19861 - LATEN Dissemination Note # 2 The Potential for Trade with the Amazon in Greenhouse Gas Reduction April 1993 7w" ~ ~ ~ ~ ~ ~ 2 35~ft. Or-te\,-;. .k~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Robert Schneider The World Bank Latin America Technical Departmnent Environment Division LATEN Dissemination Note # 2 The Potential for Trade With the Amazon in Greenhouse Gas Reduction April 1993 Robert Schneider The World Bank Latin America Technical Departnent Environment Division FOREWORD The "Dissemination Note" Series of the Latin America & Caribbean Region's Environment Division (LATEN) seeks to share the results of our analytical and operational work, both completed or in progress. Through this Series, we wil present the preliminary findings of major regional studies in an abbreviated form, as well as describe 'best practices" with regard to major environmental issues currently confronting LAC countries. In most cases, these notes represent 'work in progress' and as such have not been subject to either substantial internal review or editing. Therefore the findings, interpretations, and conclusions expressed in these notes are entirely those of the author(s) and should not be attributed to the World Bank, members of its Board of Executive Directors, or the countries they represent. Since one of the key objectives of these notes is to stimulate debate, I would encourage readers to contact the authors directly should they have any comments, or suggestions as to how the analyses could be improved. Dennis J. Mahar Division Chief Environment Division Latin America and the Caribbean Region Tne World Bank LATEN Dissemination Note 1111 'The Potential for Trade With the Amazon in Greenhouse Gas Reduction 1. Growing worldwide interest in the problems of global warming and the emission of greenhouse gases has led to a search for innovative ways to reduce carbon emissions. One approach has been to use international trade based on comparative advantage to seek cost- effective strategies for carbon reduction. The costs of carbon reduction in the developed, industrialized countries of the North are large and are well-known. However, there appears to be considerable scope to support carbon sequestration in developing countries in the South, especially in those that have large areas of tropical forests. This approach would serve several desirable goals: income transfers from the North to the South, income redistribution to poorer, frontier areas within Southern countries, and provision of cost-effective carbon sequestration while also yielding biodiversity and ecosystem benefits. 2. This note explores the potential gains from trade between Amazonia and industrialized countries of the North. The first section shows that controlling emissions in the Amazon would be considerably cheaper than greenhouse-emission controls proposed, or in effect, in the industrialized North. The second section discusses potential institutional mechanisms to facilitate trade. It also identifies several problems that would have to be resolved. Calculating the Potential Gains From Trade 3. Indicative calculations suggest that the potential gains from trade in carbon emissions between industrial countries and the Amazon are very large. These gains can be calculated by comparing the value of a hectare of forest as a store of carbon to its value as agricultural land. To calculate the value of forest land as a store of carbon requires two numbers: (i) amount of carbon sequestered in a hectare of forest, and (ii) the per-ton value to society of reducing carbon emission. The product of these numbers is the social value of a hectare of forest in carbon sequestration. The value of forest land in agricultural use is best estimated by the selling price of forest land.2' Comparing these numbers-the value of carbon sequestered on a hectare of forest relative to the land's selling price-yields the potential gains from trade between landowners and governments in the Amazon and the northern industrialized countries. 4. The value of forest land as a store of carbon can be estimated by (i) estimating the global damages avoided by not releasing additional carbon to the atmosphere; (ii) comparing the value society has been willing to tax itself to reduce further greenhouse emissions; or (iii) comparing the costs of alternative sources of greenhouse reductions. Since 1/ I would like to thank my colleagues in LATEN who provided numerous helpful comments, especially John Dixon who was particularly generous with his time. David Steeds and Andrew Steer also provided valuable comments. This note forms part of LATEN's Economic Sector Work on the Role of Government on the Frontier. 21 It is often argued that land speculation overvalues land relative to its value in agricultural use. In general however, one finds that speculator's prices are based on potential future agricultural potential of the land, not when any large land ownership confers special benefits. More generally, land values often exceed the capitalized value of farming profits. In any case, we will see that whatever is driving the current price of land in the Amazon, its value in carbon sequestration exceeds its value in alternative market use. 2 proposals for carbon taxes are typically based on studies of the amount of carbon emission that can be controlled at different levels of taxation, (ii) and (iii) are reduced to the same concept. Indicative values, based on a range of existing taxes and proposals, are shown in Table 1. Table 2 illustrates the range of values obtained by various analysts interested in the amount of carbon sequestered per hectare of forest. 5. We can 'bracket" the potential range values of Amazon land in carbon sequestration as being between US$245/ha and US$28,300/ha. The low estimate is derived by multiplying Fearnside's value of 136 tons of Carbon (for the average hectare of forest in the legal Amazon) by Nordhaus' "low" estimate of global warming damage costs. The upper bound is obtained by multiplying CBO's estimate of US$ 100/t carbon, required to reduce emissions to their 1988 level by 2000, by the 283 ton of carbon per hectare estimated by the German Bundestag. 6. The extreme values for land in carbon sequestration are therefore between US$245/ha and US$28,300/ha. Using values for carbon sequestration that societies have actually demonstrated their willingness to pay generates a narrower and more interesting range. Using the US$ 45/tC of the Netherlands and Sweden and multiplying by Fearnside's average, carbon content of dense Amazon forest, yields a carbon-storage value of US$ 7,200 per hectare of dense Amazon forest; the Finns tax of US$ 6. 1/tC yields a value of US$ 976 per hectare; and finally, a tax of a penny per gallon of gas would yield US$560 per hectare of land. This leaves, say, US$600-US$7000 as a particularly relevant range. 7. Table 3 compares the author's (unsystematic, 1992) observations on the market price of forest land in the Amazon to estimates of the value of carbon sequestering based on the information in Tables 1 and 2. The conclusion that emerges is that the value of the forest as a stock of carbon is greater than its "present" value in agriculture at even the lowest of estimates, and that in the most relevant range of implicit values of carbon (US$ 600-US$ 700 per hectare), it exceeds by a multiple of 4 to 50 times the value of forest land even in the relatively agriculturally active areas of Rondonia. To achieve an accurate estimate of the global warming cost of deforestation, however, we must take account of the carbon content of crops established under subsequent land use. In the Amazon, economic and agronomic forces combine to make the most likely ultimate use to be pasture. Even after subtracting the value of carbon in pasture (Table 3), the net value of carbon loss would remain a multiple of 2 to 30 times the value of forest land in agriculturally active, expanding frontier areas of the Brazilian Amazon. Table I Total Carbon Storage in Amazon Forest a/ Forest Type tC/ha (assumes Observations Source carbon is 50% of biomass) Average for Hilea 225 Estimates 112 t/ha above ground and 80-130 t/ha Sombroek, Region below ground (1992) Dense Amazon Forest 160 Represents weighted average of dense forests Fearnside ._______________ comprising 49.3% of Brazil's Legal Amazon (1992) Average for Brazil's 136 Area weighted average based on RADAMBRASIL's Fearnside Legal Amazon timber inventories (1992) Average for Amazon 160 Above ground carbon only Houghton et al. (1987) Closed primary forest 283 Estimates 167 t/ha above ground and 116 t/ha below German ground Bundestag (1990) Ci Carbon stored in above and below ground biomass. Table 2. Indicative Values of Carbon Sequestered Basis of Valuation Value US$/ton of Carbon Observations Source Marginal Damage Estimate 1.8 'low' estimate Based on estimates of costs and Nordhaus 7.3 "medium" estimate damages to the world economy of (1991) 66.0 "high" estimate global warming. l Enacted taxes 6.1 Finland Shah and Larson 45.0 Netherlands and Sweden (1992) Proposed Taxes 5 phased to 25 in 1995 Submitted to US Congress Shah and Larson 9 phased to 70 in 2000 Debated in EC (1992) Penny a Gallon of Gas 3.5 Required to reduce US 10 in 1991 increases 10 Conclusions of a 1990 study by the CBO (1990) Gteenhouse emissions to annually to 100 in 2000 Congressional Budget Office 1988 levels by 2000 l 4 Table 3. Comparison of the Market Value of Forested Land in Brazil to its Value in Carbon Sequestration Table 3a Table 3b Expected Value of Amazon Value of Amazonian Forest Land in Carbon Forest Land in Agriculture Sequestration 2/ 1/ Location Value Value Value Net Valuation Basis US$/ha US$/ha Carbon in Pasture 3/ Para, 300 7,200 4,950 Carbon tax in Paragominas Sweden and area, near Netherlands Belem Brazilia Rondonia, 150 1,168 803 Nordhaus' BR364 South of "medium" Porto Velho estimate of marginal damage from global warming Rondonia, 50 976 671 Carbon tax in Br364 West of Finland Porto Velho Rondonia, 15 560 385 carbon equivalent Guajara Mirim of one cent a area gallon gas tax Para, 2.5 288 198 Nordaus' 'low" Transamazonia estimate of Altamira area marginal damage from global warming 1/ Current market price of the land. 2/ Based on carbon content of 160 tons per hectare (see Table 1.). 3/ Assumes 60 tons C per hectare (above and below ground). Impediments to Trade 8. The numbers above demonstrate that very substantial potential exists for gains from North-South trade in greenhouse-gas reduction. Administrative difficulties are large, however, and despite these potential gains, a number of hurdles will have to be overcome to generate willing buyers and sellers. These are addressed below. 9. Transaction Costs. There are several difficulties which fall in the category of transaction costs. These costs reduce the potential gains calculated above-if they exceed 5 them, no trade will occur. However, the size of the potential gains suggests clearly that an effort to minimize these transaction costs, thereby creating a market, is justified. The most important transaction cost is contract enforcement. How can the buyer be assured that having purchased carbbn sequestration, the land will not be cleared anyway, if not by the contractee, then by someone else? Similarly, how can the seller be assured that payments will be made as promised? The second is contract facilitation. How can potential buyers and sellers be brought in contact? The third is product gradine. How can the buyer get information necessary to make an informed choice concerning the value of his intended purchase of carbon sequestration? Important information would include forest density, the probability that it would be converted in the absence of intervention, and for many potential buyers, biodiversity value. 10. Moral Hazard. The major concern over using positive incentives to influence landowner behavior rather than negative incentives (taxes and/or command and control) is that of potential moral hazard.3' In this case, moral hazard takes the form of landowners or governments taking, or threatening to take, environmentally adverse action that they would not otherwise take, in order to increase the value of their contracts. At the individual level moral hazard is minimal; once the land is burned or cleared, the landowner has forfeited any possibility to benefit from the program, which applies only to intact forest. An additional problem would have to be dealt with at the governmental level, however. Since building a road would increase the probability of land conversion, and therefore increase the value of a contract to not convert, a clear governmental commitment on road building, and other government policies, would be necessary. 11. National Sovereignt,. Any program to allow global interest to influence activity in the Amazon would have to be effectively designed to minimize real or apparent impingement on national sovereignty. Illustrative Mechanisms 12. One mechanism to avoid most of the potential barriers discussed above would be for government, NGOs, and others interested in preservation to enter into short-term rental contracts (of conversion rights, for example) that allow the landowner to carry out limited activity consistent with the environmental objective. These contracts would explicitly make the landowner responsible for enforcement of environmental restrictions. Ideally, an auction market for short-term rental contracts could be developed to generate rapid feedback to 31 The reason for using positive incentives in this case is that negative incentives are probably unenforceable (see Schneider, 1992). Briefly, (i) in a frontier setting government has little potential to act in a manner that is contrary to local interests and local incentives- thus getting local incentives consistent with desired international outcomes is critical; and (ii) clear property rights are essential to establish responsibility for land use. Property rights only emerge where justified by economic rent relative to transaction costs. Thus, in a frontier setting taxing carbon emissions has two fatal problems. First, practically, because it is against the interests of nearly everyone on the frontier, it is probably administratively impossible; and second, theoretically, since it would eliminate what little economic rent now exists at the frontier land, it would have no owners to assert responsibility for land use. Squatting and natural resource "mining" would become the norm. 6 landowners. Contract values would fall rapidly in areas where violations occur, while good enforcement would be rewarded. Restricted and short-term rental contracts would not be seen as a threat to sovereignty, as would outright land purchases. NGOs, parties to 'debt for nature' arrangements, and other bilateral and multilateral organizations (such as the Global Environmental Facility) could participate either through a concerted strategic program or independent action. 13. Another mechanism might be franchising agreements, entered into at, say, the municipio level. Municipios would contract with the international community to control the level and nature of development in their jurisdiction. Municipios, in turn, would be responsible for determining the nature of incentives and disincentives to be used to control activities at the municipio level. Competition among municipios would ensure efficiency in international resource allocation. Franchising appears to be a particularly promising way to deal with public lands. Other Issues 14. A minimum critical size of contiguous protected area is essential for protecting biddiversity. This suggests that any mechanism to facilitate trade between the north and the south should contain a mechanism allowing contiguous land-use rights to receive a higher value than those that are isolated. 15. If successful, the program would probably lead to pressure to clarify land titles and,. perhaps in some areas, to an increase in land concentration. This process may reduce the prospects for squatters and small fairmers. Extractivists, and others interested in sustainable economic activity in the intact forest should benefit, however. In the past extractivists' meager income has not made it possible to compete with farmers and ranchers for land. These low-impact land uses could now operate under the cover of the landowners' contract, or a franchise with the municipio. 7 Bibliography CBO. 1990. Carbon Charges as a Response to Global Warming: the Effects of Taxing Fossil Fuels, Congress of the United States, Congressional Budget Office. Fearnside, P.M. 1992. Forest Biomass in Brazilian Amazonia: Comments on the Estimate by Brown and Lugo, Interciencia. German Bundestag (Ed), 1990. Protecting the Tropical Forests: A High Priority International Task. Bonner Universitats-Buchdruckerei: Bonn. Houghton, R.A., Boone, R.D., Fruci, J.R. et al. 1987. The flux of carbon from terrestrial ecosystems to the atmosphere in 1980 due to changes in land use: geographic distribution of the global flux Tellus 39B: 122-139. Nordhaus, W., 1991b. A Sketch of the Economics of the Greenhouse Effect, American Economic Review, Papers and Proceedings, Vol. 81, No. 2, 146-150. Schneider, R. 1992. Brazil An Analysis of Environmental Problems in the Amawon, World Bank. Shah, A. and Larson, B. 1992. Carbon Taxes, the Greenhouse Effect and Developing Countries, World Development Report 1992. Sombroek, W.G. 1992. Biomass and Carbon Storage in the Amazon Ecosystems, Interciencia.