Investments under non-stationarity: economic evaluation of adaptation pathways

Abstract

Investment decisions about capital-intensive, long-lived infrastructure are challenging due to uncertainty about their future performance, particularly if the performance is sensitive to climate change. Such investments, like those made for water infrastructure, are rarely evaluated over their total operational lifetime, during which socio-economic and environmental changes can cause potential lock-ins and reduced options for future choices that lead to high costs to transfer to other options. We propose an economic evaluation framework to explore adaptation pathways, or sequences of strategic investments options, that can be implemented if needed due to changing conditions. A novel feature is the inclusion of “transfer costs” associated with a switch to alternative pathways to allow adaptive decision-making and to minimize the cost of adjustment over time. Implementing a pathway-driven approach represents a break with most institutional decision-making processes and can significantly improve decision-making under uncertainty compared to the conventional single-investment perspective. We present a case study on flood risk management in the Netherlands to show the long-term socio-economic consequences of short-term decisions by going beyond the project cycle horizon.