A s y s t e m s h o c k , s a yi n t h e f o r m o f a g r i c u l t u r a l c o l o n i s a t i o n o f a h i t h e r t o a f f o r e s t e d a r e a , i s s e e n t o

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D VID PE RC E ND NIL M I~K NDY

have various '~nock-on effects. Loss of tree cover increases soil erosion,erosion adds to watercourse sedimentation, reducing electricity output, raisingflood plains, and so on. The direction and scale of these effects depends on asecond layer of the economy-ecosystem interaction, namely the level of socialorganisation. Thus the social response to deforestation could be its replacementwith stable agricultural systems which prevent soil erosion. In figure l, ~ Qrefers to effects which show up in measured or measurable developmentindicators.The essential point is that economic development is not independent ofthe renewable resource base. In Norgaard's terms, economy and ecosystem arecoevolutionary : development of one requires the harmonious evolution of theother [16, 17]. In the language of neoclassical economics, the system shockgenerates external effects. But analysis in terms of the theory of externaleffects needs to be broadened in light of the following:(i) the externalities may well be pervasive because of extensiveecosystem linkages accompanied by the direct dependence phenomenon;(ii) the externalities may well extend over wide geographic areas,although the watershed appears to set a reasonably bounded system beforeeffects are dissipated;(iii) the externalities have a temporal aspect, in that resourcedegradation now precludes resource use benefits in the future; and(iv) development, in the sense of processes which are currentlythought to contribute to sustainable growth in social indicators, is often itselfthe source of externality which, in turn, is compounded to feed back negativelyon development.Marginal opportunity cost (MOC), as a social cost measure, seeks toidentify and measure the true social costs of actions and policies such asdeforestation. As such, it has to begin by identifying the relevant ecosystem

linkages. MOC is already an organising concept.Ill. Alternative Models

It is fashionable to speak of the social goal in developing economies assustainable development. Unfortunately, the term has come to mean all thingsto all men, not least because development itself is value loaded as a concept.Four strands seem discernible:(i) traditional mode~s of 'steady state' growth such as can be found inthe theory of economic growth; ~( i i) development paths which are resilient to external shocks such asdrought, population change, and exogenous events such as world price changes incommodity and input markets [8];(iii) development with an explicit bias to the rural poor and toimmediate benefits [@; and(iv) development which honors certain 'rules of the game,' notably thephysical requirements for the sustainable use of resources such as land, water,biomass and the assimilative capacity of the environment [19, 21, 18].

2For a survey, see Jones [12] and Hache [9].

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MAI~GINALO P P O R T U N T Y COSTSThese alternative views are discussed in detail in Pearce [23]. The fourthvariant, which has its heritage in the work of Boulding, is the most suggestiveand has direct relevance to the processes giving rise to NRD in developingcountries. Moreover, when translated to a dynamic context, it has affinitieswith the few attempts that have been made to develop an ecological theory ofeconomic change, notably the major neglected work of Wilkinson [32], recentlyrevived and tested by Common [7]. On Wilkinson s heory, development actuallyonly occurs as a result of some disequilibrium relationship between the economyand its population, and the natural resource system supporting it. But the kindsof change that take place in response to the disequilibrium offer no guaranteethat the economy will get on to a stable path--it might also collapse or enter adepression stage. In the modern context, the risk of failure may be quite high asthe social forces responding to disequilibrium are accompanied, and oftenswamped, by policy responses from government and other authorities. If the twoare not in harmony, the failure risk is high. Up to the level of the ecologicalbound set by the endowment of natural resources-especially renewable ones--economic change may be steady. As the bound is encountered disequilibriumoccurs. Pursuit of the traditional development path can easily lead to short rungains, notably as the renewable resource stock is depleted: borrowing from thenatural capital base takes place. In the absence of major technologicalbreakthroughs, the development path is short-lived (a few decades rather than

many).A sustainable development path occurs only if the ecological bound itselfis shifted. Mechanisms for doing this will be the application of relevanttechnology, management of renewable resources to secure higher natural yields,investment in assimilative capacity, recyclingf and a switch to borrowing fromexhaustible resources such as oil and coal. ~ Policies to shift the boundsthemselves may be risky--technology may create as many problems as it solves,as, for example, with some of the experience of agricultural mechanisationunsuited to soil depth. In this sense, development is no more guaranteed than itis in any of the traditional models of economic growth. What the model does dois to suggest a central role for ecological factors in the development process, sothat it becomes clear that the risks of the push for development are greatlymagnified if these factors are ignored.How does this, albeit very sketchy, outline of an ecological developmentprocess fit with the concept of marginal opportunity cost? By forcing attentionto be paid to the components of MOC their role in the development process ishighlighted. As we shall see, MOC is future oriented as well as spatiallyoriented. Ecological bounds enter the picture through a user cost componentwhich measures the benefit foregone in the future by depletion of the resourcetoday. Arguably, even this user cost component has to be modified to ensurethat the full costs of non-sustainable actions today are accounted for [22], butthe general point is adequate for current purposes.Having invoked MOC several times, we now explain the concept in moredetail.

3Such a path is very likely to have the features of Conway s concept [8] ofsustainability, i.e., development will take place through diversification of inputsand outputs rather than monocultural activity.

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DAVID PEA.~CE AND ANIL MAI-hKANDYAIV. The Concept of MarginalOpportunity Cost

When a small amount of a natural resource is used up, the true value ofthat resource is measured by the ma rginal opportunity cost. In this definition,the word marginal occurs because the calcula tion is done for a small change inthe rat e of usage. Economists frequently use marginal concepts in deter miningthe rules for r esource allocat ion and in measuring scarcity. The reason for thisis that the appropriate level of use of a resource can often be calculated byequating the marginal cost of that resource with the margina l benef it derivedfrom its use. If both marginal cost and bene fit can be calculated, then we cancheek to see whether they are equ al If the cost exceeds the bene fit at themargin, then this indicates that the resource is being overexploited and its useshould be cut back a little. Equally, f the marginal benefit exceeds the cost,then increasing exploitation slightly should be beneficial. In addition to workingout the appropriate level of use of a resource, calculations of marginal cost canalso be of use in evaluating public investment projects and governmentregulations. Such activities often involve small changes in the composition andlevel of the natural resource base of the country. If the costs of such changescan be measured, they can be included in the overall calculus of costs andbenefits, from which a decision on the suitability of the investment or regulationcan be made. In this respect, the marginal opportunity cost, which we describein detail below, is the same as the marginal social cost of any input used in, oraffected by, the project or regulation. The difference is that it refers to themarginal cost of a natural resource and is calculated somewhat differently.Although we have argued that MOC is generally the right measure ofsearcity, there are situations where the appropriate concept is not a marginalone. In particular, this will be so when the policies being considered involvelarge changes to the stocks of natural resources. Then the value of a smallchange in the resource, suitably scaled up, will not be an accurate measure andwhat is required is a comparison between the value of the total stock before andafter the change. Also, changes in the values of related resources andcommodities should be compared ex ante and ex post. Such global' comparisonswill be required typically in the context ol natural resource management whenevaluating the consequencesof eeologieal disasters. In such eases, the notion ofa 'marginal disaster' is something of a contradiction in terms. Thisqualificationto the use of marginal measures is important and should always be borne inmind. However, it remains true that the most relevant and frequently usedconcept in the management of scarce natural resources is MOC.The words opportunity cost in the term that we are considering efer tothe best alternative use to which a particular set of resources could be put ifthey were not being used for the purpose which is being costed. These costs canbe broken down into three components. First, there is the direct cost of theactivity. Extracting natural resources requires labor, materials, etc. Forexample, cutting down a tree may require one man day of labor. Suppose thatthe same man day could, if devoted to another activity, produce goods andservices to the value of SX. ~'hen he opportunity cost of that labor is said to beSX and that is the figure that should be entered into the direct cost calculation.The relationship between the opportunity cost as described above and what isactually paid in to the worker can be quite complex, and involves a number ofconsiderations that are not relevant to this paper. What is relevant is to notethat, in general, actual payments for inputs and commodities will need to beadjusted in the light of taxes and market imperfections in order to obtain their

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opportunity cost. Such a process is sometim es referr ed to as shadow pricing.The second componen t of MOC is refe rred to as the extern al cost. Thesecosts arise, as was explained earlier, because changes in any one component ofthe natural resource base have impacts on the other components of that base andon the efficiency with which other economic activities can be conducted. Forexample, deforestation may result in s0il erosion and river and reservoirsiltation. This could affect agricultural output, electricity output, and the leveland quality of drinking water now and in the future. Such mpacts are measuredin terms of the value of the activity or commodity in its alternative use. So,referring to the above example, reduced agricultural and electricity output anddrinking water have a cost equal to the sum of the willingnesses o pay for thesecommodities by the consumers. The fact that some costs occur in the futuremeans that we discount them using a discount factor to make them comparableto present day costs. If, for example, the social discount rate is 5% per annumthen a cost of 1.05 in one year's time is equivalent to a cost of one dollar today.In order to obtain these external costs, one has to look at the data on theactual prices paid for the commodities concerned, the nature and structure oftaxes that apply to them, and to obtain more general information on thedeterminants of the demand for them. The latter will be relevant in finding outwhether at the present time there is excess supply or demand for the itemsconcerned, and in ascertaining what the likely future demand for them is likelyto be. Although information on these issues is difficult to obtain, and imprecisewhen obtained, we believe that a useful approximation to the value of themarginal external cost can be calculated in many cases.As was stated at the beginningof this paper, the external costs ofparticular relevance are those that arise when the resource is being exploited ona n on-susta inable basis. Such spiilover effects as do arise in a sustainable usesituat ion are likely to be small and also, in some cases, to be internallsed. Thismeans that, with repea ted use, people will eventu ally realise the impact tha t theexploitation of natural resources has, and its costs will appear as a direct cost.The final component of MOC arises from inter tem por al considerations.Initially, let us suppose that the resource we are dealing with is not renewablebut fixed in supply, so that any positive rate of exploitation will imply eventualexhaustion. In that ease, using one unit of the resourc e now implies that it wiUbe unavaila ble in the f uture. This places a scarcity premi um on the resource, theamount of which will depend on how large the stock is relative to the rate ofexploitation, how strong future demand is relative to present demand, whatsubstitutes are likely to be available in the future and at what cost, and what thediscount factor is. For details of the calcu lation of this premium, which isdefined as the user cost, the r eader is refe rred to Munasinghe and Sehramm [15].Assume, for example, that, on current expectations, a resource which has a(direct plus external) cost of one dollar per unit will be exhausted in ten year'stime. At tha t stage, it will be replaced by a subst itute which has a price of $2.Then, at the moment of exhaustion of the first resource, we would expect it alsoto have a price of $2. Otherwise, either the subst itute would be cheaper, inwhich case no one would buy the fixed resource, or the substitute would be more

expensive, in which ease no one would want to buy that.The present value of $2 in ten years' time will depend on the rate ofdiscou nt. I f the r ate is 5% per annum, then this valu e is $1.23 (i.e., 2/(1.05)10).This means that one unit not used today but used in ten years' time has a value of$1.23. Consequent ly the oppor tunity cost of consuming the unit today can besaid to be $1.23. Since we have calculated the margi nal direct and extern al

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DAVID R. PE ARCE AND ANIL MARKANDYAcosts as one dollar, ther e re main s a premium of 23 cent s to be added in order toobtain the overall marginal opportunity cost. This last component, which is theuser cost, clearly depends on a large number of factors. The discount rate isobviously a key variable, but so are the future price of the substit ute and thetime at which it comes into use. Hence, uncer tain ty about future developmentsand prices will play a signific ant part in determining user cost.The above discussion has taken place in the context of an exhaustibleresource. If the resource is renewable, and if its present and future use is likelyto ta ke place on a sustainable basis, then any of the resource tha t is exploitedtoday will be exactly repla ced through natu ral or managed regener ation. In thatcase, there will be no scarcity premium to be added to the present direct andexte rnal costs. However, the pre sent situa tion in many countries is not one ofsustaina ble use. In some of these, complet e exhaustion of the resource is themost likely possibility. In that case, we can treat the resource as exhaustibleand calc ulate the user cost as outlined above. In other cases, it might bepossible to arrest the r ate of exploitation so that at least a minimum stock e.g.,one that prevents major ecological disasters) is preserved. Doing so will takesome time but once that minimum stock is attained, it would seem logical forthe aut horities to maintai n it. Under this scenario, a scarcit y premium can beattached to current usage of the resource because future use is going to berest rict ed and hence future prices are going to be higher other things beingequal). ~To sum up, MOC is made up as follows:

MOC = MDC + MEC + MUCwhere MDC is the marginal direct cost, MEC the marginal external cost andMUC the marginal user cost. A considerable amount of information is requiredfor each of the components and particularly for the last two. MEC requiresdetails of the engineering and scientific relationship between natural resourcesand economic activities. It occurs mainlywhen the resource is being exploitedon a non-sustainable basis. MUC requires expectations to be formed aboutfuture patterns of exploitation; and about future developments n the demand fornatural resources and the supply of substitutes for these resources. Forrenewable resources MUC only arises when the resource is being used on a non-sustainable basis.V. The Uses of MarginalOpportunity Cost

We have defined MOC and have also attempted to show how it relates tothe wider theory of the relationship between an economyand its ecosystems, allin the context of the development process. We now illustrate the uses to whichthe concept can be put.(i) MOC as an OrganizingConcept

Because MOC is a logical extension of the economist s traditionalpreoccupation with marginal cost pricing to achieve allocative efficiency both

4Details of the calculation of user cost for this and related situations canbe found in Pearce and Markandya [24].

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intra- and inter-temporally, it serves as a mechanism for listing the kinds ofcosts and benefits that need to be considered when evaluating investments tocounteract NRD. Similarly, NRD is frequently a side effect of investmentpolicy. In the investment context, MOC amounts to a marginal version of cost-benefit analysis in general. For example, consider an investment to counteractdesertification. A package of measures is introduced that includes shelterbeltforestry, soil management techniques, and tree growing for livestock fodder andfuel The benefits will show up as (a) savings in time spent collecting scarcefuelwood, (b) increases in farm productivity arising from improved livestock andimproved soils, and (c) avoided damage due to desertificat~on. These benefitsare the mirror images of the component cost items in MOC.~ Similarly, the truecosts of allowing NRD to continue are indicated by MOC, just as we saw theywere at the macroeconomic level when considering the costs of NRD in terms ofconventional development objectives.(ii) MOC and Shadow Pricing

MOC also has implications for shadow pricing--i.e., the prices that reflectthe true state of scarcity of the natural resources in question. In the context ofdeveloping countries, shadow pricing practice for cost-benefit analysis tends tobe based on the methodologies developed by Little and Mirrlees [14] and Squireand van der Tak [30]. In broad terms, this requires that input and outputs bevalued according to their opportunity cost. For goods that either are or could beinternationally traded, the relevant shadow price is the border price, the pricethat could be obtained by exporting it, or the price that has to be paid ifimporting it. If a tonne of oil is consumed domestically, for example, what isforegone is the foreign exchange that could have been earned if it wereexported. For goods that are not (internationally) traded, the marginal cost ofsupply is the relevant shadow price since this reflects the cost of the resourcesused up in that supply.MOC now replaces the usual marginal cost concept, and thus becomes theshadow price for non-traded goods and inputs. For tradeables the border priceremains the correct shadow price. Figure 2 shows the relationship between MOCand border prices. If the border price exceeds MOC the tradeable goods sectorshould be expanded since the marginal benefit of that expansion (the borderprice) exceeds the true marginal cost of the expansion (the MOC). A frequentlyheard complaint in developing economies is that the world market does notadequately compensate for the true costs of supply; the exporting nation bearsall the costs of NRD and these outweigh the foreign exchange revenue. But interms of Figure 2 this implies that the nation is operating to the right of Q*, thepoint where marginal benefits equal marginal costs of supply. If so, thetradables sector is too large and should be contracted.MOC as a pricing principle again forces attention on to the externalitiesassociated with NRD. Moreover, t guides actual pricing policy in terms of theprovision of incentives for alloeative efficiency. It is widely argued that pricingpolicy should first be concerned with the elimination or reduction of subsidies

which encourage excessive resource use. As an allocative principle this iscorrect, i.e. , proper marginal cost pricing will tend to have incidental

5For a detailed example of an evaluation which shows high rates of returnto investments in reducing MOC from desertification, see Anderson Ill.

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Price Coat

D A V I D t{ . P E A I ~ C E A N D A N I L M A . R K A N D Y A

, ~ / JMOC

Border Price

~0 Quantity of Traded Good

environmental benefits if it reduces improper and wasteful uses of resources.Failure to set irrigation water charges on the basis of user benefits, for example,is a notorious cause of inefficiency in the irrigated agricultural sector [28]. Butit may well be that the divergence between marginal (private) cost and MOC isstill very large even when marginal cost pricing is approximated.(iii) MOC and the Unit of Account

The externality component of MOC reflects the ecological linkagesbetween sectors. Observation of Figure I, however, shows that the effects canshow up in locations quite distant from the initial act of NRD. Projectevaluation thus needs to consider effects arising within a spatial unit ofaccount, and the natural unit is the watershed. The watershed as a managementunit is, of course, well established in both developed and developing economies.Less practised is the analysis of entire watershed effects from the introductionof specific investments. An example of neglected feedback effects from theconstruction of hydroreservoirs is the magnet effect of the reservoir on humansettlement in the immediate vicinity. In turn, the settlement may give rise toland clearance for agriculture and soil erosion which then contributes to siltationrates in the reservoir. In itself, MOC does not detect these effects, but allied toan understanding of watershed ecosystem functioning it will.

i v ) D i s c o u n t R a t e sMany of the external effects from NRD will show up in the future,perhaps being borne by those involved in the process, perhaps being borne by

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future generations. The user cost component will tend to be borne by futuregenerations. We noted previously that MOC has urged on the policy maker thefact that the non-sustainable harvesting of renewable resources will have futurecosts, both in terms of externalities MEC) and in terms of foregone resourcebenefits MUC). In both cases, the relevant cost is expressed in present valueterms, i.e., the cost of future losses is expressed in terms of how they are viewednow. The size of these components will, therefore, be partially determined bythe discount rates, that are often argued to reflect high rates of return thatexist in underdeveloped agricultural sectors, or which reflect high interest ratesin credit markets. Yet in both cases, it is the process of NRD which actuallycontributes to the high discount rates. NRD will make risk permia very high inactual credit markets, and if it is severe, it will generate high time preferencerates as the search for immediate gains to prevent starvation becomes all themore urgent. Moreover, if high discount rates are adopted, there is a pardox, forthey will reduce the MEC and MUC components of MOC, making t seem thatNRD is less serious. The optimal level of investment in NRD avoidance thusappears less. NRD both creates high discount rates and is made worse by thosediscount rates. The fallacy lies in using market rates or inferred rates of timepreference to guide the choice of social discount rate. High discount rates are,in many respects, a restatement of the NRD problem.V) MOC and the National Accounts

The national accounts of a country attempt to measure the value of thegoods and services produced in that country and to show the division of thatvalue between various categories of households. It is well known, of course, thatthis exercise is extremely difficult to do accurately, especially in developingcountries, and that there are items that are both included and omittedincorrectly from the final calculation of national income. As far as naturalresources are concerned, we need to consider those that are marketed and thosethat are used outside the cash economy separately. The former will be pricedtypically in terms of their direct cost alone MDC), and the value included in thenational accounts will reflect the equality between MDC and the willingness opay by the consumer for the resource that is used. However, the true value isless than that. This is because consumers of the resource impose costs on otheragents in the form of restricted output and/or higher prices now and in thefuture. We measure these costs as MEC and MUC. Hence, n order to obtain thetrue value to society of the present consumption of the natural resource, weshould subtract from the value of the marketed output, MEC plus MUC times thenumber of units consumed. MUC acts here as an analogue to the depreciationfactor on capital, and so should be subtracted not from the calculations of grossincome but from the net income figures. MEC is a mixture of present day andfuture costs, and its treatment with respect to gross and net income is unclear,without looking at each case in detail.In some cases, government expenditure might be undertaken to mitigatesome of the external effects of NRD. Such expenditures are frequently includedas final government consumption, and appear in the national accounts as such.This, of course, is incorrect, because they are a cost of consumption of naturalresources and should be properly treated as an intermediate input and netted outof the national accounts. Indentifying these expenditures is made clearer oncewe start to measure MEC, to which they are relevant.When the natural resources used up do not go through the cash economy,

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D V I D P E A R C E N D N I L I ~ K N D Ythey are either excluded from the national accounts or included on an estimatedbasis. The most likely situation here is that users of the resource bear themarginal direct cost and equate that to their marginal willingness o pay for it.Hence, that is the direct value of the use of the resource. However, he sameuse imposes costs on others equal to MEC+MUC. Therefore, these should besubtracted from MDC to obtain the net value of consumption. What adjustmentis then made to the accounts depends on what value had been originally includedin them. One further point to note here is that while we have assumed that MDCis equal to the marginal willingness o pay for the resource, this may not be thecase if the resource is subject to private ownership and if the owners take along-term view of the profitability of the resource. In that case, some or all ofthe MUC may be included in the price and the above propositions have to bealtered appropriately.v i) M O C a nd O p t i m a l Re s ou r c e S t oc ks

The requirement of sustainable use for a resource does not imply aparticular stock level for that resource. The choice of the optimal level of stockis arrived at by comparing MOC and the marginal benefits at different stocklevels, assuming that the rate of extraction is equal to the rate of regeneration--i.e., that the resource is being used on a sustainable basis. Sincewe are dealingwith sustainable use only, MOC will be calculated as the sum of MDC and MECalone. It will, however, need to be calculated at different stock levels. EquatingMOC and the marginal benefits then defines the optimal stock level, which wecall S*.It is q~ite possible that this optimal stock is different from the currentstock level, SU. For example, a resource rich country may take the view that itshould reduce its stock level permanently, and use the proceeds to build up~ itsproductive capital The path that the economy should take in going from Su toS* is determined by a dynamic optimisation exercise, in which the rates ofcapital accumulation and resource utilisation are the key variables. How fast orhow slowly one proceeds will depend, among other things, on the marginalbenefits of different levels of extraction, the marginal costs of those levels(MDC plus MEC), and the marginal productivity of capital. The scarcitypremium associated with the use of the renewable resource is now endogenous othe whole analysis and does not have to be fed in as a separate piece ofinformation. However, from the optimisation, this value of MUC for the pathfrom SO o S* will be a potential output.Hence, we see that in determining both the equilibrium stock level andthe path by which we get to that stock level, MDC and MEC are required piecesof information.vii) The Social Incidence of MOC

The present and future costs of resource exploitation fall on manyparties,some of whom are themselves significant users of the resource and others whoare not. From a policy point of view, the incidence of these costs by incomegroup is clearly important. There are a number of indications that, indistributional terms, it is often the poorest sections of the community hatsuffer the external costs of NRD. Although MOC does not provide the requiredinformation directly, the process of collecting the relevant data is facilitatedwhen the framework for the estimation of MEC and MUC has been laid out.

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MARGINAL OPPORTUNITY COSTSVI. Conclusion

The concept of marginal opportunity cost is not new. We suggest that inthe context of nonsustainable use of renewable resources, MOC functions as anorganizing concept. Its component parts serve to focus attention on therelationship between acts of resource depletion now and their effects elsewherein the economy and in the future. Moreover, it is linked to a view of thedevelopment process which emphasises the role of renewable natural resources,and which argues that development and environmental preservation areinseparable parts of the process of social improvement.The informational requirements for the calculation of MOC areconsiderable and, to some extent, subjective. This is because expectations haveto be formed about the likely pattern of future exploitation and the likely futuredemands and supplies of the resource and its substitutes. However, suchexperience as we have, indicates that the exercise can be undertaken and thatthe results, although necessarily approximate, are a useful tool in the planningand management of natural resources.

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Documents

Marginal Oportunity 1987