Permanent and Temporary Policy Incentives for Conservation under Stochastic Returns from Competing Land Uses

Rapid conversion of private land for agricultural and urban use has raised concern worldwide over the loss of ecological services. To inform conservation policy, we model privately optimal land use decisions using a real options framework that assumes both the ecological and commercial values of land are stochastic and that land conversion is irreversible. We analyze permanent and temporary land conservation policy incentives using this dynamic framework to guide policy makers interested in designing efficient payment mechanisms to achieve ecological preservation goals. We find that while the financial cost of temporary policy incentives is generally much lower than permanent policy incentives, this difference is very small in scenarios with high discount rates and lower uncertainties in conversion returns and lower expected trend in conservation returns. Alternately, the financial cost of temporary conservation is substantially lower than that of permanent conservation when the expected trend in conservation returns and uncertainties in conservation and conversion returns is high and the discount rate is low. Comparison with net present value and single-source uncertainty models indicates that the presence of a second uncertainty increases the option value of delaying conversion, and shows that permanent and temporary policy incentives based on either of the two simpler models can be seriously misguided if multiple uncertainties are present. We illustrate the analytical results with a case study of tropical deforestation in Indonesia where private landowners can either conserve forests and earn carbon credits, or convert to palm oil agriculture and earn profits from the sale of palm oil.