Revisiting the relationship between equity and efficiency in PES

1. Revisiting the relationship between  equity and efficiency in PES Roldan Muradian Development Research Institute Tilburg University, The Netherlands Unai Pascual Department of Land Economy University of Cambridge, UK Luis C. Rodriguez CSIRO - Sustainable Ecosystems, Australia

2. Outline The Neoclassical platitudes and the need to move beyond A political economy approach to analyse equity and efficiency effects of PES Conclusions Moving beyond �first-best� market based platitudes A political economy approach to analyse: Acknowledge trade-offs between efficiency & equity Institutional factors affecting the trade-off Fairness and equity in PES What fairness principles for what equity outcomes? Equity vs. efficiency according to fairness principles Conclusions Moving beyond �first-best� market based platitudes A political economy approach to analyse: Acknowledge trade-offs between efficiency & equity Institutional factors affecting the trade-off Fairness and equity in PES What fairness principles for what equity outcomes? Equity vs. efficiency according to fairness principles Conclusions

3. Introduction Main issue: A Coasean approach is insufficient to understand the relationship between equity and efficiency in PES A conceptual (institutionalist) approach beyond Neoclassical platitudes is needed We try to provide answers to: What is the role of social perceptions of economic fairness in the performance of PES ? What are the key factors conditioning the relationship between equity and efficiency ? What are the limitations of the conventional Neoclassical approach towards PES? Part of the recent PES literature has turned its eye to understanding the effects of PES on poverty in developing countries. There is an aura of PES as a pro-poor market based instrument although even when it works in favour of the poor, negative social side-effects can also occur, including raising inequality, thus creating the potential for social tensions and a risk to the sustainability of the policy instrument. This paper aims at shedding new theoretical insights on the relationship between efficiency and equity in PES. We recognize that in a real world scenario such relationship is shaped to a large extent by the institutional setting -> We argue that a narrow interpretation focused on market forces is not appropriate to understanding the complex interactions between agents that take place in PES programs We propose a broader approach that makes emphasis on uncertainty and institutions, and devotes special attention to social perceptions of fairness and equity, bringing in different criteria that may be adopted in PES design. Part of the recent PES literature has turned its eye to understanding the effects of PES on poverty in developing countries. There is an aura of PES as a pro-poor market based instrument although even when it works in favour of the poor, negative social side-effects can also occur, including raising inequality, thus creating the potential for social tensions and a risk to the sustainability of the policy instrument. This paper aims at shedding new theoretical insights on the relationship between efficiency and equity in PES. We recognize that in a real world scenario such relationship is shaped to a large extent by the institutional setting -> We argue that a narrow interpretation focused on market forces is not appropriate to understanding the complex interactions between agents that take place in PES programs We propose a broader approach that makes emphasis on uncertainty and institutions, and devotes special attention to social perceptions of fairness and equity, bringing in different criteria that may be adopted in PES design.

4. 1. Moving beyond Neoclassical platitudes So far, the foundation of PES programs is predominantly based on neoclassical economics Main assumption: If transaction costs are low enough and property rights are well allocated, individuals would trade their rights away towards a Paretian solution, provided that an enabling institutional environment exists The core justification for the design and implementation of PES schemes is that the lack of markets for ES result in a market failure manifested as an environmental externality. Based on a Coasean view of advantageous bargaining over scarce resources, it is assumed that as far as transaction costs are low enough, individuals would trade their rights away until a Pareto-efficient allocation is achieved. Market operation includes costs of information gathering, negotiation, contract formulation, monitoring and enforcement. Ostrom et al (1993) provide the following breakdown of market operational costs: (i) Ex-ante costs associated with obtaining relevant information needed to plan, negotiating agreements, making side-payments to gain agreement and communicating, (ii) Ex-post costs associated with monitoring performance, sanctioning and governance, re-negotiation when the original contract is unsatisfactory, (iii) Strategic costs associated with shirking free-riding and corruption. the efficiency of PES scheme is guaranteed in an inter-temporal sense prima facie. As Pagiola (2007) notes, any PES contract would be broken and the scheme halted when the necessary condition of mutual self-interest of service buyers or/and providers no longer holds, that is when the Paretian improvement can be achieved by other means or by inaction. But the problem: There is need to tackle uncertainty at the expense of incurring in informational costs about characterizing ecosystem functions, let alone services! The core justification for the design and implementation of PES schemes is that the lack of markets for ES result in a market failure manifested as an environmental externality. Based on a Coasean view of advantageous bargaining over scarce resources, it is assumed that as far as transaction costs are low enough, individuals would trade their rights away until a Pareto-efficient allocation is achieved. Market operation includes costs of information gathering, negotiation, contract formulation, monitoring and enforcement. Ostrom et al (1993) provide the following breakdown of market operational costs: (i) Ex-ante costs associated with obtaining relevant information needed to plan, negotiating agreements, making side-payments to gain agreement and communicating, (ii) Ex-post costs associated with monitoring performance, sanctioning and governance, re-negotiation when the original contract is unsatisfactory, (iii) Strategic costs associated with shirking free-riding and corruption. the efficiency of PES scheme is guaranteed in an inter-temporal sense prima facie. As Pagiola (2007) notes, any PES contract would be broken and the scheme halted when the necessary condition of mutual self-interest of service buyers or/and providers no longer holds, that is when the Paretian improvement can be achieved by other means or by inaction. But the problem: There is need to tackle uncertainty at the expense of incurring in informational costs about characterizing ecosystem functions, let alone services!

9. 2. A political economy approach �Policy trade-off curve (PTOC) identifies the potential combination between the efficiency gain and equity effect given the institutional context and the set of economic and ecological factors Efficiency Gain (EG) => [Gross welfare gains for the target population] � [total cost incurred] measured in standard NPV of program Equity Effect (EE) => net impact on inequality, measured, e.g., income Gini (among others), among the target population The efficiency gain is defined as the difference between the total cost incurred and the gross welfare gains for the target population achieved by payments aimed to internalize the targeted environmental externalities. If a scheme is unable to induce a positive environmental additionality, then it would hold a negative efficiency gain, since costs have been incurred without making some agents better off (in the Paretian sense). The assessment of the equity effect depends on the implicit (or explicit) notion held by the observer (e.g., policy maker) and the target population of what constitutes a �fair� payment scheme. That is, what is their (often implicit) notion about distributive justice. Due to a diversity of notions about economic fairness (what is a just distribution of payments) the evaluation of the EE may be more complex than EG. The concept of the possibility frontier is just heuristic. It is useful as far as it stresses the institutional factors that shape the relationship between equity and efficiency. It is mainly meant to emphasize that efficiency gains and equity effects are mutually dependant, and the fact that not all the combinations between these two variables are feasible. The efficiency gain is defined as the difference between the total cost incurred and the gross welfare gains for the target population achieved by payments aimed to internalize the targeted environmental externalities. If a scheme is unable to induce a positive environmental additionality, then it would hold a negative efficiency gain, since costs have been incurred without making some agents better off (in the Paretian sense). The assessment of the equity effect depends on the implicit (or explicit) notion held by the observer (e.g., policy maker) and the target population of what constitutes a �fair� payment scheme. That is, what is their (often implicit) notion about distributive justice. Due to a diversity of notions about economic fairness (what is a just distribution of payments) the evaluation of the EE may be more complex than EG. The concept of the possibility frontier is just heuristic. It is useful as far as it stresses the institutional factors that shape the relationship between equity and efficiency. It is mainly meant to emphasize that efficiency gains and equity effects are mutually dependant, and the fact that not all the combinations between these two variables are feasible.

10. Identification of quadrantsIdentification of quadrants

11. The PTOC: Efficiency Gain

12. The PTOC: Equity Effect

13. The PTOC : Trade-offs These factors can be seen in the following example described by Mu�oz Pi�a et al. (2008) about the payment scheme for the water-related services of forests implemented at the national level in Mexico. This scheme mainly target indigenous communities for forest conservation. However, there are doubts about its net additional effect on forest conservation (since most forests under the scheme are not highly threatened). Nevertheless, the scheme is effective as wealth re-distribution mechanism, since most of these communities are considered very poor according to the government�s classification. For the sake of the example, let�s assume that the environmental additionally of the scheme is cero (since the forests will be conserved independently of its implementation). Let�s also assume that from the distributional point of view, the scheme has a positive equity effect, since it transfers resources from richer (water fee payers) to poorer social groups (indigenous communities who may control or by de facto hold the property rights to the forest) through the intermediary action of the state. Thus, in this example scenarios with positive efficiency gains or negative equity effect are excluded. Thus, only scenarios in quadrant IV in Figure 1 are possible. These factors can be seen in the following example described by Mu�oz Pi�a et al. (2008) about the payment scheme for the water-related services of forests implemented at the national level in Mexico. This scheme mainly target indigenous communities for forest conservation. However, there are doubts about its net additional effect on forest conservation (since most forests under the scheme are not highly threatened). Nevertheless, the scheme is effective as wealth re-distribution mechanism, since most of these communities are considered very poor according to the government�s classification. For the sake of the example, let�s assume that the environmental additionally of the scheme is cero (since the forests will be conserved independently of its implementation). Let�s also assume that from the distributional point of view, the scheme has a positive equity effect, since it transfers resources from richer (water fee payers) to poorer social groups (indigenous communities who may control or by de facto hold the property rights to the forest) through the intermediary action of the state. Thus, in this example scenarios with positive efficiency gains or negative equity effect are excluded. Thus, only scenarios in quadrant IV in Figure 1 are possible.

16. Read title: Different criteria differ in terms of their potential equity effect and efficiency gain. there is empirical support to the assumptions that the providers of ES are much poorer than the buyers. The Scenario assumptions: This suggests that the most common scenario for PES implementation might correspond to one where the poor are small landholders with access to only marginal and fragile land, while the better-off have larger extensions of land and usually of better quality. The axis of the figure: For the target group for the analysis (beneficiaries of the payments) this figure illustrates the way different fairness criteria would differ in their capacity to promote or ensure (i) a redistribution of income within the target group involved in the program and (ii) the environmental additionality as a measure of efficiency gain for a given payment Read title: Different criteria differ in terms of their potential equity effect and efficiency gain. there is empirical support to the assumptions that the providers of ES are much poorer than the buyers. The Scenario assumptions: This suggests that the most common scenario for PES implementation might correspond to one where the poor are small landholders with access to only marginal and fragile land, while the better-off have larger extensions of land and usually of better quality. The axis of the figure: For the target group for the analysis (beneficiaries of the payments) this figure illustrates the way different fairness criteria would differ in their capacity to promote or ensure (i) a redistribution of income within the target group involved in the program and (ii) the environmental additionality as a measure of efficiency gain for a given payment

17. The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG

18. The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG

19. The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG

20. The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG The curve could have been linear. It just states that either effiency of equity may need to be sacrified, both cannot be attained. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG

21. The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG The transfer of resources between buyers and providers of ES set additional constraints to the feasible combinations between EE & EG

22. 3. Conclusions We identify 5 issues that should form the core of a conceptual model for understanding PES beyond a Coasean approach Trade-offs between efficiency and equity. This includes distribution of rights and other institutional factors affecting this relationship Economic fairness / distributive justice considerations Implications of high uncertainty Role of conventions, shared beliefs and perceptions Role of the intermediary