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Weekly UpdatesA fairly recent innovation in environmental policy--and one that is favored by a number of economists--payments for environmental services (PES) are beginning to be implemented in order to protect water sources in Latin America. In a typical scheme, compensation is given to people in the upper reaches of watersheds, who in return refrain from land uses that exacerbate flooding, seasonal water shortages, and other problems at lower elevations. The receptivity of rural households to PES varies considerably, depending much on individual circumstances and livelihood strategies. For people who engage only in subsistence farming, which was long the economic mainstay of the African, Asian, and Latin American countryside, giving up a few hectares that yield little output in exchange for an unvarying conservation payment can be appealing, even if that payment is modest.
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In contrast, PES may be less attractive to rural dwellers with diverse sources of income. For example, numerous households in E1 Salvador have risen out of poverty by starting micro-enterprises, working in clothing factories, etc. Nevertheless, they do not abandon farming entirely. Since few of these households have savings accounts or deal in other ways with financial institutions, growing some of their own food is the way most of them deal with the downside risks of off-farm employment. Clearly, any payments directed toward households of this sort would need to reflect the de facto insurance value of resources needed for subsistence whenever there is a shortfall in off-farm earnings.
To clarify linkages between households' participation in PES initiatives and their livelihood strategies, we have carried out field research in a rural community in the Ecuadorian Andes, thanks to support provided by the US Agency for International Development and the US Department of Agriculture. Based on this research, we conclude that the poorest rural households depend heavily on subsistence farming and would also accept lower conservation payments than those demanded by other segments of the population, who have higher living standards because of off-farm work but who also deal with the risks of that work by growing some of their own food. If households that are non-diversified and poorer are actually paid less--as would make sense if environmental services are to be secured at least cost--then PES initiatives are not the best way to alleviate rural poverty, contrary to the claims of those who are enthusiastic about this approach to poverty reduction.
Conservation Payments and Risk-Aversion
Fluctuations in earnings have been shown to detract significantly from the well-being of low-income house-holds in the countryside, so a conservation payment that does not vary has obvious attractions. This is particularly true for people who are risk-averse and survive entirely on the food they produce. The minimum payment such people will accept in return for not cultivating a few hectares is directly related to the average value of the crops they expect to raise on that land--an average value that is quite modest on average. Actually, the minimum payment is less than the average value if output is variable (as it always is) and if the recipient is risk-averse, as rural households tend to be.
While much of the rural population in the developing world engages solely in subsistence farming, a large and growing segment has two or more sources of income and consequently tends to be less impoverished. The latter segment of the rural population predominates in many watersheds where conservation initiatives are being undertaken. These settings are not out of reach of cities and other market hubs, so opportunities exist to complement the production of one's own food with an alternative--such as earning wages or running a microenterprise.
Two observations can be made about these alternatives. One is fairly well known, which is that off-farm work usually pays better than subsistence production. But the other observation is no less important and is well-documented in the literature on economic development: the returns to subsistence farming tend to be less, not more, variable than the returns of alternative activities. This is true of commercial agriculture, as Theodore Schultz, a winner of the Nobel Prize in Economics, pointed out more than 40 years ago. The returns of off-farm employment are also more variable than those of subsistence production, as economists John Harris and Michael Todaro argued in a 1970 article published in the American Economic Review. Some of the variation in off-farm earnings has to do with wage adjustments, resulting from changes in the demand or supply of labor. But fluctuating earnings are mainly the result of labor-market rigidities, which often prevent recent migrants from finding urban jobs at prevailing wages.
One reason why a household ends up with diversified earnings is that it is less averse to risk than subsistence households. Another reason is that it finds off-farm employment more rewarding, perhaps because its human capital is superior. Greater willingness to run risks can also coincide with superior returns to non-agricultural work, in particular when someone who is not put off by occasional unemployment ends up acquiring the contacts that lead to remunerative off-farm employment.
A household with diversified earnings has a portfolio management problem, similar to what Nobel-laureate Harry Markowitz has examined in financial settings. Aside from providing edible goods, subsistence production balances the risks associated with off-farm work. If a diversified household cuts back on agricultural land use, as it must do to qualify for PES, the resulting decline in the returns to subsistence farming causes the household to reallocate labor to off-farm work. The household's conservation payment depends directly on the additional risks created by this reallocation.
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To summarize, PES and associated declines in farmed areas are not viewed the same by all segments of the rural population, some of which engage solely in subsistence production while others grow their own food in part to cope with the risks associated with off-farm work. For subsistence farmers, conservation payments represent a risk-free alternative to the meager yields of farmland that must be given up in order to qualify for payments. In contrast, people who are better off because their earnings are diversified participate in PES only if payments compensate entirely for the additional risks they run by reallocating labor from subsistence farming to off-farm employment.
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A Survey in Cangahua, Ecuador
One expects that payments demanded by diversified households generally exceed what subsistence households demand. However, the only way to verify this is with empirical research, of the sort we have carried out using data collected in a survey of 199 individuals in Cangahua, Ecuador in January and February of 2004.
Cangahua is representative of rural communities in the upper reaches of the watershed where the national capital, Quito, is located. For the most part, agriculture is non-commercial and off-farm work is the main alternative to subsistence production. Small holdings predominate, with median farmed area per household slightly less than three hectares. Practically all land is planted to potatoes and other staple crops, which are consumed mainly by the producing household. Much of the male population works outside the community, quite often in floricultural enterprises nearby or at construction sites in Quito and other cities. By and large, wages are modest, as reflected in an average annual income of US$1,496 for households in the sample. Low wages are, in turn, a consequence of limited formation of human capital, as indicated by limited schooling and elevated illiteracy in the community.
General observations in the economic literature about subsistence production and other activities for rural households apply well to Cangahua. Relative to national standards, crop yields are low. For example, the average annual yield of potatoes in the community is 1.19 metric tons per hectare (mt/ha), which is less than one-quarter the national average of 4.99 mt/ha. However, subsistence farming is, if anything, less risky than working off-farm, in the sense that potato yields vary less among households than off-farm earnings. This is consistent with the finding mentioned above that subsistence agriculture is less risky than off-farm employment.
Since watershed conservation is needed to safeguard water supplies for the national capital, our survey, which was undertaken to collect economic, agricultural, and other data, also included questions related to PES. To be specific, participants were asked to respond to contingent-valuation (CV) questions of the stylized form: "Would you be willing to stop farming on A hectares for five years in exchange for a monthly payment of B dollars during these same five years?" The time limit was placed on the transaction in order to emphasize that accepting payments would pose no risk to recipients' property rights.
In addition, each respondent was randomly assigned a decrease in farmed area (A), which ranged from one to five hectares. If someone owned less than one hectare, then a reduction of 25 or 50 percent was specified. Monthly payments (B) were randomly drawn from the bid vector, US$1, US$10, US$20, US$30, US$40, or US$50. Of the 199 households interviewed in Cangahua, most answered the CV question. Non-responding households were not found to be significantly different from the rest of the sample in terms of earnings and other key variables.
Findings
Responses to CV questions having to do with PES were entirely consistent with the idea of a downward-sloping demand curve, with land withdrawals rejected at low levels of compensation but accepted if a high payment was offered. To be specific, all but one of the 33 households offered a monthly payment of US$1 to take a hectare out of production rejected the deal.
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