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On Balance: Revealed Preference Methods for Nonmarket Valuation: An Introduction to Best Practices

October 28, 2020
By: Catherine L. Kling

For over 50 years, economists have developed and refined methods to value environmental and other nonmarket goods to provide benefit estimates that are commensurate with goods that are exchanged in markets. Without these estimates, benefit cost analysis of environmental regulations risk erroneous conclusions regarding the net benefits of a regulation. The methods can be broadly categorized into revealed preference (that infer values from behavioral clues) and stated preference (which directly elicit values through surveys). Despite their longer history and the many documented shortcomings, revealed preference methods have not been subject to the intense validity and reliability challenges as their stated preference counterparts. And, unlike stated preference methods (see Johnston et al.2017), there has not previously been an effort for scholars of the approaches to develop a set of “best practice” guidelines for the implementation and reporting of these analyses.

With the publication of a symposium entitled “Best Practices for Using Revealed Preference Methods for Nonmarket Valuation” published in the Review of Environmental Economics and Policy (Volume number 14, issues 2, summer 2020), revealed preference methods now have their foundational, best practices guide. The four papers focus on three of the most common modelling approaches for inferring benefits and costs from market behavior observed by households in related markets: hedonic property values, hedonic wage, and recreation demand.
The symposium begins with an overview and introduction to the use of these methods in policy making in the U.S. and E.U. and identifies the regulatory and legal role for benefit-cost estimates. The authors emphasize the pivotal role these estimates have played in developing and altering the degree of environmental protection afforded by regulatory and other policy decisions. The Trump administration has disregarded the economic and scientific principles underlying benefit cost analysis for decision making (Revesz, 2020) which makes the documentation of best even more important as we seek to ensure that policy decisions employ the best economic analysis possible.

Bishop et al (2020), provide a carefully constructed first principles approach identifying the basics of the hedonic property method and discuss the variety of modeling decisions that analysts face in implementing the method, noting that the underlying assumptions of identification in the model that can be challenging in implementation. Evans and Taylor (2020) provide an equally thorough assessment of hedonic wage approaches, which they note are crucial for the accurate representation of important health benefits due to the value of reduced mortality risk in environmental and health regulations.  While they identify existing shortcomings, they also establish a set of best practices upon which to further build this important empirical work. The third piece in the symposium addresses recreation demand models. Lupi, Phaneuf, and von Haefen (2020) carefully review the full suite of activities related to data collection, modeling, specification of environmental quality, and assumptions that analyst must make in implementing these approaches.  By developing a set of guidelines based on the existing knowledge in revealed preference approaches, these authors have provided an invaluable service to the policy community.  Future advances will add to the stock of knowledge, and lead to new guidelines that may retain many of the current suggestions or result in major alterations.  Either way, these guidelines now provide a firm base from which to evolve.
Benefit-cost analysis has a proven record of informing environmental regulation and policy decisions at all levels of government. With the publication of a set of best practices that have been independently peer-reviewed, this symposium provides a strong platform on which to build and provide unbiased economic analysis.   

Catherine L. Kling is a Tisch University Professor in the Dyson School of Applied Economics and Management and Faculty Director at the Atkinson Center for a Sustainable Future. She is past Director of the Center for Agricultural and Rural Development at Iowa State University where she also held the President's Chair in Environmental Economics.
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