1. Payments for Ecosystem Services: towards a more sustainable, just and efficient allocation of natural capital Joshua Farley Community Development and Applied Economics Gund Institute for Ecological Economics University of Vermont

2. Outline of Presentation Economics on a finite planet Why markets fail Solving market failures: the role of PES PES: the role of institutions Ignorance, urgent decisions, high stakes and adaptive management Summary and conclusions

3. Economics on a Finite Planet

4. The Laws of Physics You can't make something from nothing –All economic production requires the transformation of resources provided by nature Energy is required to do work –All economic production requires energy –Fossil fuels drive our economy

5. (though there are exceptions to every rule)

6. The Laws of Physics You can't make nothing from something, and you can't burn the same match twice –Everything the economy uses eventually returns to the ecosystem as waste © Basel Action Network

7. The Laws of Ecology The raw materials converted into economic products are elements of ecosystem structure Ecosystem services are provided by a special configuration of ecosystem structure

8. The Laws of Ecology If we deplete ecosystem structure, we deplete ecosystem services When we return waste to the ecosystem, we deplete ecosystem services. All economic activity affects ecosystem services

9. The Ecosystem Sustains and Contains the Economic System Ecosystem services are the limiting factor in enhancing human well being

10. The Economic Problem 200 years ago: How do we allocate raw materials provided by nature (ecosystem structure) among different economic products? Markets are one effective solution

11. The Economic Problem Today: How do we allocate finite ecosystem structure between: –Economic production –Production of life sustaining ecosystem goods and services Can markets achieve this?

12. Why Markets Fail

13. Tropical forests provide: Erosion control Climate regulation (local to global) Disturbance regulation Water purification, regulation Many other ecosystem services Estimated value: $2006/ha/yr (Costanza et al., 1997)

14. Converted to Pasture for $20/ha/yr Why? Benefits of conservation ($2006/ha/yr) accrue to community (local to global) Benefits of conversion ($20/ha/yr) accrue to landowner Market forces and private property favor conversion

15. Non-excludable Resources  Excludable resource regime One person can prevent another from using the resource Requires government enforcement of property rights Necessary for markets to exist  Non-excludable No enforceable property rights Can’t charge for use Many ecosystem services are non-excludable Cooperative management required  Some resources non-excludable by nature. None are inherently excludable.

16. Why Markets Fail II Record ozone loss in 2006 Why? Air-conditioning boom in India and China Cannot afford to pay royalties on refrigerants that do not deplete ozone

17. Rival Resources  My use leaves less for you to use, e.g. Raw materials provided by nature  Competition for use  Appropriate to use prices to ration consumption  Markets can be efficient

18. Non-Rival Resources  My use does not affect you –Many ecosystem services –Rationing reduces benefits without reducing costs: MARKETS INEFFICIENT –Cooperative provision appropriate  Non-rival but congestible –Non-rival, but becomes rival at high levels of use, e.g. Beaches, hiking trails, recreation –Prices ration use, efficient when congested

19. Anti-Rival Resources My use makes you better off –e.g. alternatives to compounds that deplete the ozone, alternatives to carbon intensive energy, cures for contagious diseases –Knowledge improves through use –Price rationing (markets) are PERVERSE –Provision and consumption must be cooperative –Common property solutions are essential

20. Solutions to Market Failures

21. When no explicit property rights exist Example: waste absorption capacity Propertize: create common property rights E.g. cap (assumes common property), distribute (can be turned into private property, but bad idea) and trade mechanism for carbon emissions Can also tax

22. When Explicit Property Rights Exist Option 1: Status quo –Let rights to ecosystem structure trump rights to services –Unsustainable, unjust, inefficient Option 2: Regulate or revoke property rights –More sustainable. Is it just and efficient? Option 3: Purchase existing rights, including payments for ecosystem services –Many mechanisms available

23. Regulation can be sustainable and efficient

24. Appropriateness of PES may be determined by justice

25. How does PES work? Generally instigated by beneficiaries Provider must receive more than opportunity cost (next best alternative) Beneficiaries must pay opportunity, transaction and implementation costs. Benefits received in addition to what they would have received without the payments must be greater than their costs.

26. How does PES work? Payments are typically conditional on management practice/service provision Payments are typically for a specific service, provided by specific management practice or activity Is this appropriate?

27. Ecosystems Provide a Bundle of services Goal is to maintain life support functions and other services Focus on single service may undermine Others Markets must be adapted to ecological necessities, not vice versa

28. PES: the Role of Institutions

29. Importance of Institutions Must collect money from beneficiaries and disburse to service providers Payments for market goods and marketable goods can come from individual beneficiary –e.g. Perrier Payments for services should be provided by all beneficiaries –Free rider problem for public goods Institutions required to reduce transaction costs

30. Transaction costs often greatest obstacle to PES Institutions (private sector, public sector, civil sector) reduce transaction costs Conditions of monopsony (single buyer) reduce transaction costs –Perrier –Irrigation cooperative –NY Water authority –Costa Rican government

31. Institutions Must be at Scale of Problem Local Regional Global: missing link –Ecosystems are interdependent –Richest nations are free riders –Carbon offsets inadequate –Support for PES schemes should not be grants or loans, but payments

32. Market Failure 1: Forest Loss Forest loss: Countries sized in proportion to forest loss

33. Market Failure 2: Royalty Flows Flow of Royalties: Countries sized in proportion to royalty payments made to them

34. Types of PES Rival Non-rival ExcludableNon-Excludable Market Good: Purchase of waste absorption capacity CO2 (CDM); water supply (Perrier) Congestible: Club goods: e.g. ecotourism Pure Public Good: Government payments; Green certification Open Access Regime: Create common property regimes; e.g. cooperatives, government payments, caps on CO2 emissions Non-rival Anti-rival Tragedy of the non- commons: (NOT PES) Avian flu, Ozone depleting compounds, etc. Public provision: Public investment in and free use of technologies that protect ecosystem services.

35. Ignorance, urgent decisions, high stakes and adaptive management

36. Facts are Uncertain How does ecosystem provide services? What are human impacts on services? Thresholds of irreversibility What is service worth?

37. Economic Value and Inelastic Demand The loss of agriculture does matter even if it’s only 3% of GNP

38. Stakes are High Life support functions Food security Water security Fuel security Irreversible thresholds

39. Decisions are urgent When will we pass irreversible thresholds? How long before we lose life support functions?

40. Adaptive Management Must act on knowledge we have Must learn from action –Design PES schemes to generate knowledge Must evaluate actions Must act again in presence of increased information

41. Summary and Conclusions Must begin acting now: no time to delay Must experiment with variety of policies, including PES Experiments increase knowledge Must learn from mistakes and successes, communicate knowledge Conferences like this one are necessary and will remain so until we've solved the problem