Topic Area: Deforestation and Water

Geographic Area: Costa Rica

Focal Question: Does paying for forests’ water services promote socially optimal land use?


(1) Bishop, Joshua; Natasha Landell-Mills; and Stefano Pagiola. Selling Forest

Environmental Services: Market-based Mechanisms for Conservation and Development. Earthscan Publications Ltd: London. 2002.

(2) Zbinden, Simon and David R. Lee.  “Paying for Environmental Services: An Analysis of Participation in Costa Rica’s PSA Program.” World Development.,Vol. 33, No. 2 2004. 255-272.

Reviewer: Matthew Hirsch, Colby College ‘08


Rampant deforestation in Central America has been problematic for decades, and its impact on hydrological flows has become a major concern. In the late 1970s and early 1990s, Costa Rica maintained one of the highest rates of deforestation and experienced an estimated loss of about 35-40% of its forest cover (1). Much of this loss occurred as a result of generating more land for agriculture and pastures.


This decline in forest cover and the increase in demand for water services have created immense political pressure to curb deforestation in part because of the conventional wisdom that forest ecosystems provide valuable hydrological services. As a result, the Costa Rican government developed a program to provide a system of payments for environmental services in order to promote reforestation.  This revolutionary program called Pago por Servicios Ambientales (PSA) was implemented in 1997, and it allows land users to be compensated for the environmental services their land generates.


The main objective of PSA is to correct the coordination failure that exists in the market for forest environmental services so that the value of forest cover is internalized.  Two fundamental problems plague this market. The first is that many land owners and users are not directly compensated for the environmental services their forest creates. If land users provide these services by not expanding pastures and farmland or by participating in reforestation practices, they forgo profit their land could create. Therefore, land users do not have any incentive to provide these services. Secondly, those who use these services are at some distance from the forests, which makes it difficult to understand the precise impact on them of landowner decisions (1). Moreover, in many cases the beneficiaries of forest services lack the facility to pay for the ability to maintain the supply of these services.  Consequently, this coordination failure produces socially suboptimal land use.  By attempting to compensate land users for the services their forests create from revenues derived from the beneficiaries, the PSA program aims to correct this coordination failure.


How does the PSA program work? Landowner participants must present a sustainable forest management plan that is certified by a licensed forester. The national agency, Fondo Nacional de Financiamiento Forestal (FONAFIFO), collects, manages, and negotiates the payments from those who receive the benefits from the water services that forests provide.  The program then relies on Sistema Nacional de Areas de Conservacion (SINAC) to pay and monitor the participants. 


Under the Costa Rican Forestry Law No 7575, hydrological services, including the provision of water for human consumption, irrigation, and energy production, are explicitly acknowledged as a service provided by forest ecosystems. This law, however, does not require payment from those who benefit from the hydrological services (1).


One of the biggest problems for FONAFIFO in obtaining payments under the PSA program is the total lack of any conclusive evidence on the extent to which forest cover provides improved and/or sustained water services for hydroelectric power (HEP), irrigation, and consumption.  Some studies do provide a basic formula FONAFIFO uses to charge for the water services, but this is not perfect (1). 


Fortunately, many HEP producers have been willing to participate in the program because the changes in the forest ecosystems may threaten the current conditions (1).  As a result, the PSA program has been moderately successful in convincing at these water users to pay for forests’ water services.


Although requests to participate in the PSA program exceed the resources available (2), the important question is how effective and efficient has the program been in eliminating socially suboptimal land use? Although the data are limited, the PSA program appears to have had a greater impact on preventing deforestation (82.5% of contracts) than reforestation (7% of contracts) (1). The general consensus is that the program has improved the protection of Costa Rica’s forests.  The PSA program’s shift away from a more universal payment system to a more targeted one in recent years has helped improve the efficiency of this market. This shift in emphasis allows the program to devote more resources to areas that create the most valuable water services (1).  Additionally, targeting the funds to their specific watersheds enables the beneficiaries, especially HEP producers, to pay for services they actually use, which helps eliminate free-rider incentives. 


The lack of reliable qualitative and quantitative information about the links between forest cover and water services illustrates a large weakness in the program’s effectiveness, efficiency, and sustainability.  This lack of quality information makes it incredibly difficult to determine the value of water services generated by forest cover. In order for the PSA program to work effectively and efficiently it must pay the suppliers no less than the opportunity cost for the other uses of the land, but no more than the value of the benefit. However, it is important to be able to determine where the value of the service is low and the opportunity cost to society of forgone land use is high so that the program does not absorb valuable land for society (1). Costa Rica faces a substantial cost of being wrong for water payments that are either too low or too high. Without an understanding of the value of the water services forest cover provides, it is impossible to determine where and if the program is cost effective. Until reliable information about the link between forest cover and water services becomes available one must question the sustainability of the PSA program. The PSA program possesses the necessary structure to generate an effective and efficient market to promote socially optimal land use, but it is incapable of completely correcting the suboptimal land use problem until it can accurately value the forests’ environmental services.