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What are the key design features that make payment for environmental services (PES) schemes effective?

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This paper seeks to answer the question, What are the key design features that make payment for environmental services (PES) schemes effective?

This paper seeks to answer the question, What are the key design features that make payment for environmental services (PES) schemes effective?

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  • 1. What are the key design features that make payment for environmental services (PES)schemes effective?Ashley L. CamhiDuke UniversityPublic Policy 501 1
  • 2. IntroductionPayment for environmental services (PES) has been touted as a successful market mechanism forconservation for over the past ten years and has become a much-researched topic (Engel et al,2008). As James Salzman observed in his keynote lecture at Pace Law School in 2010, thenumber of articles published in academic journals regarding environmental services hasgrownnearly one hundred fifty-fold since 1990 (Salzman, 2011). With increased focus on costeffective methods used to mitigate and adapt to climate change, the need to address the ever-growing threat ofwater scarcity, and the exponential reduction in critical biodiversity, PES hasbeen thrown into the limelight as a panacea; the popular policy toolof choice to value, protect,and restoreenvironmental services. Yet, despite the scholarly attention and rapid increase in PESprojects (approximately 172 projectsin 36 countries [Camhi, 2010]), there has beenlittleevaluation to demonstrate that these PES schemes are actually effective.This paper establishes a list ofcriteria that contribute to the effectiveness of a PES scheme.Effectiveness is defined as the ability of a PES scheme to produce an environmental service.According to the Millennium Ecosystem Assessment, environmental servicesare the benefitshumans obtain from ecosystems.These are broken down into four types of services:(1)supporting services such as soil formation, photosynthesis, and nutrient cycling;(2) provisioning services such as food, water, and fiber; (3) regulating services that affect climateregulation, water quality, and water quantity; and (4) cultural services that provide recreational,spiritual, and aesthetic benefits (Millennium Ecosystem Assessment, 2005).Based on rigorous literature review, field studies, and personalexperience,eightcharacteristicshave been determined. These eight criteria have been grouped intothree categories:1. Contracts provide incentives that are likely to result in compliance.a) Existence of a monitoring system for compliance;b) Tenure security is present;c) Payments go to those providing services;d) The time horizon of payments must be comparable to the project time horizon;e) Payments are contingent on performance;f) Payment level is adequate for land use change;2. Contracts are written in a way so as to ensure that if the agent complies, additional 2
  • 3. environmental services will be produced.g) Existence of a monitoring system to verify the provision of environmental services; and3. Administrative costs of contracting, monitoring, and enforcement are reasonable.h) Low transaction costs.Four PES schemes have been chosentodemonstrate the usefulness of a PES effectiveness list.These include: (1) Germany‟s conservation procurement auction; 2) Costa Rica‟s national PESprogram; (3) Coopeagri, a reforestation project in Costa Rica that is implemented outside theauspices of the national program;and 4) New York City‟s watershed. The eight criteria for eachcase study are rated on a scale of 0-4: 0 if the criteria are not present in the PES scheme, 1 if theyare minimally present, 2 if there is moderate presence, and 3 if there is significant presence. Ahigh score on all eight dimensions indicates that the PES scheme is likely to be effective (ie.produces the desired environmental services). By analyzing these four cases utilizingthe list foreffective of a PES scheme, lessons can be drawn that are informative for the future design of PESschemes as well as the evaluation of current schemes. This paper concludes with preliminaryobservations that can be drawn from the utilization of the PES listto determine effectiveness.PES as an Incentive MechanismPESis a market-based policy tool for conservation established on the principle that those whobenefit from environmental services should pay for them, and those who contribute to generatingthese services should be compensated for providing them (Engel et al, 2008; Pagiola and Platais,2007; Wunder, 2005). The main characteristics of a PES mechanism are that it is(1) A voluntary transaction where(2) awell-defined environmental service (or land use likely to secure that service)(3) is being bought by a (minimum of one) service buyer(4) from a (minimum ofone) service provider(5) if and only if the service provider secures service provision (conditionality) (Wunder, 2005).PES alters an individual‟s actions by compensating him or her for making appropriate land usedecisions that are linked to environmental service provisions. Climate regulation, water quality,water quantity, andecosystem integrityare the traditional services that have been valued in PES.There is a wide range of activities that could lead to the creation, preservation, or maintenance ofenvironmental services. In a particular watershed these could be reforestation, avoided 3
  • 4. deforestation, agroforestry, natural regeneration, and/or silvopastoral systems. The results lead tocollective outcomes: reduction of carbon dioxide (CO2) emissions in the atmosphere, reduction ofsedimentation, regularity of water flow, water source protection, reduction of contamination, orprotection of critical species and their habitats. These outcomes are not mutually exclusive.Traditional conservation activities have focused on command-and-control regulation. Yet, it hasbeen shown that institutional weaknesses in developing countries tend to prohibit theeffectiveness of such programs. The provision of environmental services has been mostsuccessfully accomplished through market-based mechanisms. Incentive-based policies addressexternalities by altering the economic incentives private actors face, while allowing those actorsto decide whether and how much to change their behavior. Most incentive-based mechanismshave been initiated through public policies, although privately negotiated incentive-basedsolutions are possible. Incentive-based mechanisms include charges, subsidies, tradable permits,and market friction reduction (Jack et al, 2007). As an incentive-based mechanism, PES is seen asa policy solution for realigning private and social benefits resulting from decisions related to theenvironment (Jack et al, 2007).The Economic Backbone of PESThe failure to assign values to environmental services is a market failure. Dating at least as farback as Pigou (1920), economic theory suggests that some form of subsidy from the beneficiaries(buyers) of environmental services to the providers (sellers) of these services could result in anoptimal supply. Experience has shown that command-and-control institutions are not sufficient toregulate non-point sources of pollution, such as those occurring when downstream waterpollution or water scarcity are the result of a combination of individual actions carried out bygeographically disparate and heterogeneous upstream economic agents (Kosoy et al, 2007).PES is an example of an incentive mechanism intended to internalize externalities. An externalityas defined by Hindriks and Myles (2006) is present whenever some economic agent‟s welfare isdirectly affected by the action of another agent in the economy. These authors posit that if thereare competitive markets for externalities, efficiency will be achieved. In accord, Coase believedthat in a competitive economy with complete information and zero transaction costs, theallocation of resources would be efficient with respect to legal rules of entitlement. According toHindriks and Myles, the implication of the Coase theorem is that there is no need for policyintervention with regard to externalities except to ensure that property rights are clearly defined. 4
  • 5. Where they are, the theorem presumes that those affected by an externality will find it in theirmutual interest to reach private agreements with those causing the externality to eliminate anymarket failure (Hindriks and Myles, 2006).Complete information and zero transaction costs will almost never occur in PES. Nevertheless, itis still possible to design PES schemes that work towards the valuation of environmental servicesin the market, though their efficiency and efficacy should be evaluated on a case-by-case basis.Four Case StudiesThis section is designed to provide the reader with a brief understanding of the four-abovementioned case studies in preparation for the analysis of the effectiveness list.Germany’s conservation procurement auctionThis PES scheme was established in Northeim in Lower Saxony of Germany in 2007. The pilotregion is dominated by farms and canbe regarded as a typical agricultural region ofWesternEurope. Regional stakeholders allocated the availablebudget towards the conservation ofarable plant diversityand the associated environmental services on conventionallymanaged fields.Farmers received payments for their arable fields only if aconservation threshold of ten differentarable plant speciesassessed in plots of 100 m2 was achieved. Two conservation procurementauctions with a total budget of €50,000 were conducted. Thefirst auction was carried out in 2007-2008 with 12 farmers participating and submitting 26 bids;and the second auctionin 2008-2009with 11 farmers submitting 48 bids and 7 farmers participating with 30 bids.Within each auction,farmers submitted a sealed bid by mail with a corresponding bid price per hectarefor the deliveryof the environmental service on their fields. Bid prices were accepted from the lowest bidupwardsuntil the budget was exhausted.Paymentswere made annually immediately after thecompliancemonitoringof participating fields (Ulber et al, 2011).Costa Rica’s national PES programThe National Institute of Biodiversity (Instituto Nacional de Biodiversidad, INE) of Costa Ricaestablished the first nationwide PES program (Pagos por ServiciosAmbientales, PSA) in 1997.The PSA program is operated by the National Fund for Forest Financing, (Fondo Nacional deFinanciamiento Forestal, FONAFIFO).The PSA program compensateslandowners for valuecreated by either planted or naturalforest on their land and recognized four services: carbondioxide mitigation, hydrological services, biodiversity, and scenic beauty. The program‟s primary 5
  • 6. focus has been on forest conservation, which accounts for approximately 95% of the enrolled area(Pagiola, 2008). The PSA program is financed primarily by an earmarked portion of fuel taxrevenues, which provides about US$ 12–13 million a year, and to a smaller extent by voluntaryagreements with individual water users who are paying to conserve their watersheds (generatingabout US$ 0.5 million a year) (Zhang and Pagiola, 2011).The PSA program currently coversapproximately 275,000 ha of land.Analysis of PSA within the PES list will be restricted to the first phase of the program since thatis where the largest body of information exists to date. Payments in the first phase of the programwere designed to addressrelevant forest conservation failures from a legal andinstitutionalstandpoint. Three types of contracts were part of the first phaseof the PSA program:forest conservation, reforestation,and sustainable forest management. Forestconservationcontracts required landowners to protect existing (primaryor secondary) forest for 5years, with no land coverchange allowed. Reforestation contracts bound owners toplant trees onagricultural or other abandoned land andto maintain that plantation for 15 years. Sustainableforestmanagement contracts compensatedlandowners who prepared a sustainable loggingplan toconduct low-intensity logging while keepingforest services intact. Just as in the reforestationcontracts,obligations for sustainable forest management contractswere for 15 years, althoughpayments arrived during thefirst 5 years (Sanchez et al, 2007).Coopeagri Forestry Project is a PESschemeinitiated in 2006 that was funded through theBioCarbon Fund1 and is located in the Perez Zeledon County of San José Province, Costa Rica. Thescheme‟s initial objective was to sequester 588,565 tons of CO2by reforesting 4,140 ha of privatelyowned lands (World Bank, 2006). At project start, these lands were being used for pasture and forcrops, primarily coffee and sugarcane. The BioCarbon Fund was to purchase the Certified EmissionReductions (CERs) at US$4.15 per ton of CO2 sequestered until 2017, providing an estimated 65percent of total project cost. Afforestation/reforestation activities were projected to occur over thefirst 3 years of the project, including natural regeneration of 3,600 ha of pasture lands, establishmentof forest plantations on 300 ha, and conversion of 450 ha of crop and pasture lands to agroforestrysystems (planting 180,000 trees). At least 150 small and medium size farmers were expected toparticipate in project activities; there are currently 143 farmers participating.1 Part of the World Bank‟s carbon financing is the BioCarbon Fund. It acts as a mediator between companies and countries that donated funds towards reducing greenhouse gas emissions and pilot projects that received the funds upon validation of reducing GHG emissions by the UNFCCC. 6
  • 7. New York City’s watershed is perhaps the oldest and best example of a PES scheme. New York City (NYC) is a surface water system that gathers its water from three watersheds that cover an area of 2,000square miles. The watershed serves 9 million people, half the population of the state of New York. It delivers 1.1 billion gallons per day and is operated and maintained by the NYC Department of Environmental Protection (DEP) (Appleton, 2002).A major component of the institutional framework of the NYC water is that the NYC DEPhas the responsibility for management of the water and sewer system.In 1986, outbreaks of Giardia and microbacteria led to the implementation of the American Drinking Water law. This is the point at which the connection was made linking farming with the environment in order to promote environmental stewardship as an economic activity. The desire of farmers and others to maintain their ways of life (i.e., not sell their land) was the ultimate driver of the program. The city abandoned the “traditional” way to deal with water (i.e. water filtration plant) and bypassed desires to utilize regulation to address water providers. Whole farm planning was instituted in order to look at the environmental and business aspects of the farmers in the NYC watershed. The plan was to invest in the long-term agriculture industry as opposed to income support, which fostered a landscape based economy. NYC paid the capital costs for the farms, a small annual stipend for employment, and expanded the sustainable tourism and forestry industries as part of the agreements with the communities of the Catskills watershed. Thus, New York was able to avoid the enormous expenseof building filtration works to treat and purify its drinking water. Eight Characteristics to Determine theEffectiveness of PES Schemes Numerous articles have analyzed individual PES schemes to demonstrate whether the schemes achieved cost effectiveness and compliance. Based on these analyses, economic theory on externalities, and field base evidence, eight criteria (as enumerated in the introduction) have been designatedto determine the effectiveness of PES schemes.The criteria for each case study are rated on a scale of 0-4, 0 if the criteria are not present in the PES scheme, 1 if they are minimally present, 2 if there is moderate presence, and 3 if there is significant presence. Figure 1. PES Effectiveness List for Four Case Studies Time horizon Existence of payments Existence of of Payments go must be Payment level monitoring monitoring Tenure to those comparable to Payments are is adequate for provision of Low Score system for security is providing the project contingent on land use environmental transaction compliance present services time horizon performance change services costsGermany 3 3 3 3 3 3 2 3 23 7
  • 8. Costa Rica PSA 2 3 2 3 3 2 1 1 17Coopeagri 3 2 1 1 3 1 1 1 13New York City 3 2 3 3 3 3 3 1 21 1. Contracts provide incentives that are likely to result in compliance. a) Existence of a monitoring system for compliance. While it seems obvious that monitoring should be incorporated into the design and implementation of a PES scheme, it is often neglected due to lack of funding or experience in designing an appropriate monitoring system. There are two types of monitoring that are necessary for a PES scheme: 1) compliance and 2) verification of environmental service provisions. The former is an output-based system that ensures that the sellers are fulfilling their contractual obligation to modify their land uses. The latter is an outcome-based system that certifies environmental services are actually being created. Output-based monitoring is significantly easier to establish than outcome-based monitoring since the valuation of environmental services is still a contentious issue that needs further research. The goal of PES is to make privately unprofitable but socially desirable practicesbecome profitable to individual land users, thus leading to their adoption (Engel et al, 2008). This target dictates that compliance must be ensured through site inspection and sometimes combined with remote-sensing satellite images. Yet, while a compliance monitoring system may be sufficient, it does not guarantee that service providers are actually complying since monitoring quality or frequency is not often known. It is possible that hidden action may arise after a contract has been negotiated.That is, the conservation agent may find monitoring contract compliance expensive, andsanctioning noncompliance politically costly, and will thus fail to enforce the contract. Under such conditions, the landowner has an incentive to breach contractualresponsibilities. In most case studies the primarysanction for noncompliance is the loss of future payments rather than the return of past payments. In addition, monitoring quality typically varies over time, anddepends on funding and politics (Pattanayak et al, 2010). Germany (Score: 3) – Compliance monitoring was an integral component of the German conservation procurement auctions. To verify whether the contracted farmers complied, plots of 100 m2were locatedrandomly in each field by the conservation agency.Monitoring was conducted at the end of the contract period of each of the two auctions. Monitoring of participating fields 8
  • 9. revealed that 73%and 90% of the bids were successful in achieving the defined compliancethreshold in the first and second auction, respectively (Ulber et al, 2011).Costa Rica PSA (Score: 2) – Compliance monitoring is undertaken by FONAFIFO, who haslimited staff with which to supervise allPSA activities. FONAFIFO utilizes a database to trackcompliance. Once applicants have submitted land use plans to FONAFIFO and they have beenapproved, landowners begin adopting specified practices and receive payments. Theinitialpayment can be requested at contract signing, but subsequent annual payments are madeafterverification of compliance by inspectors. Noncomplyingparticipants forfeit further payments.Coopeagri (Score: 3)– In this case study compliance monitoring was conducted on an annualbasis by the five forestry specialists of the Coopeagri cooperative. Since the project was limited toone region within Costa Rica, it was determined to be less challenging to monitor than thenational PSA program. That being said, forestry specialists expressed concerns that they faceddifficulties in reaching participants that lived in isolated areas of the Brunca region.New York City (Score: 3) – While the DEP is the enforcement agency for the NYC watershed, itrelies heavily on local and community NGOs to monitor for compliance on farms. This has beenextremely effective since local extension agents are able to build a critical level of trust with locallandholders that permits them to do effective compliance monitoring. Each property in the wholefarm planning program is monitored twice annually. This includes one aerial monitoring,photographing of the property, and one land-based inspection with the landowner to discuss anychanges that may have occurred since the last visit (NYC Watershed Monitoring website, 2011).b) Tenure security is present.Cooter and Ulen (2011) define property as a bundle of rights. Some form of property rights in theform of land tenure is necessary for PES schemes. This is more often an issue in developingcountries, where rights to land are tenuous. The issues of land tenure are not new. It has beenrecognized for decades to be a significant constraint to tree cultivation among small landholders(Thacher et al, 1997).Many studies have highlighted the importance of land and tree tenure forpromoting long-term investments and activities such as adoption of agroforestry systems andprogram participation (Godoy, 1992). 9
  • 10. Germany (Score: 3)– Tenure rights were not an issue in this case study.Costa Rica PSA (Score: 3) – Legal land title was required in all three PSA program modalities. Inorderto participate in the PSA program landowners alsohad to present a sustainable forestmanagement plan preparedby a licensed forester. These plans described the proposed land useand includedinformation on land tenure and physical access; topography, soils, climate, drainage,actual landuse, and carrying capacity with respect to land use; plans for preventing forest fires,illegalhunting, and illegal harvesting; and monitoring schedule (Pagiola, 2008).Zbinden and Leeconducted a study in 2002 of 133 farmers participating in the national PSA program and 141 non-participants in the northern lowlands of Costa Rica. Discussions with landowners suggested thatland tenure and legal land title were critical to participation. Any PSA contract creates a legaleasement that remainswith the property if it is sold. For carbon sequestration, owners transferrights to the CO2mitigation potential of the parcel to thenational government. Costa Rica can thensell these abatementunits on any international market.Coopeagri (Score: 2)– In the Coopeagri case study, adherence to the requirement of land tenuresecurity was taken through satellite imagery at the regional level. It has been stated that land titlesand property boundaries were verified, but no data exists on land title eligibility at the parcellevel. Farmers often had land titles where the boundaries overlapped with their neighbors. Thosethat were not able to have those clarified in court were rejected from the applicant pool of theproject. Land tenure was demonstrated to be the greatest constraint in the regeneration modality.42 percent of project applicants were lost due to lack of land title. In the regeneration modalityfarmers without land title were initially allowed to apply and then were not allowed to participate.The highest number of losses for reforestation applications was from discrepancies in land title.In addition, 12 percent of applicants to the reforestation modality had discrepancies in land title.The acceptance of farmers with sole land possession would have gone a long way to increase thenumber of farmers that participated in the regeneration modality (Camhi and Pagiola, 2009).New York City (Score: 2)– In 1905, NY State gave NYC the authority to regulate land outside ofits borders based on state health law. This unique situation gave NYC the ability to acquire landto show that they were protecting the watershed for the long term. In 1965, eminent domain wasone of the main tactics used to free up land to create reservoirs in the Catskills. This created apoor relationship with upstream residents for many years, but it did allow NYC to have greatercontrol of land use.Currently, the NYC owns about 30% of the land in the watershed. 10
  • 11. c) Payments go to those providing services.What is drawn into question under this criterion is whether or not land uses paid for under a PESscheme would exist in the absence of a payment. This is called additionality. Simply put, if thiscannot be proven then there is no need for a payment. Additionality would lead to a financiallyinefficient outcome as funds could have been used elsewhere and transaction costs would beunnecessarily incurred. PES programs that offer low, undifferentiated payments are particularlylikely to experience this problem (Engel et al, 2008). What is implicit in this criterion is the linkbetween land use change and the provision of environmental services.Germany (Score: 3)- A recent paper by Ulber et al. (2011) demonstrates that arable plant diversity(i.e. specific weed species) has the potential to provide multiple environmental services (Ulber,2011). In this study, arable fields that were participating in the PES scheme were matched withcontrol fields that were not enrolled. The two groups of fields were matched on the basis of theirsimilar shape, size, soil, and landscape. In the first auction, a total of 45 and 26 differentarableplant species were detected on the surveyed PESand control fields respectively.Farmersreceived payments for their arable fields only if aconservation threshold of ten different arableplant speciesassessed in plots of 100 m2 was achieved. This threshold was established based onexpert knowledge from regional stakeholders.Costa Rica PSA (Score: 2) - Particularly in the case of forest protection it has been shownthrough a rigorous impact evaluation conducted by Sanchez et al (2007) that the 1997-2000deforestation rate was not significantly lower in areas that received payments. It is thought thatpolicies that were previously in place prior to the inception of the PSA may explain the reductionin deforestation rates. The Sanchez et al study concluded that PSA contracts might not havetargeteddeforestation pressure explicitly. In fact, the PSAcontracts may have been targeted wherethere was a lackof deforestation pressure because the level of PSA contractscorrelated negativelywith the 1986–1997 forestclearing. This could have resulted from a policy designin which thePSA contracts were fixed across space (i.e.,each of the locations in the country is assumed toprovidethe same services and is offered the same level of paymentper hectare) and enrollmentwas voluntary. Targeting these kinds of lands could lead to unprofitableor low-profit land beingthe dominant land participants enrolled in the program. While the estimated impact of PSA onforest cover is small, it is possible that theprogram has a larger impact on forest quality byencouraging better management andprotection of forests. 11
  • 12. Coopeagri (Score: 1)This was an extremely contentious issue for the Coopeagri project due to thefact that the participants received the same payment as they would have had they participated inthe national PSA program. Without clear proof of additionality on the basis of barriers toimplementation or carbon finance being economically unattractive, the emissions reductionscreated through this project will not be validated. The designers of the Coopeagri project arguethat this particular region of Costa Rica had traditionally low levels of participation in the PSAprogram and would not have participated without the additional work done by forestry specialistsof Coopeagri to inform them and assist them in the application process.New York City (Score: 3)– Given the history of the NYC watershed, it is clear that farmers wouldnot have participated in a whole farm planning program without the introduction of in kindcontributions. In this program, farmers received technical assistance and environmentalinfrastructure development, such as efficient septic tanks. Altogether, NYC provided US$ 60million to assistin the economic development of the NY state region. There was a clear shift infarmers‟ attitudes and behaviors that continue to allow NYC water to remain unfiltered.d) The time horizon of payments must be comparable to the project time horizon.Whether payments are front-loaded or distributed throughout the duration of the project can affectthe participation rate of a PES scheme. It is important to look at the distinction between no landuse change (forest protection) and a land use management change. Where there is no land usechange, there is no need for a front loaded payment since the opportunity cost is simply that ofnot cutting down the trees. The farmer may be actually saving money if he or she does not need totake the time to cut the trees down. On the other hand, if a farmer needs to clear his land, buyseeds, put up a fence, etc. then there is little incentive to invest without a front loaded payment,even if the revenue he or she would receive in the future would exceed the money that heoriginally invested. Risk of not receiving the payment also plays a large role when looking at thetime horizon of a PES scheme. Hindricks and Myles (2006) demonstrate that because externalityeffects will generally be different, payments need to be differentiated in order to achieveefficiency. Whether PES schemes are set up with differentiated payment streams or a uniformpayment for land use changes can greatly impact the success of a PES scheme.Germany (Score: 3)– Payments in this PES scheme were made annually immediately aftercompliance monitoring of participating fields. The PES scheme was limited to one-yearconservation contracts. Since there was no land use change, there would have been no need to 12
  • 13. front load payments. This was clearly effective since most of the farmers who participated in thefirst auction enrolled substantially more land in the section auction.Costa Rica PSA (Score: 3) – Within the PSA program, forest conservation contracts provide forequal annual payments over the five-yearlifetime of the contract. These contracts are renewable bymutual agreement. In contrast, timberplantation contracts front-load most of the payment into theearly years of the contract: 50% ofthe payment is paid in the first year, 20% in the second year, 15%in the third, 10% in the fourth,and 5% in the fifth. These contracts call for participants to continuewith the agreed land use for15 years, a restriction that is written into the land title so that it transfersto the new buyer shouldthe land be sold (Pagiola, 2008). The time frame of these payments is muchlonger than those of the other identified PES schemes.Coopeagri (Score: 1) Adoption of agroforestry and reforestation in the Coopeagri project werelimited due to high initial costs and a long wait for benefits that made adoption only marginallyattractive to farmers. It is difficult to get farmers to participate when the payments are receivedafter the establishment of the project. This is a critical issue in terms of who bears the risk. Manyfarmers needed funds in advance to purchase supplies, clear the land, hire labor, etc. Unless thefarmer already had another large source of funding, lack of initial funding was prohibitive toparticipation.New York City (Score: 3) - It took seven years to come to an agreement with environmentalists,regulators, the city, farmers, etc. Despite numerous challenges to the initiation of the NYCwatershed program, participation remains high and there has been little backlash on the level andduration of the payments.e) Payments are contingent on performance.Conditionality is one of the main tenets of a PES scheme. Without conditioning payments onwhether sellers are actually “performing” there is no incentive for sellers to actually change theirland uses. Payments should also be contingent on users accepting the services, so that they woulddecide not to pay if they are not receiving the service as designated in the contract. This isappropriate on the level of the institution, company, or agency that is often the intermediarybetween the providers and the direct users. The rationale for a PES approach is that therecipientsof the services have some measurable value or willingnessto pay for those services. However, 13
  • 14. converting that latentdemand into funding that reaches the suppliers of environmentalservices is acentral challenge of PES schemes (Jack et al, 2007).Germany (Score: 3) – Performance in the German conservation procurement auctions wasdefined as a conservation threshold of ten different arable species assessed in plots of 100 m2.Payments were clearly contingent on performance. As soon as monitoring was completed farmerswere informed as to whether they had met the requirement or not. Only those who completelycomplied received their stated bid price. Here the third party conservation agency, considered the“user,” was responsible for deciding if farmers were compliant in achieving the conservationthreshold.Costa Rica PSA (Score: 3) – Landowners must have a land management plan approved byFONAFIFO. Once their plans have beenapproved, landowners begin adopting the specifiedpractices, and receive payments. The initialpayment can be requested at contract signing, butsubsequent annual payments are made after verification of compliance by regulators. There is aclear compliance contract in existence for those who participate in the PSA program.Coopeagri (Score: 3) – For the Coopeagri project, payment contingency was decided on anannual basis upon conclusion of compliance monitoring. Here Coopeagri acts as the “user” andrepresents global citizens who are receiving the benefits of the reduced CO2 emissions.New York City (Score: 3) – For the NYC watershed New York City, payments were contingenton compliance with contracts designated by the farmers and the local extension agencies.Failureto comply resulted in non-payment and farmers had the opportunity to adjust contracts on anannual basis.f) Payment level is adequate for land use change.The payment needs to be greater than the opportunity cost of the farmer, but not so much largerthat the environmental service is being overvalued. Opportunity costs of conservation are thoseassociated with the benefit foregone from alternative land activities (Wunder et al, 2008). While itis necessary that sellers perform specified activities there will be no buy-in to the PES scheme ifvaluations are incorrect. Landholders have better information than the buyer about theopportunity costs of supplying environmental services. As is well known, hidden information canlead to inefficient equilibria (Pattanayak et al, 2010). Opportunity costs are not static (they are 14
  • 15. subject to changes in the market, weather, etc.) and the adequacy of payment levels is likely tochange and difficult to assess.Germany (Score: 2) – Opportunity costs ranged quite extensively in this PES scheme and weremainly associated with reduced crop yields on PESfields, which accounted for 65% of overallopportunity costsand also differed widely among farmers. Mean variable costs were higher onPES fields and made up 28% of the total opportunity costs. Onone hand, farmers were able toreduce costs for fertilizerson PES fields, which might have partially offset the increaseinopportunity costs generated by lower yields. On the otherhand, variable costs for plant protectionproducts were higheron fields participating in the scheme. Farmers‟ bid prices submitted in thefirst auction generallyexceeded the estimated opportunity costs. Inaddition, there was nosignificant relationship betweenopportunity costs and bid prices. This demonstrates that while thepayment level may have been adequate for the seller, it may have not been what a buyer had beenwilling to pay if the conservation agency had set a bid price. It is possible that overbidding couldhave made the conservation auctions more expensive than a uniform-price PES scheme.Costa Rica PSA (Score: 2)- The PSA program has to compete with other land usereturns.Average returns from PSA vary from US$22 toUS$42/ha/year before fencing, tree planting, andcertificationcosts. The main competing land use is cattle ranching,which shows returns fromUS$8 to US$125, dependingon location, land type, and ranching practices. One measure of cattle-ranching returnsis the cost of renting 1 ha of pasture. In Cordillera Central,in the heart of CostaRica, pasture rental rangesfromUS$20 to US$30/ha/year (Sanchez et al, 2007). It is difficult toderive the opportunity costs for all of the individuals that participate in the PSA program.Coopeagri (Score: 1) – The Coopeagri project fell short of its goals. Reforestation has only achieved54 percent of its target, while regeneration has only achieved 16 percent of its target. Agroforestryhas done the best, achieving 77 percent of its target. From the survey conducted of non-participantsit is apparent that 22 percent of responses were related to issues of funding (lack of financing;project not being as profitable as other options; and insufficient payments). This response iscorroborated by the low number of applicants to the regeneration modality. Once charges werededucted the payments offered were insufficient to make adoption profitable for farmers. Even withpayments, natural regeneration would incur a net loss of US$70/ha. That any regeneration occurredat all is due to heterogeneity among farmers: only farmers whose opportunity costs were below 15
  • 16. average (because of particularly poor or degraded soils, or because of isolation, for example) werelikely to find the offered payments attractive enough to allow regeneration to occur.New York City (Score: 3) - In its entirety, NYC spent US$ 500 million and saved 5 billion inwater conservation. Payments were deemed adequate for the appropriate services or land usechanges decided on by the local extension agencies and the farmers.2. Contracts are written in a way so as to ensure that if the agent complies, additionalenvironmental services will be produced.g) Existence of a monitoring system to verify the provision of environmental services.This criterion is perhaps the most challenging to achieve. To date monitoring of the provision ofenvironmental services is largely nonexistent. In addition, there has been little data shown tocorroborate that farmers‟ compliance with a particular land use change necessarily indicates thatthe environmental services are being provided. Pattanayak et al. point out that PES programs caninduce land use changes without necessarily improving the provision of environmental services,as the biophysical links between land use and services are complex for services such as regulationof water flows (Vincent, 2010). In order to prove that environmental services are actually beingprovided, this criterion is critical and, as mentioned, often not included in PES design for lack ofinformation on how to value local environmental services.Germany (Score: 2) – This case study monitored the provision of environment services by thechange in the number of ten critical weed species. In the first auction, a total of 45 and 26different arableplant species were detected on the surveyed paired PESand control fields.Compared to the control fields, plantspecies richness was almost three times higher on PESfields.Interviews with farmers revealed that this difference was mainly attributableto reducedinput of fertilizer and broad-spectrum herbicideson PES fields (Ulber, 2011). The environmentalservices provided by the biodiversity (i.e. pollination, water purification, nutrient cycling,etc.)were not actually measured in this study. It is just assumed that there is an improvement as aresult of increased weed species. Just as importantly, this scheme did not take into account thepotential difference in ecological quality of environmental services provided on different lands.Costa Rica PSA (Score: 1) – It is impossible to determine the extent to which the PSA programhas successfully generated environmental services since the program remains weak in monitoringits effectiveness in generating desired environmental services (Pagiola, 2008). That being said, 16
  • 17. some limited research has been done on the valuation of these provisions. Tattenbach et al. (2006)found that 35% ofthe area under forest conservation contracts are in watersheds with downstreamsurface waterusers. Using their estimates of avoided deforestation, they established that 644million m3/year of waterfor consumptive uses and 7,224 million m3/year of water for hydropowerproduction are being protected from deterioration in quality. Thus a substantial part of theprogram‟s resources was spent in areas where few water services were likely to be generated.Tattenbach et al. (2006) also estimated that the PSA program prevented the loss of 72,000 ha offorests in biodiversity priority areas between 1999 and 2005. Agroforestry also appears to have asignificant impact on biodiversity in agricultural landscapes. The number ofobserved diversity ofbird species, as well as the number of individuals, is higher in land useswith trees, and higher yetwhen the tree density is higher. With regard to carbon sequestration, Tattenbach et al. (2006)useda model of avoided deforestation and anestimate of 100 tons carbon/ha, to estimate that thePSA program avoided the emission of 11 million tons of carbon between 1999 and 2005. Whilethis information is a step in the right direction, much more rigorous monitoring and investment inknowledge towards the creation of environmental services is still needed.Coopeagri (Score: 1) – For the purposes of this project, the reduction of CO2 was estimated at thestart of the project and the growth of trees was monitored periodically by forestry specialists ofCoopeagri. Since there is limited data available on the levels of CO2 sequestration by native treespecies, farmers were constrained to plant non-native species which some considered as invasive.Biodiversity and water services were not monitored.New York City (Score: 3) – Water quality and quantity is measured by the DEP daily. The NYCDEP performs more than 900 tests daily, 27,000 monthly, and 330,000 on an annual basis fromup to 1,000 sampling locations throughout New York City. This work is in addition to 230,000tests performed in the watershed (NYC Drinking Water website, 2011). The City has beenmonitoring for major forms of bacteria since 1992 as part of its comprehensive watershedmonitoring program. Over 1,000 routine samples are analyzed each year from nearly 100 sites.Samples are collected weekly from the Catskill and Croton effluents. Reservoir levels areprimarily determined by the balance between streamflow into the reservoirs, diversions for watersupply, and releases to maintain appropriate flows in the rivers below the dams.3. Administrative costs of contracting, monitoring, and enforcement are reasonable.h) Low transaction costs. 17
  • 18. To accurately assess the cost of aPES scheme, transaction costs must be included. Coase used theterm “transaction costs” to encompass all of the impediments to bargaining (Cooter and Ulen,2003). Transaction costs include the expense of negotiating contracts, performing scientificbaseline studies, and monitoring and enforcement.Implementation,monitoring, and enforcementcosts can be high underincentive-based approaches if contracts are tailoredto individual users. Allelse being equal, contracting andmonitoring are cheaper when the number of agents is small. It ispossible,however, that working with an intermediary such as anNGO or a community couldreduce the costs of working with alarge number of providers(Kelsey et al, 2007).Germany (Score: 3) – One might argue that in this case transaction costs were relatively low sinceno bargaining occurred. The buyer of the biodiversity services, the conservation agency, did notprovide a price level for what they were willing to accept. Bids were accepted from lowest tohighest until the budget was expended. In addition, no attempts to weight the values of theenvironmental services were made. Monitoring of compliance was conducted at the end of eachone-year contract period and bids were submitted from farmers minimizing contractual costs.Some costs incurred by the conservation agency accrued from having to provide informationalsessions prior to the auctions, but these remained minimal.Costa Rica PSA (Score: 1) – The PSA program is considered to have high transaction costs inrelation to site-level PES schemes. FONAFIFO as a government agency is in charge of handlingapplications, signing contracts, and monitoring implementation for the PSA program.International organizations, primarily the World Bank, have provided substantial loans to CostaRica to maintain the PSA program. A $32.6 million loan in 2000 was designed to support currentPSA contracts. $3 million of that was intended to increase human, administrative, and monitoringcapacity in the various institutions associated with the program. In addition the net value ofpayments are lower than their face value, since landowners must pay for the initial managementplan and monitoring; these fees are about 15%of payments. Complying with the provisions ofmanagement plans further reduces the net value of payments. The PSAprogram initially imposedvery high transaction costs on participants, requiring applicants to fulfilleleven separate demands,many of which (such as providing proof of payment of local taxesand being unburdened by debtto the national health system) had nothing to do with their abilityto provide environmentalservices. 18
  • 19. Coopeagri (Score: 1) – The cost of project implementation during the first 20 years of theCoopeagri project is estimated as US$ 4.140 million. FONAFIFO was to cover US$0.739 million,Coopeagriwould cover US$0.120 million, and the remaining US$3.281 million would come fromcarbon credits sales, at least US$2.207 million of which were coming from the World BankBioCarbon Fund (World Bank, 2006). The carbon credits value represents 51.6% of the projectcosts; therefore FONAFIFO and Coopeagriwould have to invest additional funds in the project topay for the other environmental services – biodiversity protection, water protection, soil protectionand scenic beauty generated by the forestry activities (Camhi and Pagiola, 2009). Afteradministrative costs have been deducted from the aforementioned organization, nearly 79% of thetotal costs are estimated to go to the farmers participating in the project.The majority of preparatorycosts incurred were fixed costs. 21 percent of the individual contracts were from farmers that hadalready submitted contracts for other project modalities. Since a farmer had to submit an applicationfor each project modality and for each farm that he or she owned, this led to the creation ofunnecessarily high transaction costs.New York City (Score: 1) – Transaction costs occur in relation to monitoring; landownerrelations; recordkeeping; processing landowner notices, reserved rights requests for approvals,and amendment requests; managing stewardship funds; enforcement and legal defense (NYCwater website). Transactions costs are likely to be high due to the multitude of buyers, sellers, andactivities that constitute the PES program. That being said, it has been demonstrated that thewhole farm planning in the NYC watershed has saved $1 billion annually in lieu of a waterfiltration plant. It is interesting to think about the scale in comparison to the PSA program and therelative level of transaction costs that result in effectiveness. Perhaps even though the transactioncosts by definition might be higher than the PSA program, it is likely much more effective.Lessons learned from the establishment of a PES listto determine effectivenessThere are many contending issues to consider when establishing a PES listto ascertaineffectiveness: determining the definition of effectiveness itself, deciding whether the appropriatecriteria have been included or important criteria excluded, considering how useful it is to rankcriteria on a 0-4 scale etc. As we can see through the ranking in the PES list, the Germanconservation procurement auctions scored the highest(23), followed by the NYC watershed (21),Costa Rica‟s national PSA program (17), and lastly the Coopeagri project (13). 19
  • 20. Evidence supports the notion that lower scoring PES schemes are less successful than higher-scoring PES schemes in their provision of environmental services. Under state water law, theNew York City watershed is under continuous threat of being forced to construct a waterfiltration plant if water quality does not meet national standards. To date, the NYC DEP has beenable to utilize whole farming planning to produce adequate environmental services andthisunderscores the second highest ranking amongst the four PES cases.In comparison,a rigorousimpact evaluation of the Costa Rica PSA program (Sanchez et al, 2007) demonstrated that there islittle evidence that the environmental services created through forest protection are in factadditional. In the case of Coopeagri, the project failed to meet its goals for regeneration and ishighly unlikely to besanctioned by the international governing body on climate change for theprovision of additional CO2 sequestration.Lastly, in the Germany conservation auctions it ischallenging to validate the provision of environmental services since monitoring was notconducted to link the land use change with increased environmental integrity. Nevertheless,research on regeneration of weeds species in Germany has demonstrated increased levels ofpollination (Gabriel & Tscharntke, 2007).I hope that this initial attempt at a PES list provides a foundation for which to move forward thediscussion and implementation of effective PES schemes. As a jumping off point to thosediscussions, I believe there arefive take home conclusions from this paper:1) Themonitoring of the provision of environmental services needs to be increased;2)Rigorous impact evaluations need to be included in PES designs;3)A balance between transaction costs and effectiveness needs to be found;4)There needs to be a differentiation of payments where possible; and5) There should be a serious attempt to ensure community buy in.Monitoring of the provision of environmental services needs to be increasedAs has been shown through the evaluation of four PES schemes in this paper, monitoring theprovision of environmental services is desperately needed to justify the existence and continueduse of PES as a cost-effective instrument for conservation. Innovative economic models arecurrently being developed to scale-up the valuation of environmental services. The NaturalCapital Project out of Stanford University has created a tool, InVEST, to value environmentalservices that outputs maps in either biophysical terms (e.g., tons of carbon sequestered) oreconomic terms (e.g., net present value of sequestered carbon) (Natural Capital Project website). 20
  • 21. In addition, ARIES, has been developed through the Gund Institute of Ecological Economics as aweb-based technology for rapid environmental service assessment and valuation (ARIES Onlinewebsite). Utilizing these innovative technologies with locally available information would greatlyexpand one‟s ability to design and implement PES schemes and go a long way in justifying PESas an “internalizer” of environmental services in the market.Rigorous impact evaluations need to be included in PES designPattanayak et al.(2010) conclude in their most recent paper that PES is probably effective only incertain institutional settings. As Vincent (2010) puts clearly, we have little understanding of whatthose settings are, because so few rigorous impact evaluation studies have been conducted and thesites where they have been conducted represent just a few points on the broad spectrum ofsettings that exist in developing countries.Additionality is a problem that draws into question howfinancially efficient PES actually is. Impact evaluations are an important means by which tojustify additionality. To date only eight impact evaluations have been conducted on PES schemes.While including impact evaluations into PES scheme design may be challenging, it is essential todemonstrate that funds are being appropriated efficiently.Find a balance between transaction costs and effectivenessIn PES design, there is always a tradeoff between minimizing transaction costs and ensuringeffectiveness. Improvements in monitoring may increase transaction costs but neverthelessprovide information necessary to better tailor PES schemes to specific contexts. Large-scale PESprograms may have high transactions costs in order to include smallholders throughout a country,but this could greatly increase the internalization of the provision of environmental services in themarket. What is more important is that transaction costs do not create a barrier to effectiveness, asit wasin the failure of the Coopeagri project.Differentiate payments where possibleThe cost-effectiveness of PES policies, compared with a uniform set of regulations, will tend tobe higher where there is high variation in marginal provision costs across the population (Jack etal, 2007).Auctions are an option that have recently arisen as was shown in the case of Germany.Some research conjectures that competitive bids for conservation contracts could deliverenvironmental services more cost-effectively than fixed payments (Naidoo, 2006). Since theopportunity costs of the seller are often unknown, a procurement auction is a useful method toeliminate information asymmetry and provide payments tailored to eachfarmer (Connor et al, 21
  • 22. 2008). The downside of auctions is that they say nothing about what they buyer is willing to pay.Differentiated payments allow for targeting areas with high value environmental services.Seek to ensure community buy inThe New York City PES program is a great example demonstrating a community‟s ability toorganize in order to protect a watershed. Landholders were able to develop mutually beneficialgoals that benefited both the upstream residents and the downstream water users allowing for thebuilding of confidence on all sides in order to maintain and protect the NYC watershed.As ElinorOstrom proffers in much of her work, good collective management can arise from communitiesof people with a mutual interest in the sustainability of the commons (Ostrom, 1990).As Vincent (2011) recently illuminated in his overview of innovative environmental programs,“Generalizability [of PES schemes] is a tall order given the enormous heterogeneity that existsacross the 140-odd countries labeled „developing.‟Because developing countries are not one andthe same, the impact of a program in one country might not be replicable in another countrywhere participants face different institutional environments and thus a different set of benefits andcosts.” While it is certainly a great challenge to draw conclusions about PES schemes, it isnecessary to analyze the experiences of PES schemes to date in order to be able to justify theirrelevance in the conservation field, look at how one might scale them up, and prove that they areactually having their intended effects. 22
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