Payment schemes for environmental services in watersheds

Papers and presentations
(available on CD-ROM)

The texts (PDF) and/or presentations (Power Point) are available in English (E) or Spanish (S), as per the indication given below. Abstracts in English can be found in Annex 1.

1. FUNDAMENTAL ASPECTS OF PES IN WATERSHEDS

Land-water linkages in rural watersheds: implications for payment schemes for environmental services
Jean-Marc Faurès
Text: E; Presentation: S

Environmental service payments: initial lessons from practical experiences
Stefano Pagiola
Text: S; Presentation: S

2. ECONOMIC VALUATION FOR PES SCHEMES

Economic valuation for the environmental service of water regulation, Southern Sierra de las Minas, Guatemala
Juan Carlos Méndez, Oscar Hernández, Carlos Roberto Cobos, Ariel Ortiz
Text: S; Presentation: S

Water service payments: service measurement and valuation
Ina T. Porras
Text: S; Presentation: S

Economic valuation of environmental goods and services of high Andean grasslands in Peru: policies for sustainable management
Oscar Ventura Quezada
Text: S; Presentation: S

Assessment of the water provision potential in La Amistad - An economically significant environmental service for communities
Felipe Carazo
Text: E; Presentation: S

Proposal for a system of payment for environmental services to protect the Río Arenillas watershed, El Oro Province, Ecuador
María Virginia Ribadeneira and Remigio Galárraga Sánchez
Text: S; Presentation: S

3. METHODOLOGICAL TOOLS AND BIOPHYSICAL ASPECTS FOR PES SYSTEMS

The CONDESAN watershed analysis methodology: an alternative to correct deficiencies in the implementation of payment for environmental services in Andean countries
Rubén Dario Estrada and Marcela Quintero
Text: S; Presentation: S

Watershed environmental services and water production: concepts, valuation, experiences and possibilities for their application in Peru
Carlos A. Llerena
Text: S; Presentation: S

Equity account for water resources in the Lerma-Chapala watershed (Querétaro region)
Alejandro Angulo Carrera and Ivonne Valdez Muciño
Text: S; Presentation: S

Environmental goods and services from pine tree thinning in watersheds
Arsenio Renda Sayou, Tomás Plasencia Puentes, Juan Herrero Echevarría, Doralys Ponce Barroso, Alberto Vidal Corona y Ariel Pérez Pirino
Text: S; Presentation: S

4. PRACTICAL EXPERIENCES: IMPLEMENTATION OF PES SYSTEMS

Payment for environmental services in PROCARYN - pooling national and international funds for water resource conservation in the Dominican Republic
Thomas Heindrichs
Text: S; Presentation: S

Payment for environmental services: an alternative for water availability and quality in Tungurahua, Ecuador
Rafael Maldonado Vásquez and Marina Kosmus
Text: S; Presentation: S

Payment for hydrological services at a municipal level and its impact on rural development: the PASOLAC experience
Carlos J. Pérez
Text: S; Presentation: S

Programme for the Conservation and Recovery of Microwatersheds (PROCUENCAS) in the province of Heredia, Costa Rica
Juan Diego Bolaños Picado
Text: S; Presentation: S

Contribution to the integral management of watersheds in Peru s coastal valleys through the creation of markets for environmental goods and services from the water resources on lands protected by vegetative cover in upland watersheds
Bertha Alvarado Castro
Text: S; Presentation: S

5. ANALYSIS AND IMPACTS OF PES SYSTEMS IN THE REGION

Experiences with payment for environmental services in Costa Rican Watersheds
F. Jiménez, J.J. Campos, F. Alpízar, G. Navarro
Text: S; Presentation: S

Some lessons about the application of payment for water protection in Colombia and Ecuador
Marta Echavarría
Text: S; Presentation: S

Management of environmental services and natural areas in Andean watersheds
Robert Hofstede
Text: S; Presentation: S

Social effects of markets for watershed protection
Ina T. Porras and Maryanne Grieg-Gran
Presentation: S

6. DESIGN OF SUCCESSFUL PES SYSTEMS IN WATERSHEDS

Assessing the efficacy of financing systems for watershed ecosystem services
Sylvia S. Tognetti, Guillermo Mendoza, Douglas Southgate, Bruce Aylward, Luís García
Text: E, S; Presentation: S

Documentation of case studies
(available on CD-ROM)

1. MICRO-WATERSHED CONSERVATION AND RECOVERY PROGRAMME (PROCUENCAS) HEREDIA, COSTA RICA
Resource person: Juan Bolaños. Empresa de Servicios Públicos de Heredia S.A.

2. PES FOR THE WATER AND WASTEWATER ADMINISTRATION BOARD IN JESÚS DE OTORO, INTIBUCÁ, HONDURAS (JAPOE) WITH METHODOLOGICAL AND FINANCIAL SUPPORTFROM PASOLAC
Resource person: Carlos Pérez, PASOLAC.

3. PIMAMPIRO MUNICIPALITY, ECUADOR
Resource person: Marta Echavarría, Ecodecisión.

4. PES IN PROCARYN - DOMINICAN REPUBLIC
Resource person: Thomas Heindrichs, GTZ-PROCARYN.

Executive summary

Payment schemes for environmental services (PES) are flexible, direct and promising compensation mechanisms by which service providers are paid by service users. PES schemes in watersheds usually involve the implementation of market mechanisms to compensate upstream landowners in order to maintain or modify a particular land use, which is affecting the availability and/or quality of the downstream water resources.

The Regional Forum on Payment Schemes for Environmental Services in Watersheds took place from 9 to 12 June 2003 during the Third Latin American Congress on Watershed Management (Arequipa, Peru, 9-13 June, 2003). The main objectives of the Forum were to:

• Exchange experiences in systems of payment for environmental services (PES) in watersheds in Latin America, particularly for water resources.

• Identify criteria and formulate recommendations to achieve: a) an appropriate economic valuation of water services, and b) an appropriate design and successful execution of PES schemes in watersheds.

The event included 80 experts, 22 presentations and 19 papers. Working groups were established as part of the Forum activities. This report summarizes the major contributions made by the Forum from oral presentations, written papers and the working group sessions.

Based on the participants experience, a set of criteria was established to characterize and assess practical experiences from the execution of PES schemes in watersheds. These criteria can be used to systematize the information regarding the various payment systems implemented for water resources and to prepare proposals for PES systems in watersheds.

During the Forum several Latin American experiences were presented regarding the planning and execution of PES schemes in watersheds. The information provided by four of those experiences was systematized by using the criteria as a guideline.

The following general lessons were identified by the participants based on the several experiences described in the Forum:

1. Until now PES systems in watersheds have been applied at very different stages and for various objectives in Latin America, from the micro-watershed level - focusing on a very specific service - and usually managed by an NGO, to national programmes controlled by the State.

2. A few countries have specific legal frameworks for PES at the national or regional level; however, most schemes operate without a specific legal basis.

3. As compared to other regions of the world, there are a significant number of examples for the application of PES schemes for water-related services in Latin America. However, these cases have not been inventoried comprehensively yet and there are few studies on the socio-economic and environmental impacts of these systems.

4. There are significant uncertainties regarding the cause-effect relationships between land use and the services.

5. In some cases, service providers show interest in PES schemes as they may be an informal mechanism to establish property rights for land and natural resources.

6. The role played by the State in PES schemes for water-related services in Latin America has varied significantly.

7. In several cases, public institutions involved in the schemes are local rather than national in scope.

8. There is a potential to replicate PES experiences presented in this Forum, but they need to be adapted to the particular contexts.

PES systems present a series of advantages and opportunities which make them a promising mechanism to improve the conditions of water resources in watersheds since they can:

• Be used for sensitizing the participating population about the value of natural resources.

• Facilitate the solution of conflicts and the obtaining of consensus among the involved actors.

• Improve the efficiency in the allocation of natural, social and economic resources.

• Generate new sources of funding to conserve, restore and value natural resources.

• Create indicators of the relative importance of natural resources.

• Transfer resources to socially and economically vulnerable sectors, which offer environmental services.

However, these schemes are not free from difficulties and limitations. Some experiences of PES schemes in execution have faced the following difficulties:

• They are based on generalizations, which have not been proven by empirical studies about the relation between land use and water-related service.

• They are not the most cost-effective method to attain the goals established.

• Service providers, users and the service itself are not properly identified.

• They have been executed without a mechanism for follow-up or control.

• The model and cost of the service were politically imposed and do not correspond to studies on demand and economic valuation of the resource.

• The design is not based on previous socio-economic or biophysical studies.

• They may offer perverse incentives to land users.

• They depend largely on external financial resources.

• Programmes and activities have been disseminated poorly among the local population.

The main recommendations of the Forum include:

• The establishment of a PES scheme must start with the identification and quantification of the demand for the service.

• A cause-effect model is required that clearly links land use and the service; the PES scheme must be based on this model.

• While the major objective of PES schemes does not aim specifically at reducing poverty, these mechanisms should be designed in such a way so as not to increase inequality and, if possible, to benefit low-income sectors.

• PES systems must be designed in such a way so as operate independently of external financial resources after a previously determined period.

• The possibility of including agricultural land use systems in PES schemes must be studied in particular.

• Monitoring is essential the smooth operation of a PES scheme. It must include the establishing of a base line, as well as the socio-economic and environmental impact of the project.

• The exchange of experiences must be fostered at the national and international level, and inter-institutional agreements must be strengthened for the exchange of technical and managerial information.

• The lack of a specific legal framework for PES is not a crucial obstacle to create a market.

• Users and providers of the service as well as the service itself must be clearly defined.

• PES schemes for water-related services in watersheds have greater probabilities of effectively improving resource management if there is a direct relationship between providers and users of the service.

Acronyms

Acknowledgements

The Regional Forum on Payment Schemes for Environmental Services in Watersheds took place during the Third Latin American Congress on Watershed Management. The Regional Forum was coordinated by Benjamin Kiersch, FAO Regional Office for Latin America and the Caribbean, with the collaboration of Jan van Wambeke, Carlos Carneiro, Kyran Thelen and Alejandro Mañón, and supported by Jean-Marc Faurès, FAO Land and Water Development Division.

This report was prepared by Roldan Muradián, FAO consultant, who also collaborated in the preparation and organization of the event. The translation into English was done by Mirtha Parada, and revised by Kyran Thelen and Benjamin Kiersch. The list of acronyms was prepared by Virginie Gillet. Special thanks are due to Lynette Chalk for the efficient preparation of the text and formatting.

The organizers acknowledge all speakers and participants, whose opinions and comments during the discussions contributed to the success of the Forum.

Finally, the organizers of the Third Latin American Congress on Watershed Management are acknowledged for providing the logistics for the Forum.

Chapter 1. Introduction

Payment for environmental services (PES) schemes are flexible, direct and promising compensation mechanisms by which service providers are paid by service users^[1]. In a watershed context, PES schemes usually involve the implementation of market mechanisms to compensate upstream landowners in order to maintain or modify a particular land use which is affecting the availability and/or quality of the downstream water resource. Usually this compensation is generated from payments made by downstream water users. The basic idea of PES schemes is to create a market for an environmental good, which usually is priceless. Economically speaking, PES schemes require the allocation of titles de jure or de facto on environmental externalities benefiting third parties (environmental service). Thus, the system identifies economic agents in charge of "positive" environmental externalities, or service "providers", and the benefited agents (or users). The establishment of cause-effect relations is required between the land use - upstream - and the water resource conditions - downstream in the watershed. In addition, PES schemes intend to establish an information flow between service providers and users to facilitate the market exchange between both types of agents.

Two types of PES schemes can be distinguished. The first type - related to services at the global or the broad geographical scale - has the purpose of using market instruments to pay for services whose users are not limited to the local level, e.g. biodiversity conservation, scenic beauty, carbon sequestration and others. The second type of PES schemes is designed to compensate providers by means of a local market, in which generally users are better defined and limited to a particular geographical area, which is close to the location where providers carry out their productive activities. Since users and providers are geographically close to each other, the operation of the PES scheme should be facilitated since transaction costs are reduced and the information flow becomes easier among the economic agents. PES systems for water services in watersheds, which are the focus of the present report, belong to the latter category.

The Regional Forum on Payment Schemes for Environmental Services in Watersheds took place during the Third Latin American Congress on Watershed Management (Arequipa, Peru, 9-13 June, 2003). The main objectives of the Forum were:

• The exchange of experiences in systems of payment for environmental services (PES) in watersheds in Latin America, particularly for water resources.

• The identification of criteria and the formulation of recommendations to achieve: a) an appropriate economic valuation of water-related services, and b) an appropriate design and successful execution of PES schemes for watersheds.

The event included 80 experts, 22 presentations and 19 papers. Two working groups were established as part of the Forum activities. While one group discussed the necessary conditions and the most relevant aspects for the successful execution of PES schemes in watersheds, the other group discussed methodological and conceptual aspects of the economic valuation for PES schemes in watersheds. Oral presentations were the main input of both groups, which also were divided to follow the programme described above.

Chapter 2. Results of the forum

The specific objectives of the Regional Forum for Payment Schemes for Environmental Services in Watersheds were to:

1. Define a set of assessment criteria based on practical experiences with the execution of PES schemes in the region;

2. Characterize some experiences with PES schemes in watersheds that were presented on the basis of these criteria;

3. Identify some general lessons about the execution of PES schemes in watersheds;

4. Specify the advantages and opportunities provided by PES schemes;

5. Identify the most common difficulties and limitations faced by the execution projects of PES schemes;

6. Prepare recommendations for the successful execution of PES schemes in watersheds.

ASSESSMENT CRITERIA

For the purposes of this report, the following definitions are used:

• Providers - economic agents whose productive activity generates, as a positive externality, the service for which the payment system has been created.

• Users - economic agents who benefit from the service through a consumer good, e.g. water.

• Environmental services refers to positive externalities - affecting a consumer good - associated with particular environmental conditions, e.g. a certain land use.

In the specific case of PES schemes in watersheds, the service usually relates to the maintenance of the availability and/or quality of water. The providers are upstream land users, whose land use is to be modified or conserved to render the service, and the users are downstream consumers - companies or individuals - of the water resources.

On the basis of the participants experience, a set of criteria was established to characterize and assess practical activities from the execution of PES schemes in watersheds. These criteria can be used for the following different but supplementary purposes:

1. To systematize and characterize the information regarding payment systems for water services under implementation;

2. To assess comparatively cases of execution of PES for water services in watersheds; this would require that the information be compiled by an entity which is not related to the project under assessment;

3. To serve as a reference of the key aspects to be considered in drawing up proposals for PES schemes in watersheds.

The most relevant criteria are listed below, grouped in five categories.

a. Context

• Is there a national or regional policy on PES schemes?

• Is there a specific legal framework for PES in the country or region?

• Is the scheme part of a wider-ranging watershed management programme at a regional or national level?

• Was water a market commodity for providers and users before execution of the scheme? Do local communities accept the notion of water as a market commodity?

• Is there any legal protection for forests or land use systems which provide this service? Through what law?

• Is there a management plan for the resource providing the service?

• Do the actors have previous experience in ecosystem management?

• What is the size of the watershed where the scheme is implemented?

• What is the timeframe for the execution of the scheme?

b. Actors

• Name and type of sources of financial resources (percentage per source).

• Name and type of the institution collecting financial resources.

• Name and type of the institution managing financial resources.

• Name and type of the institution paying the providers.

• Socio-economic level of the providers.

• Socio-economic level of the users.

• Number of providers.

• Number of intermediate and end users.

c. Valuation, financing and costs

• Amount to be paid to service providers.

• Amount to be paid by users.

• Is there a differentiated payment for the water resource related to the socio-economic level of the users and the type of use?

• Does the scheme depend on foreign resources (e.g. international cooperation) to continue its present operations?

• Does the scheme foresee the possibility of financial self-sufficiency? In what timeframe?

• Was the service appraised before execution of the scheme? What appraisal mechanism was used? Estimated value of the service.

• Cost of preliminary and feasibility studies.

• Cost of current operations of the scheme (annual).

• Cost of the system s initial installation (in addition to feasibility studies).

• Was the opportunity cost of the scheme estimated before project execution? How?

• Amount of the initial funds allocated to design and implementation of the scheme.

• Did the project consider willingness to pay for the service before its execution? Estimated value.

d. Operation and design of the scheme

• Expected duration of the scheme under current operating conditions.

• Is the service identified clearly? What is it?

• Participation mechanism for local populations in the design of the scheme.

• Which social groups and national and international institutions have been involved in the design of the scheme?

• Does the scheme serve to promote diversification the means of production?

• What production activities are favoured by the scheme?

• Are land ownership titles of the providers clearly defined?

• Has the relationship between land use change and the service been estimated before project execution? What method was used?

• Is the scheme based on a cause-effect model between land use and the service?

• Is the scheme explicitly involved in the maintenance of other environmental services? Which ones?

• Does the scheme consider training activities for the actors involved? In which areas?

• Does the scheme include sensitization and dissemination for the users?

• Does the project identify external variables, which may significantly affect its performance? Which ones?

• What are the major internal sources of risk identified in the design of the scheme?

• What mechanisms does the scheme include to adapt to new situations?

• What is the intended land use change under the scheme?

• Does the scheme contemplate legal action in case of default by the service providers?

• Were informal - traditional - rules for water management considered in the design of the scheme? How?

e. Monitoring and follow-up

• Does the PES scheme include a mechanism for performance assessment and monitoring?

• Is there monitoring of biophysical variables? Which variables?

• Is there monitoring of socio-economic variables? Which variables?

• Was a baseline established for socio-economic variables?

• Was a baseline established for biophysical variables?

• Is there an external evaluator (auditor) for the project? Name and type of institution.

• What aspects does the auditor assess?

• Has the experience been documented and systematized? By whom, when?

Characterization of PES experiences

Various Latin American experiences with planning or execution of PES schemes in watersheds were presented in the Forum. Four of these experiences were systematized by using the criteria listed above as a working guideline. The results are presented in the CD-ROM included with this report.

General lessons

From the different experiences presented at the Forum, participants identified the following general lessons:

1. In Latin America, PES schemes in watersheds have been applied at very different scales and to attain various objectives, from the micro-watershed level - addressing a very specific service - and usually managed by an NGO, to national programmes controlled by the State.

Generally, PES systems in watersheds have been restricted to one of the two following purposes: a) to improve the availability and quality of water for human consumption, mainly in urban areas, and b) to improve the availability and quality of water used in hydroelectric generation. However, the payment mechanisms, the system structure and the scale of application show a high degree of variability due to the heterogeneous characteristics, both institutional and geographical, of the Latin American region. For instance, while in the JAPOE case in Honduras (Case study 2)^[2] providers are paid by means of tools and knowledge to improve the productive practices, in other regions of relatively high income - such as the PROCUENCAS case in Costa Rica - (Case study 1) up to US$735/ha/year are paid for reforestation. The latter figure differs from the US$12 paid to landowners for forest conservation in Pimampiro, Ecuador (Case study 3). On the other hand, the scale of the schemes varies considerably. For instance, while in the Achuapa case, Nicaragua, the PES scheme makes payments to 16 producers, Costa Rica has implemented a national programme for environmental service payments (FONAFIFO).

During the Forum, it was concluded that PES systems are more easily managed and more effective in attaining the objectives when they are restricted to small scales, e.g. micro-watersheds. This is because transaction and administration costs usually are lower at the local level; there is a better information flow among providers and users, the service can be defined more clearly and the institutions involved may have a greater adaptation capacity.

2. A few countries have specific legal frameworks for PES at the national or regional level, however, most schemes operate without a specific legal basis.

During the Forum, the importance of a specific legal framework for the operation of PES schemes was discussed. It was concluded that while a particular legal framework for PES schemes may contribute effectively to its regional or national promotion and to the design of strategic policies, this type of legislation is not essential for the good operation of PES schemes. In some cases, an excessively rigid or bureaucratic legal framework may be an obstacle for such a scheme by imposing ineffective prices (which do not match the actual supply and demand) or very high transaction costs due to cumbersome regulations.

3. As compared to other regions of the world, there are a significant number of examples for the application of PES schemes for water-related services in Latin America. However, these cases have not been inventoried comprehensively yet and there are few studies on the socio-economic and environmental impacts of these systems.

The Forum is one of the first initiatives which try to establish state-of-the-art in PES schemes in watersheds in the Latin American region. There is a need for additional efforts to systematize - and assess - PES experiences in Latin America. During the Forum two studies regarding the local impact of PES systems in watersheds were presented which were financed by the International Institute for Environment and Development (IIED). These studies revealed that impact assessments are a very useful tool to determine the effectiveness and efficiency of PES schemes as management mechanisms for water resources. Such assessments should be conducted systematically in all cases.

4. There are significant uncertainties regarding the cause-effect relationships between land use and the services due to the system complexity and the lack of information.

The cause-effect relationships between the land use and water availability and quality are difficult to assess and often uncertain due to the large number of variables and their complex relation. The high variability of geographical and climatic conditions in watersheds especially makes it difficult to attain generalizations about land use and its impact on water resources which are universally applicable. At present, most PES schemes in watershed management are based on assumptions about land use impacts on water resource that have not been verified in the particular case.

5. In some cases, service providers show interest in PES schemes as they may be an informal mechanism to establish property rights for land.

Generally, it is considered that the clear definition of titles is an essential requirement for the smooth operation of markets, including markets for environmental goods and services. In Latin America, land titles are usually not clearly defined in rural areas. Some PES cases show, however, that this is not an unsurmountable obstacle to establish compensations to the users providing the desired environmental services, at least temporarily, since this type of system can be considered as the beginning of a legal recognition process of their land use.

6. The role played by the State in PES schemes for water-related services in Latin America has varied significantly. While in some cases the State has been the major promoter and executor of this type of mechanisms, it has not played an important role in others.

The establishment of PES schemes in watersheds does not necessarily involve the active participation of the State as service provider, user, or manager of the scheme. One of the most distinguished advantages of these systems is that they can be applied in a flexible and decentralized manner among private agents reducing, for example, the bureaucratic transaction costs.

7. There are specific legal frameworks for PES in some countries of Latin America.

In Costa Rica, a legal framework for PES schemes has been developed and State participation has been essential to promote and implement this type of systems. Colombia is another example, where the electricity sector has made transfers (3 percent of sales) to the environmental authorities to finance watershed management projects.

8. In several cases, public institutions involved in the schemes are local rather than national in scope.

One of the main advantages of PES schemes is that they can operate properly at small scales and relatively low operating costs when there is sufficient information flow between providers and users of the service.

9. There is potential to replicate PES experiences presented at this Forum, but these need to be adapted to particular contexts.

Despite the high variability of watershed conditions in the Region, the Forum concluded that some successful experiences can be replicated in other locations considering the local conditions, especially the institutional framework and the biophysical characteristics of the area, as well as the cause-effect relationship between land use and the service.

Advantages and opportunities of PES schemes in watersheds

During the event, participants identified the following advantages and opportunities of PES schemes in watershed as the most remarkable:

1. PES schemes can serve as an instrument to educate the population about the value of the natural resources.

PES schemes set a price for environmental services, which were previously priceless. This causes users and providers to associate a market value to such services, which should lead to a more efficient use of the water resource, and recognition of the benefits of particular land uses which provide the required environmental service.

2. PES schemes can facilitate the solution of conflicts and the reaching of consensus among the actors involved.

PES systems can contribute to solving conflicts about the alternative uses of land and water resources by fostering the information flow between providers and users of the services and considering economic compensation mechanisms.

3. PES schemes can enhance efficiency in the allocation of natural, social and economic resources.

One of the basic assumptions underlying the schemes is that the use of market mechanisms increases the efficiency in resources allocation. As in other markets, efficiency can be increased if the required institutional conditions are in place, including a sufficient degree of competition, information availability and the lack of externalities, among others. The design of PES schemes should make certain that these conditions are met to ensure that market mechanisms have a positive effect on the efficient allocation of resources.

4. PES schemes can generate new sources of funding for the conservation, restoration and valuation of natural resources.

The appropriate implementation and execution of a PES scheme requires an important number of preliminary studies to establish relations between the land use and the water resources, and to estimate the economic value of the service. These studies may constitute a significant contribution to the knowledge of the ecosystems involved, as well as an important input for its conservation. On the other hand, ideally PES schemes should be self-financed. Therefore, they should constitute a local - and mostly private - financing source for the better use or protection of the natural resources.

5. PES schemes can create indicators for the relative importance of natural resources by means of the valuation of environmental services.

As previously stated, PES schemes can generate useful knowledge about human impacts on the condition of water resources in watersheds, as well as the economic importance of these impacts and other resources.

6. PES schemes allow the transfer of resources to socio-economically vulnerable sectors providing environmental services.

Generally, PES schemes are more suitable for increasing the efficiency of resource allocation than to deal with inequality problems in income allocation, since they are based on the use of market tools. However, these systems, if explicitly designed for this purpose, can contribute to poverty reduction. In many cases, upstream service providers belong to marginalized social groups. Therefore, a financial compensation might help to raise low incomes to a certain extent. In some cases, low compensation values to providers may imply considerable increases in incomes. In other cases, however, providers belong to rather high socio-economic layers and do not depend greatly on the environmental service payments to improve their income.

Difficulties and limitations of PES schemes in watersheds

From experiences described during the Forum, participants identified the following general limitations and difficulties of PES schemes developed in Latin America until now:

1. Some PES schemes are based on generalizations, which have not been verified by empirical studies about the relation between the land use and the water-related service.

This is one of the main limitations identified by the participants. Generally, watershed management has been undermined by generalizations or "myths", which usually are not based on sound and empirical facts. In some situations, the real impacts can be totally different from those expected on the basis of the generalization. Some of the most common "myths" are:

2. In some cases, PES schemes are not the most cost-effective method to attain the objectives of the project, since there may be other more efficient management mechanisms to guarantee delivery of the environmental service.

The appropriate design of a PES scheme requires an assessment of its cost-effectiveness relative to other mechanisms that can be used to attain the objectives. Market tools require certain social conditions in order to function appropriately. In the absence of these conditions, there might be more cost-effective alternative instruments to attain the goal. In highly unequal contexts in terms of power or income, for instance, market instruments usually are not capable of solving social conflicts. On the other hand, in many social groups water is considered as a right rather than as a market good. In these cases, it is not convenient to "internalize" the environmental externalities influencing water supply through a market price, since other mechanisms can be more effective and generate less local opposition, such as community management and territorial planning.

The high transaction costs involved in the preliminary study and implementation phases may cause PES scheme to be very expensive as compared with other management options. Transaction costs can be reduced if the institutions involved in the implementation of the scheme know the local situation comprehensively and if the scheme is part of a broader programme on natural resource management.

3. Providers, users and the service itself are not well identified.

The lack of a clear definition of the service for which the payment system has been established is a common problem in many schemes. This causes serious deficiencies in the system, since it reduces the users willingness to pay. Likewise, in some cases, not all relevant users or providers participate actively in the system, causing reluctance on the part of the users who do pay - they consider it is unfair to pay for the service while others benefit for free - and conflicts within providers, since those who do not participate feel excluded from the benefits granted for the services they are providing.

4. Some PES schemes have been executed without a monitoring or control mechanism.

The monitoring of biophysical and socio-economic variables is fundamental to determine the scheme s impact and its efficiency to attain the foreseen objectives. A monitoring system must be an integral part of all PES schemes.

5. In some cases, the cause-effect model and the cost of the service have been politically imposed and are not based on actual demand or economic valuation of the service.

Since they are based on market instruments, PES schemes must be based on the actual supply and demand for the services in question. If the system is politically imposed, there is a risk of being inefficient in allocating resources. Because of this, studies to quantify demand for the service and the economic value of the natural resource are a key input for the good design of the PES scheme.

6. In some cases, the design of the scheme has not been based on previous socio-economic or biophysical studies due to their relatively high cost. The design and implementation of a PES system may involve high transaction costs, sometimes due to the complicated design of the scheme.

In the design of the PES scheme, a compromise has to be found between soundness and feasibility depending on the availability of financial resources. However, it is very important that the PES scheme be based on local information about causal relations between land use and the service, as well as the economic value of the water resources. These variables must be assessed and taken into account if the scheme should contribute effectively to the improvement of the allocation of water-related services. In many cases, this prerequisite represents a serious limitation due to the high costs of the information and the restrictions in the budget allocated for preliminary studies and project design. In Latin America the information at the local scale is usually scarce. This implies that the installation of PES systems generally should involve an extended phase of basic information gathering on local conditions. Therefore, the proper design and implementation of PES systems in the region can be relatively expensive. International cooperation agencies can play an important role in the promotion of these systems by financing these initial phases, which involve high costs.

7. Some PES schemes in watersheds may have perverse incentives such as the promotion of the unsustainable exploitation of resources in areas not included in the scheme, or deforestation on the providers properties to increase the probabilities to benefit from the scheme.

Perverse incentives are an inherent risk to any market mechanism applied to attain environmental goals. In the case of PES schemes, such incentives may include the accelerated land clearing on part of the providers to benefit from higher payments offered under the scheme to restore deforested lands, as compared to conservation of existing forest. Perverse incentives can be avoided only by considering them in the scheme design and through a detailed assessment of the scheme s implementation. Monitoring systems must be capable of detecting "secondary" or "unintended" effects of the PES scheme.

8. Some PES schemes are highly dependent on external financial resources, threatening their long-term sustainability.

Self-financing should be a key objective of PES schemes. The design of the system must ensure maintenance of the scheme with local financial resources, i.e. the contribution by the users, after a previously determined period. International cooperation can play a very important role in the initial financing of these systems. However, many existing projects run the serious risk of not being able independent of external resources in the medium and long term. Once initial transaction costs have been covered for market establishment purposes, the local market forces should ensure the scheme s sustainability.

9. PES programmes and activities have been poorly disseminated among the local population.

The information flow among the various actors and the participation of local agents in decision-making processes is fundamental to ensure the local acceptance and the proper operation of PES schemes. It is especially important to disseminate the initiative and explain its advantages in improving water management among users, whose willingness to pay for the service determines the success of the scheme. The willingness to pay, i.e. the basis of PES systems, can be increased with the implementation of an effective programme of dissemination and environmental education.

Recommendations for the design and implementation of PES schemes in watersheds

The following proposals summarize the recommendations for actors involved in the design and implementation of PES schemes, based on the deliberations at the Forum. Many of these recommendations apply to more than one group of actors. However, they are mentioned only under a single category for the purpose of simplicity.

a. NGOs, international agencies for technical cooperation, multilateral organizations, academic centres

· Initial considerations for the design of PES schemes

a.1. The establishment of a PES scheme must start with the identification and quantification of the demand for the service.

a.2. It is necessary to establish a verified cause-effect model between the land use and the service. The PES scheme must be based on this model.

a.3. "Hydrographic response units", geographical units with uniform cover, slope and soils, can be used to establish cause-effect relations and identify priority areas for application of the scheme.

a.4. The successful design and execution of a PES scheme is facilitated if the initiative is included in a broader watershed management programme.

a.5. The payment mechanism must be flexible and adaptable to the local situation. Providers are usually compensated in cash but sometimes other payment mechanisms may be convenient.

a.6. Although the essential objective of PES systems does not aim to reduce poverty, the design of these mechanisms must not increase inequality and, if possible, benefit marginalized and poor sectors.

a.7. PES schemes must ensure the existence of a functional local institutional framework, which is required for the implementation of the payment scheme.

a.8. The local vision of water - as a good or a right - is one of the key aspects to be considered in feasibility studies. The cultural dimension of water is a basic element to be considered in drawing up PES systems.

a.9. PES systems must be designed in such a manner so as to operate independently of external financial resources after a previously determined period.

a.10. PES systems should ensure the delivery of the service in the long term.

a.11. The local acceptance of the scheme is enhanced if there is a training, sensitization and dissemination programme.

a.12. International cooperation agencies can play an important role in the design and implementation phases, as well as in providing projects with technical assistance. However, these institutions should not be involved in the long-term financing of the scheme.

a.13. It is important to consider long-term socio-economic and ecological repercussions of the productive activities to be promoted under the scheme. PES systems must be capable of adapting to dynamic situations through the years and avoid specialization and poverty traps.

a.14. PES schemes for water-related services should consider all types of land use in watersheds which can render these services: agriculture, forests, pastures, and infrastructures. The implementation of PES schemes in agricultural land-use systems must be explored in particular.

· Operation and monitoring

a.15. A monitoring system is essential for the good operation of a PES system. This system must include baseline studies as well as socio-economic and environmental impact studies of the scheme.

a.16. The monitoring system must clearly identify biophysical and socio-economic variables to be used in assessing the performance of the PES scheme.

a.17. The PES scheme must include a control system to assess whether providers and users are complying with the agreements, and an appropriate system to sanction noncompliance.

a.18. The system uncertainties must be identified and incorporated into the decision-making model through the participation of local agents.

· Research and exchange of information

a.19. Cases of PES schemes in watersheds in Latin America need to be documented and systematized, and studies must be developed to assess their socio-economic and environmental impact.

a.20. The exchange of experiences must be fostered at the national and international level, and inter-institutional agreements must be strengthened for the exchange of technical and managerial information concerning PES schemes.

a.21. More research on cause-effect relations between land use and the water-related services must be conducted.

· Economic valuation (see Boxes 1 and 2)

a.22. The valuation method must allow the identification of the marginal contribution of each type of activity to provide the service under the PES scheme.

a.23. The minimum area to be included under the scheme which is required to secure the intended impact or service must be identified.

a.24. The values for environmental services must not be standardized or extrapolated from other experiences. These values depend greatly on the context where the services are generated.

a.25. The valuation methodology must remain flexible to be adapted to the particular context where the PES scheme is to be implemented.

b. Local or national governments

b.1. An assessment must be conducted to determine if a PES scheme is the most cost-effective mechanism to attain the goal set as compared with other resource management strategies.

b.2. The lack of a specific legal framework for PES schemes is not an important obstacle to create a market for environmental services.

b.3. A specific law on PES schemes is not always necessary. Such a law may be useful, but it may also imply restrictions on the necessary flexibility of such schemes.

b.4. The role of the State will depend on the payment scheme to be used.

c. Potential users and providers of the service

c.1. Users, providers and the service must be defined very clearly.

c.2. PES schemes for water-related services are more likely to improve the resource management effectively if there is a direct relation between providers and users.

c.3. PES schemes must be initiated with the voluntary participation of the providers, thus emphasizing local participation.

c.4. The payment made by users should be voluntary. However, there are exceptions which might justify a compulsory payment (e.g., when a large number of users hinders the reaching of a consensus).

c.5. Land use rights must be defined clearly for the proper operation of a PES scheme, but under some circumstances it is not essential for providers and users to hold a formal land title.