Section 2: Incentives: key concepts, typology and rationale

While there is no dearth of definitions for incentives, a single agreed definition does not exist (Meijerink 1997). Defined in very broad terms, an incentive is anything that motivates or stimulates people to act (Giger 1996; cited in FAO 1999). Sargent (1994; cited in Tomforde 1995) defines incentives as signals that motivate action. Other definitions refer to the “incitement and inducement of action” (Enters 2001). Within the context of development projects, incentives have also been described as “bribes” and “sweeteners” (Smith 1998).

To be of interest and to have an impact, incentives need to affect the cost-benefit structure of economic activities such as plantation management. Hence, in the context of the regional study, incentives can be defined as policy instruments that increase the comparative advantage of forest plantations and thus stimulate investments in plantation establishment and management.

This definition is broader than the more narrow definition for subsidies. The latter are of a purely pecuniary nature and usually viewed as payments provided to reduce the costs of or raise the returns on an activity. The broader definition includes research and extension, which are important elements in supporting plantation development.

The definition also includes sectoral and macro-economic policies which, as will be argued in the concluding chapter, establish much of the general investment climate and heavily influence the economic behaviour of individuals and corporations. Consequently, the spectrum of incentives is considerably broadened and a distinction is made between direct and indirect incentives (Figure 5).

Direct incentives are designed to influence returns to investment directly

The distinction between direct and indirect incentives is somewhat blurred. Direct incentives are designed to have an immediate impact on resource users and influence returns to investment directly. Indirect incentives on the other hand have an indirect effect through setting or changing the overall framework conditions within and outside the forestry sector. There are some overlaps. For example, tax concessions for plantation investors are a direct incentive, whereas general tax reductions for fuel are considered indirect incentives, because they lower production and transport costs within - as well as outside - the plantation sector.

Figure 5: Typology of incentives

Direct incentives are provided directly by governments, development agencies, non-governmental organizations and the private sector. Direct incentives include the following:

• goods and materials (e.g. seedlings, fertilizers etc.);

• specific provision of local infrastructure;

• grants;

• tax relief or concessions;

• differential fees and access to resources;

• subsidized loans; and

• cost-sharing arrangements and price guarantees.

Indirect incentives can be divided into variable incentives and enabling incentives (Table 1). Variable incentives are economic factors that affect the net returns that producers earn from plantation activities. Enabling incentives on the other hand mediate an investor’s potential response to variable incentives and help to determine land use and management (FAO 1999). They can also be viewed as elements in the investment environment that affect decision making.

A country’s enabling incentives determine to a considerable extent investment risks, and information about them needs to be constantly updated to guide investors.

Table 1: Distinguishing variable from enabling incentives

In the Asia-Pacific region, virtually all of the incentives in Table 1 have been or are currently used somewhere to stimulate tree growing. There has been a gradual evolution in the way that governments in the region have provided encouragement, with increasing recognition that provision of enabling incentives, the removal of structural impediments and market distortions or the creation of an “overarching climate of enterprise” is the most effective (and economically efficient) incentive in the long run. This shift in thinking has also unfolded in Latin America with a move from subsidies as corrective measures to the removal of impediments (Haltia and Keipi 1997).

Justification for providing incentives

Why are incentives necessary, or more specifically, what is the rationale for providing incentives to potential investors in forest plantation development? Why should taxpayers be interested in supporting the economic activities of others? Why should the private sector provide support to small-scale growers? If potential investors are dissatisfied with the low returns on their investments in plantations, would it not be more appropriate to suggest they invest in a more profitable land use?

Meijerink (1997) argued that incentives should only be applied for public goods. From an economist’s perspective, incentives are meant to correct discrepancies between the financial attractiveness and the broader benefits to society (FAO 1999). Gregersen (1984; cited in Pardo 1990) pointed out that incentives from the public to the private sector are justified in an economic sense when one or both of the following conditions exist:

• Social benefits are greater than private benefits associated with a given private action; and

• Social costs are less than private costs associated with the given action and social benefits are at least equal to private benefits.

Incentives are not needed when the private returns from plantation management exceed those from other land uses

Where plantations provide environmental services such as watershed protection and carbon sequestration, incentives are appropriate because private net returns are often lower than social benefits. Real world incentives that fall into this category include those offered under the:

• Soil Bank Program, Agricultural Conservation Program and the Conservation Reserve Program in the United States of America;

• “Grain for Green Project” and the Great West Development Program in China;

• Landcare deductions for capital expenditures on soil conservation, prevention of land degradation and related measures in Australia;

• The Green Isarn Project in Thailand; and

• Benefit-sharing arrangements under joint forest management in India.

In each of these cases, incentives bridge the divergence between public and private goals and support activities that are primarily in the public interest.

Incentives are not needed when the private returns from plantation management exceed those from other land uses (Haltia and Keipi 1997; Williams 2001). In this case, the provision of incentives translates into a misallocation of public sector resources, merely enabling investors to earn “above normal” returns.

While addressing environmental concerns is an important justification, others include the goal of generating employment (particularly in less developed rural areas), and to jump-start the development of national forest industries in countries with comparative advantages such as Indonesia and Chile (Williams 2001). Incentives may be particularly justified to increase the pace of plantation development where a developing industry requires a minimum supply of raw material (Scherr and Current 1999). A rapid increase in scale is especially critical in commodity industries like pulp and paper, where economies of scale are essential for competitive operation (Clapp 1995).

The downside of incentives

The use of incentives, especially direct incentives, to induce particular behaviour, has been at the centre of intense, and sometimes fierce, debates. Incentives, particularly subsidies^[4], are not without their critics who contend that incentives can lead to economically incorrect allocation of productive factors.

Programmes pressured to show progress frequently offer incentives to people “to win friends and influence people by resorting to handouts under the guise of incentives” (Smith 1994, p. 8). This should not come as a surprise considering that a briefing note for project desk officers, consultants and on-site project staff defined incentives in the following way (GTZ 1995):

Incentives are understood to be project measures geared to motivating the local population to use their natural resources on a sustainable basis.

Attractive incentives run the inherent risk of simply “buying” participation

Attractive incentives offered in the early stages of a new initiative or project run the inherent risk of simply “buying” participation; the interest shown is not of a long-term nature and participation is just a pretense. Especially in natural resource management projects, subsidies have often succeeded in stimulating the adoption of conservation measures that were abandoned or even actively destroyed once payments ceased (Lutz et al. 1994). The same has been observed for plantations (Sawyer 1993). It should be obvious that particularly with regard to commercial activities, incentives should act as a catalyst and should not be the cause for change. If an incentive is the primary cause for behavioural change, the discontinuation of that incentive is likely to become a cause for reversal.

Related to the issue of triggering activities for the wrong reason, sometimes people defer activities they would normally initiate without assistance until they have been given an anticipated incentive. In the worst-case scenario, the provision of incentives might have unintended, perverse side effects. For example, incentives for plantation development may contribute to unplanned conversion of natural forests. A lack of financial support for the management of plantations coupled with incentives limited to plantation establishment may lead to intensive planting activity without any real expansion of the total plantation area in the long run. Young plantations are simply destroyed and the land replanted to capture the financial support.

As Tiffen (1996, p. 168) has pointed out, “even poor people can find capital for what is really profitable....” Hence, low levels of investments in plantations, especially by small-scale farmers, may not be caused by a lack of capital but rather by insufficient information about suitable technologies, market opportunities and legislation, particularly related to environmental issues and taxation. The risk is that the reasons for inaction may not be properly understood and that financial incentives, provided in lieu of advice, are wasted. Technology transfer and extension programmes are the appropriate medicine for lack of knowledge.

Crowding out of investment

The “crowding-out effect” occurs when government spending directly substitutes for private sector expenditure that would otherwise have occurred. Thus, a degree of crowding out occurs when incentives are provided to plantation growers who would have planted trees without them - or when a higher rate of incentive is paid than would have been necessary to induce a grower to plant trees. Thus, crowding out is a theoretical measure of the overall efficiency of an incentive. In practice, of course, crowding out is impossible to measure, except in very broad terms.

Among most of the case study countries, very little work has been done to measure the relative efficiency of incentives. In Indonesia, it can be observed that during the 1990s, subsidies encouraged around 900 000 hectares of planting under joint venture arrangements, while independent private companies planted 700 000 hectares during the same period, receiving no such subsidies. The significant planting carried out by private companies that were ineligible for subsidies suggests an element of crowding out was likely present. It also shows that subsidies were not absolutely necessary to encourage the establishment of short-rotation plantations.

Zhang (2004, see full report) reports several studies examining crowding-out effects in the United States of America:

Among the existing landowner behaviour studies, Boyd (1984) and Boyd and Hyde (1989) find that landowners who would have invested on their land anyway would use public funding instead. Bliss and Martin (1990) report that cost-sharing does not change the level of management practiced by active forest managers, and Cohen (1983) concludes that the substitution effect of public for private funding in tree planting on non-industrial private forestlands is between 30 to 50 percent, while Zhang and Flick (2001) find a smaller (17 percent) impact. On the other hand, both de Steiguer (1984) and Lee et al. (1992) find no evidence of such substitution effect on plantation investment on non-industrial private lands.