Working in the field of environmental management as researchers, and being particularly interested and concerned by the fate of tropical forests and the diversity of the planet’s biological riches, we are struck by the extremely rapid emergence of “market-based instruments” (MBIs).
When attending conferences, reading scientific articles and influential reports such as TEEB (the Economics of Ecosystems and Biodiversity) or when chatting with stakeholders during field trips, we cannot avoid references to MBIs.
MBI refers to mechanisms such as certification of timber products or organic agriculture, payments for environmental services and eco-taxes those intended to change behaviours by sending price signals to either producers or consumers. The term also covers agro-environmental measures like subsidies provided to farmers in order to promote environmentally-friendly practices) and mitigation or species banking (which are systems whereby land developers can offset the degradations to ecosystems with the purchase of certificates indicating restoration elsewhere), etc.
Despite the popularity, a global yet rigorous definition of MBIs is undeniably lacking, for as the examples just listed show, they encompass various instruments with contrasted characteristics and links to markets. This poses some fundamental problems from an economic or policy-making point of view: are we really talking about markets?
The answer to this question came after we conducted some research to clarify the content of the rather mysterious term. What we found is that it appears that MBI-labelled modes of intervention — let’s call them instruments for simplicity’s sake — constitute a very heterogeneous group, which mixes ‘apples and oranges’ or taxes and permits.
This preliminary result was slightly troubling because such instruments are usually presented as more efficient and effective than forms of intervention that are more coercive and prescriptive in nature, such as forbidding farmers to use more than a given threshold of fertilizers, or landowners to convert more than a percentage of their forests. But how can we evaluate their potential and performance if they do not share common characteristics?
The only shared characteristic we could identify is the use of monetary values to deal with nature. That said, these values do not necessarily (and hardly, in fact) rely on economic valuations of the benefits provided by ecosystems, but may refer to production costs or alternatively opportunity costs, i.e., the foregone revenues from, say, not cutting trees to practice agriculture. What’s more, the approaches used in applying monetary values (through the use of MBIs) are numerous and contrasted. Commonly this means the setting up of a one-size-fits-all tax or subsidy, negotiating a contract between beneficiaries and providers of a service, setting the price of tradable permits for the use of natural resources, etc.
First step: a lexicon
The desire to support the appropriate use of these MBIs, and not prejudging their relevance and desirability in all contexts and for all goals, led us to elaborate a lexicon based on the characteristics of these instruments. Here, their weaknesses aside, we recognise that markets can provide advantages and it is therefore important for policy makers and other stakeholders (e.g., NGOs or tax-payers) to better understand what can be expected from them and under what conditions.
We therefore propose six categories with which we aim to encompass the entire range of instruments presented as MBIs in discourse and in the grey and scientific literature.
Direct markets refers to the creation of markets where goods and services derived from biodiversity and ecosystem services are traded, be they non-timber forest products, genetic resources or other products.
Tradable permits refers to the creation of markets, but where traded goods and services are standardised, are usually intentionally limited to reflect or impose scarcity, and are under the tight control of public authorities. Widely known examples include cap-and-trade systems to reduce greenhouse gases, or mitigation banking to compensate for the degradation of wetlands or other types of ecosystems, and the controversial “species banking” that has mostly developed in the United States.
Regulatory price signals. Regulations can be implemented to impose changes in relative prices for various agents’ decisions. This is usually done in order to correct market failures when some environmental impacts — in economic terms “externalities” — are not reflected in the market prices of related goods. For instance, taxes can be set up to push farmers to use fewer chemicals, given that their products could be sold at a price that is similar to the price of equivalent products with fewer impacts on the environment.
Voluntary price signals. The idea of changing relative prices is also applied to certification schemes that are established, in most cases, at the initiative of producers and are purely voluntary. The objective is to send a signal to consumers in order to either sell products at a premium and / or gain greater access to market (e.g., the Forest Stewardship Council for timber).
Coasean type agreements.
Beneficiaries and providers of environmental services may find a mutual interest in negotiating a contract stipulating the conditions under which the provider — usually a producer or a land owner — will receive a payment from the beneficiary. This process relates to what economists call “the Coase theorem”, according to which agents exchange use or property rights on a voluntary basis. This scheme is at the basis of the Payments for Environmental Services (PES) that are very popular among conservationists and environmental managers. They are mostly developed for watershed management with downhill residents or companies paying uphill landowners in order to secure practices that guarantee various water services, such as the quality of water or regular water flows over the year.
Reverse auctions. The last category derives from the theory of auctions: buyers (of a service) select the lowest available offers, as happens in the case of public procurement. Large programs such as the Conservation Reserve Program in the United States or BushTender in Australia are illustrations that show promising results. These schemes call for financial offers from landowners to set aside and protect their agricultural lands, with the lowest eventually being selected. They are regularly refined to address their weaknesses, amongst which are the strategic behaviour of sellers and the difficulty in evaluating the specific environmental contributions beyond the financial criterion.
Out of the office and onto the ground
These findings on the nature of these supposedly “innovative instruments” — namely heterogeneity and questionable links to markets — resonate with conclusions made many years ago by senior economist and expert on environmental management Robert W. Hahn pointing to the substantial differences between tools designed by economists in their offices on one side, and the mechanisms that are effectively implemented on the ground. These differences significantly degrade the positive outcomes initially expected from market-based instruments, but are totally justified by the need to stick to local conditions and various political objectives.
This leads us to the second part of our study, which was devoted to the links between MBIs and public policies. If MBIs belong to a single category, determined by a relationship to the market, they are also commonly thought to hail a “roll-back” of the state, whether this is seen as a positive or a negative evolution. Indeed, one of the main interests of MBIs is thought to be that they hand decision-making capacity to non-state, and mostly private, actors, thus moderating the inefficiencies of “traditional” (understood as coercive or prescriptive) management that is largely associated with states.
The use of the market by these actors, through the implementation of MBIs, is expected to enable improved allocation of resources and effort and a better revelation of information about things such as the costs and benefits of given courses of action for individuals and society. In theory, this leads to increased cost-efficiency of the instruments compared to “traditional” prescriptive tools. It follows that this devolution of decision-making should also have the effect of diminishing the scope of action and authority of states in environmental policy-making.
Once again, the results of our research show that such common beliefs, i.e., the “roll back” of the state because of the use of market-based instruments, may not always be accurate. Here, we distinguished between three levels of decision-making:
- the definition of objectives (e.g., reduction of GHG emissions or conservation of wetlands);
- the choice and design of the appropriate management tools (e.g., cap and trade system, biodiversity offsetting, creation of protected areas); and
- concrete decisions on the ground (e.g., changing a production technology to reduce emissions, degrade or restore a wetland).
We found that the links between MBIs and public authorities remain very strong, particularly on issues of monitoring, objective-setting and the choice of instruments, to the point that it could be argued they constitute a new form of regulation. We also found that the implementation of MBIs could result in a shift in decision-making from the state to non-state actors, when it concerned the third level of decision-making, namely concrete decisions on the ground.
A number of examples are proposed throughout the paper (downloadable from the right hand column) to illustrate this finding. Two case studies in particular, both concerning PES, which are the most popular and publicised type of MBIs at least in the conservation community, are analysed more in-depth.
The Costa Rican “Pago por servicios ambientales” programme was implemented on a national level, with the objective of promoting a rational use of natural resources. To do so, it offers payments to land owners according to their land uses, based on the fact that they produce ecosystem services. In Indonesia, a voluntary PES mechanism was established to prevent the degradation of water supplies, presumably caused by deforestation in the Rinjani volcano area, through more adequate land use (more sustainable land clearing and cultivation strategy; restoration of degraded land). All water consumers therefore pay a monthly fee in addition to their water bill.
In both case studies, the organisational capacity, legal frameworks and financial support of the state (as well as development agencies for the latter) was needed to implement the mechanism. In Costa Rica, an ad-hoc public agency was set up to manage contracts and payments, while in Indonesia, a multi-stakeholder organisation was set up to manage the collection and redistribution of the money, headed by the chief of the district forest agency.
Noteworthy, only certification schemes and specific markets for environmental products involve decision-making by non-state actors on all three levels.
The search for consistency
Ultimately our research shows that MBIs are a highly heterogeneous group with loose links to markets, as defined by economic theory. However, they also have close ties to public policies and legal frameworks as they represent a prominent policy tool for the environment. They could therefore to a large extent be compared to traditional regulations.
The heterogeneity of MBIs with regards to their relationship with the market limits any sweeping judgements being made on their usefulness, cost-efficiency, equity or any other characteristic, compared to other instruments, especially if the judgment refers to MBIs as a whole.
For MBIs to lead to optimized efforts and a better revelation of information on costs and benefits of various courses of action and for various entities, they should theoretically go through a preliminary stage involving the transformation of certain properties of an ecosystem into standard commodities (e.g., tons of carbon for climate regulation, cubic meters of clean water for watershed services, number of trees per hectare for preventing land erosion, number of species for genetic resources, etc.).
This could then lead to the emergence of exchange systems that would, in turn, have to be developed in order to ensure that the market interactions of buyers and sellers of ecosystem services reveal the true value of commodities, and enable their optimal management for current and future generations.
The road ahead is thus far from being smooth and easy. Ecosystem services from an ecological perspective are extremely complex. There is the challenge of dividing ecosystems in order to avoid the conflicts between services that are bound to emerge (e.g., carbon sequestration versus biodiversity richness), as well as inherent limitations on economic valuations methodologies to capture economic values of ecosystems. Finally, there are also the high transaction costs that this whole exercise entails if one is to achieve a satisfactory level of accuracy.
Yet, society has to bear in mind the risks and ethical issues associated with the commodification of nature. This reflection on an archetypical definition remains theoretical, and many would have sound arguments against a scenario in which markets become the decision-makers on the future of nature.