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

Ashley L. CamhiDuke UniversityPublic Policy 501

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Introduction

Payment for environmental services (PES) has been touted as a successful market mechanism for

conservation for over the past ten years and has become a much-researched topic (Engel et al,

2008). As James Salzman observed in his keynote lecture at Pace Law School in 2010, the

number of articles published in academic journals regarding environmental services has grown

nearly one hundred fifty-fold since 1990 (Salzman, 2011). With increased focus on cost effective

methods used to mitigate and adapt to climate change, the need to address the ever-growing threat

of water scarcity, and the exponential reduction in critical biodiversity, PES has been thrown into

the limelight as a panacea; the popular policy tool of choice to value, protect, and restore

environmental services. Yet, despite the scholarly attention and rapid increase in PES projects

(approximately 172 projects in 36 countries [Camhi, 2010]), there has been little evaluation to

demonstrate that these PES schemes are actually effective.

This paper establishes a list of criteria that contribute to the effectiveness of a PES scheme.

Effectiveness is defined as the ability of a PES scheme to produce an environmental service.

According to the Millennium Ecosystem Assessment, environmental services are the benefits

humans obtain from ecosystems. These are broken down into four types of services:

(1) supporting services such as soil formation, photosynthesis, and nutrient cycling;

(2) provisioning services such as food, water, and fiber; (3) regulating services that affect climate

regulation, water quality, and water quantity; and (4) cultural services that provide recreational,

spiritual, and aesthetic benefits (Millennium Ecosystem Assessment, 2005).

Based on rigorous literature review, field studies, and personal experience, eight characteristics

have been determined. These eight criteria have been grouped into three categories:

1.  Contracts provide incentives that are likely to result in compliance.

a) Existence of a monitoring system for compliance;

b) Tenure security is present;

c) Payments go to those providing services;

d) The time horizon of payments must be comparable to the project time horizon;

e) Payments are contingent on performance;

f) Payment level is adequate for land use change;

2.  Contracts are written in a way so as to ensure that if the agent complies, additional

environmental services will be produced.

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g) Existence of a monitoring system to verify the provision of environmental services; and

3.  Administrative costs of contracting, monitoring, and enforcement are reasonable.

h) Low transaction costs.

Four PES schemes have been chosen to demonstrate the usefulness of a PES effectiveness list.

These include: (1) Germany’s conservation procurement auction; 2) Costa Rica’s national PES

program; (3) Coopeagri, a reforestation project in Costa Rica that is implemented outside the

auspices of the national program; and 4) New York City’s watershed. The eight criteria for each

case study are rated on a scale of 0-4: 0 if the criteria are not present in the PES scheme, 1 if they

are minimally present, 2 if there is moderate presence, and 3 if there is significant presence. A

high score on all eight dimensions indicates that the PES scheme is likely to be effective (ie.

produces the desired environmental services). By analyzing these four cases utilizing the list for

effective of a PES scheme, lessons can be drawn that are informative for the future design of PES

schemes as well as the evaluation of current schemes. This paper concludes with preliminary

observations that can be drawn from the utilization of the PES list to determine effectiveness.

PES as an Incentive Mechanism

PES is a market-based policy tool for conservation established on the principle that those who

benefit from environmental services should pay for them, and those who contribute to generating

these services should be compensated for providing them (Engel et al, 2008; Pagiola and Platais,

2007; Wunder, 2005). The main characteristics of a PES mechanism are that it is

(1) A voluntary transaction where

(2) a well-defined environmental service (or land use likely to secure that service)

(3) is being bought by a (minimum of one) service buyer

(4) from a (minimum of one) service provider

(5) if and only if the service provider secures service provision (conditionality) (Wunder, 2005).

PES alters an individual’s actions by compensating him or her for making appropriate land use

decisions that are linked to environmental service provisions. Climate regulation, water quality,

water quantity, and ecosystem integrity are the traditional services that have been valued in PES.

There is a wide range of activities that could lead to the creation, preservation, or maintenance of

environmental services. In a particular watershed these could be reforestation, avoided

deforestation, agroforestry, natural regeneration, and/or silvopastoral systems. The results lead to

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collective outcomes: reduction of carbon dioxide (CO2) emissions in the atmosphere, reduction of

sedimentation, regularity of water flow, water source protection, reduction of contamination, or

protection of critical species and their habitats. These outcomes are not mutually exclusive.

Traditional conservation activities have focused on command-and-control regulation. Yet, it has

been shown that institutional weaknesses in developing countries tend to prohibit the

effectiveness of such programs. The provision of environmental services has been most

successfully accomplished through market-based mechanisms. Incentive-based policies address

externalities by altering the economic incentives private actors face, while allowing those actors

to decide whether and how much to change their behavior. Most incentive-based mechanisms

have been initiated through public policies, although privately negotiated incentive-based

solutions are possible. Incentive-based mechanisms include charges, subsidies, tradable permits,

and market friction reduction (Jack et al, 2007). As an incentive-based mechanism, PES is seen as

a policy solution for realigning private and social benefits resulting from decisions related to the

environment (Jack et al, 2007).

The Economic Backbone of PES

The failure to assign values to environmental services is a market failure. Dating at least as far

back as Pigou (1920), economic theory suggests that some form of subsidy from the beneficiaries

(buyers) of environmental services to the providers (sellers) of these services could result in an

optimal supply. Experience has shown that command-and-control institutions are not sufficient to

regulate non-point sources of pollution, such as those occurring when downstream water

pollution or water scarcity are the result of a combination of individual actions carried out by

geographically disparate and heterogeneous upstream economic agents (Kosoy et al, 2007).

PES is an example of an incentive mechanism intended to internalize externalities. An externality

as defined by Hindriks and Myles (2006) is present whenever some economic agent’s welfare is

directly affected by the action of another agent in the economy. These authors posit that if there

are competitive markets for externalities, efficiency will be achieved. In accord, Coase believed

that in a competitive economy with complete information and zero transaction costs, the

allocation of resources would be efficient with respect to legal rules of entitlement. According to

Hindriks and Myles, the implication of the Coase theorem is that there is no need for policy

intervention with regard to externalities except to ensure that property rights are clearly defined.

Where they are, the theorem presumes that those affected by an externality will find it in their

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mutual interest to reach private agreements with those causing the externality to eliminate any

market failure (Hindriks and Myles, 2006).

Complete information and zero transaction costs will almost never occur in PES. Nevertheless, it

is still possible to design PES schemes that work towards the valuation of environmental services

in the market, though their efficiency and efficacy should be evaluated on a case-by-case basis.

Four Case Studies

This section is designed to provide the reader with a brief understanding of the four-

abovementioned case studies in preparation for the analysis of the effectiveness list.

Germany’s conservation procurement auction

This PES scheme was established in Northeim in Lower Saxony of Germany in 2007. The pilot

region is dominated by farms and can be regarded as a typical agricultural region of Western

Europe. Regional stakeholders allocated the available budget towards the conservation of arable

plant diversity and the associated environmental services on conventionally managed fields.

Farmers received payments for their arable fields only if a conservation threshold of ten different

arable plant species assessed in plots of 100 m2 was achieved. Two conservation procurement

auctions with a total budget of €50,000 were conducted. The first auction was carried out in

2007-2008 with 12 farmers participating and submitting 26 bids; and the second auction in 2008-

2009 with 11 farmers submitting 48 bids and 7 farmers participating with 30 bids. Within each

auction, farmers submitted a sealed bid by mail with a corresponding bid price per hectare for the

delivery of the environmental service on their fields. Bid prices were accepted from the lowest

bid upwards until the budget was exhausted. Payments were made annually immediately after the

compliance monitoring of participating fields (Ulber et al, 2011).

Costa Rica’s national PES program

The National Institute of Biodiversity (Instituto Nacional de Biodiversidad, INE) of Costa Rica

established the first nationwide PES program (Pagos por Servicios Ambientales, PSA) in 1997.

The PSA program is operated by the National Fund for Forest Financing, (Fondo Nacional de

Financiamiento Forestal, FONAFIFO). The PSA program compensates landowners for value

created by either planted or natural forest on their land and recognized four services: carbon

dioxide mitigation, hydrological services, biodiversity, and scenic beauty. The program’s primary

focus has been on forest conservation, which accounts for approximately 95% of the enrolled area

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(Pagiola, 2008). The PSA program is financed primarily by an earmarked portion of fuel tax

revenues, which provides about US$ 12–13 million a year, and to a smaller extent by voluntary

agreements with individual water users who are paying to conserve their watersheds (generating

about US$ 0.5 million a year) (Zhang and Pagiola, 2011). The PSA program currently covers

approximately 275,000 ha of land.

Analysis of PSA within the PES list will be restricted to the first phase of the program since that

is where the largest body of information exists to date. Payments in the first phase of the program

were designed to address relevant forest conservation failures from a legal and institutional

standpoint. Three types of contracts were part of the first phase of the PSA program: forest

conservation, reforestation, and sustainable forest management. Forest conservation contracts

required landowners to protect existing (primary or secondary) forest for 5 years, with no land

cover change allowed. Reforestation contracts bound owners to plant trees on agricultural or other

abandoned land and to maintain that plantation for 15 years. Sustainable forest management

contracts compensated landowners who prepared a sustainable logging plan to conduct low-

intensity logging while keeping forest services intact. Just as in the reforestation contracts,

obligations for sustainable forest management contracts were for 15 years, although payments

arrived during the first 5 years (Sanchez et al, 2007).

Coopeagri Forestry Project is a PES scheme initiated in 2006 that was funded through the

BioCarbon Fund1 and is located in the Perez Zeledon County of San José Province, Costa Rica. The

scheme’s initial objective was to sequester 588,565 tons of CO2 by reforesting 4,140 ha of privately

owned lands (World Bank, 2006). At project start, these lands were being used for pasture and for

crops, primarily coffee and sugarcane. The BioCarbon Fund was to purchase the Certified Emission

Reductions (CERs) at US$4.15 per ton of CO2 sequestered until 2017, providing an estimated 65

percent of total project cost. Afforestation/reforestation activities were projected to occur over the

first 3 years of the project, including natural regeneration of 3,600 ha of pasture lands,

establishment of forest plantations on 300 ha, and conversion of 450 ha of crop and pasture lands to

agroforestry systems (planting 180,000 trees). At least 150 small and medium size farmers were

expected to participate in project activities; there are currently 143 farmers participating.

New York City’s watershed is perhaps the oldest and best example of a PES scheme. New York

1 Part of the World Bank’s carbon financing is the BioCarbon Fund. It acts as a mediator between companies and countries that donated funds towards reducing greenhouse gas emissions and pilot projects that received the funds upon validation of reducing GHG emissions by the UNFCCC.

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City (NYC) is a surface water system that gathers its water from three

watersheds that cover an area of 2,000 square miles. The watershed serves 9

million people, half the population of the state of New York. It delivers 1.1 billion gallons per

day and is operated and maintained by the NYC Department of Environmental Protection (DEP)

(Appleton, 2002). A major component of the institutional framework of the NYC water is that the

NYC DEP has the responsibility for management of the water and sewer system. In 1986,

outbreaks of Giardia and microbacteria led to the implementation of the American Drinking

Water law. This is the point at which the connection was made linking farming with the

environment in order to promote environmental stewardship as an economic activity. The desire

of farmers and others to maintain their ways of life (i.e., not sell their land) was the ultimate

driver of the program. The city abandoned the “traditional” way to deal with water (i.e. water

filtration plant) and bypassed desires to utilize regulation to address water providers. Whole farm

planning was instituted in order to look at the environmental and business aspects of the farmers

in the NYC watershed. The plan was to invest in the long-term agriculture industry as opposed to

income support, which fostered a landscape based economy. NYC paid the capital costs for the

farms, a small annual stipend for employment, and expanded the sustainable tourism and forestry

industries as part of the agreements with the communities of the Catskills watershed. Thus,

New York was able to avoid the enormous expense of building filtration works

to treat and purify its drinking water.

Eight Characteristics to Determine the Effectiveness of PES Schemes

Numerous articles have analyzed individual PES schemes to demonstrate whether the schemes

achieved cost effectiveness and compliance. Based on these analyses, economic theory on

externalities, and field base evidence, eight criteria (as enumerated in the introduction) have been

designated to determine the effectiveness of PES schemes. The criteria for each case study are

rated on a scale of 0-4, 0 if the criteria are not present in the PES scheme, 1 if they are minimally

present, 2 if there is moderate presence, and 3 if there is significant presence.

Figure 1. PES Effectiveness List for Four Case Studies

Existence of

monitoring system for compliance

Tenure security is

present

Payments go to those

providing services

Time horizon of payments

must be comparable to

the project time horizon

Payments are contingent on performance

Payment level is adequate for

land use change

Existence of monitoring provision of

environmental services

Low transaction

costs

Score

Germany 3  3 3 3 3 3 2 3 23

Costa Rica PSA 2  3 2 3 3 2 1 1 17

Coopeagri 3  2 1 1 3 1 1 1 13

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New York City 3 2 3 3 3 3 3 1 21

1.  Contracts provide incentives that are likely to result in compliance.

a) Existence of a monitoring system for compliance.

While it seems obvious that monitoring should be incorporated into the design and

implementation of a PES scheme, it is often neglected due to lack of funding or experience in

designing an appropriate monitoring system. There are two types of monitoring that are necessary

for a PES scheme: 1) compliance and 2) verification of environmental service provisions. The

former is an output-based system that ensures that the sellers are fulfilling their contractual

obligation to modify their land uses. The latter is an outcome-based system that certifies

environmental services are actually being created. Output-based monitoring is significantly easier

to establish than outcome-based monitoring since the valuation of environmental services is still a

contentious issue that needs further research.

The goal of PES is to make privately unprofitable but socially desirable practices become

profitable to individual land users, thus leading to their adoption (Engel et al, 2008). This target

dictates that compliance must be ensured through site inspection and sometimes combined with

remote-sensing satellite images. Yet, while a compliance monitoring system may be sufficient, it

does not guarantee that service providers are actually complying since monitoring quality or

frequency is not often known. It is possible that hidden action may arise after a contract has been

negotiated. That is, the conservation agent may find monitoring contract compliance expensive,

and sanctioning noncompliance politically costly, and will thus fail to enforce the contract. Under

such conditions, the landowner has an incentive to breach contractual responsibilities. In most

case studies the primary sanction for noncompliance is the loss of future payments rather than the

return of past payments. In addition, monitoring quality typically varies over time, and depends

on funding and politics (Pattanayak et al, 2010).

Germany (Score: 3) – Compliance monitoring was an integral component of the German

conservation procurement auctions. To verify whether the contracted farmers complied, plots of

100 m2 were located randomly in each field by the conservation agency. Monitoring was

conducted at the end of the contract period of each of the two auctions. Monitoring of

participating fields revealed that 73% and 90% of the bids were successful in achieving the

defined compliance threshold in the first and second auction, respectively (Ulber et al, 2011).

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Costa Rica PSA (Score: 2) – Compliance monitoring is undertaken by FONAFIFO, who has

limited staff with which to supervise all PSA activities. FONAFIFO utilizes a database to track

compliance. Once applicants have submitted land use plans to FONAFIFO and they have been

approved, landowners begin adopting specified practices and receive payments. The initial

payment can be requested at contract signing, but subsequent annual payments are made after

verification of compliance by inspectors. Noncomplying participants forfeit further payments.

Coopeagri (Score: 3) – In this case study compliance monitoring was conducted on an annual

basis by the five forestry specialists of the Coopeagri cooperative. Since the project was limited

to one region within Costa Rica, it was determined to be less challenging to monitor than the

national PSA program. That being said, forestry specialists expressed concerns that they faced

difficulties in reaching participants that lived in isolated areas of the Brunca region.

New York City (Score: 3) – While the DEP is the enforcement agency for the NYC watershed, it

relies heavily on local and community NGOs to monitor for compliance on farms. This has been

extremely effective since local extension agents are able to build a critical level of trust with local

landholders that permits them to do effective compliance monitoring. Each property in the whole

farm planning program is monitored twice annually. This includes one aerial monitoring,

photographing of the property, and one land-based inspection with the landowner to discuss any

changes that may have occurred since the last visit (NYC Watershed Monitoring website, 2011).

b) Tenure security is present.

Cooter and Ulen (2011) define property as a bundle of rights. Some form of property rights in the

form of land tenure is necessary for PES schemes. This is more often an issue in developing

countries, where rights to land are tenuous. The issues of land tenure are not new. It has been

recognized for decades to be a significant constraint to tree cultivation among small landholders

(Thacher et al, 1997). Many studies have highlighted the importance of land and tree tenure for

promoting long-term investments and activities such as adoption of agroforestry systems and

program participation (Godoy, 1992).

Germany (Score: 3) – Tenure rights were not an issue in this case study.

Costa Rica PSA (Score: 3) – Legal land title was required in all three PSA program modalities. In

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order to participate in the PSA program landowners also had to present a sustainable forest

management plan prepared by a licensed forester. These plans described the proposed land use

and included information on land tenure and physical access; topography, soils, climate, drainage,

actual land use, and carrying capacity with respect to land use; plans for preventing forest fires,

illegal hunting, and illegal harvesting; and monitoring schedule (Pagiola, 2008). Zbinden and Lee

conducted a study in 2002 of 133 farmers participating in the national PSA program and 141 non-

participants in the northern lowlands of Costa Rica. Discussions with landowners suggested that

land tenure and legal land title were critical to participation. Any PSA contract creates a legal

easement that remains with the property if it is sold. For carbon sequestration, owners transfer

rights to the CO2 mitigation potential of the parcel to the national government. Costa Rica can

then sell these abatement units on any international market.

Coopeagri (Score: 2) – In the Coopeagri case study, adherence to the requirement of land tenure

security was taken through satellite imagery at the regional level. It has been stated that land titles

and property boundaries were verified, but no data exists on land title eligibility at the parcel

level. Farmers often had land titles where the boundaries overlapped with their neighbors. Those

that were not able to have those clarified in court were rejected from the applicant pool of the

project. Land tenure was demonstrated to be the greatest constraint in the regeneration modality.

42 percent of project applicants were lost due to lack of land title. In the regeneration modality

farmers without land title were initially allowed to apply and then were not allowed to participate.

The highest number of losses for reforestation applications was from discrepancies in land title.

In addition, 12 percent of applicants to the reforestation modality had discrepancies in land title.

The acceptance of farmers with sole land possession would have gone a long way to increase the

number of farmers that participated in the regeneration modality (Camhi and Pagiola, 2009).

New York City (Score: 2) – In 1905, NY State gave NYC the authority to regulate land outside of

its borders based on state health law. This unique situation gave NYC the ability to acquire land

to show that they were protecting the watershed for the long term. In 1965, eminent domain was

one of the main tactics used to free up land to create reservoirs in the Catskills. This created a

poor relationship with upstream residents for many years, but it did allow NYC to have greater

control of land use. Currently, the NYC owns about 30% of the land in the watershed.

c) Payments go to those providing services.

What is drawn into question under this criterion is whether or not land uses paid for under a PES

scheme would exist in the absence of a payment. This is called additionality. Simply put, if this

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cannot be proven then there is no need for a payment. Additionality would lead to a financially

inefficient outcome as funds could have been used elsewhere and transaction costs would be

unnecessarily incurred. PES programs that offer low, undifferentiated payments are particularly

likely to experience this problem (Engel et al, 2008). What is implicit in this criterion is the link

between land use change and the provision of environmental services.

Germany (Score: 3) - A recent paper by Ulber et al. (2011) demonstrates that arable plant

diversity (i.e. specific weed species) has the potential to provide multiple environmental services

(Ulber, 2011). In this study, arable fields that were participating in the PES scheme were matched

with control fields that were not enrolled. The two groups of fields were matched on the basis of

their similar shape, size, soil, and landscape. In the first auction, a total of 45 and 26 different

arable plant species were detected on the surveyed PES and control fields respectively. Farmers

received payments for their arable fields only if a conservation threshold of ten different arable

plant species assessed in plots of 100 m2 was achieved. This threshold was established based on

expert knowledge from regional stakeholders.

Costa Rica PSA (Score: 2) - Particularly in the case of forest protection it has been shown

through a rigorous impact evaluation conducted by Sanchez et al (2007) that the 1997-2000

deforestation rate was not significantly lower in areas that received payments. It is thought that

policies that were previously in place prior to the inception of the PSA may explain the reduction

in deforestation rates. The Sanchez et al study concluded that PSA contracts might not have

targeted deforestation pressure explicitly. In fact, the PSA contracts may have been targeted

where there was a lack of deforestation pressure because the level of PSA contracts correlated

negatively with the 1986–1997 forest clearing. This could have resulted from a policy design in

which the PSA contracts were fixed across space (i.e., each of the locations in the country is

assumed to provide the same services and is offered the same level of payment per hectare) and

enrollment was voluntary. Targeting these kinds of lands could lead to unprofitable or low-profit

land being the dominant land participants enrolled in the program. While the estimated impact of

PSA on forest cover is small, it is possible that the program has a larger impact on forest quality

by encouraging better management and protection of forests.

Coopeagri (Score: 1) This was an extremely contentious issue for the Coopeagri project due to

the fact that the participants received the same payment as they would have had they participated

in the national PSA program. Without clear proof of additionality on the basis of barriers to

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implementation or carbon finance being economically unattractive, the emissions reductions

created through this project will not be validated. The designers of the Coopeagri project argue

that this particular region of Costa Rica had traditionally low levels of participation in the PSA

program and would not have participated without the additional work done by forestry specialists

of Coopeagri to inform them and assist them in the application process.

New York City (Score: 3) – Given the history of the NYC watershed, it is clear that farmers

would not have participated in a whole farm planning program without the introduction of in kind

contributions. In this program, farmers received technical assistance and environmental

infrastructure development, such as efficient septic tanks. Altogether, NYC provided US$ 60

million to assist in the economic development of the NY state region. There was a clear shift in

farmers’ attitudes and behaviors that continue to allow NYC water to remain unfiltered.

d) The time horizon of payments must be comparable to the project time horizon.

Whether payments are front-loaded or distributed throughout the duration of the project can affect

the participation rate of a PES scheme. It is important to look at the distinction between no land

use change (forest protection) and a land use management change. Where there is no land use

change, there is no need for a front loaded payment since the opportunity cost is simply that of

not cutting down the trees. The farmer may be actually saving money if he or she does not need

to take the time to cut the trees down. On the other hand, if a farmer needs to clear his land, buy

seeds, put up a fence, etc. then there is little incentive to invest without a front loaded payment,

even if the revenue he or she would receive in the future would exceed the money that he

originally invested. Risk of not receiving the payment also plays a large role when looking at the

time horizon of a PES scheme. Hindricks and Myles (2006) demonstrate that because externality

effects will generally be different, payments need to be differentiated in order to achieve

efficiency. Whether PES schemes are set up with differentiated payment streams or a uniform

payment for land use changes can greatly impact the success of a PES scheme.

Germany (Score: 3) – Payments in this PES scheme were made annually immediately after

compliance monitoring of participating fields. The PES scheme was limited to one-year

conservation contracts. Since there was no land use change, there would have been no need to

front load payments. This was clearly effective since most of the farmers who participated in the

first auction enrolled substantially more land in the section auction.

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Costa Rica PSA (Score: 3) – Within the PSA program, forest conservation contracts provide for

equal annual payments over the five-year lifetime of the contract. These contracts are renewable by

mutual agreement. In contrast, timber plantation contracts front-load most of the payment into the

early years of the contract: 50% of the payment is paid in the first year, 20% in the second year,

15% in the third, 10% in the fourth, and 5% in the fifth. These contracts call for participants to

continue with the agreed land use for 15 years, a restriction that is written into the land title so that it

transfers to the new buyer should the land be sold (Pagiola, 2008). The time frame of these

payments is much longer than those of the other identified PES schemes.

Coopeagri (Score: 1) Adoption of agroforestry and reforestation in the Coopeagri project were

limited due to high initial costs and a long wait for benefits that made adoption only marginally

attractive to farmers. It is difficult to get farmers to participate when the payments are received

after the establishment of the project. This is a critical issue in terms of who bears the risk. Many

farmers needed funds in advance to purchase supplies, clear the land, hire labor, etc. Unless the

farmer already had another large source of funding, lack of initial funding was prohibitive to

participation.

New York City (Score: 3) - It took seven years to come to an agreement with environmentalists,

regulators, the city, farmers, etc. Despite numerous challenges to the initiation of the NYC

watershed program, participation remains high and there has been little backlash on the level and

duration of the payments.

e) Payments are contingent on performance.

Conditionality is one of the main tenets of a PES scheme. Without conditioning payments on

whether sellers are actually “performing” there is no incentive for sellers to actually change their

land uses. Payments should also be contingent on users accepting the services, so that they would

decide not to pay if they are not receiving the service as designated in the contract. This is

appropriate on the level of the institution, company, or agency that is often the intermediary

between the providers and the direct users. The rationale for a PES approach is that the recipients

of the services have some measurable value or willingness to pay for those services. However,

converting that latent demand into funding that reaches the suppliers of environmental services is

a central challenge of PES schemes (Jack et al, 2007).

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Germany (Score: 3) – Performance in the German conservation procurement auctions was

defined as a conservation threshold of ten different arable species assessed in plots of 100 m2.

Payments were clearly contingent on performance. As soon as monitoring was completed farmers

were informed as to whether they had met the requirement or not. Only those who completely

complied received their stated bid price. Here the third party conservation agency, considered the

“user,” was responsible for deciding if farmers were compliant in achieving the conservation

threshold.

Costa Rica PSA (Score: 3) – Landowners must have a land management plan approved by

FONAFIFO. Once their plans have been approved, landowners begin adopting the specified

practices, and receive payments. The initial payment can be requested at contract signing, but

subsequent annual payments are made after verification of compliance by regulators. There is a

clear compliance contract in existence for those who participate in the PSA program.

Coopeagri (Score: 3) – For the Coopeagri project, payment contingency was decided on an

annual basis upon conclusion of compliance monitoring. Here Coopeagri acts as the “user” and

represents global citizens who are receiving the benefits of the reduced CO2 emissions.

New York City (Score: 3) – For the NYC watershed New York City, payments were contingent

on compliance with contracts designated by the farmers and the local extension agencies. Failure

to comply resulted in non-payment and farmers had the opportunity to adjust contracts on an

annual basis.

f) Payment level is adequate for land use change.

The payment needs to be greater than the opportunity cost of the farmer, but not so much larger

that the environmental service is being overvalued. Opportunity costs of conservation are those

associated with the benefit foregone from alternative land activities (Wunder et al, 2008). While

it is necessary that sellers perform specified activities there will be no buy-in to the PES scheme

if valuations are incorrect. Landholders have better information than the buyer about the

opportunity costs of supplying environmental services. As is well known, hidden information can

lead to inefficient equilibria (Pattanayak et al, 2010). Opportunity costs are not static (they are

subject to changes in the market, weather, etc.) and the adequacy of payment levels is likely to

change and difficult to assess.

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Germany (Score: 2) – Opportunity costs ranged quite extensively in this PES scheme and were

mainly associated with reduced crop yields on PES fields, which accounted for 65% of overall

opportunity costs and also differed widely among farmers. Mean variable costs were higher on

PES fields and made up 28% of the total opportunity costs. On one hand, farmers were able to

reduce costs for fertilizers on PES fields, which might have partially offset the increase in

opportunity costs generated by lower yields. On the other hand, variable costs for plant protection

products were higher on fields participating in the scheme. Farmers’ bid prices submitted in the

first auction generally exceeded the estimated opportunity costs. In addition, there was no

significant relationship between opportunity costs and bid prices. This demonstrates that while

the payment level may have been adequate for the seller, it may have not been what a buyer had

been willing to pay if the conservation agency had set a bid price. It is possible that overbidding

could have made the conservation auctions more expensive than a uniform-price PES scheme.

Costa Rica PSA (Score: 2) - The PSA program has to compete with other land use returns.

Average returns from PSA vary from US $22 to US $42/ha/year before fencing, tree planting, and

certification costs. The main competing land use is cattle ranching, which shows returns from US

$8 to US $125, depending on location, land type, and ranching practices. One measure of cattle-

ranching returns is the cost of renting 1 ha of pasture. In Cordillera Central, in the heart of Costa

Rica, pasture rental ranges from US$20 to US$30/ha/year (Sanchez et al, 2007). It is difficult to

derive the opportunity costs for all of the individuals that participate in the PSA program.

Coopeagri (Score: 1) – The Coopeagri project fell short of its goals. Reforestation has only achieved

54 percent of its target, while regeneration has only achieved 16 percent of its target. Agroforestry

has done the best, achieving 77 percent of its target. From the survey conducted of non-participants

it is apparent that 22 percent of responses were related to issues of funding (lack of financing;

project not being as profitable as other options; and insufficient payments). This response is

corroborated by the low number of applicants to the regeneration modality. Once charges were

deducted the payments offered were insufficient to make adoption profitable for farmers. Even with

payments, natural regeneration would incur a net loss of US$70/ha. That any regeneration occurred

at all is due to heterogeneity among farmers: only farmers whose opportunity costs were below

average (because of particularly poor or degraded soils, or because of isolation, for example) were

likely to find the offered payments attractive enough to allow regeneration to occur.

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New York City (Score: 3) - In its entirety, NYC spent US$ 500 million and saved 5 billion in

water conservation. Payments were deemed adequate for the appropriate services or land use

changes decided on by the local extension agencies and the farmers.

2.  Contracts are written in a way so as to ensure that if the agent complies, additional

environmental services will be produced.

g) Existence of a monitoring system to verify the provision of environmental services.

This criterion is perhaps the most challenging to achieve. To date monitoring of the provision of

environmental services is largely nonexistent. In addition, there has been little data shown to

corroborate that farmers’ compliance with a particular land use change necessarily indicates that

the environmental services are being provided. Pattanayak et al. point out that PES programs can

induce land use changes without necessarily improving the provision of environmental services,

as the biophysical links between land use and services are complex for services such as regulation

of water flows (Vincent, 2010). In order to prove that environmental services are actually being

provided, this criterion is critical and, as mentioned, often not included in PES design for lack of

information on how to value local environmental services.

Germany (Score: 2) – This case study monitored the provision of environment services by the

change in the number of ten critical weed species. In the first auction, a total of 45 and 26

different arable plant species were detected on the surveyed paired PES and control fields.

Compared to the control fields, plant species richness was almost three times higher on PES

fields. Interviews with farmers revealed that this difference was mainly attributable to reduced

input of fertilizer and broad-spectrum herbicides on PES fields (Ulber, 2011). The environmental

services provided by the biodiversity (i.e. pollination, water purification, nutrient cycling, etc.)

were not actually measured in this study. It is just assumed that there is an improvement as a

result of increased weed species. Just as importantly, this scheme did not take into account the

potential difference in ecological quality of environmental services provided on different lands.

Costa Rica PSA (Score: 1) – It is impossible to determine the extent to which the PSA program

has successfully generated environmental services since the program remains weak in monitoring

its effectiveness in generating desired environmental services (Pagiola, 2008). That being said,

some limited research has been done on the valuation of these provisions. Tattenbach et al. (2006)

found that 35% of the area under forest conservation contracts are in watersheds with

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downstream surface water users. Using their estimates of avoided deforestation, they established

that 644 million m3/year of water for consumptive uses and 7,224 million m3/year of water for

hydropower production are being protected from deterioration in quality. Thus a substantial part

of the program’s resources was spent in areas where few water services were likely to be

generated. Tattenbach et al. (2006) also estimated that the PSA program prevented the loss of

72,000 ha of forests in biodiversity priority areas between 1999 and 2005. Agroforestry also

appears to have a significant impact on biodiversity in agricultural landscapes. The number of

observed diversity of bird species, as well as the number of individuals, is higher in land uses

with trees, and higher yet when the tree density is higher. With regard to carbon sequestration,

Tattenbach et al. (2006) used a model of avoided deforestation and an estimate of 100 tons

carbon/ha, to estimate that the PSA program avoided the emission of 11 million tons of carbon

between 1999 and 2005. While this information is a step in the right direction, much more

rigorous monitoring and investment in knowledge towards the creation of environmental services

is still needed.

Coopeagri (Score: 1) – For the purposes of this project, the reduction of CO2 was estimated at the

start of the project and the growth of trees was monitored periodically by forestry specialists of

Coopeagri. Since there is limited data available on the levels of CO2 sequestration by native tree

species, farmers were constrained to plant non-native species which some considered as invasive.

Biodiversity and water services were not monitored.

New York City (Score: 3) – Water quality and quantity is measured by the DEP daily. The NYC

DEP performs more than 900 tests daily, 27,000 monthly, and 330,000 on an annual basis from

up to 1,000 sampling locations throughout New York City. This work is in addition to 230,000

tests performed in the watershed (NYC Drinking Water website, 2011). The City has been

monitoring for major forms of bacteria since 1992 as part of its comprehensive watershed

monitoring program. Over 1,000 routine samples are analyzed each year from nearly 100 sites.

Samples are collected weekly from the Catskill and Croton effluents. Reservoir levels are

primarily determined by the balance between stream flow into the reservoirs, diversions for water

supply, and releases to maintain appropriate flows in the rivers below the dams.

3.  Administrative costs of contracting, monitoring, and enforcement are reasonable.

h) Low transaction costs.

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To accurately assess the cost of a PES scheme, transaction costs must be included. Coase used the

term “transaction costs” to encompass all of the impediments to bargaining (Cooter and Ulen,

2003). Transaction costs include the expense of negotiating contracts, performing scientific

baseline studies, and monitoring and enforcement. Implementation, monitoring, and enforcement

costs can be high under incentive-based approaches if contracts are tailored to individual users.

All else being equal, contracting and monitoring are cheaper when the number of agents is small.

It is possible, however, that working with an intermediary such as an NGO or a community could

reduce the costs of working with a large number of providers (Kelsey et al, 2007).

Germany (Score: 3) – One might argue that in this case transaction costs were relatively low

since no bargaining occurred. The buyer of the biodiversity services, the conservation agency, did

not provide a price level for what they were willing to accept. Bids were accepted from lowest to

highest until the budget was expended. In addition, no attempts to weight the values of the

environmental services were made. Monitoring of compliance was conducted at the end of each

one-year contract period and bids were submitted from farmers minimizing contractual costs.

Some costs incurred by the conservation agency accrued from having to provide informational

sessions prior to the auctions, but these remained minimal.

Costa Rica PSA (Score: 1) – The PSA program is considered to have high transaction costs in

relation to site-level PES schemes. FONAFIFO as a government agency is in charge of handling

applications, signing contracts, and monitoring implementation for the PSA program.

International organizations, primarily the World Bank, have provided substantial loans to Costa

Rica to maintain the PSA program. A $32.6 million loan in 2000 was designed to support current

PSA contracts. $3 million of that was intended to increase human, administrative, and monitoring

capacity in the various institutions associated with the program. In addition the net value of

payments are lower than their face value, since landowners must pay for the initial management

plan and monitoring; these fees are about 15% of payments. Complying with the provisions of

management plans further reduces the net value of payments. The PSA program initially imposed

very high transaction costs on participants, requiring applicants to fulfill eleven separate

demands, many of which (such as providing proof of payment of local taxes and being

unburdened by debt to the national health system) had nothing to do with their ability to provide

environmental services.

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Coopeagri (Score: 1) – The cost of project implementation during the first 20 years of the

Coopeagri project is estimated as US$ 4.140 million. FONAFIFO was to cover US$0.739 million,

Coopeagri would cover US$0.120 million, and the remaining US$3.281 million would come from

carbon credits sales, at least US$2.207 million of which were coming from the World Bank

BioCarbon Fund (World Bank, 2006). The carbon credits value represents 51.6% of the project

costs; therefore FONAFIFO and Coopeagri would have to invest additional funds in the project to

pay for the other environmental services – biodiversity protection, water protection, soil protection

and scenic beauty generated by the forestry activities (Camhi and Pagiola, 2009). After

administrative costs have been deducted from the aforementioned organization, nearly 79% of the

total costs are estimated to go to the farmers participating in the project. The majority of preparatory

costs incurred were fixed costs. 21 percent of the individual contracts were from farmers that had

already submitted contracts for other project modalities. Since a farmer had to submit an application

for each project modality and for each farm that he or she owned, this led to the creation of

unnecessarily high transaction costs.

New York City (Score: 1) – Transaction costs occur in relation to monitoring; landowner

relations; recordkeeping; processing landowner notices, reserved rights requests for approvals,

and amendment requests; managing stewardship funds; enforcement and legal defense (NYC

water website). Transactions costs are likely to be high due to the multitude of buyers, sellers, and

activities that constitute the PES program. That being said, it has been demonstrated that the

whole farm planning in the NYC watershed has saved $1 billion annually in lieu of a water

filtration plant. It is interesting to think about the scale in comparison to the PSA program and the

relative level of transaction costs that result in effectiveness. Perhaps even though the transaction

costs by definition might be higher than the PSA program, it is likely much more effective.

Lessons learned from the establishment of a PES list to determine effectiveness

There are many contending issues to consider when establishing a PES list to ascertain

effectiveness: determining the definition of effectiveness itself, deciding whether the appropriate

criteria have been included or important criteria excluded, considering how useful it is to rank

criteria on a 0-4 scale etc. As we can see through the ranking in the PES list, the German

conservation procurement auctions scored the highest (23), followed by the NYC watershed (21),

Costa Rica’s national PSA program (17), and lastly the Coopeagri project (13).

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Evidence supports the notion that lower scoring PES schemes are less successful than higher-

scoring PES schemes in their provision of environmental services. Under state water law, the

New York City watershed is under continuous threat of being forced to construct a water

filtration plant if water quality does not meet national standards. To date, the NYC DEP has been

able to utilize whole farming planning to produce adequate environmental services and this

underscores the second highest ranking amongst the four PES cases. In comparison, a rigorous

impact evaluation of the Costa Rica PSA program (Sanchez et al, 2007) demonstrated that there

is little evidence that the environmental services created through forest protection are in fact

additional. In the case of Coopeagri, the project failed to meet its goals for regeneration and is

highly unlikely to be sanctioned by the international governing body on climate change for the

provision of additional CO2 sequestration. Lastly, in the Germany conservation auctions it is

challenging to validate the provision of environmental services since monitoring was not

conducted to link the land use change with increased environmental integrity. Nevertheless,

research on regeneration of weeds species in Germany has demonstrated increased levels of

pollination (Gabriel & Tscharntke, 2007).

I hope that this initial attempt at a PES list provides a foundation for which to move forward the

discussion and implementation of effective PES schemes. As a jumping off point to those

discussions, I believe there are five take home conclusions from this paper:

1) The monitoring of the provision of environmental services needs to be increased;

2) Rigorous impact evaluations need to be included in PES designs;

3) A balance between transaction costs and effectiveness needs to be found;

4) There needs to be a differentiation of payments where possible; and

5) There should be a serious attempt to ensure community buy in.

Monitoring of the provision of environmental services needs to be increased

As has been shown through the evaluation of four PES schemes in this paper, monitoring the

provision of environmental services is desperately needed to justify the existence and continued

use of PES as a cost-effective instrument for conservation. Innovative economic models are

currently being developed to scale-up the valuation of environmental services. The Natural

Capital Project out of Stanford University has created a tool, InVEST, to value environmental

services that outputs maps in either biophysical terms (e.g., tons of carbon sequestered) or

economic terms (e.g., net present value of sequestered carbon) (Natural Capital Project website).

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In addition, ARIES, has been developed through the Gund Institute of Ecological Economics as a

web-based technology for rapid environmental service assessment and valuation (ARIES Online

website). Utilizing these innovative technologies with locally available information would greatly

expand one’s ability to design and implement PES schemes and go a long way in justifying PES

as an “internalizer” of environmental services in the market.

Rigorous impact evaluations need to be included in PES design

Pattanayak et al. (2010) conclude in their most recent paper that PES is probably effective only in

certain institutional settings. As Vincent (2010) puts clearly, we have little understanding of what

those settings are, because so few rigorous impact evaluation studies have been conducted and the

sites where they have been conducted represent just a few points on the broad spectrum of

settings that exist in developing countries. Additionality is a problem that draws into question

how financially efficient PES actually is. Impact evaluations are an important means by which to

justify additionality. To date only eight impact evaluations have been conducted on PES schemes.

While including impact evaluations into PES scheme design may be challenging, it is essential to

demonstrate that funds are being appropriated efficiently.

Find a balance between transaction costs and effectiveness

In PES design, there is always a tradeoff between minimizing transaction costs and ensuring

effectiveness. Improvements in monitoring may increase transaction costs but nevertheless

provide information necessary to better tailor PES schemes to specific contexts. Large-scale PES

programs may have high transactions costs in order to include smallholders throughout a country,

but this could greatly increase the internalization of the provision of environmental services in the

market. What is more important is that transaction costs do not create a barrier to effectiveness, as

it was in the failure of the Coopeagri project.

Differentiate payments where possible

The cost-effectiveness of PES policies, compared with a uniform set of regulations, will tend to

be higher where there is high variation in marginal provision costs across the population (Jack et

al, 2007). Auctions are an option that have recently arisen as was shown in the case of Germany.

Some research conjectures that competitive bids for conservation contracts could deliver

environmental services more cost-effectively than fixed payments (Naidoo, 2006). Since the

opportunity costs of the seller are often unknown, a procurement auction is a useful method to

eliminate information asymmetry and provide payments tailored to each farmer (Connor et al,

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2008). The downside of auctions is that they say nothing about what they buyer is willing to pay.

Differentiated payments allow for targeting areas with high value environmental services.

Seek to ensure community buy in

The New York City PES program is a great example demonstrating a community’s ability to

organize in order to protect a watershed. Landholders were able to develop mutually beneficial

goals that benefited both the upstream residents and the downstream water users allowing for the

building of confidence on all sides in order to maintain and protect the NYC watershed. As Elinor

Ostrom proffers in much of her work, good collective management can arise from communities

of people with a mutual interest in the sustainability of the commons (Ostrom, 1990).

As Vincent (2011) recently illuminated in his overview of innovative environmental programs,

“Generalizability [of PES schemes] is a tall order given the enormous heterogeneity that exists

across the 140-odd countries labeled ‘developing.’ Because developing countries are not one and

the same, the impact of a program in one country might not be replicable in another country

where participants face different institutional environments and thus a different set of benefits and

costs.” While it is certainly a great challenge to draw conclusions about PES schemes, it is

necessary to analyze the experiences of PES schemes to date in order to be able to justify their

relevance in the conservation field, look at how one might scale them up, and prove that they are

actually having their intended effects.

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