19821 October 1993 LATEN Dissemination Note # 7 Forest Management and Competing Land Uses: An Economic Analysis for Costa Rica October 1993 Nalin M. Kishor Luis F. Constantino The World Bank Latin America Technical Departmnent Enviromment Division o *~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ LATEN Dissemination Note # 7 Forest Management and Competing Land Uses: An Economic Analysis for Costa Rica October 1993 Nalin M. Kishor Luis F. Constantino The World Bank Latin America Technical Department Environment Division l~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ FOREWORD The "Dissemination Note" Series of the Latin America & Caribbean Region's Environment Division (LATEN) seeks to share the results of our analytical and operational work, both completed or in progress. Through this Series, we present the preliminary findings of larger studies in an abbreviated form, as well as describe "best practices' with regard to major environmental issues currently confronting LAC countries. In most cases, these notes represent 'work in progress' and as such have not been subject to either substantial internal review or editing. Therefore the findings, interpretations, and conclusions expressed in these notes are entirely those of the authors and should not be attributed to the World Bank, members of its Board of Executive Directors, or the countries they represent. This Dissemination Note, by Nalin Kishor and Luis Constantino, arose from operational work done in Costa Rica, and from a study on "Policies Affecting Forests in LAC' currently being managed by LATEN. This note develops an useful and simple analytical model for the investigation of factors affecting land use and deforestation, which can be easily applied to other countries. Dennis J. Mahar Division Chief Environment Division Latin America and the Caribbean Region The World Bank I I I FOREST MANAGEMENT AND COMPETING IAND USES: AN ECONOMIC ANALYSIS FOR COSTA RICA' Nalin M. Kishor Luis F. Constantino Environment Division, Technical Department Latin America and Caribbean Region, The World Bank Abstract. This paper, using site specific data from Costa Rica as an example, tries to explain why sustainable natural forest management, which is a declared goal for governments in the region, is seldom observed with the exception of half a dozen cases of little commercial relevance. Instead, private landowners prefer to mine the forests, convert to cattle ranching, or convert to forest plantations. The main reason is that sustainable natural forest management cannot compete financia11y with alternative types of land management. The structure of policy incentives prevalent have helped make matters worse. To promote sustainable forest management, which may be economicaly justifiable under certain conditions and for specific sites, the best policy instruments awe likely to be direct incentives for forest management. These will be more effective if offered to small farmers than to corporate owners. Because a large proportion of environmental benefits from forest management accrue to the World, it would not make sense for Costa Rica alone to finance these incentives, and the World should consider sharing in their costs. The paper alo calls attention to the importan=c of discount rates in explaining land use decisions, a fact widely known but often absent in many of the recent discussions of deforestation. The results indicate that the incentives to deforest increase as the discount rate approaches zero. NATURAL FOREST MANAGEMENT: OBJECTIVES AND OUTCOMES 1. 'Sustainable' natural forest management is an objective of public policy in most counties in Latin America. Although the definitions of sustainability vary considerably depending on who is using the word, there is some consensus that "sustaining" the natural capital in a more or less unintervened form, is better for the environment than most altematives. 'Sustainable' management is consistent with the continuity of important environmental functions from the forests. Although some biodiversity may be lost, many other environmental services, such as carbon sequestration, hydro-ecological buffering and soil conservation will continue as long as there is no major disruption of the forest cover. Irreversible environmental losses, including biodiversity, can best be dealt with through networks of strictly protected set-asides. Forests outside of these set asides still provide environmental benefits, however, and a relevant question is how to best protect these ui6 paper repesents te views of the authos sd not necearily those of the Wodd Bank The autho wi& to thank Robet (Andy) Anderon, Willim Beaie, Dough. Graham, Richard Di Hustait, Rober irase, Andrea Lbnthal Augua Molnar and David Steeds for reviewing an earier verso of this papet. R inine ane the aut responility. Coamems ae wecme. 2 environmental values. 'Sustainable' forest management could be one solution. Because "sustainable" management allows for some productive and/or extractive activities, it entails lower opportunity costs, at least in principle, than cordoning-off forests in strictly protected set-asides. It is also more politically acceptable in developing countries, because it is seen as contributing directly to the local economy, while strict protection is often viewed as a service to foreign countries only. Sustainable forest management policies and projects are thus understandably being promoted by regional govemments as well as by intemational and bilateral organizations. 2. The reality is different however, as sustainable management is the exception in the region, not the rule. The half a dozen documented examples are very special cases of little commercial significance. They are mostly the result of foreign-funded projects or NGO initiatives; a clear trend towards this type of land use is not visible in any country of the LAC region. Similarly, in other regions, namely in Asia and Africa, there are serious questions about the sustainability of forest utilization practices. Often it is argued that sustainable management is not more popular due to insurmountable information and technological constraints. This is partially true, but research and technology development is responsive to demands, and one reason for lagging sustainable management technologies is precisely the lack of private demand for this form of land use. 3. This brief study proposes to show that the lagging development and adoption of sustainable management technologies is because this form of land use is economically dominated by alternative options. That is, from a private agent point of view, it is better to do something else than to do 'sustainable" forest management. This is the outcome of the existing market incentives and of pervasive policy incentives as well. Although the study uses site specific data, we believe that the results can be generalized to other sites as well. The study also concludes that correction of existing policy distortions is unlikely to be sufficient to make sustainable management privately profitable. Because sustainable management may be economically justifiable for some sites, the report recommends that for these sites governments should (i) use direct incentives to make sustainable management to attractive to the private sector; or (ii) create the necessary conditions to develop private transactions in the most important environmental services.2 Because the opportunity costs of doing "sustainable management" may be large, and most environmental benefits accrue to the World, the world community should consider sharing these costs. DEFORESTATION, DEGRADATION AND POLICY IN COSTA RICA 4. Costa Rica's total land area covers about 5.2 million hectares with a variety of ecosystems offering opportunities for diversified agriculturl production. About 3 million hectares or 59% of the country's total area is under agricultural production. Bananas, the number one export earner, account for 8% of the cultivated land. Coffee is another 2 In this now, direct incenives sa sbsidies will be usd inlubadsbly uad ae being broadly defid to incAde any publc or mwaet payment to ownet of the fiont to conme_a thom for envimnal aence ptvided. 3 important export crop, accounting for 22% of the cultivated land and 38% of the annual export earnings. Rice, sugarcane and cocoa are the other three major crops accounting for about 37% of the agricultural crop land. Pasture land covers some 2 million hectares; export earnings from beef account for only 7% of the total. 5. Primary natural forests have shrunk to 1.5 million hectares, from over 4.5 million hectares at the turn of the century. Of these 1.5 million hectares less than 400 thousand hectares remain outside of strictly protected areas and are thus available for production activities. The Direcci6n General Forestal (DGF) estimated an annual deforestation rate of 50 thousand hectares per year during the 1980s and at this rate it was estimated that all primary forests would be cut sometime between 1995 and 2000. From 1988 through 1992 this rate slowed down considerably to 17 thousand hectares/year, in part because there were very few forests left to convert. Deforestation is caused by the conversion of primary or degraded forests to other uses, including forest plantations. 6. Costa Rica's situation is typical of the region. Most natural forests are privately owned. The roots of deforestation and degradation are partially found in a policy framework, including past donor strategies, that sent conflicting signals to landowners and natural resource users. Direct and indirect incentives to competing land uses, agriculture and cattle ranching promoted deforestation. These incentives were offered primarily through trade protection and special credit, which was often subsidized.3 Land titling policies skewed in favor of those that removed forest cover, made matters worse. Forests have historically been open access lands and there exists a strong sentiment that a right exists to settle public land. Occupation of public lands contributed in the past to a situation in which around 60 percent of farms lacked land title, and where they existed, there were often competing land claims4. This provides an incentive to undertake activities on that land which clearly show the fact of possession. Further, without title, landowners cannot mortgage their property or obtain loans (Peuker, 1992). The limited possibility of using forest land as collateral adds to the incentives for conversion, and for using the natural capital by logging the forest. On the other hand, bank loans can be obtained using cattle for collateral. Thus although the law of "informaciones possesorias' that associated titling to forest clearing has been changed, most of the incentives against forest conservation are still in place. 7. The rapid deforestation was a cause of great concern and, starting in 1987, the government introduced forest policies to try to shift the structure of incentives in favor of forest conservation. Most of these were ineffective because, although the policies had sound ' Since 19S5, in the context of xtucural adjusmet, Coa Rica has been progressiely rewmving policy distortions, icludiog thoe in the trad ector, aMd liberalizing ad increasing conpetivmue iD the ecomy. Current eM of the govenme witd intenational banb, to be implemented through the Deregulation LIa, include the remow of rmaining trade distortios and special trade licenses (including a log export ban), removl of controb over prices and profit magins, and tigt caps on subsidized credit. Through the World Bank Aiculual Sector Project (World Bank, 1992), Coda Rica intends to rtionalize the land titling ituation in the near future. 4 objectives, the choice of instruments was inadequate. Forest policies relied on four broad categories of instruments to counter the negative incentives from agriculture and titling policies: (i) biodiversity set-asides under which large expanses of territory have been removed from any productive activities, and where the prevalent objective is protection of biodiversity; (ii) regulation of private natural forests with the primary objective of controlling rates of harvest and ensuring continuity of the resource; (iii) protection of the forest products industry though a ban on the export of logs and tariffs on imports of certain kinds of forest products; and (iv) subsidies for forest plantations, justified by the view that, left to its own, the private sector would plant fewer forests than would be economically desirable. 8. Biodiversity set-asides have been fairly successful and today about 73% of the primary forest that remains in Costa Rica is in set-asides. Part of the success has been an active govemment policy of private land buy-outs. If current World Bank proposals are implemented this network of set-asides will cover about 15% of the territory and include representations of all major ecosystem types in the country (World Bank, 1993a). Biodiversity would thus be fairly well protected from irreversible losses. However, policies targeted at private forests outside of set-asides were not successful. Government intervention in most of these forests is warranted because they supply important additional environmental services which are not captured in private decision making. But all the thiree major policy instruments chosen by the government-regulation, log export ban and subsidies to plantations-are equivalent, in practice, to a tax on private natural forests, which added to the incentives for conversion, implicit in the prevailing agricultural and titling policies. CORRECTING FOREST POLICY 9. The discrepancy between land capability and actual land use is an indication that the land use pattern resulting from market forces and policy distortions is not sustainable in the long term. For Costa Rica, land capability studies found that in 1984, 44% of the land was suited for agricultural use and 56% for forest use. In reality, 58% was under agriculture use and only 34% was forested. Clearly, by favoring agricultural activities over forest uses, the incentives and other forces operating in the economy distorted land use away from the pattern suggested on the basis of sustainable use of land resources (Peuker, 1992). 10. Another important factor for determining the socially desirable allocation of land is the externalities associated with land use, which are generally not considered in land capability mapping. For example, clear-cutting forest land for purposes of cattl-ranching or raising annual crops can impose significant costs in the form of reduced carbon sequestration. Thus, depending upon the extent of the non-market benefits arising from forests (carbon sequestration, conservation of biodiversity, soil conservation, etc.), there can be a significant divergence between social and private profitability of land use, a divergence which suggests that these externalities must be quantified and incentive mechanisms must appropriately reflect these costs and benefits. 5 11. Economic reasoning would suggest that to correct these policy failures, the government should focus on shifting the structure of incentives in favor of forest conservation, and that the incentives offered should be commensurate with the value of environmental services from these natural forests. There are three basic approaches for doing this: regulation, taxes and positive incentives. 12. Regulation is overwhelmingly the approach used in all of Latin American countries. Costa Rica is a typical model. Logging permits are issued on the basis of management plans, and the monitoring is done though transportation controls. For a myriad of reasons this approach has not worked. Management plans are cumbersome and often copies of each other (World Bank, 1993b) and do not focus on environmental quality of the resource, but rather on ensuring harvests in perpetuity (sustained yield). Sustained harvests can be ensured through a conversion to plantations, in which case there might be substantial environmental losses. Transportation controls do not monitor results but rather processes (where did the timber come from?), and are an open invitation for bribes and corruption (according to some estimates 50% of all logging in Costa Rica is done illegally, and wood is transported at nights or on weekends). Regulations attenuate private property rights. They reduce the option value of land and impose costs on private land owners and thus add to the incentives for conversion. For example, banks in Costa Rica refuse to accept natural forests as collateral because it would be very unlikely that all permits would be obtained for legal logging. If all controls were effectively implemented, the bureaucratic apparatus to efficiently manage such a system would be tremendous. The Costa Rican society is characterized by a deep respect for private property and attempts to Ocentrally plan" private harvests have faced strong opposition in courts. In fact, the 1990 forestry law, which introduced several of the controls, was considered unconstitutional. Most importantly, and as we shall see, "sustainable' forest management does not make much economic sense from a landowner's private point of view. There are thus strong incentives for disobeying the laws, particularly in a country with weak institutional capacity for enforcement. 13. The second alternative would be to tax land use conversions. In Costa Rica wood is taxed, if extracted in association with a logging activity. However if a forest is burnt for conversion to graing no taxes are applied. These tmes thus reduce the profitability of forest production relative to conversion to other activities. Ideally there should be taxes on logging and on forest conversion or deforestation. Although tames are probably the first best policy instrument, they would have little probability of being adopted, let alone implemented. Deforestation taxes would be equivalent to land taxes on alternative land uses, and they would face strong opposition from powerful agricultural and livestock lobbies. They also raise equity issues if affecting subsistence farmers, who, at least in some countries, are important actors in land use conversions. 14. The third alternative is to provide incentives to maintenance of a forest cover capable of sustaining environmental services. One possibility would be for the government to offer subsidies to those farmers willing to manage or conserve the forest according to some predetermined rules. The subsidy in this case should be less or equal to the environmental 6 values lost due to conversion. Subsidies have better hopes of working than regulations or taxes. The most successful forest policy instrument used in Latin America, in terms of impacts, have been subsidies to forest plantations, a market based policy mechanism. They have not been successful in terms of protecting natural forests because they again subsidized an alternative land use. However the fact that they had the intended impact adds to the argument for market based mechanisms. Thus, what is probably needed is a subsidy to conservation of natural forests. Costa Rica has already taken some pilot steps in this direction by introducing the CAFMAs, a subsidy for forest management. These subsidies still have a bias, because they implicitly tax a farmer that protects the resource instead of utilizing it. Nevertheless they are a positive departure from past practices.5 15. Another possibility would be to promote private transfer mechanisms. If the economic gains from forest management are greater than the losses from not doing something else, it may be possible, at least in principle, to create markets for some of the environmental values needing protection. The beneficiaries from protection would compensate those incurring the opportunity costs of protection for benefits foregone. For this to happen property rights and enforcing institutions would have to be put in place. This may be feasible for some environmental values, but this option has not yet been explored in the Latin America region. 16. To recap, the preceding discussion suggests that there are several incentives influencing land use decisions and which are contributing to the divergence between the desirable pattern and actual pattern of land usage. It is believed that this may best be corrected through modification of existing policies and perhaps the provision of new policies to change private incentives. Thus, in order to quantify these incentives, we consider the relative profitability of four land-use options in Costa Rica-liquidation, catde-ranching, managed natural forestry and plantation forestry. THE LAND USE OPITONS 17. To develop incentives schemes for private natural forests it is important to understand the economics of land use conversions, and this is the focus of the remainder of this paper. We develop stylized land use models representing the most significant altematives facing a farmer in marginal agricultural lands covered with a quasi-primary forest. Our analysis is based on average land use returns. Land use returns would vary considerably depending on site conditions, distance from markets, roads and other infrastructure. Initially we developed the analysis for two distinct sites and checked it against other site specific studies in Costa Rica. Because the results are similar we present values for only one site. Although our data is not perfect, we believe that the results are robust over a large parameter range and that the ' e nw For Law under discusin in the Nation Asembly propos a noel sheme dht shws hope of cormcting the peraive mm of inctives ainau cometio, nalud6g the ba towa fe tiliao. e w introduces ideable proeti certificates, which would entide a farmer who agrees to protect hisher fkweas to a certain flow of income. 7 key conclusions of this paper are unlikely to change if better quality data becomes available.6 The reasonableness of our data is corroborated by the fact that our predictions are consistent with what we observe in different regions of the world: private agents prefer to deforest, liquidate the forests or convert to forest plantations rather than to practice "sustainable" forest management. 18. Starting from a situation of quasi-primary forest land7 we consider four possible uses of that land. The first option is liquidation, which does not imply clear-cutting or deforesting but consists of harvesting all the wood of commercial value in the first instance (60% of forest cover), and then harvesting residual wood of low commercial value as it becomes available, which we assume to be once in every forty years. There is no input into the land in the interim period and sustainable production is not an important consideration. Furthermore, there are substantial external costs associated with the loss of some environmental values associated with primary forests. 19. In contrast to liquidation, there is the managed natural forestry option. This consists of managing the quasi-virgin forest area on a sustainable basis, by essentially extracting wood such that the original nature of the forest is largely preserved (20% of canopy is lost). Thus, about 20 cubic meters/ha of wood of different quality are harvested once every twenty years under this option. Logging is selective but mining does not occur because the forest, twenty years hence, is of the same quality. This option maintains most of the forest cover, forest structure and biomass, and it is in that sense that we call it 'sustainable". This option would sustain the natural capital.' There are small annual supervision and maintenance costs, which are ignored.9 Clearly, from an environmental point of view, natural forestry is considered the second most desirable option, after strict conservation. There are extemal (environmental) costs from sustainable management, but these are lower than for liquidation, because the environmental services will continue more or less uninterrupted. 20. Planttign fQrty consists of clear-cutting the natural forest, including marketing of all commercial species, and then planting a monoculture of relatively fast growing species, in our example, laurel (Cordia Alliadora, a native species). Harvesting is done in accordance with revenue maximization. The first thinning begins at ten years after planting and there are two more harvests up to the thirtieth year, when the final harvest takes place and the entire £ Our anlyis builds an work developed by Stewat (1992) for US AID and the Wodd Bank. The main ourc of daa wen sudies carried out by CATIE in 1991 for the Northem Region. We also eched our data an biologicl assumptions againt a report produced reently by the COSEFORMA project in Coda Rica which inchldes a fam e reat mment intaive (COSEFORMA, 1993). We define a quasi-prmary forest as one that has been aibject oy to very selective loging. a I is impoant to emphaiz the disinction between a sustainable yield option and managed naural fretry as defined in this note. The objective of a sutained yield plan is to harves the maimunn poible timber every year in perpetui without any coneern for die prsenrytion of the forest cover or the original nature of the forest. By contuast, managed natural foruery has the basie objective of preserving the original nature of the forest, and choos that volume of timber harvest that best achieves the objective. We ignore the possbility of incread grutb rat through intenivew forest mangement or of increasd valUe throub forest- enrichme-nt 8 land has to be replanted again. Although wood revenues are large, the initial input and annual management costs are also significant. Although this option could sustain (sustained yield) and even increase timber production, it would not sustain the natural capital which would be destroyed in the conversion process. Most of the environmental values such as biodiversity, carbon sequestration, etc., would be lost. Some of these values, such as carbon sequestration, are partially recovered but only several years in the future. Thus although under this option timber yields may be sustainable, most environmental services from the forest will not be. 21. Cattle-ranching is a very important agricultural pursuit for Costa Rica. It was promoted in a big way in the 60s and 70s by international donor agencies (Peuker, 1992) and driven by the high price of beef in the US market. It was also supported by domestic policies. However, because of a fall in the price of beef and removal of some policy supports, this activity is currently in decline. The cattle fattening model in this paper assumes, as for plantations, that the forest is first cleared and all commercial trees are marketed. It also assumes that it takes two years for the calves to fatten so that the farm has to be restocked once every two years. There are annual expenditures on feed costs and maintenance, and revenue from the sale of cattle comes once in two years. On account of the destruction of practically all vegetative cover, forest land converted to pasture results in the greatest loss of environmental values. COMPARISON OF TElE PROFT]ABILTY OF LAND USE OPTIONS Domestic Prices, No Externalities 22. Our first question is 'How does sustainable management compare with alternative land uses from a private point of view?" In this section we compare the relative domestic profitabilities of the four land use options in terms of net returns (NPV per hectare). In Table 1, the returns are given in terms of 1989 dollars per hectare, when domestic prices are used and all subsidies and tames have been removed. 23. The table reveals some interesting features. At low (4%-8%) rates of discount, plantation forestry is the most profitable option. Thus, at a discount rate of 8%, the NPV to plantation forestry is about 2.5 times that in cattle ranching, the next best option. At a 12% discount rate, liquidation and plantation forestry are about equally attractive options, followed by cattle ranching. At these low rates of discount the returns to managed forestry are relatively very low. As the discount rate is increased further, plantation forestry becomes quite unattractive, reflecting the fact that the returns, although very large, come after a big time lag. At a discount rate of 20%, liquidation is the most attractive option, followed by cattle ranching, managed forestry and last of all, plantation forestry. 9 24. Figure 1 plots the information contained in Table 1 and shows the dominance of the liquidation option over the others at higher discount rates'°. Note that the return to managed forestry is half of that from liquidation. The attractiveness of liquidation at high rates of discount stems from the fact that the bulk of the retums accrue in the initial 2-3 years. Table 1: NPV of Land Use Options, Domestic Prices"1,'2 (US dollars/ha) Discount Raw 4% 8% 12% 15% 20% 25X 30% 35% Liquidation 1503 1292 1217 1180 1129 1083 1041 1003 Cattle Ranching 1727 1319 1157 1081 991 925 872 827 Managed Forestry 1271 854 719 666 613 578 552 530 Plantation Forestry 10669 3223 1218 627 228 60 S3 Rates of lnme Preference and Choice of Land Use Options 25. According to Table 1, the best land use depends critically on the discount rate of farmers. The personal rate of time preference (or personal discount rate) will be different for different individuals in the economy. It depends upon the income and assets of the households, family size, composition and education, access to market funds, etc. While firm evidence has to be gathered, it is believed that the personal discount rates for corporations and large landholders are the lowest and typically range from 5% to 10%. On the other hand, for small and marginal farmers and small landholders, these rates are high and probably lie above 20%. 13,14 26. In terms of the information presented in Table 1, large landowners and corporations would prefer the forest plantation option over all the others and evidence supports this point since corporations are increasingly undertaking plantation forestry in Costa Rica without recourse to the available plantation subsidies.'5 Conversion of natural forests to plantations s Ahe emial role of high private discount ratea on the choice of unusainable farming tchniquea at the fontier is demonstted in Schneider eta (1993). Underlying modcls a daa can be obtained from Lies Consantino or Nalin lG hor, LATEN, World lanmk We aumme that the opportuny cost of espital to the govement is 8%. A rough test of this hypothesis can be done by comparing land vahles in 1mal fumcr land transactions with the NPV of land according to our more theorecl cluuor. Dcgmtdcd forest Wand for grazing sells in Costa Rica for about US$400 to US$500 per hectmre, which is consistent with discount rates of 25X or higher. X For an empiricl proof that rtes of time prefeence vary widely acros econo gen see Lawrence (1991). 1 In 1990, 57% of al plntation forestry was canied out by lrge cOrpowations without recours to subsidies. 10 Flgure 1. NPV of Land Use Options, Domestic Prices 2 1.9 1.8 1.7- *1.6 1.5- 1.4 - 1.3 - 1.2 0. 9 0 0.86 0.4 0. 3 0.2 0.1 4 6 12 15 20 25 30 35 Discount rate 0 LiQditn + Rnching 0 Mgfocrest A PI ntfrat is also observable in other countres. A pattern that appears to be emerging in Southern Para, Brazil, is that land under primary forest is sequentially converted to selectively logged forest, to shifting cultivation and to cattle ranching. There are indications that some of this pasture land could be converted to fast growing forest plantations to supply pig iron smelters and pulpmills, expected in the region within the next 10 years. Similar patterns are observable in Indonesia and Chile (with temperate natural forests). 27. For the high discount rate individuals, liquidation is the most preferred option and, again, to encourage these individuals to adopt the managed forestry option, positive incentives would be required. How can one explain then the widespread conversion to cattle ranching observed in the past, namely on the part of small farmers? Liquidation, because it maintains a degraded forest cover, does not prove land possession in land ownership conflicts. Conversion to grazing would establish a much more secure land claim. 28. For maximum economic returns, the forest owner will leave trees on the ground as long as these grow at the interest rate or faster."6 Otherwise he could obtain higher returns by cutting the forest and depositing the money in a bank or investing elsewhere in the economy. Because natural forests grow very slowly it never pays for the owner not to liquidate the forests. Domesticated forest (plantations) grow much faster, however. So if interest rates are below a certain critical level, a forest plantation becomes an attractive venture relative to other investment alternatives in the economy. One implication of these results is that, contrary to common intuition, the incentives to convert are higher, the lower the discount rate. This is because the alternative land use, forest plantations, becomes more attractive. The highest incentives to convert would clearly be at a discount rate of zero. Another implication is that in an unstable macro climate characterized by high personal discount rates due to macroeconomic risks, the liquidation option would dominate. There would be a tendency to "mine' natural resources, and in fact to convert them to ready capital. This capital would not be reinvested in the land. 29. The most important result of this section is that 'sustainable' management never dominates from a private point of view. For corporate owners and large farmers facing discount rates of 12% or lower the best option is to clear-cut the forest and install a plantation. For small and subsistence farmers facing discount rates higher than 12% the best option is to liquidate the forest. Ranching would become the best option -under these higher rates if we were to factor in the tenure insecurity associated with natural forest cover. Adjusting Taxes and Subsidies 30. The next question we ask is "What is the impact of existing subsidies and taxes on conversion decisions in marginal agricultural lands?" At the present moment, in Costa Rica, there is about a $500 per hectare subsidy to managed forestry (the CAFMAs17) and about a $1000 per hectare subsidy (CAFs) to plantation forestry. Furthermore, there is a general sales tax on wood of 10%. Table 2 (and Figure 2) reports the NPV of the various options after adjusting for the tax and the subsidy. 31. Inclusion of subsidies makes both plantation forestry and managed forestry much more attractive options. Thus, up to a discount rate of 15 %, plantation forestry is the most attractive option, as distinct from the 12% rate for the earlier table. However, at higher discount rates liquidation again becomes the most profitable option. The data also indicates that, the existing subsidies make managed forestry even less attractive than plantation forestry at low rates of discount. Also, the subsidy to managed forestry is inadequate in making it more attractive than liquidation at higher rates of discount. In other words, the existing W This a not exactly tnue bece the owner wi have to conider so the oppeeny co" of not freeing the lad for future Foret Management Fsal Cuelifica 12 subsidy structure would have to be modified to adjust private incentives in conformity with environmental objectives. Table 2: NPV of Land Use Options, Domestic Prices, Taxes and Subsidies (US dollars/ha)I' Discount Rates 4% 8% 12% 15% 20% 25% 30% 35% liquidation 1366 1175 1107 1073 1026 985 947 912 Cattle Ra6ching 08 1205 1047 974 888 826 777 736 Managed Foretry 1637 1240 1100 1040 974 926 S86 852 Pkn"taon Foresry 10442 3696 1844 1280 871 710 637 596 32. Thus current policies improve 'sustainable' management relative to liquidation, but are not sufficient to make management the most profitable option. On the other hand the current subsidy structure favors plantation forestry relative to natural forest management in marginal agricultural lands. Adjusting the trde regime: border prices. 33. Our next question is 'How does the log export ban distort land use decisions in marginal agricultural lands?". The complete log export ban in Costa Rica in May 1986 delinked domestic wood prices from the international market. Nominal protection coefficient for logs range from 0.2 to 0.619 . We will take the more conservative estimate of 0.6 and raise domestic prices by a factor of 1.67 to simulate the prices that log owners in Costa Rica could get if they could sell at world prices. The profitability of land use options as analyzed (with and without the subsidies to plantation forestry and to managed forestry, Table 2) above are recalculated at the international prices (excluding taxes). 34. From Table 3 it is seen that the NPV of turns from removing the ban increases for each option. Up to a discount rate of 20% plantation forestry (inclusive of CAFs) is the most profitable option. At higher discount rates, liquidation becomes the most desrable option. It is also important to note (compare Tables 2 and 3) that the profitability of liquidation, cattle ranching or plantation forestry rises, relative to managed forestry, implying U Noe *at undxr liquidation and caulra nchivg diere is imber nrmova. Thus twh poftabity of teA optons is also affected by timber pnc. Nominal protectio of I mum* neautra trade regnime. A nominal protectio of i= than oute means dt produncr ar reachving ls than if they wor paid according to imenationa pnces. 13 Figure 2. NPV of land Use Options, Domestic Prices, Taxes and Subsidies 2 1.6 1.5 1.4 - 1.3- 1.2- 11 > ~~0.8 a. 0 z r 0. 7- 0.56 0.4 0. 3 0.2- 0.1 4 8 '12 15 20 25 30 35 Discount rate 0 Liqdtn + Rnchlng 0Mngforest & Plntfrst a pressure to convert land under natural forests to other uses2O. Thus, given the substantial environmental values associated with the presence of natural forest cover, it is important to protect them from the likely impacts of trade liberalization. It is therefore critical that a system of protecting natural forest areas be put in place bfore trade in wood and wood products is liberalized in Costa Rica. For example, bigger incentives must be given to managed natural forestry (to make it the most profitable alternative) when trade is liberalized. On the other hand, becauw de profitabiity of phatatio forestry icreaes ative to cattle ranching, trade iberalation wiD lead to a substitution of the land under ranching, towards phlantion. 14 35. Thus the effect of the log export ban is to make plantations the dominant land use at interest rates of 15% or lower (22% or lower with subsidies). Above these discount rates liquidation would be the preferred land use.21 Table 3: NPV of Land Use Options, Border Prices (US dollars/ha) __ ~~~~~~Dis-nt Rates 4% 8% 12% 15% 20% 25% 30% 35% Liquidation 2277 1958 1845 1788 1710 1641 1578 1519 Cattle Ranching 2397 1965 1779 1687 1572 143 1408 1343 Managed Forestry i) No Subsidy 1926 1294 1089 1009 929 876 836 802 ii) With Subsidy 2407 1757 1535 1444 1345 1276 1221 1173 Plintation Forestry i) No CAFs 17709 5894 2666 1692 1001 746 641 594 ii) With CAFE 18724 6838 3548 2S33 1780 1471 1321 1233 MAKING MANAGED FORESTRY THE MOST PROFITABLE PRIVATE OPTION 36. Given the interest of LAC govemnments and intenional and bilateral organizations in promoting 'sustainable' natural forest management, the obvious question is, 'What market changes would have to take place to make it the most profitable land use?". We look at three alternative scenarios: (i) an expected appreciation of tropical timber prices due to increasing scarcity; (ii) price differentiation between sustainable and non-sustainable timber products ssociated with 'green' certification of wood products from 'sustainablew forests; and (iii) direct subsidies to producers of sustainable management timber. Increasing tropical timber scarcity 37. We asked the following question: 'At what annual rate would tropical timber prices have to appreciate to make 'sustainable' forest management the most profitable option?' We assess this against our policy neutral scenario, that is, with border prices and no subsidies or taxes. (Table 3). 38. For sustainable natural forestry to overwhelm plantation profitability at 8% discount rates, tropical timber prices would have to appreciate at about 7.9% per annum, assuming all other prices (including the price of plantation timber) and costs remain at their 1989 real levels. For sustainable natural forestry to be more profitable than plantations at all rates of discount, real tropical timber prices would have to increase at about 10% per annum. Sustainable natural forestry never outdoes liquidation for any real price increase at rates of a Cumnt policy propoal in Coa Rica incude lImlizzg ude firm plution fiamy but aisiin tzadedreto. fow ntal foesy. This would skw the ucaue of ictidvs agauit foret mnae o n re. 15 Figure 3. NPV of Land Use Options, Border Prices 2.4 - 2.3- 2.2- 2.1- 2- 1.9 1.6 1.7- 1.6 1.5 1.4- 1.3 In1.2 - 0. 0 ~~1.1- zi L i = 0.97 0.8 0.75 0.6 4 8 12 i5 20 25 30 35 Discount rate 0 LiQdtn + Rnchlng M Ingf wlIo A Mngf wI X Pint w/o V Plntn w/ discount of 8% or higher, in part because liquidation also produces tropical timber. 39. Are these rates of real appreciation believable? At least one company in Costa Rica, a large manufacturer of tropical timber products, and exporter to international markets, seems to believe them. The company has adopted sustainable management techniques, pardally justified by expected appreciation of real prices.2 However past behavior of tropical timber prices would not support such high expectations of real price increases in the future. In a forthcoming LATEN Dissemination NoteP, we arrive at the following conclusions: (i) tropical timber prices have been amongst the very few commodity prices that did not experience a decline in real terms during the last 30-40 years; (ii) however the average real a bi. information wa provded by company rpremnaive. 2 S. VarnS (1993): TkpiA Tibr Pne: Own Tred and Conaimoa A1mg Tead aWih Odhr Tumber Puicus 16 annual appreciation has been only 1.2% per annum from their 1950-55 level to their 1990-92 level. 40. It can happen that real price increases will be higher in the future in part due to conservation efforts, in Costa Rica and elsewhere, and declining supplies.' The relevant question here is how easily can other products, including wood products from temperate sources or plantations, substitute for tropical timber. Constantino (1988) estimated low short- run elasticities of substitution between tropical and temperate or fast growing timber (plywood: 0.75; sawnwood: 1.30), but larger long-run substitution elasticities (plywood: 1.23; sawnwood: 2.11). The forthcoming LATEN Dissemination Note corroborates this result. Although in the short-run there is no evidence of substitution between the two kinds of products, over the long-run they behave like substitutes. The LATEN study found that the prices of different commodities behave like substitutes if observed over a 10 year period or longer. The bottom-line result is that substitution is likely to take place over the long term, so before real prices could increase at 7.9% or higher over a long period of time, demand would shift towards substitutes, namely temperate timber and plantation timber, and slow down the price appreciation. Capturing consumer's willingness to pay for sustainable timber 41. The other alternative is that if sustainable timber could be differentiated from timber from other management regimes, the price differential consumers might be willing to pay could be sufficient to make sustainable natural forest management more profitable than the alternatives. There is a strong movement towards certification, and 'green labelling services' have proliferated around the world. To date there are probably more than 100 groups offering "green* certification. Several timber companies in Latin America, including at least one in Costa Rica, have already been certified or "green labelledw. Although this movement is still in its infancy and there are issues such as 'what is the trustworthiness of each label?", it is likely to increase in importance. There are two issues: (i) 'How much would consumers have to pay to make sustainable management the most profitable alternative?"; and (ii) 'How much are consumers willing to pay?" 42. To answer the first question we again solved for the price differential that would make the 'sustainable' forest management land use the most profitable one. To make managed forestry superior to plantations at all discount rates including 8%, the price of sustainable timber would have to be 460% higher than the price of timber from other land uses. A 190% price differential between sustainable and liquidation timber would be sufficient to make sustainable natural forestry more profitable than the timber coming from the liquidation option. a Lumbw markets have been recenly diset due to expected lan widrmwals fir conseation in the U.S. (the qwtted owl contovery), nd abo to expected harven fall.down in Canada, dte largest exporter. Lumber prices skyrockd in U.S. fitures mkets. 17 43. We could not find extensive studies of consumer's willingness to pay for 'sustainable" timber. However Bishop and Baan (1992) have presented some preliminary esfimates of this willingness to pay. According to their results willingness to pay is far below the price differential necessary. In a study conducted by Milland Fine Timber Ltd. 65% of consumers were willing to pay more, but of these only 4% were willing to pay between 21 and 25% more. In a questionnaire of tropical timber importers the London Environmental Economics Centre reports that 25 % of the importers believe consumers are willing to pay between 5 and 10% more. The WWF (UK) reports an average consumer willingness to pay of only 13.6% above current prices. Thus the answer to our second question is that it is unlikely that market signals alone will make 'sustainable" management the most profitable technique. Given that "green" certification is also possible for plantations timber, and that consumers may favor this product because it is not seen as "natural", the prospects for this mechanism appear to be quite limited. Incentives for sustainable natural forest management 44. As we argued in the beginning, a command-and-control approach to conserving forest land has not been very successful in Costa Rica or elsewhere. One way of making "sustainable" natural forest management attractive to private landowners, large and small, is by providing direct incentives to the activity, either through government subsidies or private incentives. The obvious question then is what level of incentive would be necessary to make "sustainable" management the most profitable option. Table 4: Extent of Incentives Required (US$/ha) to Managed Natural Forestry and Strict Protection 4% 8% 12% 15% 20% 25% 30% 35% For sustinable forest management i) NPV Of Subsidy 15783 4600 1573 779 781 765 742 717 ii) Annualized Equivalent Streum 631 368 189 117 156 191 223 251 For strict protection i) NPV of subsidy 17709 5894 2666 1788 1710 1641 1578 1519 ii) Annualized Equivalent Stream 708 472 320 268 342 410 473 532 45. Based on the information in Table 3, Table 4 gives the total difference in NPV between managed natural forestry and the next best available option, as well as the corresponding annulized returns, at the different rates of discount. This value reflects the minimum amount owners of the resource would accept as compensation for doing sustainable management instead of choosing the land use that maximizes their returns. Note that the subsidy is calculated at the free trade wood prices and without any sectoral taxes or subsidies. (For discount rates of up to 12%, the most attractive option is plantation forestry, whereas at higher discount rates liquidation becomes the most privately profitable). According to our results the incentive would be highest for farmers with low discount rates. 18 Clearly these estimates apply to the specific site we modelled. For example, as forest becomes more inaccessible, and the relative costs of alternative land uses change, so do the levels of incentives necessary. 46. Untouched forests would provide more environmental services than managed forests. Thus it is useful to calculate also the incentive necessary to convince landowners to protect these forests and abstain from utilization. These estimates are the present value of the best option from Table 3, and are repeated in Table 4. The incentives needed for strict protecdon are higher than for sustainable management (about twice higher for interest rates of 15% or greater). However this differential will decline for poorer and less accessible sites, where the returns to productive activities will be smaller5. ARE INCENTIVES ECONOMICALLY JUSTIFABLE? What Are the Environmental Values From Forests? 47. The conclusion of the previous section was that incentives needed to promote 'sustainable' forest management could be very large. The obvious question then is: 'Is it worthwhile, from an economic point of view, to allocate scarce resources to subsidize this activity?" Another way of asking the same question is: 'What would be the maximum amount beneficiaries from environmental services would be willing to offer to providers of those services as compensation for abstaining from maximizing private returns to the land?' If willingness to pay is at least as great as the willingness to accept, but the free market does not permit of such transfers (because transaction costs are high, there is a free-rider problem, etc.) then government intervention to promote forest management would be justified. An answer to these questions requires a comparison of the subsidy required with the value of incremental environmental benefits of 'sustainable' forest management relative to the best prvate option. 48. There is another option for beneficiaries of environmental services. It is to pay forest owners to strictly protect their forests instead of utilizing them. The opportunity costs of this option would be higher (about twice higher) but so would the environmental values. We thus analyze the benefits and opportunity costs of these two options, (i) sustainable management and (ii) strict protection, in the following paragraphs. 49. We need two kinds of information to carry out this analysis: (i) Estimates of the amount of environmental services associated with each land use option; and (ii) Esimates of the economic values of these services. Because data on environmental services associated with different land uses is scanty, and environmental valuation of some services is still highly = hI impoant to point out tha th analysis has desk with th he allocatio of land which is initialy covered wih prmay fores. If the economic run (to plntion ad catle ranching) ae calculte on de8raded land, it is found that planation fory is th dominant uwe till about a discount rate of IS%, after which catle ranching dominates. Since there are ignificant carbon fixation benet to plations relative to cle ranching, there is a cas to subsidis sall farme with higb discun rates to switch over to pi.atio 19 controversial and very difficult to conduct, this is a difficult area. We nevertheless attempt some gross estimates of orders of magnitude for these environmental values, based on evidence from the literature (rable 5),I and compare it with the levels of incentives required. Evaluating the orders of magnitude can at least indicate whether more careful measurements are warranted, or whether the probability that incentives will be justified is very small. Table 5: Rough estimates of environmental values from primary forests27 (US dollars/ha) TYPES OF BENEF1TS Average Annual Dollar Value Per Hectare (1989 dollars) 1) Hvdrolo2ical benefits a) Urban water supply $2.3-S4.6 b) Loss of Hydroelectric Productivity SO-120 c) Protection of Agricultural Lands $0.25-42.0 d) Flood Control $4.0-$9.0 Total $16.55-$35.6 2) Carbon swquestration $60.0-S120.0 3) Ecotourism (Recreation or non-consumptive values) S12.56-S25.12 4) Future Pharmaceuticals (Oution Value) $D.15 5) Transfer-of-Funds (Existence & Option Values) $12.8-S32.0 6) Total(l +2+3 +4+5) $102.2-4213.7 7) NPV (@8%) S1,277.5-$2,671.3 NOW.a (I) For dtailsa n eainaimi meobda,s we Kisbwr mad Caigaiino (1992, Ruitenbetk (1959) mad Gommus (1992). (a) For aib,mn we someu SWOAn tu SOmk mm CIbw (1992) and NorDian (1991) for umdcrtfiag mvamumpima; amc alm Schacide (199). 50. We separate environmental values into three groups and deal with them sequentially: (i) carbon sequestration; (ii) hydrological benefits; and (iii) existence value, option values and ecotourismi. Table 5 shows the values used in our analysis. Table 6 in the Annex measures the externality costs from choosing the best private option, i.e. the environmental values lost, instead of sustainable management. Table 7 in the Annex measures the extemnality costs of For details ane the draft pape on 'Rough Eaidmats of Envirornmental Valhe of Troical Fore" in LAV, which can be obtaned from the authors. For some of the, globa valua we, estimate what a deveoping comnty mach as Cost Rica could hope to capture give appropriate property rights and enforcing instiutors. ' Reprewets the laa if dth enatir forst, including the entire stock of abore groud caiton, is lost. 20 choosing the best private option instead of strictly protecting forests. The results can be more easily seen in Figures 4 and 5, which plot the data from Tables 4, 6 and 7. Figure 4 compares the private opportunity costs of sustainable forest management with the environmental benefits from doing it: (i) carbon sequestration; (ii) carbon sequestration and hydrological services; and (iii) total benefits including also existence, option and ecotourism values. Figure 5 compares the private opportunity costs of protection (no productive uses) with the same categories of benefits. 51. Carbon sequestration. For carbon fixation we were able to develop production functions of carbon released and sequestered under different land use options, keeping also track of the end use to which timber is put and of its life cycle. According to our range of estimates of carbon sequestration values, the benefits from carbon sequestration (assuming high carbon value) do not cover the private opportunity costs of sustainable management or strict protection. For those farmers facing a discount rate of 12% or higher, incentives of US$1573 and US$2666 would be needed for sustainable forest management and for strict protection, respectively, but the benefits from sequestration would only reach US$1356 in the first case and US$1940 in the second case. In Figures 4 and 5, the opportunity cost line is always above the carbon sequestration value line. One reason for this result is that the best private options, plantations and liquidation, also play an important carbon sequestration function. 52. These results apply only to our data conditions. For example, as one moves into more marginal and distant sites, the present value of productive activities will decline, and their ranking may even change. There may be a point beyond which it may make sense to pay farmers to do nothing, because the carbon sequestration benefits will exceed the productive value of the land, which will approach zero. 53. Hydrological benefits. A similar approach was followed in estimating the hydrological benefits to different land-use options. For off-site costs of erosion due to dam sedimentation associated with forest clearing, we were able to obtain data for a specific site in Costa Rica. For the other values we extrapolate estimates from the literature. We basically assume that hydrological services under sustainable management are identical to those of untouched forests. Under the liquidation option, in keeping with the loss of canopy cover about 60% of the hydrological benefits are lost. Under plantations, the benefits vary with the age of the plantation and the extent of harvests, but on average benefits are only about 40% of those to unintervened forests. Finally, all hydrological benefits are lost when land is cleared for purposes of cattle ranching. 54. We had seen that when only carbon benefits were considered, incentives to forest management was not justified. However when hydrological benefits are added to carbon benefits, incentives make sense under some special circumstances. The external costs from not doing sustinable management could reach US$767 (high carbon value), while the private opportunity costs of doing sustainable management would be US$779 or lower for individuals with discount rates of 15% or higher. For low discount rate individuals, however, incentives 21 Figure 4. Private Opportunity Costs at Different Discount Rates and External Benefits from Sustainable Management (US$'000/hectare) v j 4 X L * L5 4.5 4 3. S 3 D0 2.5 c 2 1.5 -I 0. 5 0 a 12 Is 20 25 30 35 0 opp. Cost Sums. Mot. + Carbon Ext. o Carb.. Hydro. A Total Ext. would not be large enough to keep them from converting to plantations. 55. A comparison of Table 7 in the Annex (extemality costs from doing nothing in the forest, i.e., strict protection) with Table 4, shows that the level of incentives required to stop the owner from intervening would just be too high. Thus, for this site at least, it would make more sense to sustainably manage the forest than to strictly protect it. These results can be seen in Figures 4 and 5. While in Figure 4 (sustainable management) the benefits line (carbon plus hydrological) lies above the market opportnity cost line, this does not happen for strict protection (Figure 5). This is a site specific result, however. As the profitability of forest utilization declines, with poorer sites, increasing distances, and less infrastructure, the net economic returns to strict protection will increase. There may be a point beyond which paying farmers to do nothing may be the best policy. 22 Figure 5. Private Opportunity Costs at Different Discount Rates, and External Benefits of Strict Protection (US$'000/hectare) 7 \ 5 t 4 1~~~~~ I~~~~~~ B 12 15 20 25 30 35 0 Opp Cost prtoct I on + Cgrbon Ext. Carb.* Hycko. A Tote l Ext. 56. Ecotourism, existence and option values. We now add additional environmental services. This group includes existence and option values (including future pharmaceuticals) and consumer surplus to eco-tourists (3,4,5 in Table 5). Our estimate of existence and option values does not measure total consumer surplus. Instead it reflects what Costa Rica might be able to capture of these values from the World community, based on past performance for selected areas in the country. 57. It could be argued that these values are met through the system of strictly protected areas in Costa Rica, which, if Bank advice is followed, would cover 15% of the territory and include sizeable representations of all major ecosystems types from a total of 48. If this were the case we should ignore these values in our analysis. The contrary argument is also valid however, that there is substantial existence and option value and ecotourist consumer surplus to natural forests outside of biodiversity set asides. It could also be argued that these values would be higher for an untouched forest than for a sustainably managed forest. Given 23 the lack of information on this topic we assume that these values accrue equally to strictly protected and sustainably managed forest outside of set-asides, but that they do not accrue to plantations, liquidated forests or pasture lands. 58. When all externalities are considered, and assuming a high carbon value, it makes economic sense to pay landowners facing discount rates of about 10% or higher to either do sustainable management or even to strictly protect their forests, (Figures 4 and 5). Who should finance the incentives? 59. An important issue is what environmental benefits accrue to the World and to Costa Rica. For simplicity we assume that the bulk of hydrological benefits accrue to Costa Rica alone (16%), and all the other ones to the World (84%). These results, if true, have important policy implications. What would be in Costa Rica's interest to do in marginal agricultural lands? Assuming a discount rate of 8% or lower its best option is to convert to plantations. What would be in a foreign country's self interest that Costa Rica do in its muarginal agricultural lands? The foreign country would prefer that Costa Rica protect forests in strict set-asides. The foreign country's second best option would be that Costa Rica do sustainable forest management. These would yield higher benefits to the foreign country in the form of non-consumptive forest values than the competing land uses. Finally, given that the World is the main beneficiary of environmental services from Costa Rica forests, but that Costa Rica bears most of the costs of providing these services, the World should consider sharing these costs. Asusuming sustainable forest management is the best option 60. The discussion of the previous section has argued that sustainable natural forest management (or strict protection for more marginal sites) is superior to the alternative most likely chosen by private farmers facing discount rates of 12% or higher, which would be liquidation. Although this is true, forest management is not the best option for Costa Rica under an 8% or lower discount rate. The best option from the country's point of view would be to convert to plantation forestry because, even after accounting for the loss of extemralities associated with conversion of old growth forests to plantations, the revenues far outweigh those from any other option. Thus, at discount rates of 8% or below, Pareto optimality suggests that Costa Rica should subsidize small farmers hfed with high discount rates to do plantation forestry in order to exploit its intertemporal "externalities', arising from the divergence between the social and private rates of discount. 61. We recognize that the social desirability of plantations is a very site specific result and could vary from area to area. However, even for the present data which supports the development of plantations, there are several practical reasons why advocating plantations is not likely to be the best option from Costa Rica's point of view. In general, this has to do with the political consensus generated around sustainable forest management and the stigma attached to unsustainable forestry including, to a large extent, conversions to plantations. A 24 large part of bilateral and multilateral aid that the country receives, whether for projects specific to the forestry sector or for general development assistance, is loosely tied to the proviso that Costa Rica manage its natural resources on a sustainable basis (for the forestry sector policy, see World Bank OD 4.36, and for wildlands policy, see World Bank OPN 11.2). In other words, if Costa Rica is to continue to receive developmental assistance it has to emphasize sustainable natural resource management and not conversion to plantations. Advocating plantation forestry would obviously jeopardize its green image and its chances of getting a continuing flow of funds. Thus there would be an additional opportunity cost of converting to plantations, which we have not quantified. 62. Additionally, if Costa Rica pursues sustainable management practices, it may be possible to get the international community to pay for the externalities which accrue to the global community (as pointed out in the preceding subsection and emphasized in the Forestry Policy paper, World Bank, 1991). Clearly, this would be impossible if the country were following a policy of developing plantations since the benefits are mostly local and national in character. Any subsidies to plantations would most likely have to be covered from the government budget. They might not even be the best use of scarce fiscal resources. In sum, we feel that these are compelling reasons for Costa Rica to choose sustainable forest management for smaU farmer lands as the best option from the social point of view. 63. We have established that for specific sites in Costa Rica and rough estimates of environmental values of tropical forests, it would make sense to offer incentives to land owners to either do sustainable management or protect the forests. For our specific data conditions, promoting 'sustainable management appears to be the superior strategy. This depends however on whether managed forests will also carry ecotouristic, existence and option values, and only applies to sites with easy access to markets. 64. As one moves away from markets, site conditions deteriorate and production costs increase, the rankings will change and so will the levels of incentives required. At the marginal site all production activities, including management, will have a value of zero, but environmental services will stilU have a positive value. Beyond that point there is no need to offer incentives as forest conversion is not a threat. For sites close to the margin it may make more sense to pay owners to pursue strict protection than to pay them to do "sustainable' management. For still other sites 'sustainable' management may be the superior economic choice. One important conclusion is thus that this kind of analysis must be site specific. The consistency of our predictions with reality suggests however that the rankings between the four land use options are applicable to a large number of sites. 65. Our results also indicate that incentives may make sense pnmarily where at least two of the three categories of environmental values are present: (i) carbon sequestration in upper watersheds where hydrological benefits are important; or (ii) carbon sequestration in lands that also have high ecotourist, existence and option values. 25 66. We acknowledge that 'sustainable' management strategies are often the consensus reached through complex political bargaining between constituencies with different rights and interests. So we assume that the optimum policy, arrived at through public consensus, or for specific sites, would be to promote "sustainable' natural forest management. From the policy point of view, it appears that an additional incentive to managed forestry (of about $279, over the existing one of $500 currently offered in Costa Rica) will be sufficient to encourage smalholder cultivators to practice natural forestry. For the large corporate farmers, with lower rates of time preference, plantation forestry is an overwhelmingly attractive option and the amount of subsidy required is very large. In other words, under budget constraints, the Government should target subsidies first towards groups in the economy that face large discount rates, presumably small and subsistence farmers removed from credit markets. 67. So far we have taken the view tha publicly financed subsidies would be offered. How to implement such schemes is a complex matter that we take up on another paper. The other alternative to public subsidies are private based transfers. We have shown above that for a plausible range of values, the gainers from 'sustainable' management or forest protection, may be willing to compensate the losers (the land owners) from not undertaking the best private option. There is therefore an opportunity for such payments to take place through market transactions. Necessary conditions for that to happen would include (i) an appropnate structure of property rights; (ii) capacity to enforce those rights; (iii) capacity to monitor and enforce contracts. Schneider (1993) has discussed the opportunity for developing carbon-offset markets for the Amazon. Hydrological benefits and existence and option values may also suit themselves for private types of transactions. This is a complex area and will be dealt with in a forthcoming paper. SUtMMARY AND CONCLUSIONS 68. 'Sustainable' natural forest management is a declared objective for resource management in countries of the LAC region. There are not many examples however of "sustainable' forest management in the region, and private agents have preferred to either mine the forest (liquidation), or convert to other land uses, including forest plantations. This paper looked into why sustainable forest management is not more popular in Costa Rica and what it would take to make it an attractive land management option from a private point of view. In Costa Rica, while protection of forests inside of publicly owned and strictly protected set-asides has been fiirly successful, the same did not happen with policies targeted at pnvately owned natural forests. Since the command-and-control (attenuating pnvate property nghts though resource use restrictions) approach to conservation of forest land has not been successful it appears that recourse must be taken to market based incentives to sustain the area under natural forest cover. Thus, this paper examined the profitability of four important land-use options from the private entrepreneur's viewpoint. gt is a oo.4ime, cumn period pamst. Sec ab $ of te. 26 69. Our analysis indicated that sustainable forest management is not popular because from a private perspective it is always dominated by alternative land uses. For large farmers or corporate owners facing low discount rates and operating in maginal agricultural lands it is better to convert a primary forest to artificial plantations of fast growing species. For subsistence farmers facing high discount rates, or in a situation of high discount rates due to macroeconomic risks, it is better to liquidate the forest and convert natural capital to other uses. If we allow for tenure insecurity associated with natural forest cover the best option under high discount rates would be to convert to cattle ranching. Our analysis further indicates that the existing structure of incentives in forest policy is not successful in maldng sustainable natural forest management more attrcve. 70. We then asked what would it take to make sustainable forest management an attractive option to private landowners. We found that high rates of real price appreciation would be needed and that these were unlikely based on past trends and the availability of substitutes. We also found that consumer willingness to pay for "green-labelling" is unlikely to be sufficient to cover the opportunity costs of sustainable management. 71. For privately owned natural forests outside of set-asides, which have important environmental functions, we see two possible strategies. One would be to weaken the sustainability constraint imposed on these lands. Instead of striving for maintaining the natural capital more or less intact, one could accept some degradation (mining) or conversion to artificial capital (plantations). A weaker sustainability constraint might be maintenance of marginal agricultural lands under some kind of forest cover, including tree crops. Some of the environmental values would be protected. If freed from current policy distortions, markets would suffice to bnng about that outcome. The economic costs of sustaining forest cover would be less than those of sustaining the natural forest cover. Large and corporate farmers would establish plantations and small farmers would liquidate (mine) the forests. The big loser could be biodiversity, but this value would be effectively protected from irreversible losses in 15% of the territory. 72. The other alternative, if environmentally sustainable forest management is chosen as the preferred land use from a social point of view, would be to offer direct subsidies to pnvate farmers to practice it. Thus we also estimated levels of subsidies necessary to promote the activity and found these subsidies to be large. Based on rough, back of the envelope calculations of extenal benefits from sustainable management relative to alternative land uses, we conclude that only under some special conditions would it make sense to subsidize this activity. However we raise doubts that this activity would make sense to Costa Rica, except under localized circumstances, when the concern is to protect important watersheds or buffer zones. Sustainable natural forest management would make more sense to the World than plantations, liquidation or cattle ranching, and the world community should consider co-financing these incentives. From a budgetary efficiency point of view, it would make more sense to target the subsidies to small farmers (i.e. agents with high discount rates), who face lower opportunity costs from doing sustainable management, than to large farmers or corporate owners. Sustainable management would also make more sense than 27 strict protection for our site specific data. These results would most likely be reversed however as one moves towards more marginal sites. Finally, the possibility of facilitadng private transfers between demanders and suppliers of environmental services must be investigated. 73. Our conclusions are very sensitive to the quantity, quality and value of environmental services assumed for each land use option. Thus, our key recommendation is that research on the physical and biological implications of different land uses, and on the valuation of environmental gains and losses, should be high priority. Our conclusions are also very specific to the data we analyzed. Thus, it is important to extend this kind of analysis to a varied range of sites in order to assess the robustness of our conclusions. REFERENCES Bishop, J. and Camille Bann. 1992. In wThe Economic Linkages between the International Trade in Tropical Timber and the Sustainable Management of Tropical Forests", London Environmental Economics Centre report to the MlO. Cline, William R. 1992. The Economics of Global Warming. Institute for International Economics, Washington DC. COSEFORMA. 1993. Analysis Financiero De La Produccion Forestal En La Zona Norte. Documento Del Proyecto #28. DGFIGTZ, May 1993. 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Tropical Science Centre and World Resources Institute. 29 ANNEX 1 Table 6: Externality Costs from Choosing the Best Private Option Rather than "Sustainable" Forest Management (Present Value US$/ha) DIXcount Rate 4% 8% 12% 15% 20% 25% 30% 35% (1) NPV Of Carbon Oi Low Carbon Value 0 $10t 678 678 678 250 250 250 250 250 4u) High Carbon Value 0 $20/t 1356 1356 1356 500 500 500 S00 S00 (2) NPV Of Hydrological Externaities i) Low Esimate 122 122 122 124 124 124 124 124 (u) High Estimate 262 262 262 267 267 267 267 267 13) Sub Total (1)+(2) O) Lorw Estmate 800 800 800 374 374 374 374 374 (u7 High Esimate 1618 1618 1618 767 767 767 767 767 3) NPV of ecotourism, option and existence value externalities 1) Low Esimate 321 321 321 321 321 321 321 321 ii) High Esimate 726 726 726 726 726 726 726 726 4) Totd Externality Values i)ILow sUmate) 1121 1121 1121 695 695 695 695 695 ii) gh etinate) 2344 2344 2344 1493 1493 1493 1493 1493 5) Global Values i) Lowe nsnate 999 999 999 571 571 571 571 571 ii) High estimate 2082 2082 2082 1226 1226 1226 1226 1226 N* Al szOmufor_ 1w bens d aul 4 in. a z _ SI. l & U b t z 6 e b s fac eas o ernprmmw Tabb 4. 30 Table 7: Externality Costs from Choosing the Best Private Option Rather than Not Utilizing the Forest (Present Value US$/ha) Discount Rate 4% 8% 12% 15% 20% 25% 30% 35% (1) NPV Of Carbon C1) Low Carbon Value a $10/t 970 970 970 542 542 542 542 542 (ii) High Carbon Value 0 $20/t 1940 1940 1940 1084 1084 1084 1084 1084 (2) NPV Of Hydrological Externalities li) Low Estimate 122 122 122 124 124 124 124 124 (ii) High Estimate 262 262 262 267 267 267 267 267 (3) Sub Total (1)+(2) 6) Low Esdimate 1092 1092 1092 686 686 686 686 686 (ii) High Estimate 2202 2202 2202 1351 1351 1351 1351 1351 3) NPV of ecotourism, option and existence value externalities i) Low Estimate 321 321 321 321 321 321 321 321 ii) High Estimate 726 726 726 726 726 726 726 726 4) ToUl Externality Values i) Low estimate) 1413 1413 1413 1007 1007 1007 1007 1007 ii) High estimate) 2928 2928 2928 2077 2077 2077 2077 2077 5) Global Values i) Low esimate 1291 1291 1291 863 863 863 863 863 ii) High estimate 2666 2666 2666 1810 1810 1810 1810 1810 Note: All exlies have bvm dam g tie atoaned moda xe of S%. Tbc diacom rMaw iniec Am rn of Table 7 hm ave hpA dhe for aen of compa_hm wh Table 4.