10.3. Framework for Evaluation

10.3.1. Methodology for Economic Analysis

Economic appraisal provides a conceptual framework for assessing benefits arising from environmental mitigation measures and the costs they impose. This appraisal involves defining objectives, examining options, and summing costs and benefits (and uncertainties) associated with each option. All environmental regulations or market-based options aim to internalize external costs and are likely to raise the costs of production, leading to higher prices along with benefits resulting from reduced amounts of pollution and associated damage costs. In conducting an economic appraisal of an environmental mitigation measure, the loss of material benefits to those who purchase goods or services needs to be weighed against the benefits from reduced pollution.

CBA is a common method for assessing benefits arising from an investment project, regulation, or policy and the costs that it imposes. It seeks to quantify-in monetary terms, where possible-as many of the costs and benefits as possible, taking into account their timing. Other techniques include risk analysis, cost-effectiveness, and environmental impact analysis; these approaches are generally not mutually exclusive, and in many cases they are used complementarily as part of a CBA framework. CBA has a long history as a useful aid to decisionmaking across many areas of economic activity. There are important obstacles, however, to its complete application-notably the lack of transparent information, where information is closely held for competitive reasons by private-sector companies; the difficulty of putting monetary values on environmental benefits; and the challenge of applying it to proposals that are implemented over a long time. Where benefits cannot be valued, it may be necessary to present them in physical units or to rely on some form of cost-effectiveness analysis (EASG, 1995; U.S. Department of Transportation and Federal Aviation Administration, 1998).

The following principles, set out in the 1992 Rio Declaration on Environment and Development (UNCED, 1992) regarding the precautionary and "polluter pays" principles, are relevant to the economic analysis framework:

"In order to protect the environment, the precautionary approach shall be widely applied by states according to their capabilities. Where there are threats of serious or irreversible damage, lack of full scientific certainty shall not be used as a reason for postponing cost-effective measures to prevent environmental degradation." (Principle 15)

"National authorities should endeavor to promote the internalization of environmental costs and the use of economic instruments, taking into account the approach that the polluter should, in principle, bear the cost of pollution...." (Principle 16)

The UNFCCC provides further guidance on the thinking underlying the precautionary principle (UNFCCC, 1992). Article 3 states:

"The Parties should take precautionary measures to anticipate, prevent, or minimize the causes of climate change and [to] mitigate its adverse effects. Where there are threats of serious or irreversible damage, lack of full scientific certainty should not be used as a reason for postponing such measures, taking into account that policies and measures to deal with climate change should be cost-effective so as to ensure global benefits at the lowest possible cost. To achieve this, such policies and measures should take into account different socio-economic contexts, be comprehensive, cover all relevant sources, sinks, and reservoirs of greenhouse gases and adaptation, and comprise all economic sectors. Efforts to address climate change may be carried out cooperatively by interested Parties."

The precautionary principle is a guideline that indicates when mitigation action should be taken. CBA is a useful analytical tool to guide policy decisions. The "polluter pays" principle establishes upon whom the cost should fall.

10.3.2. The Application of Economic Analysis

Studies examining the economic impact of environmental measures affecting aviation have included the ICAO policy framework for imposing operating restrictions on certain noisier aircraft, global implementation of CNS/ATM, and potential noise and emissions stringency reduction options available to ICAO. Although the precise methodologies have differed according to the circumstances and available information, the common approach in all of these studies has been the use of a cost-benefit framework.

The ICAO study, "The Economic Implications of Future Noise Restrictions on Subsonic Jet Aircraft," estimated operating cost and revenue loss implications of early replacement of Chapter 2 aircraft as a result of certain states' implementation of operating restrictions on these aircraft for noise reasons (ICAO, 1989). The benefit of the proposed noise restrictions was analyzed by estimating the land area and population around affected airports with and without the proposed restrictions on noisy aircraft. The cost of the phaseout to air carriers would be acceleration of the fleet modernization process, reducing the value of the operators' assets and requiring them to make capital commitments earlier than might be justified from purely commercial considerations. A similar study was conducted for Chapter 2 phaseout of noisy aircraft in the United States (U.S. Department of Transportation and Federal Aviation Administration, 1991). These types of issues would need to be examined if proposals for operating restrictions to limit emissions were put forward. Studies on the economic impact of implementation of CNS/ ATM are discussed in Chapter 8 and summarized in Table 8-1. Similarly, a report conducted for CAEP's third meeting (CAEP/3) (ICAO, 1996a) described steps required to carry out an economic analysis of environmental policy measures for aviation (EASG, 1995). It considered alternative methodologies for appraising policy options and judged that CBA was the most appropriate economic appraisal methodology to apply to aviation environmental issues. This methodology was applied to noise and emissions stringency options under consideration at CAEP/3. CBA methodology was also applied to the emissions stringency option considered at CAEP's fourth meeting (CAEP/4) (FESG, 1998).

A number of issues and uncertainties have arisen in the application of CBA to potential environmental issues affecting aviation:

. The absence of transparent cost data capable of independent validation (related to industry commercial confidentiality)
. The need to forecast over a sufficiently long appraisal period to reflect the gradual buildup of benefits from emissions stringency measures
. Scientific uncertainties regarding the impact of aviation emissions, leading to the use of estimated reductions in the amount of pollutant emitted as a surrogate measure for benefits
. Uncertainties about future trends in technology, underlying trends in traffic growth, and aircraft fleet mix. This uncertainty is illustrated by recently revised projections for fleet NOx emission index (EI) made by Boeing for 2015, showing more than a 50% increase from its previous estimate, caused primarily by reassessment of technology likely to be present in the 2015 fleet (Sutkus, 1997).

In addition, uncertainty has arisen regarding whether new worldwide standards for aircraft engine emissions would encourage additional local rules by airports and governments, leading to a reduction in the value of the existing aircraft fleet. Two studies reported in the economic analysis subgroup (EASG) report to CAEP/3 (EASG, 1995) concluded that emissions stringency options under consideration would lead to a reduction in existing aircraft fleet values for this reason. Some subsequent studies commissioned by the forecasting and economic support group (FESG) and included in its report to CAEP/4 found that the limited quantitative data available provide inconclusive evidence of any material impact on aircraft fleet values arising from an earlier change in the worldwide emissions stringency standard agreed at CAEP/2 for NOx (ICAO, 1998a).

CBA may have to be applied somewhat differently in the context of environmental levies. All environmental mitigation measures aim to internalize external costs, but environmental levies achieve this internalization more explicitly and to a greater degree. External costs arise where, for example, the cost of pollution from an economic activity does not accrue to the party responsible for it. Placing monetary values on external costs may eliminate the need for CBA, so the focus of economic analysis can be compliance costs, economic distortion, and the environmental effectiveness of alternatives. With aircraft emissions, however, the monetary value of these external costs is subject to a wide range of uncertainty, as discussed in Section 10.4.3. In these circumstances-and in particular under a regime of emissions targets introduced on the basis of the precautionary principle-CBA techniques will be necessary in providing assistance to decisionmakers on the most economically efficient means of meeting such targets.

10.3.3. Elasticity of Demand Considerations

The extent to which cost increases arising from environmental mitigation policies are passed on to consumers and affect demand for aviation services depends on elasticity of demand (the responsiveness of consumers to fare increases).

Evidence regarding fare elasticities is particularly relevant in considering the impact of environmental levies (charges or taxes) that directly increase the cost of air travel. If demand is relatively unresponsive to fare increases (i.e., price is inelastic), such measures will have little impact in reducing emissions through dampening of demand. Conversely, if passenger responsiveness is high (i.e., price is elastic), policy measures will have a greater impact. This analysis can be illustrated as follows: A fare elasticity of -0.5 would mean that a 10% increase in fares would result in a 5% reduction in traffic volume; a fare elasticity of -2.0 would mean that a 10% fare increase would reduce traffic by 20%.

Estimates of fare elasticities differ by journey purpose; leisure travel generally is significantly more price elastic than business travel. Fare elasticities also exhibit some regional variation; for example, studies show comparatively higher price elasticities in North America than in other regions of the world. A study commissioned by the U.S. Federal Aviation Administration (FAA) (U.S. Department of Transportation, 1995) reviewed more than 25 price elasticity studies and found that most presented elasticity of demand estimates in the range of -0.8 to -2.7.

Studies examining the effectiveness of environmental levies have had to make assumptions about the reaction of airlines and how the demand for air transport changes in response to a change in fare. Many commentators agree that in the long term, in addition to encouraging more energy-efficient technological alternatives, an increase in the price of fuel will lead to an increase in the cost of travel and consequent reduction in demand. However, airlines operate in a highly competitive environment, and in the short term many may absorb fare increases at a cost to profitability rather than pass them on to passengers.

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