On the Evaluation of Government Programs to Reduce Environmental Risk

Abstract

This paper attempts to identify the correct benefit measure for a government project which might reduce the subjective probability of an environmental risk to health. The evaluation of government projects whose costs or benefits are uncertain occupies a considerable literature including Arrow and Lind, Fisher, and Graham. The value of reducing the probability of an adverse state (outcome) has been examined by Cook and Graham and more recently by Gallagher and Smith. In the latter two papers it was assumed that the individual at risk had access to perfect insurance or contingent claims markets. In such a perfect world the value of reducing the probability of an adverse state could be bounded by measures which Cook and Graham referred to as ransom and compensation and which Gallagher and Smith show to correspond to the more traditional Hicksian notions of compensating and equivalent variation. If the assumption of perfect contingent claims markets does not hold, it is not possible to set upper and lower bounds on the value of reducing the probability of an adverse state. While general forms of insurance are available to individuals at risk from an environmental hazard, specific policies do not allow for the continuous adjustment (reallocation of wealth) assumed to occur when the individual has access to perfect markets. In the next section a more plausible model is constructed. It assumes that the individual has a finite set of self-protective actions which he or she may take in response to a risk to future health. In addition, the government may undertake a project to reduce the risk to health. It is assumed that both the selfprotective action and the government project have the ability to influence the subjective (personal) probability of the future states, continued good health or ill-health. There are three major conclusions which emerge from this model. (a) The value of the government project is an option price (Graham) which may be zero or positive. If positive, the benefits from the project may take the form of cost-savings, risk (probability) reduction, or both. (b) The value of the government project is dependent on the set of self-protective actions and may change as new actions become available or the effectiveness of existing actions is reassessed by the individual. (c) The method of contingent valuation, in theory, would appear capable of eliciting the proper option price estimates for the project's value to the individual. It is even possible to distinguish between the value attributable to cost-savings and risk reduction. In the next section I present the model and demonstrate the above conclusions. In the final section an assessment is made of the in-