Economic Analysis and Environmental Assessment

Successful economic development depends on the rational use of natural resources and on reducing as far as possible the adverse environmental impacts of development projects. Environmental assessment (EA) is a primary tool for achieving this objective, by inserting critical environmental information into the process of project identification, preparation, and implementation. Economic analysis, by comparison, is employed to determine if the overall economic benefits of a proposed project exceed its costs, and to help design the project in a way that produces a solid economic rate of return. Adverse environmental impacts are part of the costs of a project, and positive environmental impacts are part of its benefits. Consideration of environmental impacts, therefore, should be integrated with the other aspects of the project in the economic analysis to the extent possible. This EA Sourcebook Update discusses the relationship of EA and economic analysis and gives guidance on how economic analysis might incorporate environmental costs and benefits. This Update replaces guidance provided in Chapter 4 of the EA Sourcebook. The World Bank's Operational Policy on EA (OP 4.01) states that " environmental costs and benefits should be quantified to the extent possible, and economic values should be attached where feasible. " This should be done for both alternative project designs and alternative mitigation options. Moreover, the Operational Policy on Economic Evaluation of Investment Operations (OP 10.04) states that EA findings and recommendations should be taken into account in project appraisal and supporting benefit-cost analysis. EA is an information-gathering and analytical process that helps avoid environmentally unsound development. It focuses on environmental externalities: unintended adverse effects of development projects on the environment. For example, land clearing for an aquaculture project could convert wetland areas, resulting in reduced bird habitat and water quality. EA seeks to identify and evaluate these environmental effects in qualitative terms, and to quantify them when feasible (for example, air pollution in parts-per-million, or tons of topsoil lost to erosion). The impacts identified in the EA process have not often been converted into monetary terms, however. A major reason behind the generally weak link between EA and economic analysis has been the lack of useful guidance on converting physical impacts into monetary terms. Recently, however, the science of environmental economics has moved to a point where it can be more readily applied in the project context. This Update seeks to explain how this might be done. The role of EA …