Designing Payments for Environmental Services with Weak Property Rights and External Interests

Abstract

Payments for environmental services (PES) are often promoted as a mechanism for alleviating poverty and providing environmental benefits. This chapter analyzes PES design in a context where actors such as forest-dependent communities have only weak property rights over the forest, and where firms interested in commercial resource exploitation are present. A game-theoretical model of community-firm interactions is applied to the Indonesian setting where communities have been observed to negotiate logging deals with firms. As an alternative, PES design could focus on those communities with the lowest expected payments from logging deals. But these communities may not be able to enforce a PES agreement, while others would conserve the forest anyhow. Most importantly, the introduction of PES may increase a community’s expected payoff from a logging deal. A failure to consider this endogeneity in expected payoffs would lead to communities opting for logging deals despite PES, simply allowing communities to negotiate better logging deals. Potential trade-offs are shown to exist between maximizing environmental benefits and poverty alleviation, which implies the need for two policy tools, and not just one.

Appendix

Let b denote per period values from the undisturbed forest to the community. If the firm wins the conflict, it receives profits v from logging unilaterally. The discount rates of the community and the firm are, respectively, r ^C and r ^F. Let c denote the firm’s fixed logging costs in each period it attempts to log unilaterally. The community can blockade firm activities at a cost of s per period. Where s > b/r ^C (in which

$$ \int\limits_{t = 0}^\infty {be^{ - rt} dt} = \frac{b}{{r_C }} $$

), the community never fights and the firm logs as long as v − c > 0. Where s < b, the community always fights, and the firm, knowing this, withdraws. For intermediate values of b (sr ^C < b < s), the boundary condition is found by equating the time that each actor can stay in conflict and still obtain non-negative net benefits:

$$ v = \Omega ,{\rm{ }}where{\rm{ }}\Omega \equiv \frac{c}{{r^F }}\left[ {\left( {\frac{{s\left( {1 - r^C } \right)}}{{s - b}}} \right)^{\frac{{\ln \left( {1 - r^F } \right)}}{{\ln \left( {1 - r^C } \right)}}} - 1 + r^F } \right] $$

((3.1))

The probability that the community is able to establish de facto property rights (PR) can thus be written as a function of model parameters:

$$ PR = g\left( {v,b,r_C ,r_F ,c,s} \right) $$

((3.2))

As argued in Engel et al. (2006), inspection of v =

$$ \Omega $$

indicates that

$$ \frac{{\partial PR}}{{\partial v}} \le 0,\;\frac{{\partial PR}}{{\partial b}} \ge 0,\;\frac{{\partial PR}}{{\partial r_C }} \le 0,\;\frac{{\partial PR}}{{\partial r_F }} \ge 0,\;\frac{{\partial PR}}{{\partial c}} \ge 0,\;\frac{{\partial PR}}{{\partial s}} \le 0 $$

((3.3))

As explained in the text, bargaining leading to a logging agreement is possible only when v <

$$ \Omega $$

. We distinguish two types of reservation utilities. Inside options are the payoffs obtained by each player while parties temporarily disagree and negotiations are ongoing (Bulow & Rogoff, 1989), denoted by d ^C and d ^F, for the community and the firm, respectively. Outside options, denoted by R ^C and R ^F, are the parties’ payoffs available when bargaining fails permanently (Binmore, 1985).

For an interior solution, the negotiation outcome in an alternating-offers bargaining game is given by the NBS (Muthoo, 1999). Thus, the negotiated payments to the community (

$$ \Pi $$

^C) and firm (

$$ \Pi $$

^F) are obtained by solving the following Nash bargaining problem

$$ \mathop {\max }\limits_{\Pi ^C ,\Pi ^F } \quad \left[ {\Pi ^C - d^C } \right]\,^\tau \;\left[ {\Pi ^F - d^F } \right]^{1 - \tau } \quad {\rm{s}}{\rm{.t}}{\rm{.}}\quad \Pi ^C + \Pi ^F = v - c $$

((3.4))

, ^{17 17}

where

$$ \tau $$

is the community’s bargaining power vis-á-vis the firm (

$$ 0 \le \tau < 1 $$

). The solution to Eq. (3.4) for the community’s payment is

$$ \tilde \Pi ^C = d^C + \tau \left( {v - c - d^C - d^F } \right) $$

((3.5))

The total “cake” to be divided in negotiations is v − c. The community’s inside option in the case where the community is able to self-enforce its property rights is given by the present value of the standing forest to the community. Thus,

$$ d^C = \frac{b}{{r_C }} $$

, and:

$$ \tilde \Pi ^C = \frac{b}{{r_C }} + \tau \left( {v - c - \frac{b}{{r_C }} - d^F } \right) $$

((3.6))

Equation (3.6) implies that community payoffs from a logging agreement are increasing in b and decreasing in r _C . Engel and López (2004) show that the community’s payment can be written as

$$ \Pi ^C = h\left( {v,c,b,\tau ,d^F ,PR} \right)\quad {\rm{with}}\quad \frac{{\partial \Pi ^C }}{{\partial v}} \ge 0,\;\frac{{\partial \Pi ^C }}{{\partial c}} \le 0,\;\frac{{\partial \Pi ^C }}{{\partial b}} \ge 0,\;\frac{{\partial \Pi ^C }}{{\partial \tau }} \ge 0,\;\frac{{\partial \Pi ^C }}{{\partial d^F }} \le 0,\;\frac{{\partial \Pi ^C }}{{\partial PR}} \ge 0 $$

((3.7))

Using the expressions for PR, given in Eqs. (3.2) and (3.3), and considering that

$$ \tau $$

is itself increasing (decreasing) in the firm’s (community’s) discount rate, and increasing in other factors associated with higher bargaining power (p), Engel and Palmer (2006) obtain the following reduced-form relationship between

$$ \Pi ^C $$

and the model parameters:

$$ \Pi ^C = \tilde h\left( {v,c,b,r_F ,r_C ,\bar d^F ,s,p} \right)\quad {\rm{with}}\quad \frac{{\partial \Pi ^C }}{{\partial v}}\frac{ > }{ < }0,\;\frac{{\partial \Pi ^C }}{{\partial c}}\frac{ > }{ < }0,\frac{{\partial \Pi ^C }}{{\partial b}} \ge 0,\;\frac{{\partial \Pi ^C }}{{\partial r_F }} \ge 0,\;\frac{{\partial \Pi ^C }}{{\partial r_C }} \le 0,\;\frac{{\partial \Pi ^C }}{{\partial \bar d^F }} \le 0,\;\;\frac{{\partial \Pi ^C }}{{\partial s}} \le 0,\;\frac{{\partial \Pi ^C }}{{\partial p}} \ge 0 $$

((3.8))

As shown by Muthoo (1999), the interior solution in Eq. (3.5) holds only if

$$ \tilde \Pi ^C > R^C $$

. Otherwise, the community would receive R ^C in negotiations. Moreover, if

$$ R^C + R^F > v - c $$

, then negotiations will fail and the actors obtain their outside options.

Let P denote the per-period payment made under PES, which is conditional on the conservation of the forest, and b ₀ is the community’s per-period valuation of the standing forest in the absence of PES. Thus, the community’s total valuation of the standing forest is

$$ b = b_0 + P $$

((3.9))

The community’s outside option increases with PES:

$$ R^C = \frac{{b_0 + P}}{{r_C }} $$

((3.10))

By raising b PES also raise the community’s willingness and ability to stay in a potential conflict. In summary, community payoffs from interacting with the logging firm are:

$$ \Pi ^C = \left\{ \begin{array}{l} 0\;\quad \;{\kern 1pt} {\kern 1pt} {\kern 1pt} {\kern 1pt} {\rm{if}}\quad v > \Omega \\ \tilde \Pi ^C \quad {\rm{if}}\quad v \le \Omega \quad {\rm{and}}\quad \tilde \Pi ^C > R^C \\ R^C \quad {\rm{if}}\quad v \le \Omega \quad {\rm{and}}\quad \tilde \Pi ^C \le R^C \\ \end{array} \right. $$

((3.11))

Moreover, if

$$ R^C + R^F > v - c $$

, where R ^C is given by Eq. (3.10), and v <

$$ \Omega $$

, negotiations would fail and forest protection would result (Engel et al., 2006). Because P affects

$$ \Omega $$

, R ^C, and possibly

$$ \tilde \Pi ^C $$

(the latter if and only if inside options are also affected by PES), the community’s expected payoff from a logging agreement is also affected by PES. More specifically, Eqs. (3.1), (3.6), (3.9), (3.10), and (3.11), together imply that

$$ \Pi ^C $$

are (weakly) increasing in P.

The conditions for effective PES can be summarized as follows:

Proposition: An effective PES scheme with per-period payment P conditional on resource conservation requires

• 1. v <

  $$ \Omega $$

  (P) (Community can enforce resource conservation),

• 2.
  $$ \frac{{b_0 }}{{r_C }} + R^F < v - c $$

  and v> c (Additionality, i.e., no negotiation failure in the absence of PES and logging is profitable), and

• 3.
  $$ \frac{{b_0 + P}}{{r_C }} + R^F > v - c $$

  ((3.12))

  (PES induce a breakdown of any potential resource extraction agreement).

With secure property rights, condition (1) in the proposition would be satisfied by default. Effective PES then have to satisfy conditions (2) and (3). Solving for the minimum effective payment (from condition 3), P _min,

$$ P_{\min } = r_C \left[ {v - c - R^F } \right] - b_0 $$

((3.13))