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Financing forest plantations in Latin America: Government incentives

K. Keipi

Kari Keipi is Senior Forester, Inter-American Development Bank.

An analysis of the desirability and role of government incentives for plantation forestry, in Latin America.

The largest urea of forest plantations in Latin America is found in Brazil. Pictured is a stand of eucalyptus

The will to sustain the world's forests and to manage them for future generations is based on appreciation of the growing demands on their goods and services. The worldwide projections by FAO indicate that, in the period between the present day and the year 2010, the total land area under crops will increase to 850 million ha, with most expansion being in Latin America and sub-Saharan Africa.

During the same period, about 85 million ha of forests are expected to be cleared for agriculture in the world (FAO, 1993). Between 1990 and 2010, consumption of wood products is expected to continue growing, with rates ranging from 1.2 percent per annum for fuelwood and charcoal to 3 percent per annum for paper and 4.3 percent per annum for panel products. There will also be growth in demand for non-wood forest products essential for rural societies, including medicinal plants; for recreation based on forests and wildlife; and for the protective roles of forests. Forest gene pools will remain of crucial importance. These trends are indicative of the pressures which forests can be expected to meet. It will be necessary to protect and manage existing forests and create additional forest resources to meet growing demand (UN, 1995).

Latin America and the Caribbean have about one-quarter of the world's existing forests. Forests cover about 970 million ha, of which 115 million ha are in Central America, Mexico and the Caribbean subregion and 855 million ha in South America. The approximately 52 million ha of temperate forests are situated in Argentina, Chile and Uruguay and in high-elevation areas of the region's tropical countries (WRI, 1994).

The rate of deforestation is high in the region: some 7.5 million ha (0.77 percent) of forest disappear yearly. The highest deforestation rate is observed in Central America and Mexico: 1.6 percent per year. It is more than the deforestation rate in continental Southeast Asia, which has the second highest regional rate in the world (1.5 percent) (WRI, 1994). The annual biomass losses resulting from deforestation amount to about 1303 million tonnes, which corresponds to 40 percent of total losses in developing countries of 2671 million tonnes (FAO, 1995)

According to the World Resources Institute (WRI, 1994) plantations cover about 8.6 million ha in tropical Latin America and the Caribbean. The temperate zone of the region has about 2.5 million ha of plantations. Thus, the extent of planted areas of 11. 1 million ha corresponds to only 1.1 percent of the area of natural forests. While most of the fuelwood, non-wood products and environmental benefits come from natural forests, more than half of the industrial timber is produced in plantations.

The largest plantations are in Brazil, with approximately 7 million ha including 4.1 million ha of industrially utilizable planted forests. Chile has 1.6 million ha of reforested area, practically all for industrial purposes, Argentina 0.7 million ha, Venezuela 0.5 million ha, Cuba 0.4 million ha and Peru 0.3 million ha. Colombia, Mexico and Uruguay have about 0.2 million ha each. In each of the other countries of Latin America and the Caribbean region the reforested area is less than 100000 ha. The estimates of the current yearly reforestation rate vary from 460000 to 520000 ha (Haltia, 1995; WRI, 1994).

Practically all the plantations have been established on abandoned agricultural lands that are often in a process of erosion. Only in exceptional cases has prime agricultural soil been used for tree plantations. This has been the case lately in Chile where industrial plantations are highly profitable and encouraged by a system of incentives.

Although the majority of existing plantations are industrial in nature, agroforestry and social forestry are widely practiced in the region. These plantations have yielded important benefits to local communities and improved environmental conditions. For example, in the case of the Inter-American Development Bank (IDB), about half of the targeted 774600 ha of plantations financed in the past 15 years have been financed for community forestry through 33 loan projects (Keipi, 1995). The primarily industrial plantations have been executed through only three large programmes.

The rationale behind government incentives for establishing forest plantations

Prevailing reasons for incentives

Another view of Brazilian plantation forestry: Aromo australiano, a relatively newly introduced species

Most Latin American countries today provide incentives for private investment in forestry. The following reasons for subsidies have been given (Beattie, 1995; McGaughey and Gregersen, 1988; Southgate, 1995):

· modifying the social bias against forestry investments among farmers who have traditionally considered forests as an obstacle to agricultural development;

· increasing the rates of return on investments that may have a relatively low private profitability but offer externality benefits for society as a whole;

· reducing risk and uncertainty that arise particularly from the long time period of reforestation investments;

· reducing cash flow problems during the often long periods required to recover planting and operational costs through harvest income;

· establishing a critical mass of plantations needed for the initial building of competitive forest industries; or

· accelerating ("jump starting") the initial development of plantations either for industrial or social forestry purposes.

Traditional "development" arguments for subsidies have included import substitution or the creation of exportable production. However, the validity of this rationale depends on the competitive advantage of the forest sector with respect to forest production in other countries or relative to activities in other sectors in the corresponding country. On the other hand, a social justification for plantation subsidies on the basis of employment generation and reduction of rural poverty can be made, although this raises obvious questions about the labour intensity of plantations versus alternative investments in rural areas. Therefore, an analysis has to be carried out on the effectiveness of forest investments compared with other sectors.

Sometimes an argument has been presented to consider forest incentives as a self-financing investment in the sense that the income generated over time may greatly exceed the subsidy and, if that income is taxed, the government may at least partly recover its contribution. In the case of Chile, the subsidies have been reported to be profitable to the state (Beattie, 1995).

The issue of incentives and government subsidies is highly controversial. Vaughan (1995) quotes two different views. The "old" conventional wisdom is reflected in the study of McGaughey and Gregersen (1988):

"Debate over the various arguments about subsidies for forestry investments is not as critical as the recognition that subsidization is already widely accepted and practiced by Latin American governments. Subsidies have become a politically legitimate and accepted tool for promoting investment in forestry and forest industries."

The "new" conventional wisdom not advocate subsidies as corrective measures to offset distortions existing elsewhere in the economy; rather it proposes the direct elimination of those distortions. Stewart and Gibson (1995) make a strong case, recommending: i) the removal of forest products export bans and tariff and non-tariff barriers to international trade of all products; ii) the elimination of export subsidies; iii) the removal of all forest product consumption taxes other than the general sales tax. They argue that once these reforms are in place, direct incentives for forestry are not necessary; therefore, subsidy programmes for afforestation and forest management should be eliminated.

Conditions for the success of plantation programmes with or without incentives

The role of the public and private sector has experienced major changes in Latin America during recent years. Many countries such as Brazil and Uruguay have eliminated or reduced subsides for forestry as part of general policy The key is to identify conditions in which tree plantations may prosper. Constantino £1995) cites studies carried out in Child that-mention the following elements for success: i) political and macroeconomic stability; ii) trade liberalization and open - foreign investment; iii) clearly established property rights for land with and without trees, iv) credible government with adequate institutional capacity to enforce laws and administer possible incentive schemes; and v) good natural growing conditions; availability of proper technologies, and basic infrastructure (roads, electricity, ports, etc;) to support investment decisions.

A pine plantation in Honduras

In the cases of Brazil and Chile, the availability of adequate incentives for the establishment of forest plantations was a minor factor contributing to forest industry growth, once a critical initial mass of plantations was established (Beattie, 1995). For example, Wunder (1994) claims that subsidies had only a secondary impact in promoting plantations in Chile. More important factors have been a comparative advantage and a favourable general economic environment. Today, many Chilean forest companies choose not to access incentives in order to avoid major government controls related to long-term tying of the land to forestry and restrictions on the management and harvesting of the plantations. It is therefore no surprise that Brazil has discontinued many of the incentives and that widespread criticism is mounting against their continued use in Chile in favour of large landowners and companies. Consideration is being given instead to their reorientation towards small farmers.

Yet, in other countries, new subsidies are being proposed. For example, in Colombia and Ecuador, the Chilean case has been taken as a model, although the justification for the use of incentives may be different. In Colombia the rationale has been largely environmental. In Ecuador the traditional arguments of getting the wood products sector off the ground, generating jobs and increasing forest product exports prevail. However, a lack of competitive advantage may limit the effectiveness of the government investment incentive programme in that country (Southgate, 1995).

Eucalyptus in arid Mexico

When choosing possible government support targets, the sectors with clear potential comparative advantages in the country and internationally should be strengthened. However, subsidies may not be necessary if the activity is already financially attractive or if other policy measures are more effective in promoting the activity other than financial incentives.

Criteria for selection of incentives

The owner of a forest plantation can expect economic returns from future sales of timber, fruits, latex and other marketable products. The projected financial profitability, the risks involved and the availability of financing are the most important factors affecting the investment decision. The decision is also influenced by the returns on the land under alternative uses. In Latin America, the predominant alternative use is extensive cattle ranching. Lack of liquidity during the long gestation period for forest plantations is one of the major disadvantages.

General economic justification for incentives

Based on the financial analysis of forestation investment for the landowner, three basic cases can be identified with regard to the justification of incentives. First, incentives are not justified if forestry yields higher private net present values than alternative unsubsidized land uses. If the investment opportunity provided by tree planting under these conditions is not realized, the reason may be in capital market imperfections or in macroeconomic factors. These factors can be eliminated by reforms different from incentives (Stewart and Gibson, 1995).

Second, incentives are not justified if the net present values of forest investments including externalities are lower than returns obtained from alternative land uses. This may be due to the fact that externalities of forestry are positive but small (compared with private losses) or are negative.

Finally, the case for incentives arises when the private net returns are lower but the returns including externalities are greater than the returns from alternative land uses. Here incentives could be effective in the sense that they may alter the land-use pattern towards a direction considered more socially desirable. The formulation of incentives should be guided by such principles as efficiency (Hueth, 1995) and cost-effectiveness.

Definition and types of incentives

Given that incentives have been found justified in economics terms, the question still remains as to their type and definition. Gregersen (1984) defines incentives in the following manner:

"Incentive mechanisms can be defined as public subsidies given in various forms to the private sector to encourage socially desirable actions by private entities."

Social desirability may be a vague concept. It normally incorporates some income generating goals for low-income groups and environmental benefits. The argument is that society generally benefits more from private tree planting than does the private entity undertaking it (McGaughey and Gregersen, 1988). These benefits are externalities the landowner making the decision to plant. In general, the issue is not the existence of the externalities but their measurement and magnitude.

Gregersen and Houghtaling (1978) classify incentives as direct and indirect. The direct incentives include cost sharing (in kind or money), subsidized credit, fiscal incentives, reduction of uncertainty through loan guarantees, insurance, forest protection agreements, provision of land tenure security, etc. The authors classify as indirect incentives market information, extension and education, research, etc.

Hueth (1995) reports on research by Kaimowitz in 1994 according to which direct subsidies for forestry investments in 18 watershed management projects in Central America included input financing, food for work, wage payments, directed credit and special prizes for competition. However? Kaimowitz did not find any studies on the effectiveness of the alternative forms of incentives.

Fiscal subsidies have been widely criticized since they may ignore the fundamental purpose of the incentive, which should be afforestation and the productive and environmental benefits that it produces. They are often established with inadequate technical considerations (poor species and site selection, etc.). The recipient of a tax incentive is often more interested in the short-term tax relief than future benefits from the trees once they are mature. Therefore, they are often an inefficient incentive to plant trees. Moreover, they are used by large industrial landowners, who may not need the incentive, while small landholders are not informed of them and often do not pay income or property taxes in order to benefit from them (Levingston, 1983; Ugalde and Gregersen, 1987).

Subsidized credit is not a proper incentive mechanism since it leads to decapitalization of the financial institution giving the loan. Directed credit may be difficult to administer. Loan guarantees and government-supported insurance for plantations are hard to establish in practice. Hueth (1995) criticizes using food for work as a subsidy.

Owing to the failure of other mechanisms, the most common direct incentive is government cofinancing of inputs, such as plants, and the provision of extension. The indirect incentives of research and access to market information as permanent structures of the communities may also be good ways for governments to support private forestation efforts (McGaughey and Gregersen, 1988; Southgate, 1995).

Argentina is using an auction procedure to lower the costs of forestation incentives to the government. This procedure may work well with big and medium-sized landowners but may be more difficult to implement with small farmers with fewer skills to prepare forestation bids. Hueth (1995) proposes a similar procedure for a wider use in watershed management programmes.

According to the conclusions of a workshop organized by the IDB, financial incentives should be targeted and temporary. "Targeted" means that producers should only be offered enough money to cover their marginal cost adoption. This may be implemented through an auction system. Temporary means that subsidies should be paid on a one-time basis to prevent any relationship of dependency between the beneficiary and the government (IDB, 1995).

Public participation

Keipi and Laarman (1995) cite &ray and Jenkins (1982) on requirements for policy evaluation that may be applied to the analysis of incentive policies. Political preconditions stipulate that the incentive mechanisms must have the support of high government officials; this is obtained especially when forestation produces important national benefits. Organizational preconditions indicate that a policy should be administered efficiently both at the national and local level and must be incorporated in the decision-making cycles and budgeting.

Cultural and social factors need to be taken into account when considering the appropriateness of a grant financing approach (McGaughey and Gregersen, 1988). The policies on incentive mechanisms should be subject to consultations with the relevant groups. This is gradually becoming a standard principle in Latin America after democracies became prevalent in the 1980s. Among the international donor agencies, for example, the IDB subjected its forest policy to consultation (IDB, 1992). It also has a policy on information disclosure which requires, for example, the environmental impact study results of IDB financed investment projects to be made available for public scrutiny in the respective countries.

The general objective for forestry is to manage existing resources and to establish new forests so that the different local, national and global requirements from forest uses may be met both now and in the future. The task is to establish favourable conditions for private investments to take place (Mayers, 1995). This is not an easy task. It calls for strategies on different levels. It requires that incentive mechanisms be flexible. Therefore, it may not be advisable to incorporate them in forest laws but through decrees, or administrative and budgetary measures that can be adapted to changing situations and also directed locally if necessary.

The criteria of having incentives targeted and temporary discussed earlier also indicates the necessity for flexible mechanisms. Developing countries may provide incentives to plantation investments that provide important benefits on local and national levels. They are not necessarily ready to provide them for forestation with primarily global benefits. For the latter, the international community should provide the appropriate grant financing.

Conclusions on government provision of incentives for forest plantations

The roles of public and private sectors have experienced major changes in Latin America during recent years. In addition to the progress in democracy, the countries have reevaluated the responsibilities of the public sector, which is assuming an increasingly normative role. Private investments are preferred and government subsidies are not considered to be the primary tool in the process of obtaining economic development through privatization. Incentives should not be a dead language and rhetoric, as has often been the case in the Latin American legislation in the past. Instead they should be real and effective, directed to the indicated purpose (McGaughey and Gregersen, 1988).

The major vehicles to obtain significant levels of tree plantation investment are probably the macroeconomic, political and institutional reforms whose major goal is to create a thriving private sector without the support of subsidies. At the same time, there is an increasing environmental awareness in the region. Forestry investments bring potentially important social benefits to rural areas with high poverty rates. Forestation programmes may bring important ecological and social externalities.

The justification for incentives has to be made through applied economic analyses based on beneficial externalities (IDB, 1995). In addition to improving the general economic environment of a country for private investments, the indirect incentives support to research, training, extension and possibly providing market information - may be the areas where the governments can make cost-effective contributions to promote forestation programmed in the private sector.

If direct financial incentives are used also they should be cost-effective. They should be targeted: producers should be offered enough money to cover their marginal cost of adoption. This may be gained through auctioning at least part of possible incentives. Rent-seeking behavior should be minimized and the maximum number of hectares should be forested within the available budgets (Hueth, 1995). Targeting may or may not include low-income groups. The effectiveness of forestation programmes in reducing rural poverty should be evaluated relative to other sustainable development programmed (Vaughan, 1995)

Some countries with comparative advantages in forestation may use incentives as a policy tool to accelerate the rate of establishment of plantations. However, it is not clear whether governments can control the pressures to extend the use of subsidies also to other sectors without such advantages. Chile, with the most successful incentive scheme in Latin America, is having difficulties in discontinuing the subsidy programme even though plantation investment has already received the desired initial impulse which set off massive forestation in the country (Beattie, 1995; Constantino, 1995).

Possible government participation in financing forestation in private lands should be based on assessed market and non-market benefits (IDB, 1995). Cost recovery mechanisms must be contemplated if such a participation is established. These mechanisms would ideally be indirect, on the basis of taxes and fees to the government. Direct recovery through benefit-sharing mechanisms (timber harvest, etc.) may not be feasible because of the long gestation periods of forestation investments. The changing public sector administrations and regulations may pose a risk to private investors and diminish their willingness to establish long-term investment partnerships with the government.


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