The federal Farm Bill that was passed and signed into law in June contains a little noted provision directing the USDA to establish a framework that would facilitate participation of farmers and landowners in emerging environmental services markets. At a time when the American market system seems to be collapsing all around us, how should the USDA proceed in carrying out this directive? A set of case studies of environmental service markets in agriculture and forestry around the world that was recently published by the international journal Ecological Economics provides some valuable insights.

The Farm Bill provision on environmental services markets directs the USDA to work in cooperation with other federal and state agencies, NGOs, and others to establish technical guidelines for measuring environmental services, as well as a verification process. Environmental service markets could cover such areas as water and air quality and habitat protection, but the initial focus is to be on carbon markets.

Ecological Economics‘ May 1, 2008 issue is devoted entirely to the types of issues that the USDA and its cooperators will need to grapple with in developing a framework for this new Farm Bill provision. This special issue of Ecological Economics on “Payments for Environmental Services in Developed and Developing Countries” is the end result of an international workshop on this subject that was held in Titisee, Germany in June 2005. Case studies of Payments for Environmental Service programs in Europe, North and South America, Africa, Australia, and China were presented and discussed at that workshop. Subsequently, the workshop organizers — Sven Wunder, Stefanie Engel, and Stefano Pagiola — worked with the case study authors to refine and edit the individual case study papers and synthesized the findings for this special journal issue. The result is a volume containing a framework and some lessons with wide applicability; ones that are timely for implementation of the new U.S. Farm Bill. (Jules Pretty and I authored the case study article about agri-environmental payments in the United Kingdom.)

Before summarizing the framework and lessons, we need to define just what we are talking about. In the opening article of this special issue, Engel, Pagiola, and Wunder define PES programs as ones in which there are:

a)    a voluntary transaction where
b)    a well-defined environmental service (or a land use likely to secure that service)
c)    is being ‘bought by’ a (minimum one) service buyer
d)    from a (minimum one) service provider
e)    if and only if the service provider secures service provision (conditionality).

In fact, not all of the case study PES programs fit this definition in all respects. Nevertheless, this definition provides a workable frame of reference.

The case studies included some in which the buyers were the actual users of the service, as well as cases in which others (usually government, but sometimes an NGO or international agency) were the buyers. In the later cases, governments or others, in effect, acted on behalf of the environmental service users. The majority of the cases examined were labeled government-financed, including the U.S.’s Conservation Reserve Program and Environmental Quality Incentives Program and the United Kingdom’s Environmentally Sensitive Areas program and Countryside Stewardship Scheme. Several case programs were categorized as user-financed, however, including watershed protection programs in Bolivia and Ecuador and a forestry program for carbon sequestration in Ecuador.

The last article in this special issue of Ecological Economics contains Wunder, Engel, and Pagiola’s comparative synthesis of the case study findings. The framework they (and the case study authors) used for evaluating the effectiveness and efficiency of PES programs could work well for the USDA, also, in implementing the "environmental services markets" provision of the new Farm Bill. The evaluation framework involves the following series of questions:

1)    Potential service providers must enroll in the program (PES programs, by their very nature, are voluntary).
2)    Providers must comply with the terms of their contract (hence, there must be means to monitor compliance).
3)    Compliance must result in a change in land use compared to what would have happened without the program (the ‘additionality’ problem).
4)    The induced land-use changes must, in fact, generate the desired environmental service(s).

Additional evaluation concerns included the issue of “leakage.” This issue is about the danger that environmental service improvement in one area or region (or even one part of a farm) could be offset by a loss of the same environmental service elsewhere. This is a major concern with forest protection and reforestation projects for carbon capture, for instance. If carbon sequestration services from forestry projects in one country or region of a country simply lead to higher forest product prices and loss of forest elsewhere, the leakage may be sufficiently large as to result in little or no net gain from the PES program.

Here are some lessons from the case studies that U.S. agencies and policy makers need to keep in mind as they move forward with the new Farm Bill provision on environmental services markets.

It is not enough to simply achieve high participation rates. The PES program needs to enroll the right participants — ones that contribute high levels of the desired environmental service per dollar of program cost.

The actual linkages between land use changes that PES programs pay for and desired environmental services are not well established in some programs. This is a particular problem for some types of watershed protection services.

“Leakage” will always be a real concern when the spatial coverage of a PES program is smaller than the potential service area. This is the case with most carbon storage PES programs. Many non-carbon PES programs have targeted a large enough space to reduce the risk of significant leakage.

“Transactions costs” play an important part in PES program design. These are program costs that are not provider payments proper. Among the transactions costs are those of program planning (including building or adapting necessary data bases), initial implementation (including inviting and reviewing applications and negotiating contracts), monitoring, and enforcement. Because government-financed PES programs are often larger than user-financed programs, they tend to have economies of scale that result in lower transactions costs per unit of land area than can be achieved with smaller, user-financed programs. However, user-financed programs sometimes better target service providers. What is most important is total program costs — including both provider payments and transactions costs — per unit of environmental service. Sometimes seemingly high transaction costs may be warranted, in either government or user-financed programs, if the associated targeting leads to greater overall cost efficiency. Better targeting often involves more complex differentiation of provider payment rates, and that can result in high transactions costs.

The case studies in this special issue of Ecological Economics provide many other insights and lessons that space limitations preclude discussing here. In general, we can say that user-financed PES programs work well for some types of environmental services. A good example is the case of a water quality PES program in a dairy farm catchment of France. User-financed programs may be less well suited to some other types of services, such as biodiversity services, where there could be major free-rider problems. User-financed programs also could have severe limitations with respect to carbon sequestration services, except where international agreements or national mandates effectively create a market.

Moreover, we need to avoid getting carried away with the notion that markets are the solution to everything. For some environmental services, policy tools other than PES need to be used, including outright regulation!