Incentive Systems for Forest-Based Ecosystem Services with Missing Financial Service Markets

Payments for ecosystem services (PES) is a popular paradigm to address underprovision of ecosystem services in developing economies. Potential PES recipients often experience other market imperfections, which can influence PES uptake and environmental performance. These include poorly functioning financial services markets. We develop a model of nonindustrial timber production with poorly functioning financial service markets and PES. We calibrate the model to the Panama Canal Watershed and solve the dynamic allocation decision using dynamic programming. The results of our model show that improving financial services markets, including improved access to borrowing and savings, can reduce the costs of acquiring ecosystem services. Nonenvironmental market frictions can influence the incentive properties of PES payment vehicles. Our model predicts that wealthier individuals are likely to provide the desired land uses at least cost if incentivized land uses involve production. In these cases cost-effective PES is unlikely to advance development objectives.