The Economic Impacts of Critical Habitat Designation

submitted to the Subcommittee on Fisheries, Wildlife and Water

Committee on Environment and Public Works

U.S. Senate

April 10, 2003

Mr. Chairman and members of the subcommittee, I appreciate the opportunity to speak with you today about the economic impacts of critical habitat designation. I am a professor of natural resource economics at UC Berkeley, and my areas of interest include wetlands and endangered species policy, housing and land markets, and water resources.

For the past two years, I have worked with colleagues and students at Berkeley to understand the effects of environmental permitting on the process of urban growth and development. As part of this larger research program, I have had the opportunity to consider the effects of critical habitat designation, in particular its impact on the timing and intensity of development; the availability of housing, roads and other needed infrastructure; and the costs of designation to consumers, developers, landowners and other groups.

Critical habitat designation has numerous economic impacts, including the following:

Costs of completing a Section 7 consultation. Section 7 of the Endangered Species Act requires federal agencies to consult with the U.S. Fish & Wildlife Service to insure that any activity funded, carried out or authorized will not likely jeopardize the continued existence of the species. This requirement increases the cost to complete the project, and also imposes additional costs on federal agencies involved with the consultation. Sources of cost to the applicant include hiring outside consultants and attorneys to assist with the consultation process, and also the developer’s own staff resources.

Another direct cost of Section 7 consultation is that the Service may require additional mitigation above that required by the action agency. In the case of California vernal pools, for example, the USFWS required that three acres of vernal pools be created for every one filled over and above the baseline. Adding the costs of the Section 7 consultation to the costs of mitigation, the direct, out-of-pocket cost of Section 7 consultation can be substantial, running to several thousand dollars per house in the case of some single-family housing projects.

Costs of project modification. The Section 7 consultation process may also force project developers to redesign their project to avoid modification of certain areas deemed to be critical habitat. This project redesign typically reduces the output of the project. Again using the vernal pool case as an example, additional Section 7 conservation requirements consist of avoidance of 85.7 percent of vernal pools, a condition that allows only 14.3 percent of the project site to be developed. Project redesign imposes additional costs on developers and has other, potentially large, economic impacts that stem from the attendant reduction in output, particularly in areas like California that have a well-documented shortage of housing and urban infrastructure.

Increase in price and reduction in the availability of housing and other development. Because critical habitat designation increases the cost of development and reduces the level of project output, it has the potential to alter regional markets for housing, commercial space and other types of development. In particular, critical habitat designation can increase market prices for these goods and result in large losses to consumers.

Whether for homes, schools, or other activities, there are numerous physical and regulatory constraints on site selection. Accordingly, if critical habitat designation places some land off-limits to development, there are a limited number of comparable sites that can be developed to pick up the slack. While an area may appear to have an ample supply of developable land, in reality the development process is highly constrained. In such a setting, critical habitat designation can reduce the regional stock of housing and other goods, and prices of these goods will increase to establish new market equilibria.

Delay in completion of projects. Critical habitat designation can also delay completion of projects. Unlike the supply reduction effects just described, delay is a pure loss affecting both producers and consumers. Theoretical results suggest that in many cases delay can be the largest component of overall economic impact resulting from environmental regulation.

Delay affects project developers by pushing out project receipts further into the future. Delay affects consumers in that they must postpone the enjoyment of the project output. For example, if the project is to construct a school, then parents and children must wait to use the new facilities; if the project is to construct new homes, then homeowners must live temporarily in a less than optimal location, perhaps having to commute longer distances during this waiting period.

Economic losses borne primarily by consumers. The economic impacts of critical habitat designation are borne mainly by consumers. Cost increases can be passed on to consumers to some degree, and increases in market price of project outputs actually benefit producers.

A stylized example can help to provide some sense of the magnitude of impacts and their distribution across the affected population. Consider a 1,000-unit housing project to be built on 200 acres (an average of 5 homes per acre, including roads, open spaces and other infrastructure). The pre-regulation price of the homes in the project is $250,000, and the elasticity of demand for these homes is –1.67. The pre-regulation marginal cost of homes in the project is assumed to be a constant $200,000.

Suppose that some of the project is considered to be critical habitat; development is to be avoided in these areas and any habitat impacts mitigated by some ratio of the USFWS’ choosing. Suppose that the out-of-pocket cost to the developer of the Section 7 consultation, including the mitigation exaction, is $2,000 per home. Suppose also that critical habitat designation reduces the size of the project to a total of 900 units instead of the planned 1,000. Finally, suppose that critical habitat concerns delay completion of the project by two years.

Based on these figures, what are the economic impacts of critical habitat designation for this hypothetical project? Homes in the project are now more expensive to construct and there are fewer of them, so their market price will increase. Under the assumptions above, the price of a home in the project will increase from $250,000 to $265,000.

Consumers lose from critical habitat designation in three ways. Some are unable to purchase homes at all due to the reduction in the size of the project. Some do purchase homes, but at higher prices. And what consumption does occur is two years later than it would have been without the critical habitat designation. The impacts of permitting on developers (and landowners) are more complex. While producers gain from the increase in home prices, they lose from the increase in costs and from the delay in completing the project and receiving their return on investment.

Taking consumers and producers together, the total economic losses from critical habitat designation are $19.5 million for this project. This figure counts the cost of project delay, which amounts to $12.5 million, or over half of total losses. While permitting reduces the size of the project from 1,000 to 900 completed units (which results mainly in losses to consumers), both consumers and producers must wait an extra two years for these 900 units to be completed.

Several interesting conclusions emerge from this example:

· Critical habitat designation can be quite expensive. Total economic losses amount to nearly $20 million in the example, which implies costs of $1 million per acre of habitat conserved.

· Consumers bear the brunt of losses from critical habitat designation. They are unambiguously harmed by increases in price and reductions in the number of homes available for purchase. Developers and landowners fare better because they can pass on some costs to consumers and because they benefit from price increases.

· Traditional measures of the cost of regulation, namely the out-of-pocket cost of Section 7 consultation, are far off the mark. In this example, they understate true impacts by an order of magnitude.

Regional and indirect impacts: Is conservation good for the environment? Critical habitat designation is effectively an ad hoc tax on development that changes its intensity, location and timing. As such, critical habitat designation can literally change the shape of urban areas, and another class of economic impacts results.

A natural question to ask is whether, by limiting growth in certain areas, critical habitat designation pushes development to areas more distant from the city center, away from jobs, shopping areas, schools and other amenities. If the effect of critical habitat designation is to force relocation to areas further out on the urban fringe, there can be some important regional and indirect consequences of designation as well. For example, if critical habitat designation forces commuters to locate further from their jobs, then designation may increase traffic congestion and commute times, and may contribute to regional problems of sprawl and air pollution.

Impacts beyond the federal nexus. A common claim of the USFWS is that critical habitat designation only causes economic impacts in the presence of a federal nexus, that is if the activity in question is carried out with a federal permit or federal funding. While there is no definitive research on this topic, my work with developers, local government officials and others suggests that critical habitat designation has more far-reaching implications.

One concern is that development is subject to numerous regulatory processes carried out by federal, state and local authorities. If land is designated as critical habitat by the USFWS, this designation may affect the way the project is treated by other agencies through a “signaling” effect. At a conceptual level, this signaling effect is not surprising. Regulators operate under uncertainty and are generally risk-averse. A decision by an expert environmental agency like the USFWS raises concerns about potential environmental impacts of the project and will lead other permitting agencies to take a more conservative approach to it. From a practical point of view, this signaling effect means that the costs of critical habitat designation go beyond the cost and the outcome of the Section 7 consultation process.

Another concern is that designation of critical habitat can impose costs on developers even if their project is not on critical habitat at all. The USFWS defines critical habitat in such a way that some time and expense is needed to determine whether a parcel is actually included or not. For example, critical habitat is defined in terms of landscape features and some investigation is required to determine their presence or absence on a particular parcel. Again, the practical effect is for the costs of critical habitat designation to extend beyond the Section 7 process.