Constraints for the development of Payment for Hydrological Ecosystem Services

Just as any other policy instruments, PHES schemes have instrument specific weaknesses and require certain circumstances in order to be successful. Criticism concerning the threat of commodification of nature through the introduction of ecosystem services into a classical market economy have already been addressed in Chapter 4 and this criticism applies equally to PES as expressed with the objection of the PES instrument when purely market-based for instance by McCauley (2006); Robertson (2006); Redford and Adams (2009); Kosoy and Corbera (2010).

Redford and Adams (2009), for instance, outline seven problems with ecosystem services which they consider necessary to be addressed in order to make the role of payment for ecosystems services in conservation clearer and arguments for conservation stronger:

(1) The real risk that economic arguments about services valued by humans will overwrite and outweigh non- economic justifications for conservation.

(2) Erroneous assumption that ecosystem services are necessarily benign implying a danger to limit the focus on regulating ecosystem services to times and in flows that match human needs.

(3) Environmental policy based on the optimization of ecosystem-service values will not necessarily lead to the conservation of biodiversity, e.g. preference of exotic instead of native species for the provision of services. (4) Maximization of single-service provision leading to increased ecological brittleness.

(5) Markets only exist for a certain range of ecosystem services, and some services are not amenable to pricing or valuation, e.g. where a valuable service is provided by a biodiverse ecosystem (e.g., water yield from a forested catchment), where that ecosystem is close to a major consumer, and where institutions exist to enable those consumers to pay for the service they receive, ecosystem services may provide a powerful stimulus for conservation. Elsewhere, they will not.

(6) As ecosystem services become increasingly scarce and valuable, people will compete to gain control over flows of services and the ecosystems that provide them.

(7) Impacts of climate change on ecosystem service delivery are unknown and may cause identified cause-effect relationships to become obsolete.

Furthermore, Amezaga (2006) highlights typical constraints for the implementation of benefit-sharing mechanisms which may also be true for PHES. According to Amezaga, these constraints range from the need to find a compromise among conflicting interests over the distribution of cost and benefits to institutional challenges and up-front costs of engaging stakeholders in initial planning stages. In order to be successful, a common understanding and agreement about the nature of the expected impact, the approximate magnitude of cost and benefits, and the areas of uncertainty must be clear for all stakeholders.

Besides the general criticism on PES as a policy instrument, there are some principal constraints to the development of PHES schemes. Landell-Mills and Porras (2002) identified transaction costs, demand-side constraints and supply-side constraints as particular constraints toward PES development.

Transaction costs have considerable influence on the development of a PHES scheme since these costs reduce the budget available for payments to service providers. Compared to other ecosystem services, e.g. carbon sequestration, the cost of establishing a payment scheme for hydrological ecosystem service can be high due to the specific cost of identifying potential providers and buyers, negotiating to implement a scheme, monitoring and analyzing service delivery, documentation and record keeping and administration of contracts (Landell-Mills and Porras, 2002). This is a result of the nature of hydrological ecosystem services, the possibly large number of participants involved and often the absence of cooperative structures to build negotiations on. Landell-Mills and Porras (2002) regard multiple-stakeholder transactions, lack of cost-effective intermediaries and poorly defined property rights as main reasons for the particularly high transaction cost in the context of PHES schemes.

PHES schemes between upstream and downstream communities frequently require a large number of participants, especially on the side of service providers in order to become feasible. Hydrological threshold effects imply the coverage of a minimum area of the river basin, often involving large numbers of land users, to cause the desired effects on service provision. Broad participation is also essential to avoid free-riding in consumption and to convince beneficiaries to pay (Landell-Mills and Porras, 2002). The number of potential participants as well as related transaction costs usually increases with the size of the river basin. Several authors, Ostrom (1990); Rhoades (1998); Magrath et al. (1997) among others, have highlighted the cost of multi-stakeholder participation. Besides transaction costs originating from multi-stakeholder participation, additional costs arise from building organizational structures of intermediaries who bring buyers and seller together. These intermediaries often require strong managerial, financial and technical skills. At best it can be built on existing organizations, where these are absent often NGOs or community organizations are strengthened in their capacity to function accordingly. However, this often needs higher investments (cf., Landell-Mills and Porras, 2002).

Another factor influencing transaction costs are property rights. According to Landell-Mills and Porras (2002), in most cases insecure tenure remains a principle constraint against the development of schemes. However, in their review the authors point out a number of innovative approaches to define property rights, e.g. in the form of transpiration credits, salinity credits, watershed management contracts and conservation easements.

Examples for the transaction cost of two PHES schemes in Madagascar are summarized in Table 5.11.

PHES scheme Area [ha] No. of beneficiaries No. of providers Transaction costs

Drinking water supply of the city of Fianarantsoa

3,500 150,000 196 Ä 15,456

Compensation: Ä 77,037 Drinking water supply

of the city of Andapa

910 30,000 32 Ä 16,419

Compensation: Ä 151,481

Table 5.11: Parameters and transaction costs of PHES in Madagascar; based on (Bidaud et al., 2013)

Several factors that undermine demand for hydrological ecosystem services are mentioned by Landell-Mills and Porras (2002) as further constraints to scheme development. Of course, in order to be willing to pay for the provision of hydrological ecosystems services, potential buyers need to be aware of potential benefits from specified land uses. Lack of confidence in or scientific evidence of cause-effect relationships between land use and service provision may significantly lower the willingness to join a payment scheme on the buyer, i.e. demand side. Moreover, Landell-Mills and Porras (2002) stress that “where beneficiaries are not involved in designing the payment system and ensuring against free-riding, they may be unsupportive”. Participation of potential service providers is equally important as payments should meet their needs to engage them as well. Thus, the active participation of these key stakeholder groups in the design and implementation of PHES schemes is essential. This has been explicitly acknowledged by the US Environmental Protection Agency, for instance, by issuing specific guidelines on stakeholder participation in its Water Quality Trading Assessment Handbook (EPA, 2004). Furthermore, Landell-Mills and Porras (2002) highlight the lack of willingness to pay as an additional constraint to the development of a PHES scheme because of undermined demand and stress two mayor reasons for this from literature:

(1) Resistance of stakeholders that are used to receiving watershed protection services for free. This is particularly damaging where more powerful entities are determined to face down efforts to force them to pay the full costs of water provision.

(2) Lack of finance, especially where the government is the buyer (in Vietnam, for instance, government payments for watershed protection are too low to attract the necessary landowner participation; (cf. Sikor, 2000)).

Transaction costs and factors that undermine demand are not mutually exclusive. Often increasing transaction costs result in undermined demand, for instance.

Finally, Landell-Mills and Porras (2002) also regard factors that undermine supply as potentially hindering PHES scheme development. The authors acknowledge a widespread lack of awareness of potential opportunities to exploit positive externalities. Even when land users are aware of their role in providing services, downstream beneficiaries are most likely willing to pay when they perceive their water supplies as threatened. However, Landell-Mills and Porras (2002) see potential for land users to be more proactive in bargaining for payments by taking positive externalities into account when making land use decisions. This allows them to determine the minimum payment they are willing to accept in order to abandon their plans. With this information they are in a position to initiate a bargaining process. A final aspect that may undermine supply is a lack of credibility in service delivery. It has to be clear how service providers will alter service delivery. If the provider side wants to establish a payment scheme, it may have to offer some form of insurance scheme to minimize risks to downstream buyers where reliable, site-specific hydrological data illustrating clear land use-service provision linkages is missing.

Apart from general criticism on PES (cf., Redford and Adams, 2009) and constraints to scheme development (cf., Landell-Mills and Porras, 2002), there are also critical reviews specific to the functioning and implementation requirements of PES. Wunder et al. (2008), for instance, examined 14 PES case studies to identify whether the scheme, i.e. program, succeeds in generating the desired ES. The authors identified four critical issues related to the function of PES schemes and several other issues with regard to achieving environmental goals. The four issues related to the functioning of schemes are: enrollment of potential ecosystem service providers, compliance of ecosystem service provision and additionality as well as land use-ecosystem service provision linkage.

In general, enrollment of potential hydrological service providers is not difficult in practice as long as there is no significant mistrust concerning buyer or intermediary compliance. According to Wunder et al. (2008), in most cases applications from service providers exceeded by far the available funding. However, high disposition of potential service providers is not always given for the most critical provisioning areas if opportunity costs significantly exceed the payments offered.

The issue of compliance with agreed actions is an important one and requires some kind of monitoring. The common proof of compliance is achieved through site inspections, in the case of the FIDEICOMISO scheme in Mexico additionally through remote-sensing satellite imagery since it is integrated in the national PHES scheme. Monitoring implies transaction cost which can vary widely depending on the characteristics (e.g. size and accessibility) of the area to be monitored as well as on the temporal interval. It is important that service providers and buyers agree on a feasible practice of monitoring. Moreover, agreements on monitoring require agreements on sanctions in order to ensure compliance. The principal sanction in most PHES schemes, according to Wunder et al. (2008), is the loss of future payments, either temporarily or permanently, and in some cases reimbursement of previous payments. However, there are no systematic studies on the effectiveness of different types of sanctions to achieve compliance.

With regard to ensuring service provision compared to a situation without a payment scheme, compliance is strongly related to additionality because it considers whether agreed actions (or non-actions) would have been done even in the absence of payments. In practice, situations without intervention in form of business as usual scenarios are extremely difficult to determine. Wunder et al. (2008) document just one case where additionally is formally quantified for various ex ante scenarios. However, more attempts to assess additionality have been realized, most of them in Costa Rica, in an ex

post manner with divergent results (Ferraro and Pattanayak, 2006; Sánchez-Azofeifa et al., 2007). Experience of many user-financed PHES schemes provides reasonable good evidence of high additionality. (Wunder et al., 2008) report that in the case of Pimampiro in Ecuador, for instance, previous deforestation trends were reversed in the scheme area, while deforestation continued apace in surrounding areas. Additionality can most easily be achieved, i.e. monitored where explicit land-use changes are agreed, for instance reforestation or structural changes in agricultural practices. Land use changes which are markedly different from observed land use trend may also have higher additionality. In some cases additionality can be assumed if land use changes occur within the scheme area, while promotion of the same land use changes are not achieved elsewhere, despite being promoted as well. Wunder et al. (2008) provide such an example with the success of the PROFAFOR PES in establishing more than 22,000 ha of forest plantations on degraded lands in Ecuador, while a variety of traditional subsidy-based reforestation programs elsewhere in the country failed to achieve significant results.

Improvement of the provision of hydrological ecosystem service is still not secured based on provider enrollment, compliance and additionality alone. Additionally, the assumed cause and effect relationship between land use changes and service provision has to be true as well. Reis et al. (2007) stress that this is the most important biophysical aspect influencing the success of a PHES scheme. As has been discussed in Section 4.2, clarifying these cause and effect relationships is a complex issue for hydrological ecosystem services, especially when the relationship has been little studied. There is much controversy whether assumed cause-effect relationships eventually are true, especially when considering the role of forest for quantitative aspects of water provision (Chomitz et al., 1999; Bruijnzeel, 2004; Calder, 2004). There are just a few PHES schemes where a thorough scientific investigation of land use linkages to hydrological service provision has been realized. Exceptions are South Africa where the water consumption of invasive alien species has been well-documented (cf., Turpie et al., 2007) or the Los Negros PHES in Bolivia where the role of cloud forest in increasing dry season flows was studied(cf., Le Tellier et al., 2009). However, although land use linkages to service provision are not always clearly identified it is important that providers and beneficiaries agree on some kind of principle assumptions of them which have to be verified in the future through measurements and monitoring. Moreover, in areas deemed to be suitable for conservation in order to secure continued service provision, the precautionary principle provides sufficient reason to do so. This precautionary logic has been the basis for many water user-financed PHES in Costa Rica (cf., Wunder et al., 2008). Some relationships between land use and service provision, however, are reasonably well established, e.g. erosion control by perennial vegetation (Hope et al., 2007). As most PHES schemes lack a profound scientific basis of cause-effect relationships it is very much advisable to provide for sufficient monitoring and measurements in order to learn more about them and to react accordingly.

This form of continuous learning has been repeatedly stressed by adaptive approaches of IWRM operationalization (see Section 2.4). Wunder et al. (2008) argue that it seems more reasonable to expect user-financed schemes to adapt this learning approach with a focus on monitoring because users have a strong incentive to ensure that their money is spent effectively. Moreover, the smaller scale of user-financed PHES makes it easier to observe whether the desired services are being generated or not. Hence, PHES schemes provide an incentive to gather site-specific hydrological data. In the long run, more robust explanations for land use and service provision linkages will be either beneficial on the willingness to pay or lead to a revision of previously assumed linkages in order to improve the scheme’s outcome. In the end, increasing knowledge on land use linkages can even lead to discarding a PHES scheme if service provision may not be sufficiently affected by land use changes alone. Hence, the instrument itself may control its suitability with regard to the problem to be solved.

Besides these four issues determining the provision of desired hydrological ecosystem services, Wunder et al. (2008) consider three additional aspects that help to identify (i) whether ecosystem services are provided on a long-term basis (permanence); (ii) whether environmentally-damaging land uses are displaced to areas outside the scheme area (leakage); and (iii) whether the program creates perverse incentives. Duke et al. (2011) also regard leakage and perverse incentives as well as additionality as particular pitfalls of PES schemes.

Permanence of a PHES scheme depends on its continued and sustainable financing. For user-financed schemes continuous payments depend on maintaining buyers’ willingness to pay. As long as buyers are satisfied with service provision or the agreed land use changes, they will probably continue to finance a scheme. It is important, thus, to improve the available knowledge on service provision and the impact introduced land use changes have on it (Pagiola and Platais, 2007). The permanence of schemes supported by governmental financing again depends on a continued governmental budget allocation for this purpose. During the execution of a PHES scheme, permanence can also be compromised when participants exit the scheme, e.g. by not renewing their contracts or by violating agreed terms. Incentives to exit a scheme on the provider side can be present when potential benefits of alternative activities increase. Theoretically, payments may be adjusted to increasing or declining opportunity costs of service providers, however, most PHES schemes have been in operation for too short a period of time to confront this situation in practice (Wunder et al., 2008). Some authors, for instance Swart (2003), have doubts whether actions towards service provision will be maintained once payments end. A feasible way to increase the probability of permanence is presented by the promotion of services providing land uses

which also provide permanent on-site benefits, e.g. schemes focusing on planting trees base expectations of permanence beyond the end of payments on the expected benefits from sustainable timber harvest. According to Wunder et al. (2008), some schemes apply “short-term payments on the premise that the practices being supported are privately profitable once established, and thus will be retained“. This form of incentive can be suitable to introduce transitions toward more sustainable land use.

Wunder et al. (2008) further mention leakage, a situation where environmentally-damaging activities are merely displaced rather than reduced, as another concern regarding the effectiveness of PES. This problem is especially important for global services like carbon sequestration. However, for spatially explicit services such as hydrological ecosystem services, the presence of leakage will depend on the specific scale of intervention. If undesired land use is displaced outside the considered river basin, than leakage is at least not affecting service provision but may have negative impacts elsewhere. However, case study documentations of PHES schemes have not yet raised concerns about leakage. Usually monitoring provides a good means to reduce the risk of leakage and particular contract design addressing this issue can further reduce this risk. The relatively small size of user-financed PHES schemes makes them leakage unlikely (Wunder et al., 2008).

Furthermore, PHES schemes have to take care not to create perverse incentives to potential service providers. A typical example of such an undesired incentive is when offering payments for reforestation could induce deforestation (Engel et al., 2008). Pagiola and Platais (2007) stress that schemes focusing on additionality are particularly at risk of creating perverse incentives if payments are offered only in the presence of clear threats of degradation, then potential applicants may be induced to create such threats. The Clean Development Mechanism (CDM) provides an example how to avoid this kind of incentives through careful contract design in specifying that only areas deforested prior to 1990 would be eligible to sell carbon credits from reforestation. However, PHES schemes can also introduce additional positive incentives, for instance if deforestation is declared an exclusion criteria for receiving payments in the future, hence, even non-participants may retain forests in order to maintain the option to participate. Tattenbach et al. (2006) highlight that a PES scheme in