Does the Opportunity Cost Approach Indicate the Real Cost of REDD+?

“Curbing deforestation is a highly cost-effective way of reducing greenhouse gas emissions and has the potential to offer significant reductions fairly quickly.” With this statement from his 2006 report, “The Economics of Climate Change”, Nicholas Stern, Lord Stern of Brentford Kt, FBA, gave REDD a huge boost. But how much truth there is in this statement?

The Stern Review based its figures on work carried out by Maryanne Grieg-Gran at the International Institute for Environment and Development (IIED). Grieg-Gran calculated the cost of REDD by looking at the “opportunity cost” of not deforesting in eight countries. Stern wrote that:

Research carried out for this report indicates that the opportunity cost of forest protection in 8 countries responsible for 70 per cent of emissions from land use could be around $5 billion annually, initially, although over time marginal costs would rise.

But there are serious problems with using the “opportunity cost” as a way of calculating the cost of REDD. Using this approach, the cost of REDD is based on estimated land values, which are in turn based on the (discounted) values of the agricultural products produced on the land. An obvious problem with this approach appears when the person clearing the land does so largely to feed themselves and their family. The monetary value of the agricultural products might be very low (and therefore the opportunity cost is low), but for the family concerned the food produced is extremely valuable because without it they would go hungry.

Let’s look at Cameroon, as an example of this. Grieg-Gran estimates that “annual food crops” (long and short fallow) account for 59% of the country’s deforestation annually or 129,800 hectares. (For the moment, we’ll put aside the question of whether the rotational fallow farming involved is actually a cause of “deforestation” or whether it is a long term sustainable use of the forest. Grieg-Gran describes 44,000 hectares of the “deforestation” as “long fallow farming”.) Grieg-Gran produces a figure for the value of the crops produced, multiplies it by the area involved and comes up with a figure of US$81,595,000 as the cost of stopping this “deforestation”.

But paying farmers not to produce food raises a series of questions. How and to whom would the money be paid? Since many live in remote areas, wouldn’t this also incur costs? If farmers don’t grow their own food, where is their food to come from? If it is to be imported, will this mean more greenhouse gas emissions than produced by rotational fallow farming? Would the farmers be taught “less destructive” farming techniques? If so, how much would that cost? Or would they be removed from the forest to prevent them from taking the cash and carrying on as before? If so, where would they be moved to, what would they do there, and how much would that cost? And what if they moved to the city found work and started leading a far more carbon intensive lifestyle than previously?

Since 2006, there have been several estimates of the cost of REDD based on the opportunity cost approach. A review produced by CIFOR towards the end of 2008 noted the “striking observation” that

the cost of REDD differs substantially across model approaches: global simulation models yield far higher REDD prices than empirical models, including the Stern estimate. The ‘true’ cost estimate is most likely to lie somewhere in between the values provided by the local-empirical models on the one hand (lower end) and global simulation models on the other (higher end).

True, the cost might well lie somewhere between the highest and lowest estimates. Then again, it just might not. A recent report from the Rights and Resources Initiative, calls into question the opportunity costs approach for estimating the cost of REDD. The report “Does the Opportunity Cost Approach Indicate the Real Cost of REDD+?” can be downloaded here.

The authors explain that,

While in theory and under certain real-world conditions opportunity cost provides a useful indicator of payments needed, we see a number of problems in using it in the main political, social and economic contexts faced in the tropical countries that will be implementing REDD+.

The introduction to the report highlights these problems:

1. “opportunity cost may be inappropriate, e.g., in the case of illegal logging and other illegal activities that result in deforestation”

2. “it may be inadequate in terms of understanding what payments are needed to halt deforestation, e.g., in cases where there are side payments being made or where decisions that lead to deforestation have been made for strong political reasons, or where the groups involved don’t really understand what they would be promising and what their alternatives are, or where property and/or land use rights are not adequately defined.”

3. “if one is not dealing with a well-functioning market system, it may be difficult to estimate cost correctly, e.g., in the case of slash and burn farmers or shifting cultivators that operate mostly outside established market systems. This is because it is perceived opportunity cost by the recipient that matters in terms of providing incentive not to deforest; and that might be extremely high if perceived survival this coming year depends on deforesting and growing crops on the cleared land. The farmers may face a great deal of uncertainty as to what this payment not to deforest means. The nature of the aspirations of the poor to get themselves and particularly their children out of poverty, and their perceptions of what is needed to do so also comes into play here. There is a fairness issue that needs to be addressed.”

4. “if major carbon offset markets develop, then the price paid to forest land owners not to deforest and thus create the offsets would be determined by the market and not the various opportunity costs of the various forest owners or potential users of the forest. In a well functioning carbon market, forest owners at the margin would get paid their perceived opportunity cost, while all others would be earning Ricardian rents above their various opportunity costs, since they would be lower than the market clearing price. If the actual value of REDD+ payments is to be anywhere near the value derived by aggregating across opportunity costs of various forest owners/users, then one needs to make the unrealistic assumption that there will be some sort of “discriminatory price tender” where everyone will bid their lowest acceptable price (i.e., their opportunity cost) to some discriminating entity that then will pay them that price.”

5. if there are perverse incentives that encourage deforestation, then they must be dealt with or built into the costs that need to be covered. Some twenty years ago, Binswanger (1991) argued strongly that efforts to curtail deforestation in the Brazilian Amazon were hampered by ‘ . . . tax policies, special tax incentives, rules of land allocation and an agricultural credit system that all accelerate deforestation in the Amazon.’ (p.1) While Brazil has addressed many of these distorting policies, some remain and need to be factored into calculations of what the realistic cost of reducing deforestation will be…. The costs of policy reform need to be built into the bottom line estimates of what it realistically will cost to reduce deforestation.”

6. “There also is the question of how opportunity costs are estimated. . . . Pirard (2008a): ‘numerous interpretations of the opportunity cost concept coexist in the literature and in influential reports (e.g. Stern review), with differing estimated values for similar cases.'”

7. “Finally, we have to remember that opportunity cost is not a static concept. It changes as market forces change, as technology improves, and as new technologies emerge. In the particular case of deforestation to open land for bioenergy crops, Persson and Azar (2010) point out that if the price of carbon increases so would the price of bioenergy produced from bioenergy crops that are responsible for a significant amount of deforestation. Land prices, in turn, also would go up, since the opportunity cost of not producing the bioenergy crop would increase. This relationship would continue up to the point where other renewable, non-land intensive energy alternatives would become competitive. Most of the existing studies do not add a dynamic perspective on how opportunity costs will change as relative demand and supply conditions for timber or products produced on cleared forest land will change (under the assumption of negligible leakage).

The report looks at several real-life situations: when deforestation is illegal; when removal of forest is permitted by law; and when legal property and use rights are not clear. In each of these cases, the authors examine the implications in terms of using opportunity cost to estimate what it would cost to stop deforestation.

They conclude that,

“It would appear that opportunity costs are just the tip of the iceberg when it comes to estimating the real compensation that will have to flow into tropical developing countries to implement effective, efficient and fair REDD+ programs. The institutional investment costs involved in governance reforms can be significant and such reforms cannot be done overnight. Yet in many countries they are essential before REDD+ can be a success.”