Equity over efficiency: a problem of credibility in scaling resource-based compensation? Scott G. Cole/ created by Scott G. Cole

Resource-based compensation aims to offset the public's welfare loss associated with environmental or resource injuries. Compensatory payments are frequently scaled using Equivalency Analysis (EA). EA's focus on ensuring equity in utility terms for the victim may lead to an inefficient outcome for society as it fails to incorporate the social opportunity cost of the compensatory payment. An alternative scaling approach based on Cost–Benefit Analysis (CBA) may better address the trade-offs facing society by considering the social marginal benefits of additional compensation, which may be a function of the cost of provision and the quality or quantity of existing resources. A simple numerical model illustrates differences in scaling approaches and underlying assumptions. In contrast to EA, CBA suggests that the optimal compensatory payment may be positive, zero or negative (i.e. additional damage should be allowed). EA need not lead to a decline in welfare if the environmental injury or the costs of compensation are marginal, or if policy makers have a particular welfare function in mind vis-a-vis the polluter. The lack of credible methods for pricing non-market resources may lead to a preference by policy makers for the equity-focused EA approach rather than one aiming for socially efficient outcomes. Both methods require inevitable value judgments to determine whether society is, in fact, ‘no worse off’ after compensation has been paid. EA seems in conflict with governments’ otherwise increasing, but still limited use of environmental CBA to direct scarce conservation resources – in this case, collected from the polluter on the public's behalf – to a variety of environmental challenges.