ADBI Working Paper Series: Asian Development Bank Institute

ADBI Working Paper Series
Market-Based Approaches to Environmental

Management: A Review of Lessons from
Payment for Environmental Services in Asia
Bhim Adhikari
No. 134
March 2009
Asian Development Bank Institute

Bhim Adhikari is a research fellow at the School of Natural Resources and Environment,
University of Michigan. This paper is based on research conducted while the author was
a visiting researcher at ADBI.
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reflect the views or policies of ADBI, the Asian Development Bank (ADB), its Board of
Directors, or the governments they represent. ADBI does not guarantee the accuracy of
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Suggested citation:
Adhikari, Bhim. 2009. Market-Based Approaches to Environmental Management: A Review

of Lessons from Payment for Environmental Services in Asia. ADBI Working Paper 134.
Tokyo: Asian Development Bank Institute. Available: http://www.adbi.org/working-
paper/2009/03/26/2906.market.based.approaches.environmental.mngt/
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© 2009 Asian Development Bank Institute

ADBI Working Paper 134 Adhikari
Abstract
Market-based approaches to environmental management, such as payment for

environmental services (PES), have attracted unprecedented attention during the past
decade. PES policies, in particular, have emerged to realign private and social benefits such
as internalizing ecological externalities and diversifying sources of conservation funding as
well as making conservation an attractive land-use paradigm. In this paper, we review
several case studies from Asia on payment for environmental services to understand how
landowners decide to participate in PES schemes. The analysis demonstrates the
significance of four major elements facilitating the adoption and implementation of PES
schemes: property rights and tenure security, transaction costs, household and community
characteristics, communications, and the availability of PES-related information. PES
schemes should target win-win options through intervention in these areas, aimed at
maintaining the provision of ecological services and improving the conditions for local
inhabitants.
JEL Classification: Q57

Contents
1. Introduction .................................................................................................................. 1
2. Review of Case Studies from Asia .............................................................................. 3
2.1 Payment for Environmental Services in Viet Nam: Assessing an

Economic Approach to Sustainable Forest Management
(The and Ngoc 2006) ....................................................................................... 3
2.2 Institutional Constraints and Opportunities in Developing Environmental
Service Market: Lessons from Institutional Studies in Indonesia
(Arifin 2005) ..................................................................................................... 4
2.3 Environmental Services “Payments”: Experiences, Constraints, and
Potential in the Philippines (Arocena-Francisco 2003) .................................... 6
2.4 Compensating Upland Communities for Watershed Services in the
Kulekhani Watershed, Nepal (Upadhaya 2005)............................................... 8
2.5 Payment for Environmental Services: The Sloping Land Conservation
Program in the Ningxia Autonomous Region of the People’s Republic
of China (PRC) (Zhang, Tu, and Mol 2008) ................................................... 10
2.6 Payment for Environmental Services: Experiences and Lessons from
Viet Nam (Hoang, van Noordwijk, and Thuy 2008)........................................ 12
2.7 Market for Ecosystem Services in Australia: Practical Design and
Case Studies (Whitten, Coggan, and Shelton [eds.] in press) ....................... 14
2.8 Developing Markets for Watershed Services and Improved Livelihoods:
Fair Deals for Watershed Services in India (Agrawal et al. 2007) ................. 15
3. Discussion: Some Insights for Designing PES .......................................................... 18
3.1 Institutional Arrangements ............................................................................. 18

3.2 Transaction Costs ......................................................................................... 20
3.3 Household Characteristics and the Role of Collective Action........................ 20
3.4 Information and Communications .................................................................. 22
4. Conclusions ............................................................................................................... 23
References............................................................................................................................ 25
1. INTRODUCTION
During the mid-1980s, the concept of integrated conservation and development gained
momentum in many countries in Asia and southern Africa with the goal of conserving
biodiversity and supporting rural livelihood. This approach combined social development
goals and biodiversity conservation, with an assumption that local livelihood practices are
important threats to the biodiversity and that diversifying local livelihood options will reduce
human pressures on biodiversity, leading to improved conservation (Hughes and Flintan
2001). However, many integrated conservation and development projects (ICDPs) failed in
achieving the ecosystem conservation goals as these projects were unable to understand
the complexity of socio-ecological systems, especially the interdependency that exists
between the resources and people living around them. Although ICDPs were envisaged to
be the best option for conserving biodiversity, they suffer from conceptual flaws that limit
their appropriateness, especially in reconciling an increasing human demand and inherently
unstable wildlife populations (Barrett and Arcese 1995). Many ICDPs could not take into
account external factors such as a growing market demand for forest and biodiversity
products, demographic pressures, and local social and economic realities. Illegal activities
such as logging, mineral extraction, and ranching further aggravated the failure of ICDPs,
which were often overlooked while designing these initiatives. One serious criticism of ICDPs
is that the poorest and most marginal households have hardly benefited from these
approaches. Further, most ICDPs were collapsed immediately after the technical and
business support services disappeared once the initiative ended. Many researchers later
questioned the viability of ICDPs, especially linking it with local communities and resource
management initiatives across diverse geographic conditions and economic situations
(Barrett and Arcese 1998; Gunatilake 1998).
More innovative forms of conservation strategies have gradually emerged in the past decade
in response to the failure of ICDPs. These new strategies intend to provide direct economic
incentives for land stewards for environmental services such as forest management,
watershed protection, and biodiversity conservation. The concept has attracted
unprecedented attention because natural and human-managed ecosystems produce
environmental externalities (a situation where certain actions of producers or consumers
have unintended external [indirect] effects on other producers and/or consumers) and that
internalizing these externalities through incentive-based mechanisms will encourage
individuals to take into account the effects of their actions on others, which could lead to an
efficient outcome. Among these instruments, market-based approaches to environmental
management such as payments for environmental services (PES) gained popularity both in
developed and developing countries for maintaining and ensuring the provision of ecological
services and improving the conditions of local inhabitants. The concept of PES represents a
new and more direct conservation paradigm in which producers of environmental services
receive direct compensation from beneficiaries of the ecosystem services for the benefits
they receive from the producers (Landell-Mills and Porras 2002). Wunder (2005: 24) defines
PES as “a voluntary transaction where a well-defined environmental service (ES) (or a land-
use likely to serve that service is being “bought” by a (minimum one) environmental service
buyer from a ES provider and the ES buyer does so if and only if the ES provider over time
secures the conditional provision of that service.” PES is rooted in the theory that direct
economic incentives for landowners are more effective than indirect means of financing and
command-and-control regulation for better land stewardship (Ferraro and Kiss 2002) and
that the incentives help internalize the ecological externalities associated with the use of
ecosystem services. PES usually covers four types of environmental services: watershed
protection, biodiversity conservation, landscape beauty, and carbon sequestration.
Landowners manage forests and vegetative cover to generate a variety of environmental
services, but they usually do not receive any compensation for such crucial services. As a
consequence, forest conservation and watershed management makes little sense to
landowners as they receive fewer benefits from such land uses compared to other practices
(i.e., conversion of forestland to cropland or pastures). As a result, upstream landowners
impose costs on downstream resource users in terms of decreased supply of water,
sedimentation, and reduced fish catch or diminishing supply of other biodiversity-related
goods and services. This can lead to socially sub-optimal land-use decisions. In such
situations, payments by ecosystem service users to producers help to make conservation
efforts more attractive (Engel and Palmer 2008). Payments also make land-use options with
conservation more attractive to local land users or ecosystem managers. They may be better
off because of the greater local benefits of the forest conservation option than that of land
conversion. Downstream populations are also better off as payments to land users are less
than costs that would actually be required to pay if upstream landowners opted for
conversion of forest land to cropland or pastures. The payment must be more than the
additional benefit to land users of the alternative land use and less than the value of the
benefit to downstream populations (Pagiola and Platais 2002). It should be noted that
potential payments under a PES scheme for the continued or increased supply of
environmental services includes not only direct cash payments. Payments can be comprised
of more innovative options such as the recognition of indigenous rights to local resources
and tenure security, wages for services rendered, health and education infrastructure for
local inhabitants, improved delivery of services such as education, skill training, and
mechanisms for reducing vulnerability of poorer households through enhancing social safety
nets, among others.
While advances in market-based instruments for environmental services help access diverse
sources of funding and make conservation a more competitive land use (Asquith, Vargas,
and Wunder 2008), very few empirical studies examine the factors influencing landowner
decisions to participate (with the exception of Pagiola, Landell-Mills, and Bishop 2002;
Zbinden and Lee 2005; Huberman and Leippraud 2006). Moreover, not much research has
been done towards defining the necessary conditions of the successful design and adoption
of environmental service markets so that the environmental conservation and development
objectives can be achieved simultaneously (Grieg-Gran, Porras, and Wunder 2005). While
several recent studies provide some useful insights on PES mechanisms (FAO/REDLACH
2004; Huang and Upadhaya 2007; Leimona and Lee 2008), there is a need to scrutinize
these claims more rigorously by collating and analyzing the available body of knowledge in
this area.
Researchers have put forward a number of factors influencing landowner decisions to
participate in PES schemes such as household and community characteristics (Zbinden and
Lee 2005), enabling national and international conditions (Leimona and Lee 2008), political
willingness on the part of national and local governments to develop policies in support of
environmental service markets (Huang and Upadhaya 2007), and land use and service
supply (FAO/REDLACH 2004). Yet, it remains unclear how and to what extent factors such
as property rights and tenure security, transaction costs, and household and community
characteristics influence the adoption of PES schemes by landowners, which are described
as being crucial elements in the PES literature (Grieg-Grann and Bann 2003; Swallow,
Meinzen-Dick, and van Noordwijk 2005; Pagiola, Artcenas, and Platais 2005). To date, little
research has successfully addressed the knowledge gaps with regard to the adoption
potential of environmental services markets in Asia.
This study relies on a review of eight existing case studies of ongoing PES initiatives in Asia.
PES is a relatively new concept and has only recently begun to gain ground in most of the
countries considered in this study. We therefore tried to select cases which fulfill the criteria
required for a full-fledged PES as closely as possible or those that contain basic
fundamentals of PES and have applied basic market-based instruments in developing
reward mechanisms for environmental services provision. The PES case studies we will
review here are largely exploratory and descriptive and allow us to examine the issues
discussed earlier. In the following section, we will present a synthesis of the findings of the
2
case studies. The third section will analyze and discuss the findings from these case studies.
The fourth section will provide the major conclusions.
2. REVIEW OF CASE STUDIES FROM ASIA

In this section, we will review eight case studies from Asia of watershed services,
biodiversity conservation, carbon sequestration, and initiatives on establishing markets for
landscape beauty. Since most of these schemes are at an early stage of operation, we will
summarize important findings in these studies that may have more general implications for
the success of environmental service markets in the region.
2.1 Payment for Environmental Services in Viet Nam: Assessing an

Economic Approach to Sustainable Forest Management
(The and Ngoc 2006)
This study provided a review of sustainable forest management in Viet Nam, which aimed at
assessing constraints and opportunities for adopting PES schemes in the forestry sector. A
field-based experiment was undertaken in a cluster of three selected upland communities
(Khe Tre, Huong Phu, and Xuan Loc) in the Thua Thien Hue province of central Viet Nam for
a period of 26 months. Data collection methods included stakeholder workshops, interviews
with relevant governmental and non-governmental organizations, and collection of socio-
economic data using semi-structured interview techniques. An econometric analysis
approach assessed the determinants of adoption of PES schemes.
Since the late-1990s, the Vietnamese government has pursued decentralized policies
towards environment and natural resource management, including the forestry sector. The
legislation offers a favorable environment for supporting community-based approaches to
forest management as well as PES schemes in the country. Although formal ownership of
land rests with the government, households, individuals, and organizations are allocated
land for long-term productive uses such as agriculture, forestry, and aquaculture. Three
types of forests are considered for benefit-sharing arrangements with individuals and
organizations: special, protection, and production forests. In Viet Nam, communities have
very limited rights to enter into such contracts. Special forests are allocated to households
and individuals who plant, regenerate, and protect the forest. It is possible for them to
undertake ecotourism-related initiatives in these forests. In return, they are entitled to receive
payments from the state. In protection forests, individuals and organizations can harvest dry
and diseased trees and non-timber forest products. For the non-forested land allocated for
conservation and protection purposes, they receive payments from the government for all
conservation-related interventions. Timber harvesting through selection techniques is
acceptable in the protected forests along with the use of non-forest areas for agricultural
purposes (not more than 20% of allocated land). In cases where private investments have
been made, households are entitled to receive 100% of the benefits when such forests reach
the harvesting stage.
Compared with special and protection forests, production forests provide the most benefits
to communities. In them, individuals and organizations can collect forest products such as
dead trees, trees damaged by natural calamities, timber for house construction, and residual
products of silvicultural operations for subsistence purposes. Further, forest products from
production forests can be harvested according to the condition and state of the forest. For
instance, communities are entitled to obtain 100% of the subsistence forest products from
those forests that were poorly regenerated during the time of the handover, 70–80% from
regenerated forests, and 2% of the annual products from the forests where the annual
growth rate is over 100 meters³ (m)/hectare (ha). It is possible to harvest 95% of the
products from bamboo forests. Cattle grazing is also permitted in production forests.
3
Households are entitled to obtain about 75% of the forest products from plantation forests
established by the state and later handed over to individual (or community) management.
Agroforestry and inter-planting activities are also permitted; households can enjoy 2% of the
annual harvest against adoption of such land-use practices.
This case study analyzed the relationship between household characteristics and the
decisions of upland farmers to participate in different PES schemes, particularly the adoption
of different forest management practices. It appears that the availability of family labor was
positively associated with the adoption of PES schemes. Education of the head of household
was found to be another important factor that significantly influenced a household’s decision
to participate in PES schemes. The size of the resource was another consideration as the
area of forest plantation was positively associated with the adoption of PES schemes.
Another interesting finding of this study was the role of debt in participating households.
Probability of adoption was negatively correlated with the amount of outstanding loans.
Moreover, it was demonstrated that debt stress may force households to harvest plantation
forests early. This is because income from environmental service payments would not be
sufficient to mitigate the loan burden. This indicates that the long-term sustainability of these
forests depends on the loan repayment ability of farmers. Characteristics of the resources
themselves were positively associated with PES adoption. For instance, plantations that are
easily accessible with high growth potentials are likely to be considered for PES schemes by
the villagers. Farmer’s adoption of PES schemes in Viet Nam was, therefore, found to be a
function of the area of forests, human capital, and household economic situation, particularly
education and the availability of family labor.
The study also examined potential constraints for adopting PES schemes. Lack of private
ownership was identified as a major barrier for participation in PES schemes in Viet Nam.
One important finding in this connection appears to be the type of rights people could
practice in these three different forest management regimes. Farmers could decide the type
of tree species to be planted in the case of production forests. However, this was not the
case with special and protection forests where government policy dictated the choice of
species, timing of harvests, and harvesting methods. PES schemes seem to be easily
adoptable in production forests where forest owners have some leverage on land use.
However, environmental services provided by protection and rehabilitation activities in
natural forests are often valued highly compare to that of production forests. Further,
services generated by production forests seem to be of limited concern to policy makers.
Perhaps this is one of the constraints for PES in Viet Nam where environmental services
outside protected areas have been mostly ignored.
Transaction costs for forest-based PES schemes were another concern. The total annual
transaction cost per contract in the study sites was about US$35 which is a significant
amount for poor smallholders. Further, transaction costs per hectare of forest enrolled in the
PES scheme were US$20 (about D570,000). This amount is actually two times higher than
the payments they receive for a hectare of forest under the PES scheme. The fragmentation
of plantation forests owned by households (usually two ha/household scattered in many
different places) means high transaction costs for negotiations, monitoring, and enforcement
of PES-related contracts.
2.2 Institutional Constraints and Opportunities in Developing

Environmental Service Market: Lessons from Institutional
Studies in Indonesia (Arifin 2005)
This study examined institutional constraints and opportunities for markets for environmental
services with a review of three cases of watershed, biodiversity, and carbon sequestration
services in three different provinces (Sumber Jaya, West Lampung; Bungo, Jambi; and
Singkarak, West Sumatra) of Indonesia.
4
The Sumber Jaya sub-district is a hilly area suitable for growing coffee which had been the
major land use in the upper watershed. Although people had been practicing coffee-based
agroforestry for decades, thousands of people were evicted during the Suharto
administration as a policy of protecting the sub-watershed. The government’s plan for
building a hydropower plant in the early-1990s further marginalized the local people,
culminating in a forced removal of large numbers of people from the watershed. After the fall
of the Suharto regime in 1998, a number of conflicts emerged between the government and
local coffee growers around the land-tenure issue. The degradation of the watershed
continued due to coffee monocultures, environmentally unfriendly horticulture practices, and
cultivation of secondary food crops without proper conservation measures. The shortage of
water was a particular problem to a government-owned hydroelectricity plant which is
supposed to generate 144 megawatts (mW) of electricity along with providing drinking water
for the surrounding areas. In the late-1990s, the government later adopted a regional
autonomy approach with some authorities devolving to local government that included taxing
and levying power on coffee and non-timber forest products. The central government’s
decree of community-based forest management also recognized the rights of local people to
coffee-based agroforestry and access to other forest products. As some scientific studies
have suggested the coffee multi-strata system was as effective as other environmentally
friendly land-use options, the local coffee growers were granted temporary five-year tenures
in 2001. After five years, the tenure was reviewed and was able to be extended for another
25 years, allowing local people to use state-managed protected forests.
The Bungo occupies an area of 455,208 ha of the Batang Hari watershed of high biodiversity
value. Main land uses in the watershed include forest (37%), monoculture rubber plantation
(31%), rubber agroforestry (13%), oil palm (13%), young palm (5%), and other categories.
Smallholders maintain rubber plantations and take part in rubber agroforestry under different
institutional arrangements between the landlords and share-trappers. In order to increase
production, the Smallholder Rubber Development Project assisted local people with clonal
high yielding variety of rubber which yield an average of 990 kilograms (kg) dry rubber per
hectares compared to 640 kg of relatively low yield variety. Rubber agroforestry (referred to
locally as “jungle rubber”) is a viable option for maintaining biodiversity services in humid
tropics. The product of the jungle agroforestry system in the area (latex) provides 70% of
local household income. However, jungle rubber agroforestry is under stress due to pressure
for either high-value food crops or rubber monoculture with high yielding varieties. The area
is also under pressure for other development interventions such as mining and oil palm
investors are keen to expand plantations in upland areas.
The catchment of Lake Singkarak covers 129,000 ha. Land uses include rice paddies (21%),
upland crops (17%), and other uses (30%). Lake Singkarak provides water to a hydropower
plant with a 175 mW capacity. However, production in the catchment has declined
significantly in recent years due to deforestation and land degradation. Poverty in the
Singkarak catchment has become a serious problem. Approximately 77% of the catchment
population depends on agriculture and fishery activities and 10% of them are practicing
shifting cultivation. In 2004, the catchment was selected for forest-carbon projects by the
Ministry of Environment. The project is expected to contribute to poverty reduction and
environmental conservation through afforestation and reforestation activities. It also provides
direct economic incentives to local people through the carbon sequestration service they
offer through watershed conservation.
These three cases provided a number of lessons, particularly regarding the role of
institutions for the adoption of PES schemes and development of reward mechanisms. The
strength of collective action was key in securing temporary tenure rights and reducing the
transaction costs of forest management in Sumber Jaya. In this area, five farmer
organizations were recognized by the government under its community-based forest
management program. They were crucial in adopting conservation values in local land-use
decisions. Further, the temporary written rules on “tenure” provided an adequate basis for
5
protecting water resources for downstream users. The recognition of rights to organize by
the government also helped build trust and a sense of guardianship among villagers. The
role of bonding and bridging social capital provided a foundation for the adoption and
implementation of the PES scheme in Sumber Jaya.
Institutions supporting biodiversity services in Bungo were achieved by acquiring land-use
rights through forest frontier activities such as initial planting of cash crops. Major cash crops
planted for claiming rights were rubber, cinnamon, and other tree crops. The local
community has rights to enforce certain rules such as declaring the land common property in
which agricultural activities have been absent for more than 10 years. In Bungo, there is also
congruence between locally crafted rules and the state’s rules with regard to forest
conservation. They enforce tanah batin (a locally devised land-use norm) that governs lands
assigned for upland paddies where a number of ritual activities could be performed. Local
institutions were instrumental in Singkarak for providing carbon sequestration services. The
revival of the nagari system (a very complex social system of governing land use in the area)
contributed significantly to environmental conservation. The notion of common property is
widely held in West Sumatra, which governs land use, fishing, and forests uses. The negari
system acknowledges self-ownership of resources.
In all the cases, the existing institutions were instrumental in reducing transaction costs,
particularly encouraging collective action towards forest and watershed conservation. In
Sumber Jaya, the gotong-royong (labor sharing for common property) and arisan (capital
sharing on regular basis) systems provided much required social capital for facilitating
markets for environmental services in the area. It was also true for Bungo where pelerin
(labor sharing for private land) and berselang (labor sharing for paddy planting and
harvesting) systems were instrumental in uniting local communities for marketing carbon
sequestration services. Cooperative actions mediated by these institutions helped develop
criteria and indicators required for equitable and fair payment systems that would have been
expensive without the recognition of traditional management institutions.
This review also shed light on the role of intermediary organizations which facilitated the
adoption of sustainable land-use practices in the area. Further, building the capacity of local
government in forestry and watershed management appeared as another factor which
promotes the implementation of PES schemes.
Conversely, this review found that transaction costs (currently US$55/household with annual
farm income of US$1,035 [i.e., 6%] in Sumber Jaya) of the PES schemes are still high and
that could be an obstacle for the sustainability of the PES schemes in the long run.
2.3 Environmental Services “Payments”: Experiences,

Constraints, and Potential in the Philippines
(Arocena-Francisco 2003)
This study reviewed four ongoing PES schemes in the Philippines with varying management
interventions, development assistance, and institutional arrangements. Watersheds included
in this study were: Makling Forest Reserve (MFR) managed by the University of the
Philippines, the Maasin watershed managed by the local government unit with multiple
funding sources, Northern Sierra Madre Natural Park (NSMNP) managed by a non-
governmental organization (NGO) with funding from the European Union and the United
States Agency for International Development (USAID), and Mount Kanlaon Natural Park
controlled by the Department of Environment and Natural Resources with funding from
Global Environment Facility. In terms of land area, the sites range in size from the 4,244 ha
MFR to the 359,486 ha NSMNP. While the Maasin watershed covers an area of 6,738 ha,
Mount Kanlaon National Park occupies 24,557 ha and is one of the ten priority sites covered
by the Conservation Priority Protected Areas Project in the Philippines.
6
These areas experienced severe deforestation and watershed degradation in the early-
1990s. Inadequate water supply during the dry season was a major problem in the MFR.
Encroachment of adjoining land posed a serious challenge for watershed conservation.
About 64% of the Maasin watershed is under cultivation resulting in severe degradation of
forests. At present only 35% of household water requirements are fulfilled by the watershed
and dry season irrigation is a major hurdle for local people not only due to inadequate supply
of water, but also quality and intermittent faucet flow. Widespread logging and shifting
cultivation practices pose a threat to the NSMNP watershed in which the forest area shrunk
by 25% from its 1950s level by the 1990s. Livelihoods of 5,000 households in this watershed
are under stress due to reduced supply of forest products, agriculture inputs, and fishing.
Mount Kanlaon National Park is a very diverse park in terms of the biodiversity it supports,
but there is already huge pressure on its resources. Both indigenous and migrant people
occupied a big portion of the land resulting in accelerated degradation of the watershed.
Since the early-1990s, PES schemes were supported in these areas to reverse the situation.
Reforestation and tree-planting activities were supported in the MFR along with the adoption
of agroforestry systems. Local people were provided with tenure security through some local
arrangements, paid labor, scholarships for high school students, cash incentives, and
training activities on sustainable land-use practices. People participated in watershed
rehabilitation projects in the Maasin watershed through a variety of conservation initiatives
such as reforestation, assisted natural regeneration, timber stand improvement, and rattan
and bamboo enhancement, among others. A number of national and international
organizations provided funding for PES schemes in this area including the Asian
Development Bank, the Overseas Economic Cooperation Fund, the National Economic and
Development Authority, and the national and district governments. In the NSMNP, a number
of conservation efforts have been initiated through Plan International with funding support
from the Dutch government. Some of these initiatives include community-based forest
management, forestland regeneration, nursery establishment, resource inventory, training
activities, and other interventions targeted at supporting local livelihood. Security of land
tenure was among a few incentives provided to local farmers in the area. Park management
activities vested on the Protected Area Management Board in the Mount Kanlaon National
Park. Local people are now receiving funding for non-destructive livelihood projects.
Communities in the watershed are expecting secure tenure rights through the community-
based forest management agreement which is awaiting approval from the Department of
Environment and Natural Resources.
This review captured quite a few operational issues associated with participation in and
adoption of PES schemes. A few notable issues were: the role of government support,
communication, and information; the presence of local NGOs; and local contextual factors.
As discussed in the theoretical framework, political willingness and support from the local
government was a success factor. This was confirmed by the case of the Maasin watershed
where the local provincial governor and municipal mayor were champions of PES, motivating
local stakeholders and mobilizing finance for conservation activities. The case of NSMNP
was similar as local government contributed to the PES activities, another successful
rewarding mechanism in the area. Further, continuous support from the local government
was instrumental when charging a watershed protection fee as in the case of MFR.
Information exchange and communication between different stakeholders appeared to be
critical for creating a support base for PES as substantiated by the case of the MKNP and
Maasin watersheds. In the Maasin watershed, about 70 information centers serve different
actors by providing information on watershed management and also support for
environmental movements in the area. The Watershed Management Council in MKNP is
serving the same purpose through facilitating the adoption of a watershed management
strategy. Efforts towards educating people, better communication, and exchange of
information were key in the successful implementation of PES schemes in the Kanlaon area.
7
The role of intermediary organizations was apparent in many cases, especially in raising
awareness among stakeholders. Their actions in organizing and mobilizing communities,
collecting data, garnering volunteering support, conflict resolution, and executing local
activities of environmental interest were a notable mention in Maasin. Support from outside
agencies (mainly funding agencies) was another stimulus for PES. However, the Maasin
case also offers some cautions for uncoordinated efforts in financing PES schemes. It is
recommended that less emphasis be given to external funding for local PES schemes and
more to increasing local awareness through education, communication, and information
exchange based on purely locally driven initiatives, which are likely to have more positive
impact on the sustainability of PES schemes.
Spatial coverage of PES schemes was another condition that emerged from this case study.
It appears that targeting the entire watershed yields more positive results than considering
only the upland communities. Wunder (2008) also discussed the possibility that strategic
spatial targeting could have larger biodiversity, landscape beauty, and watershed protection
benefits. These services are often very space specific. Further, reaching the offsite
beneficiary is important as they stand to benefit the most from environmental services
provisioning. However, a larger watershed implies more resources for protection. Watershed
protection activities (including the use of resource pricing) were at a very advanced stage in
the two relatively small watersheds (Maasin and MFR) compared to the larger watershed of
NSMNP. Institution building is another obstacle in larger watersheds where communities are
heterogeneous in terms of socio-economic characteristics.
The case study also highlighted the importance of a number of contextual factors. First, the
location of the watershed (proximity between where services are generated and the area
where these services are consumed) appears to be a “push factor” for creating demand for
environmental services. This is exemplified by the case of the Maasin watershed where the
forest watershed is in close proximity to the city. Due to this proximity, any negative changes
in the provision of watershed services (especially quality and quantity of drinking water
supply) could be immediately felt by the local population. Second, the case demonstrated
the impact of different levels of community preparedness for undertaking PES schemes. For
example, communities that already have social infrastructure in place, such as mature
community organizations, are more likely to succeed in implementing PES schemes than
communities without them.
2.4 Compensating Upland Communities for Watershed Services in

the Kulekhani Watershed, Nepal (Upadhaya 2005)
The Kulekhani watershed, distributed over 12,492 ha and encompassing portions of eight
village development committees (VDCs), is located in the Makwanpur district of Nepal.
About 45,000 people live in the upper catchment area of the watershed. They collect a
variety of forest products including fuel wood, fodder, and other non-timber forest products
from the forested watershed for subsistence purposes. It provides water to two hydroelectric
plants, constructed in 1982 and 1985, respectively, which generate a total of 92 mW of
electricity. The power station is operated and managed by the Nepal Electricity Authority
(NEA), a public sector utility company that owns most of the power plants in the country.
However, soon after it began operation, it was noticed that the watershed was a source of
sediment influx into the Kulekhani reservoir along with water for hydroelectricity generation.
According to a study (Amatya 2004), the soil erosion rate for agricultural land in the
Kulekhani watershed was substantially higher (73 metric tons/ hectare/ year) than that of
forest land (1 metric ton/ hectare/ year). The total storage capacity of the reservoir had been
reduced by 23 million m³ by 2002.
In the early-1980s, the government initiated watershed conservation efforts with financial
assistance from USAID, the Food and Agriculture Organization of the United Nations (FAO),
and the United Nations Development Programme (UNDP). The main objective of the project
8
was to reduce the rate of sedimentation to increase the lifespan of the reservoir and improve
land-use practices aimed at supporting rural livelihoods. Major project activities included
community forestry, conservation education, terrace improvement, and fruit plantation in
marginal lands. These conservation efforts resulted in reduced siltation and increased dry
season water flow. The study was able to establish a link between land use and the
sedimentation rate. Studies show that a total of 243,311 m3 of additional water was made
available because of forest conservation in the upstream watershed.
The NEA requires a portion of revenue generated from hydropower plants to be paid to the
central government. As envisaged in the Local Self-Governance Act of 1999, the central
government allocates 12% of the royalty to the local government through the Makwanpur
District Development Committee (DDC). According to 2006 DDC guidelines, 50% of this
revenue must be spent in the upstream-downstream of the Kulekhani watershed where
electricity is generated. Subsequently, the government made it mandatory that another 38%
of the royalty be distributed among all districts that house hydropower plants.
The conservation efforts of the communities in the upper watershed proved to be crucial in
lowering sedimentation and increasing the amount of water available for electricity
generation, especially during the dry season. Winrock Nepal, under the Rewarding Upland
Poor for Environmental Services (RUPES) program, facilitated the set up and operation of a
reward mechanism for sharing hydropower revenues with upland communities, as well as
motivating them to practice environmentally friendly land-use options. The program
facilitated the formation of the Kulekhani Watershed Conservation and Development Forum
(WCDF), a local organization comprising environmental service providers within the
Kulekhani watershed. The program recently proposed that the DDC should earmark 20% of
the hydropower revenue received by the district government for conservation of the
upstream watershed. This fund would be managed by a committee comprised of local
environmental service providers and downstream environmental service beneficiaries.
This case study provides a few insights that are crucial for the adoption and establishment of
markets for environmental services. First, the enabling of environmental policy, particularly
community-based policy aimed at natural resource management, was a key factor in the
adoption of the PES scheme. Nepal is considered a leader in community forestry for its
progressive laws and policies. Local communities were granted significant use and
management rights over local forests through the Forest Act of 1993. The government’s
emphasis on providing a sense of tenure security over forest resources has helped facilitate
not only the community forestry initiative, but also a number of other conservation
undertakings such as leasehold forestry, water, and wildlife management. Rights to forest
resources provided a good context for negotiating and initiating the reward system in the
watershed. Further, a number of other local governance regulations favor the idea of
marketing watershed services. Notably, the Local Self-Governance Act and the Electricity
Act support paying for the environmental services generated by watersheds.
Second, the role of intermediary organizations was critical to convincing service providers
and beneficiaries of the value of watershed services. These organizations have played a
crucial role in capacity building in the local communities, raising awareness about
environmental services, and providing policy support that is seldom offered, especially in
environmental service market sectors. The presence of the RUPES program (an initiative of
the World Agroforestry Center, which conducts targeted action research to examine and
explore the environmental service markets in the region) was vital in facilitating the whole
process through its research and advocacy work aimed at developing positive incentives for
service providers. The review of this case study explicitly emphasized that the presence of
credible local organizations, such as community forestry user groups, was instrumental in
mobilizing local communities for the PES program. These organizations also triggered the
establishment and functioning of the Watershed Conservation and Development Forum
(WCDF), which has played a crucial role in mobilizing local communities towards
9
conservation initiatives and managing allocated revenues for watershed management and
local empowerment activities.
The Kulekhani is a smaller watershed, for which establishing links between upstream
conservation efforts (e.g., afforestation, terrace improvement, and changes in land-use
practices) and downstream water quantity and quality was relatively easy. The watershed
service market was reinforced by a number of good case studies that established the direct
connection between land degradation in the upper watershed and its downstream effects on
the provisioning of watershed services. The ease of demonstrating the cause-and-effect
relationship helped motivate both service providers and buyers to realize the importance of
watershed management. The presence of a buyer for environmental services (i.e., the
hydropower company) proved to be another important condition for marketing watershed
services.
The Kulekhani case study also highlighted a number of policy challenges to materializing the
operation of an effective PES scheme. The first challenge was to enhance the capacity of
stakeholders to institutionalize the reward transfer mechanism. Second, an appropriate use
of received payments in conservation and development was crucial for the sustainability of
the PES scheme. Finally, continuous support to local communities through social
mobilization and institution building was another ingredient to encourage landowner
participation in the scheme. The study indicated that political instability could divert the
government’s priorities towards short-term projects and policies rather than PES schemes.
Another challenge for PES is to make sure that payments for environmental services work
for poor people and subsequently help reduce poverty in the area.
2.5 Payment for Environmental Services: The Sloping Land

Conservation Program in the Ningxia Autonomous Region of
the People’s Republic of China (PRC)
(Zhang, Tu, and Mol 2008)
In 2002, the PRC government initiated the Sloping Land Conversion Program (SLCP) aimed
at reducing soil erosion and increasing forest cover in the PRC. The program was initially
piloted in 1999 to discourage agricultural activities in steep slopes and marginal lands in
response to a severe drought in the Yellow River basin and the devastating floods in
Yangtze River basin in 1998. With a budget of US$40 billion (CNY337 billion), the program is
now being implemented in more than 2,000 counties across 25 provinces and municipalities.
Approximately 15 million farmers are covered in this first “payment for environmental
services” program in the PRC. The State Forestry Administration plans to convert around
14.67 million ha of fragile cropland (with a slope greater than 25 degrees) to forests and
grassland by the completion of the program in 2010, making it one of the PRC’s most
ambitious environmental initiatives in recent decades.
Although the initial focus of the program was on ecological restoration, the focus has shifted
slightly towards off-farm income generation. In recent years, the program has come under
scrutiny with regard to the rationality, adequacy of institutional design, and implementation
modalities adopted by the program. Particularly, concerns have been raised about the
relevance of such large-scale, campaign style, and top-down approaches to environmental
conservation.
Compensation for farmers in this program includes both kind and cash payment.
Participating farmers must modify the existing parcels of lands either into forests or
grasslands. Three major types of PES mechanisms were considered: ecological forests,
economic forests, and grasslands. In the Yangtze River basin, each household receives an
annual grain subsidy of 2,250 kg for a conversion of a hectare of existing agricultural land
into one of these land uses, whereas this is set at 1,500 kg/ha in the Yellow River basin.
These grain subsidies are decided on the basis of the average productivity of the land.
10
Currently, farmers can get a cash subsidy of CNY300/ha/year for eligible land uses. Both
grain and cash subsidies are provided for up to eight years for ecological forests, five years
for economics forests, and two years for maintaining grasslands in the watersheds. For
those farmers who are willing to undertake afforestation activities, they receive subsidized
seedling with a value of CNY750/ha. The underlying assumption of the program is that if
farmers are provided with economic incentives, it could be possible for them to divert from
traditional and destructive land-use practices towards environmentally friendly activities. This
also helps reduce poverty by encouraging surplus agricultural forces to engage in other off-
farm activities.
This paper reviewed the implementation of SLCP in the Ningxia autonomous region with
particular focus on social capital for the sustainability of the SLCP program. The high rates of
poverty, fragile and degraded ecosystems, and political and economic isolation are a few
characteristics of this region. A survey was undertaken in three southern counties: Tongxing,
Pengyang, and Xiji. A total of 316 households were interviewed to collect information on the
socio-economic characteristics of households, livelihood activities, and perceptions and
experiences in the SLCP program. In addition, information was collected with regard to
perception about land security, decision-making power, and access to credit, capital, and
market.
This review indicated that SLCP-related PES activities are highly ecologically oriented. The
program is putting less emphasis on socio-economic and institutional issues. Institutional
factors such as land rental, tenure security, and inadequate focus on social capital
development emerged as few constraints for the success of the program. Further, access to
market and credit was important to mention. About 63% of respondents stated that they
have to use personal networks based on family kinships to get information about markets,
technologies, skills, and jobs. The adoption of PES schemes was slower due to the absence
of a market as well as an absence of off-farm income opportunities for individuals and
households. Although the role of off-farm activities was greatly emphasized in order to divert
people from traditional agriculture practices, the study found that this strategy hardly
addresses the problem as the average education level of households in the region is very
low.
Farmer organizations are considered a luxury in the Ningxia region compared to more
developed regions of the PRC. Further, organization building and strengthening were not
part of the program which is considered a rather new phenomenon in Ningxia. Even where
they were present, these organizations were not strong enough to spread risk by pooling
community resources in time of economic shock and hardships. It appears that only 8% of
the respondents were members of a farmer organization. Although 70 % of laborers involved
in the SLCP are women, there is no single self-initiated women’s association. Further, top-
down approaches to SLCP excluded farmers from participating in decision-making
processes on many occasions.
This study pointed out that the sustainability of SLCP in the region depends on enabling
economic policy measures such as off-farm income opportunities, strengthening farmer
organizations, and participatory decision-making processes. Further, the current level of
compensation schemes is not adequate for the sustainability of the SCLP and these
incentives should be strong enough to change farmer behavior towards more
environmentally friendly land uses. Another fundamental problem for the sustainability of
SCLP in the region is the lack of policies in social capital development. The SCLP was
similar to other poverty alleviation programs in the government as a result of insufficient
institutionalized participation of local farmers. The study concluded that the program will not
succeed in the long run unless favorable policies for social capital development are put in
place.
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2.6 Payment for Environmental Services: Experiences and

Lessons from Viet Nam (Hoang, van Noordwijk, and Thuy 2008)
This study drew lessons from payment for environmental services by reviewing four PES
case studies from Viet Nam. During the late-1990s, the Vietnamese government enacted a
number of laws such as the Law on Water Resource (1998), Law on Land (2003), Law on
Forest Protection and Development (2004), and Law on Environmental Protection (2005).
These laws, to a certain extent, recognize environmental services provided by ecosystems
such as biodiversity conservation, watershed protection, carbon sequestration, and
landscape beauty. Later, a number of resolutions endorsed economic instruments for
environmental management. Of particular interest are the Natural Resource and Water
Resource Acts that specify taxes to be paid by users of ecosystem services.
The first case was the PES scheme in the Tri An watershed, comprised of the Dong Nai and
La Nga rivers in Dong Nai province. These rivers are sources of water for the Tri An
hydropower plant. Further, the lower Dong Nai is a source of water for the three provinces of
Hi Chi Minh City, Dong Nai, and Binh Duong. Increased pollution was a severe problem in
the Doi Nai River due to the industrial and domestic wastewater, agricultural run-off,
contamination from fish farms, and sedimentation in river beds from deforestation in the
surrounding watersheds. This substantially increased the treatment costs for water utility
companies. Water supply companies were interested in watershed protection activities in the
upper watershed for maintaining the provisioning of clean and continued supply of water. A
project funded by Danish International Development Assistance, the World Wide Fund for
Nature (WWF), and other partners was aimed at addressing water pollution in the Tri An
reservoir and the lower Dong Nai River. The group proposed the establishment of a payment
scheme between water supply companies and the upstream groups who were polluting the
river. Since finding the source of pollution and costs incurred to water companies is the first
step towards establishing payment systems, a study of pollution and hydrology in the
watershed is currently underway. Based on the findings of this study, a fund will be
established in order to encourage local communities towards environmentally friendly land
uses. A management board (consisting of representatives from relevant stakeholders) will
oversee the potential payment systems with a provision of third-party monitoring.
The second case study looked at a sustainable financing model for landscape beauty in
Bash Ma National Park in central Viet Nam. The park covers 37,499 ha, of which 32,157 ha
is upland forested area in the Perfume River watershed. In 2007, WWF Viet Nam and the
Forest Protection Department of Hue undertook a study on the willingness of tourists who
visited the national park to pay an entrance fee. The study recommended fees of D39,000
for international and D34,000 for domestic visitors. The watershed has also been providing
water to a regionally renowned water company operating in the region since 2005. Potential
contributions from the water company for the park management were also considered. The
study further identified other potential companies and downstream water users who
benefited by watershed protection and who would be willing to pay for improved watershed
services. Currently, an effort is directed towards establishing a conservation trust fund. This
fund will be invested in biodiversity conservation and sustainable agriculture practices in the
buffer zone of the park.
In the Cao Phong district of the Hoa Binh province, a pilot carbon sequestration project is
being jointly undertaken by the Department of Forestry, Japan International Cooperation
Agency Vietnam Forestry University, and the Research Center for Forest Ecology and
Environment. It has strong environmental protection and poverty reduction components
through income generation from forest products and a carbon sequestration scheme. It is
estimated that about 60,000 to 80,000 carbon credits could be obtained through the certified
emission reductions (CERs) under the United Nations Framework Convention on Climate
Change within the next 20 years. The identified buyers were domestic paper companies and
international carbon markets through the CERs. Honda Viet Nam provided financial support
12
for this project. The beneficiaries include 300 local households who will benefit from timber
and sale of carbon credits from the protected forests. The protection activities include a
plantation of 350 ha of acacia forests, an establishment of 30 ha of fodder crops for
improving cattle grazing, biogas as an alternate fuel to firewood, and effective use of crop
residues. The local government will have an important role in implementing the project
activities.
The final case study was of the Nha Trang Bay marine protected area (MPA) which contains
important coral reefs, sea grass, and mangrove habitats. This 13,000 ha MPA hosts more
than 350 species of corals and provides a number of benefits to local communities. The park
is also crucial from the tourism point of view as 400,000 tourists visited the park in 2004 for
sightseeing, snorkeling, and diving. From 2002–2005, a number of discussions were held
with the private and public sectors about how agencies could generate adequate funding for
the protection of the MPA. As a result, entrance fees were introduced for securing
sustainable financing for the protected area. The project aimed to share 10–15% of the
income generated from entrance fees with local communities for a number of development
and environmental conservation activities. To date, a total of six villages have already
received US$2,000 (for each village) to undertake specific development and environmental
activities including development of waste management system, construction of a road, a trail
path for school children, and establishment of a village learning center. These funds are
managed by the Khanh Hoa People’s Committee (a committee established for developing
formal mechanisms to allocate funds). Further, a total of US$115,000 was provided to the
Nha Trang Bay MPA Authority for the management of the park.
A number of lessons can be drawn from these PES initiatives in Viet Nam. First, the case of
the Tri An watershed emphasized that any efforts to secure payments for watershed
services should clearly demonstrate the costs and benefits of watershed protection to
relevant stakeholders. PES schemes are likely to be successful if the benefits of watershed
protection are clear, particularly to the buyers. In this regard, technical studies that identify
links between upstream land uses and downstream water quality are of prime importance.
Buyers of watershed services can only be persuaded after this connection has been
established. Second, enabling government policies were instrumental in addition to voluntary
involvements of buyers and sellers. The role of micro-credit is another factor for the adoption
of PES schemes. The study highlighted that micro-credit initiatives are instrumental if
farmers have to modify the current land uses for adopting the PES scheme. Finally,
experience shows that formal contracts between buyers and sellers are important features
for the successful implementation of PES schemes as demonstrated by the case of Tri An.
The quality of environmental services appears to be fundamental as demonstrated in the
case of Bach Ma National Park. For instance, improving tourist services was the first step
towards attracting a large number of visitors that subsequently helped raise revenues to
finance conservation and reward local people for the environmental services they provide.
The carbon sequestration project of the Cao Phong district demonstrated that integration of
the forest-based carbon sequestration objective into forestry development with voluntary
payment mechanisms serves as an important recipe for a PES scheme for carbon
sequestration. Clear and transparent benefit-sharing systems with a strong equity
component appear to be another key ingredient for successful implementation. The
importance of a clear mechanism for allocating funds appears to be important, as shown in
the case study of the Nha Trang Bay marine protected area. Support from the government
agencies in the area of capacity building and technical assistance were crucial for PES
schemes to operate sustainably. The role of government support has been emphasized in all
case studies, particularly for clear mechanisms that provide community-wide benefits, policy,
and capacity-building assistance and enforcement of contracts in addition to voluntary
contracts between buyers and sellers.
13
2.7 Market for Ecosystem Services in Australia: Practical Design

and Case Studies
(Whitten, Coggan, and Shelton [eds.] in press)
This paper analyzed three different market-based instruments in Australia. While the first
case study dealt with a rewarding mechanism for reducing salinization in the Wimmera
region of southwest Australia; the second dealt with water quality, biodiversity, and amenities
values in Muttindindi Shire in Victoria; and the third addressed the maintenance of native
vegetation. Each case study focused on an important ecosystem service that addressed a
number of environmental problems in the region. The Wimmera region is predominantly an
agriculture-based economy. The main environmental problem in this region is the recharge
of saline ground water aquifers causing soil salinization and increased in-stream salinity. The
ecosystem service studied in the Whitten et al. paper was the management of salinity
outcomes, particularly reducing recharge to saline aquifers through the establishment of
deep-rooted and perennial vegetation. Potential sellers for salinity-reducing services were
local landowners who owned land on steep hill slopes within the target region of the
catchment. The Wimmera Catchment Management Authority (WCMA) was the buyer.
Land fragmentation (especially for hobby farming and rural residencies) is a serious issue in
Murrindindi. This has an adverse impact on many ecosystem services in the region. Market-
based approaches for establishing native vegetation were a major issue for the third case
study. This is of particular importance as there is no clear cut understanding between the
use of provenance-specific seed and important ecosystem services. Institutional, industrial,
and biophysical constraints are considered to be the root cause of failure of native seed
markets in Australia.
A number of factors emerged from these cases studies, particularly the importance of market
failure, information asymmetry, and scientific uncertainty while establishing markets for
environmental services. For instance, this review showed that rights to salt and water
movement in landscapes are not clearly defined. Compared to steep hills with perennial
vegetation, hills with sparse vegetation and limited deep-rooted perennial vegetation have
greater potential to contribute to deep drainage and, therefore, to the movement of salt in
landscapes. As a result, downstream landowners expect salinity neutral land-use practices
in the upper watershed. Upstream farmers, however, do not have any incentive to meet
those expectations as a result of property rights failure (e.g., rights to salt movement). At
present, there is no mechanism for rewarding a particular action directed to reduce ground
water discharge because of the no-rivalry or non-competitive properties of this service in the
sense that all downstream users benefit from the reduction, but no one is forced to pay for
maintaining the provision of service in question. This is the most important feature of market
failure in ground water management and also, the largest potential driver of policy
intervention in the region. Information asymmetry was another constraint. Landowners were
not aware of the specific contributions that different changes to the land management could
generate different recharge outcomes and reduce the movement of salt. Scientific
uncertainties such as knowledge about recharge quantity, ground water dynamics, and salt
sources and concentrations were among a few other difficulties in identifying the potential
outcomes. Transactions costs of monitoring and difficulty in measuring the success appears
to be an obstacle for adopting market-based approaches to ecosystem services. For
instance, one challenge for the project was to identify the best possible recharge outcomes
through the modification of current use practices. Improvement in current land uses,
however, requires considerable upfront investment which is beyond the capacity of many
local landowners. Further, benefits from these investments could only be realized over the
long term, which further complicates landholder decisions to invest. The cost of monitoring
was the major concern for the success of the reward mechanism as compliance to different
land-use decisions was not easy to measure.
14
The study recommended a number of measures to address property rights failure, the
problem of information asymmetry, and scientific uncertainties associated with the market-
based approach to ecosystem services. First, negotiations around “who is to pay whom”
could be possible only after establishing well-defined property rights over the service in
question. Second, the contributions of specific land use to reduce salinization need to be
assessed at the best downstream location. Defining the boundaries of those eligible would
be an alternative means of identifying location impacts in the provisioning of services
(establishing the connection between service providers and users). Additionality was another
factor, especially measuring how changes in ecosystem services compare to the “business
as usual” scenario. Finally, the presence of a service purchaser (in this case WCMA) was an
important condition to address the issue of non-excludability (or the problem of public good)
in ecosystem service markets. Some additional elements such as decision-making
processes, transparency, and negotiation of contracts were identified as additional
ingredients for the successful implementation of PES schemes.
The remaining two case studies further stressed the establishment of property rights
because of the strong non-excludable property of the services under consideration. Further,
mechanisms to address the problem of asymmetric information were discussed. The study
suggested that competitive tender mechanisms especially designed to create incentives for
landholders by revealing the costs incurred by them due to changes in land use could help
eliminate the problem of cost-related asymmetric information. Similarly, revealing the costs
of reclaiming salt-intruded land to downstream landowners could help to solicit the support
required for implementing a reward mechanism. The case study provides three major
conclusions. First, there should be an established link between land management practices
in upper watersheds and changes in downstream ecological outcomes. By doing so, it could
be possible to create a market for ecosystem services in which ecosystem users could be
willing to pay for an increased supply of these services. Second, tender and contract
processes must be robust with the adequate participation of concerned stakeholders. Finally,
appropriate mechanisms should be in place to make sure that management changes are
successfully implemented to achieve desired outcomes. On the whole, the paper argued that
market failure associated with ecosystem services needs to be overcome by designing an
effective and efficient rewarding mechanism for land-use practices. Market-based
approaches to ecosystems are not only about creating markets for all services, but careful
selection and design of an appropriate instrument with the objective of fulfilling the needs of
participants.
2.8 Developing Markets for Watershed Services and Improved

Livelihoods: Fair Deals for Watershed Services in India
(Agrawal et al. 2007)
This case study drew together lessons from three watershed management projects (Kuhan
and Suan of Himanchal Predesh and Bhoj in Madhya Pradesh) that aimed to adopt
incentive-based mechanisms to watershed protection and rural livelihoods improvement in
India.
The Changar region of Himanchal Pradesh is a water-scarce area where springs used for
drinking water often run dry in the summer. Local people rely on a lift-based drinking water
supply (a Gesellschaft für Technische Zusammenarbeit [GTZ]-funded project has been
under operation since the early-1990s) during the dry season. The project covers 37 micro-
watersheds with a focus on watershed management and livelihood enhancement. Two
catchments of interest are Kuhan and Suan in Himanchal Pradash. The Kuhan catchment
covers about 210 ha where agriculture is the mainstay of the local economy. The major
problem in this catchment was the high silt load which resulted in silting up in the reservoir
which provides water to the nearby lift irrigation system. Another catchment, Suan, covering
an area of 406 ha, experiences a similar water scarcity problem. Forest fires, declining water
15
quality and quantity, and drying up natural springs encouraged the local political unit (the
Village Development Committee) to think about installing a lift irrigation system. Though this
did not materialize due to some local level conflicts, the focus later shifted towards upstream
land management through fire control, erosion control measures, and grassland
conservation.
The Bhoj wetlands of Madhya Pradesh cover an area of 361 kilometers2 (km) and a water
spread of 31 km2. A smaller lake was created in 1794 and receives water from the upper
lake. The Bhoj watersheds are an important source of drinking water and recreation for the
residents of Bhopal City. Currently, the upper lake provides about 40% of the city’s drinking
water requirements. A large number of local people depend on the wetlands for fishing, non-
timber forest products, and recreation. However, the wetlands are facing twin problems of
poor water quality and reduction in storage capacity due to siltation. Major sources of
pollution are an inflow of sewage and solid waste from the urban areas and runoff from
nearby agriculture fields.
Incentive-based mechanisms to watershed protection were tested through an action-learning
approach in these three watersheds. In Kuhan, the objective was to strengthen local
institutions and increase downstream coverage of irrigation in order to have a large
constituency of beneficiaries and generate funds for the catchment protection. The second
objective was to motivate villagers for ecologically sensitive land-use practices in the upper
catchment. A geo-hydrological assessment of the watershed helped to identify erosion-prone
zones and areas where immediate conservation measures were required. Villagers helped
the project by closing a small patch of land close to the stream and also agreed to plant
trees for restoring the degraded area. In return, they were provided with tree saplings and
technical assistance to implement the watershed conservation program. A number of other
conservation measures were put in place such as construction of check dams to combat soil
erosion.
Maintaining and enhancing summer flows of the stream was the chief objective in the Suan
micro-catchment for the planned irrigation scheme. Despite the initial interest of villagers,
this irrigation project was not realized due to a conflict in the lower village, limited impact of
land-use changes in the provisioning of watershed services as indicated in the geo-
hydrological assessment, and lack of initial success in securing government funds for the
project. Further, there was an issue of initial investment for fencing the cropped area to
reduce crop damage by wild animals. In the Bhoj catchment, a change in agricultural
practices in upstream farms was the major concern. Some proposed activities included
switching from chemical to ecologically-friendly agriculture, erosion control, and
improvement of lake water quality. Further, raising awareness for both upstream and
downstream stakeholders was a key component. Payments from watershed protection
beneficiaries to service providers have been attempted at all three sites, but payments have
been taking place only in Kuhan. Of the remaining two watersheds, payments may take
place soon in Bhoj, but this has not yet materialized in Suan.
A number of methodological lessons emerged for an incentive-based approach to watershed
protection in these sites in India. It was found that projects that build on the existing
partnerships are likely to come into operation sooner and also be successful over the project
cycle. Community mobilization at the initial stage of the projects is crucial for motivating
stakeholders towards collective action. PES-related initiatives usually do not have provisions
for heavy investment in physical infrastructures. It required, therefore, a greater effort to
motivate communities to participate in the scheme. An element of capacity building and
training turns out to be crucial where new concepts and techniques are being tested.
Capacity building in downstream institutions is very important for changing perceptions about
paying for watershed services. Effective communication and exchange of information play an
important role in building and maintaining support for PES-related schemes as the concept
of watershed services is still new to the local communities.
16
As in the case of other community development projects, broader participation of different

sections of the society was a stimulus for implementing market-based approaches to
watershed services. For instance, there were intense consultations with woman-headed
households in Kuhan that led to an agreement. However, this process was not visible and
inadequate in Suan where upstream stakeholders were not willing to shift grazing from the
catchment and this resulted in the collapse of negotiations in the Bhodi catchment of the
Suan watershed. Transparency in the transaction process is very important for the voluntary
market for environmental services. In Kuhan, the selection of a new VDC executive body
promoted transparency and also boosted confidence in the VDC functioning. A shorter
planning horizon is not conducive to watershed service markets because any payment
agreements should allow time required for effective land-use change.
Another lesson was congruence between the spatial scale of the biophysical processes and
administrative areas. For instance, the catchment was under the Panchayat administrative
boundary in Kuhan. The overlap of catchments with the administrative boundary made it
possible for buyers and sellers to reach an agreement. This was not the case in Bhoj, where
users and suppliers of watershed services are represented by different administrative
bodies. This review also stressed the match between the temporal scale of the biophysical
process and the decision-making process. In Kuhan, a time frame for the agreement was
adequate for changing certain activities, such as stopping grazing in the catchment. In Bhoj,
however, the negotiated time frame for switching from high external input agriculture to
organic methods was not realistic. Instead, a long-term agreement for reducing pollution and
increasing the quantity of water in the lake would have been a more effective solution.
Local available technology could be more acceptable to landowners when it comes to
changing land-use practices. This kind of local solution also creates a win-win situation and
helps provide direct benefits for the upstream community and watershed service benefits for
downstream users. For example, a bamboo plantation in Kuhan resulted in grass yields
while maintaining grass cover during the monsoon. Further, locally mobilized resources
(both cash and kind) and legitimate reasons for farmers to participate were more effective
than motivation from external funding. People highly valued cash payments generated
locally over payments by NGO or government institutions.
Credible scientific information that links watershed services to land-use practices is
important for watershed services agreements. Convincing hydrological information helps
assess problems, areas of intervention, and builds consensus among stakeholders to make
payments and change land use. However, this seems to be a significant challenge for all
PES-related schemes. Another lesson from this case study was the role of local institutions
for reducing transaction costs. In Kuhan, functional local institutions that represent both
buyers and sellers helped to reach agreements and reduce transaction costs. However, this
was not the case in Bhopal where the lack of credible local institutions at the upper
watershed together with multiple downstream beneficiaries increased the costs of
transaction.
Another interesting condition for the PES negotiation that emerged from this study was
addressing the multiplicity of ecosystem services in cases where there is no single dominant
financial benefit from watershed service markets. The Bhoj case suggests that
demonstrating multiple use and non-use values of the lake (e.g., water quality, recreation,
bird habitat, and fish catch) to both upstream landowners and downstream users expedited
the payment agreement. As in other case studies, the role of local champions (e.g., local
politicians or local NGOs) was critical for driving the process forward. Exchange visits and
field trips to successful sites help to increase understanding and motivation among
stakeholders. Finally, the study concluded that market-based approaches to watershed
services would likely be sustainable where the PES processes addressed the needs of
various stakeholders upstream.
17
3. DISCUSSION: SOME INSIGHTS FOR DESIGNING PES

Evidence from the case studies reviewed here suggests a number of factors that have
implications for the adoption of PES, and the impact this may have on livelihoods, as well as
the ultimate effectiveness of the mechanism in protecting ecosystem services. The findings
of this review could be organized into four broad categories: property rights and tenure
security, community characteristics and the role of collective action, transaction costs, and
the role that information and communication in PES schemes play in the likelihood of them
being adopted by local landowners. In the following section we will elaborate these findings
under these four headings. Although it is still too early to fully evaluate these PES schemes
as they are at an early stage of implementation and lessons are still more suggestive than
conclusive, we hope lessons from this review will offer some fundamentals for the next
generation of PES schemes to becoming a success.
3.1 Institutional Arrangements

Secure property rights arrangements have been considered prerequisite in the PES
literature (Grieg-Grann and Bann 2003). Most ecosystem services are public goods because
of the difficulty of excluding anyone from enjoying these services and also the inability of
management institutions to limit the benefits to only those who bear the cost of maintaining
these services. This non-excludability and non-rivalry in consumption means there can be
failure in the markets and free riding. As PES schemes usually require a significant upfront
investment for land-use modifications or improvements, insecure land tenure could
discourage farmers from making long-term investment decisions. This is particularly true for
poor squatter communities in rural areas where usufruct rights held by the communities are
vulnerable to development interventions. Past experience shows that countries that manage
to clarify and strengthen land tenure are most likely to succeed in implementing PES
schemes (Leimona and Lee 2008). The case studies support these prepositions and suggest
that launching large-scale PES schemes cannot be sustainable without addressing land
tenure issues, an urgent necessity for generalizing conservation contracts (Karsenty 2008).
Importance of tenure security, from identifying service suppliers to determining beneficiaries
and encouraging farmers to invest in land conservation decisions, strongly emerged as a
stimulus for the environmental service markets. For instance, even with the temporary
written rules (a sense of tenure security), communities in the Sumber Jaya province of
Indonesia were willing to maintain watershed service provisions for downstream users.
Further, the recognition of informal institutions such as rights of a local community to declare
the village land where agricultural activities have been absent for more than ten years as
common property facilitates the adoption of the PES scheme. Bungo’s case shows
congruence between locally crafted rules and the state’s rules, an important factor that helps
promote institutional efficacy with regard to forest conservation. A number of locally
practiced land-use norms such as tanah batin (lands assigned for upland paddies where a
number of ritual activities could be performed) and nagari (a complex social system
governing land use) were instrumental in Singkarak for executing a carbon sequestration
project. The notion of common property approaches to land is widely held in West Sumatra
which governs land use, fishing, and forests uses. These traditional institutions acknowledge
self-ownership of land by both the state and societal rules which, to some extent, facilitate
the PES scheme in the area. The importance of tenure security also came up strongly in the
case study of the Kulekhani watershed in Nepal. It demonstrates that the implementation of
the PES scheme was possible due to the policy of community-based forestry adopted by the
government through the enactment of the Forest Act in 1993. In contrast, the lack of private
ownership of land was identified as a factor responsible for the relatively lesser degree of
success in adopting a PES scheme in Viet Nam.
18
A large body of literature recognizes informal institutions as a key determinant in

understanding rural development outcomes (Scoones 1998; Mehta et al. 1999). This notion
appears to be consistent with the outcomes of PES schemes in Indonesia. For example, in
Sumber Jaya, two informal institutions, gotong-royong (labor sharing on common property)
and arisan (capital sharing among community members), were instrumental in facilitating the
adoption of local PES schemes. This was also the case in Bungo where pelerin (labor
sharing for private land) and berselang (labor sharing for paddy planting and harvesting)
systems were instrumental in uniting local communities for the carbon sequestration project.
These informal institutions help increase local participation and adoption of conservation
measures as well as reduce the costs of transactions. This review of the case studies
confirms that social relationships and networks are critical to uniting communities, and that
these institutions promote cooperation, share resources and risks, and facilitate the adoption
of PES schemes.
In some cases, PES schemes help strengthen land rights (e.g., temporary rights established
through frontier activities) where tenure security is very informal. For example, in the Bungo
watershed in Indonesia, institutions supporting biodiversity services were achieved through
acquiring land-use rights by forest frontier activities. This includes the planting of cash crops
such as rubber, cinnamon, and other tree crops. Plantation of these cash crops facilitates
the adoption of PES schemes, which in turn, provide a sufficient basis for farmers to claim
permanent land rights in areas where PES schemes are functional.
Enabling policy environment appeared to be crucial for both tenure security and mobilizing
resources for PES schemes. The case studies show that major support for PES usually
come from dynamic and innovative leaders at both local and national levels who can act as
champions for innovative approaches. For example, political willingness and support from
the local government was a success factor in the Maasin watershed in the Philippines where
the provincial governor and municipal mayor were champions of PES, motivating local
stakeholders and mobilizing finance for conservation efforts. Further, in the NSMNP
watershed in the Philippines local government contributed to the PES scheme directly. This
support was not only crucial to consolidate local efforts towards PES, but also instrumental
in designing acceptable watershed protection fees to be paid by watershed service
beneficiaries in the area. Even though government entities would not assume the role of
suppliers and buyers of all environmental services, participation in PES could be enhanced
through enabling policy support, and financial and technical assistance. The role of national
governments will be more relevant when it comes to creating the necessary legal framework
for PES schemes, and if sufficient governmental institutions are present, property rights can
be clearly assigned and enforced (Huberman and Leippraud 2006). Equally important is
cooperation between other relevant institutions towards the shared objectives of enhancing
environmental service markets and conservation. Since partnerships between private and
civil society institutions are relatively uncommon (Agrawal 2008), a more coordinated and
integrated approach helps efforts toward addressing poverty-related environmental
degradation and comprehensive natural resource management.
Equity has to be addressed especially in the adoption of a proactive approach in areas such
as distribution of entitlements, designing payment schemes, and crafting institutions for
resource use by reflecting the welfare of those directly affected by the scheme. The Viet
Nam case study accentuates the importance of transparency and equity in benefit sharing.
The case study of the Nha Trang Bay marine protected area unequivocally pointed out the
importance of clear mechanisms for allocating funds to legitimate stakeholders. Researchers
have emphasized the importance of accurate information, fair institutional mechanisms, and
appropriate incentives for watershed service markets (Asquith, Vargas, and Wunder 2008).
The success of the PES scheme also depends on how property rights are assigned. The
issue of property rights could be determinant in ensuring equitable participation, potentially
excluding landowners who do not hold proper land titles (Huberman and Leippraud 2006).
For instance, implementation of PES schemes could alter the existing system of resource
19
use as enjoyed by poorer households under the informal and customary institutional
arrangements. Any alteration of resource use due to the definition or redefinition of existing
property rights could have negative consequences on local livelihoods. For example, an
alteration could cause concern to the landless, who do not have formal rights to land despite
their cultural and spiritual dependency on ecological services. In such a situation, resistance
to PES could emerge if these informal rights are not considered. Evaluating the social
impacts of PES schemes is thus important for understanding the possible social
consequences of PES schemes on different stakeholders or policy changes with regard to
resource management. India’s experience shows that formalization of property rights
through a market-based mechanism for watershed services may hurt the poor where rights
to ground water are ill-defined (Kerr 2002).
3.2 Transaction Costs

Consistent with theory, this review posits that high transaction costs could be a barrier for
participation because they create disincentives for market exchange. Transaction costs in
PES schemes refer to those costs associated with negotiation and enforcement of the
scheme. Negotiation costs include time and effort in organizing buyers and sellers,
assessment of current land uses and land-use practices, establishing and designing
contracts, and preparing documentations as well as the costs of making implementation
decisions. The transaction costs of monitoring include costs of certification, monitoring of
contractual obligations of buyers and sellers, and among groups of buyers and sellers
(Swallow, Meinzen-Dick, and van Noordwijk 2005; Adhikari and Lovett 2006). Higher
transaction costs involved in PES schemes have implications on cost-efficiency,
effectiveness, and equity involved in developing PES schemes as well as sustainability in
the long run (Mayrand and Paquin 2004). Findings from this study confirmed the earlier
arguments that high transaction costs (e.g., of information, of defining property rights, and of
drawing up legal contracts) could create barriers for small holder’s participation in
environmental service markets (Asia-Pacific Forestry Commission 2006).
The role of intermediary organizations appeared to be vital to link service producers and
buyers as well as reducing the costs of transaction. Past evidence shows that awareness of
environmental services and even willingness to pay for environmental services rose through
the concerted efforts of environmental NGOs (Leimona and Lee 2008). These organizations
can mobilize and assist communities in crafting rules and regulations at the local level. The
role of NGOs was apparent in many cases, especially in raising awareness among
stakeholders. In the Maasin watershed in the Philippines, NGOs helped in community
mobilization, organization build up, data collection, conflict resolution, and execution of
environmental activities compatible with the PES scheme in the watershed. In the Kulekhani
watershed in Nepal, the presence of credible civil society organizations, such as community
forestry user groups, boosted the adoption of PES schemes through community
mobilization, advocacy, and raising awareness. Institutional access was relatively easy in
this area because of the presence of mature community-based organizations. Local
intermediary organizations could facilitate negotiation and coordinate activities to help
reduce the costs of negotiation, monitoring, and implementation.
3.3 Household Characteristics and the Role of Collective Action

The case studies highlighted a number of socio-economic factors that have important policy
implications for the adoption of PES schemes. Household characteristics such as education,
income, labor, skills, and technical capacity are central to implementing PES schemes, as
demonstrated in the Viet Nam study. Technical capacity of individual farmers was shown to
be crucial, as households with minimum levels of education were experiencing difficulty
adapting to a new land-use system. These findings are similar to those of previous studies
which found family labor availability to be a key factor in the participation of households in
20
land-use modification and technology adoption decisions (Thatcher, Lee, and Schelhas
1997). While the availability of family labor was positively associated with the adoption of
PES schemes, education of the household head significantly influenced the decision to
participate. The larger the land holding was, the greater the chance of its members
participating in PES schemes. This was due to the fact that small landholders might not be
able to allocate land for PES schemes without jeopardizing their food security.
Another finding of this review was that PES schemes can be viable where participants are
socio-economically better off and landholders are well structured. This is consistent with
previous arguments that PES schemes are likely to be more functional where land users are
well organized (Mayrand and Paquin 2004). This is due to the fact that the decision-making
procedure becomes more complicated and costly with increasing group size since the
required time and effort appear to be rapidly increasing functions of the size of the group.
Profitability of adoption or modification of existing land uses emerged as an important
concern for the poor and smallholders. Acceptability of PES schemes could be low if
payments were not sufficient to meet costs associated with socially and environmentally
acceptable land-use practices (Pagiola 2002). This could happen as a result of a mismatch
between the net value of the current payment and net costs for adopting the new technology
(e.g., land-use practices) and forgone income from existing land uses. PES schemes must
be able to meet the opportunity costs of land if sustainability conditions are to be satisfied.
Adequate socio-economic incentives for local people help shift farmers’ behavior towards
more environmentally friendly activities, even though this sort of land use provides little
benefit in the short run. The PRC case study emphasized the role of off-farm activities in
diverting people from traditional agricultural practices, but that alone might not bring the
desired outcome unless it is supported by capacity-building measures (e.g., education and
skills) for participating households.
The India case study showed the importance of participation of broader sections of society,
especially the gender dimension, for adopting market-based approaches to watershed
services. Recognition of the success of women-headed households in implementing
watershed conservation programs prompted intense consultations with women in Kuhan,
leading to a timely and much-needed agreement. This was not the case in Suan, where the
objective of shifting grazing pressure from the catchment resulted in failure due to the
inability of the management institution to consider needs of stakeholders (e.g., the Bhodi
micro-catchment). Another imperative was maintaining transparency in the decision-making
process for the voluntary market for watershed services. Once again, democratically elected
local leaders were successful in securing confidence among users in Kuhan.
Scholars have pointed out the significant association between social capital and both
transaction costs and organizational outcomes (Fussell et al. 2006). Social capital also helps
overcome factors such as group heterogeneity and controls deviant behaviors. The lack of
effort towards building institutions at the community level appears to be critical to the
success of SLCP in the PRC. Compared to other parts of the country, building strong
farmers’ organizations was considered a luxury in the Ningxia province. The absence of a
strong community-based organization resulted in weak social networks and lack of
community capacity to spread risks by pooling community resources in times of natural
disaster and economic hardship. The Ningxia case study strongly considered social capital
to be an important ingredient for PES schemes and for making the conservation program
sustainable. This case highlighted that mobilizing collective community strength, enhancing
institutional access to information and credit, and addressing inefficiencies of government
institutions were crucial if a strong case was to be made for farmer adoption of the program.
Building local institutional capacity for implementing program activities, enhancing their
competence to influence decision-making policy, and rationalizing local tenure systems were
central to inducing a change in conservation practices aimed at improving the quality of
environmental services.
21
Technology adoption may be hindered when returns are risky and insurance or other
financial markets are imperfect (Giné and Yang in press). Scholars have highlighted income
and debt as factors influencing household decisions related to adoption of or participation in
PES schemes (Sureshwaran, Londhe, and Frazier 1996). Because access to credit is very
limited in the rural areas of developing countries, micro-credit programs could facilitate
poorer household participation in PES schemes. Support for PES should therefore include
credit service and technical advice for enhancing efforts for the provisioning of environmental
services. The Viet Nam case study illustrates a strong correlation between household debt
and adoption of PES as the probability of adoption was negatively correlated with the
amount of outstanding household loans. Most land-use modifications in PES require upfront
investments which could be a barrier for participation. Moreover, it became clear that debt
burden may force households to harvest plantation forests and this could undermine the
optimal level of watershed services. Micro-credit facilitates for potential farmers may
encourage the adoption of PES in such situations. The Australia case also addressed the
issue of upfront investments for farmer decisions towards land-use modification.
Collective action towards PES is envisaged as an efficient solution for the provisioning of
environmental services such as biodiversity conservation and watershed protection.
Swallow, Meinzen-Dick, and van Noordwijk (2005) supported this proposition because
community-based approaches help to minimize the costs of transaction. Community-based
approaches help reduce the costs of transactions, particularly those related to the monitoring
and certification of PES schemes. This is because of the community’s built-in incentive and
idiosyncratic knowledge that can be used to make resource-specific decisions. The cases
from Indonesia, the Philippines, and the PRC reinforce the notion that collective action
towards PES is central to reducing the costs of transaction. It helps farmers to coordinate
spatial coverage of PES schemes with larger geographical scope such as biodiversity
conservation and watershed protection. Collective choice rules crafted by local communities
retain the potential of reducing the costs of monitoring and certification as these institutions
amplify individual’s compliance towards management decisions.
Few local contextual factors appear to be relevant for the uptake, adoption, and operation of
PES and also their outcomes. In the Maasin watershed, the proximity of the watershed to
beneficiaries was a real stimulator for the market for watershed services. The watershed is
very close to the urban area so any changes in the quality of watershed services could be
immediately realized by the nearby population, particularly quality and quantity of drinking
water supply. Another contextual factor was the level of community preparedness for
implementing market mechanisms to environmental services. For example, communities that
already have good social infrastructure in place (e.g., mature community organizations)
seemed to be more efficient in implementing PES schemes than communities without them.
3.4 Information and Communications

There is significant consensus in the case studies that participation in environmental service
markets can be realized and enhanced through maximum dissemination of information.
Through various dialog and consultative processes, households and communities could be
motivated to participate. The key purpose for consultation with strategic stakeholders would
be raising awareness on PES as well as facilitating stakeholders’ buy-in to the importance of
the PES concept. Advocacy, through media mobilization, could also facilitate the awareness-
raising process and highlight the demand for increased information on the subject. It is
therefore important to galvanize proposed PES schemes with awareness-raising efforts that
illustrate how PES options contribute to mobilizing local resources, poverty reduction, and
environmental improvement. In the Maasin watershed, approximately 70 information centers
provided information on watershed management and also supported environmental
movements. In the Kanlaon area, efforts directed towards educating people, exchange of
information, and better communication were crucial for the project. The watershed
management council of MKNP was a strong player which facilitated the adoption of a
22
watershed management strategy with a strong component of conservation education. In

Australia, landowners were not aware of the implications of different land management
practices in reducing recharge to saline aquifers. Although scientific uncertainties associated
with ground water dynamics, salt sources, and concentrations were overriding concerns,
even general knowledge about ecosystem services production processes such as changes
in vegetation cover and salinity outcomes could address impediments to creating market-
based instruments for ecosystem services.
This review finds that PES design should be influenced by well-informed technical studies.
Quite often, there is a great degree of uncertainty, as well as a disconnect between
conservation activities undertaken, and associated ecological outcomes. Willingness to pay
for environmental services often increases if there is an established link between the
upstream land-use practices and their corresponding effects on downstream environmental
outcomes. The Nepal case study shows the importance of a good technical study in order to
make the downstream beneficiaries confident about the relationship between increased
conservation activities in the upper watershed and enhanced supply of downstream
environmental services (i.e., water quality and quantity). The Viet Nam case study also put
emphasis on carefully designed cost-benefit analysis of watershed degradation to pursue
both buyers and sellers. The Australia case study further stressed an established link
between land management practices in upper watersheds and downstream environmental
outcomes. The India case study underscores the importance of credible scientific information
to assess problems, find areas of intervention, and build consensus among stakeholders to
modify land-use changes and design the payment system.
Well-informed hydrological and economic valuation studies are instrumental for PES
schemes. An effort to put monetary value on environmental services is not straightforward
because of the difficulty of measuring public goods and assigning a proper value to them
(e.g., value of wetlands such as flood control and pollution reduction), but careful choice of
valuation methods with insights from local use of resources could help design of viable
markets for environmental services.
This review suggests a need to engage and build support and partnerships at different levels
for enabling legal and environmental policy. This is essential to help build constituency for a
broad-based acceptance and interest in PES, gain legitimacy from both buyers and sellers,
and support for developing social infrastructures.
4. CONCLUSIONS
Although market-based instruments for ecosystem services are relatively new mechanisms,
they have emerged as strong candidates for addressing a number of problems such as
ecological externalities, incentive incompatibility, information asymmetries, market failure,
and provisioning of local public goods. During the past decade, a large sum of money has
been invested in carbon sequestration, watershed protection, and biodiversity conservation
through voluntary initiatives of the private sector, pilot activities of financing agencies, and
applied research programs in the developing world (UNDP/London School of Economics and
Political Science (LSE) 2005). Despite the growing interest and a mounting body of literature
on PES, there are still glaring gaps in the theory’s predictions and actual situations,
particularly how different factors affect the PES outcomes. This review paper aimed to fill this
gap, drawing on available case studies, both regional and international, in order to
understand the factors that are necessary for adoption and sustainability of markets for
This review has come to the realization that designing PES schemes is a complex task and
that there are no simple prescriptions or blueprints for optimal designs. The difference in the
success of PES schemes could be understood by examining institutional, socio-economic,
biophysical, and contextual factors associated with the individual scheme. Perhaps one
23
important message from this review is that PES is likely to be more successful where there
are secure property rights to land and forest resources as well as enabling policies that
promote community-based approaches to natural resource management. The argument of
tenure security consistently emerged in all the case studies. However, this conclusion
obviously needs to be approached with some caution. Although the adoption of PES
schemes could be linked to reforming existing property rights, all reforms can create both
winners and losers. The agents who benefit from such a change will have a larger stake as a
result of the reform, but new systems of property rights may impose a corresponding
disincentive effect on others. This is particularly true in cases where communities are
enjoying greater access to common pool resources, but such traditional rights could be
threatened due to the formalization of property rights for the sake of establishing markets for
Another principle message that emerges from this review is that PES schemes will benefit
greatly from capacity-building support and availability of information. The aim of capacity
building is to raise awareness of market-based approaches to environmental services,
develop legal instruments, and provide training on technical aspects of implementation.
Access to information was critical and education programs have increased awareness in
downstream communities about the potential impacts of land-use change in the upper
watershed. Equity and transparency in decision making in payment schemes are additional
areas where capacity-building support should be directed. Political economy aspects of the
program such as getting support from dynamic and innovative leaders at local, regional, and
national levels, and from politicians, the administration, and civil society (who can act as
champions for innovative approaches) should be an integral component for designing
markets for environmental services.
Credible intermediary institutions can play an important role and, in this review, their support
was a key ingredient for success. Adoption of PES was higher in cases where there is the
presence of NGOs and civil society institutions, particularly community-based organizations.
Moreover, factors such as markets, access to credit, and appropriateness of proposed
technology appear to be critical. Building trust between buyers and sellers is also important.
Even where there is initial lack of support, PES initiatives should seek to create a policy
dialog among different actors. A well-informed dialog may involve multiple components, all
having a foundation in local engagement and consultation. Greater inclusiveness and
transparency of the program design helps improve program effectiveness, strengthen links
between producers and beneficiaries, reduce the enforcement costs, and improve outcomes.
Further, the gender dimension of PES, such as consultation with women members for
ensuring their participation in all aspects of PES design, is very crucial.
Promoting synergy between poverty reduction and environmental conservation goals could
help achieve equity and sustainability. Further, credible scientific information, particularly the
hydrological regime within the watershed, became apparent and demonstrated in the case
studies. For example, market-based instruments could work well where there is an
established link between land-use practices in the upper watershed and downstream
provisioning of ecosystem services. Finally, PES schemes should be informed by good
valuation studies that link payment options with increased environmental service provisions.
24
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ADBI Working Paper Series

Market-Based Approaches to Environmental

Asian Development Bank Institute

Adhikari, Bhim. 2009. Market-Based Approaches to Environmental Management: A Review

Asian Development Bank Institute

© 2009 Asian Development Bank Institute

Market-based approaches to environmental management, such as payment for

JEL Classification: Q57

2. Review of Case Studies from Asia .............................................................................. 3

2.1 Payment for Environmental Services in Viet Nam: Assessing an

3. Discussion: Some Insights for Designing PES .......................................................... 18

3.1 Institutional Arrangements ............................................................................. 18

2. REVIEW OF CASE STUDIES FROM ASIA

2.1 Payment for Environmental Services in Viet Nam: Assessing an

2.2 Institutional Constraints and Opportunities in Developing

2.3 Environmental Services “Payments”: Experiences,

2.4 Compensating Upland Communities for Watershed Services in

2.5 Payment for Environmental Services: The Sloping Land

2.6 Payment for Environmental Services: Experiences and

2.7 Market for Ecosystem Services in Australia: Practical Design

2.8 Developing Markets for Watershed Services and Improved

As in the case of other community development projects, broader participation of different

3. DISCUSSION: SOME INSIGHTS FOR DESIGNING PES

3.1 Institutional Arrangements

A large body of literature recognizes informal institutions as a key determinant in

3.2 Transaction Costs

3.3 Household Characteristics and the Role of Collective Action

3.4 Information and Communications

watershed management strategy with a strong component of conservation education. In

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