Maximizing Returns from Payments for Water‐Based Ecosystem Services: Incorporating Externality Effects of Land Management

Abstract

AbstractGiven the expansion of payments for water‐based ecosystem services (PWES) worldwide, two relevant issues are as follows: (1) determination of efficient allocations of payments among land managers, and (2) how this might change when paying one manager to implement a best management practice (BMP) to enhance an ecosystem service impacts the cost‐effectiveness of BMPs considered by other land managers not currently involved in PWES. Such externalities may be negative if diminishing returns dominate, or positive if mechanisms such as “social diffusion” dominate. We analyze how a planner should optimally allocate payments, depending on whether the expected externalities are negligible, negative, or positive. We employ (1) an optimal control model to gain insights on the problem’s dynamics, and (2) stochastic dynamic programming to determine optimal funding strategies using a specific application. The study contributes to the literature by identifying dynamically optimal PWES payment patterns, and illustrates how they should change when one accounts for externalities induced by the program. Because such impacts have not been addressed previously in a rigorous way, this treatment provides useful value added for PWES design and implementation.