Modelling Winners and Losers in Contingent Valuation of Public Goods: Appropriate Welfare Measures and Econometric Analysis

Abstract

Contingent valuation is now the most widely used method for valuing non-marketed goods in cost-benefit analysis. Yet, despite the fact that many externalities manifest themselves as costs to some and benefits to others, most studies restrict willingness to pay to being non-negative. This can result in significant errors in policymaking. This paper examines the importance of this, explores appropriate welfare measures for assessing losses and gains, demonstrates how these can be elicited explicitly, highlights the sensitivity of the results of such studies to the econometric specification employed and suggests ways of dealing with it. Finally, the implica- tions for policy are examined. assessment, including passive-use values', this technique has become the most widely used method for placing values on non-marketed goods. This paper examines some outstanding issues in relation to the validity of the method as a basis for policy-making. In particular, most studies ignore the fact that many externalities manifest themselves as costs to some and benefits to others. In addition, the results of contingent valuation studies are often quite sensitive to the econometric specification assumed. The significance of these issues is examined, techniques for their resolution are outlined, and the implications for public policy are highlighted. The importance for economists of the debate on the validity of contingent valuation was emphasised in a series of papers from a symposium on the contingent valuation method (CVM) published in the Journal of Economic Perspectives in 1994. In his paper, Portney (1994) predicted that, whether the economics profession liked it or not, the CVM would inevitably play a role in public policy formulation and, therefore, it was important that economists be aware of the controversies and have their say on the topic. Portney's prediction was correct and contingent valuation has become a routine approach to valuing environmental goods with hundreds of studies being produced each year.1 The CVM places a value on a change in the provision of a public good by asking households in a survey how much they are willing to pay for the change or the minimum compensation they would require if the change were not to happen. The role that contingent valuation studies play in public policy is