Daowei Zhang Alumni and George W. Peake Jr. Professor Auburn University, Alabama

1. The Shadow Price of Environmental Services from U.S. ForestsorValuing ecosystem services from productive forests in the U.S. (and elsewhere): A Supply-side Approach Daowei Zhang Alumni and George W. Peake Jr. Professor Auburn University, Alabama zhangd1@auburn.edu

2. Outline • Purpose/Motivations • Methods • Assumptions/Arguments • Linkage between timber market and the market for environmental services: Supporting evidences • Computation/Calculations • Results • Discussion

3. Purpose • To quantify the marginal value of environmental services from productive forests in the U.S. (arguably, from all U.S. forests) • in a simplistic and economic fashion • in aggregation • In the long-run (although the marginal value is an annual estimate) • for informed debate • for tradeoff (decision-making)

4. Notes • Environmental services =Ecosystem services • My definition is slightly different fromUN 2004 Millennium Ecosystem Assessment • Forests produce timber and else (environmental services) • Productive forests=Timberland=forest land can produce >1.43 m3/ha/year, not being restricted from timber production (harvesting)

5. Reserved forests=no timber production/ forests are too valuable for something else (i.e., ecosystem services) • Other forests= mostly are not recoverable economically for timber

6. Motivations (1) • High (wild?) estimates of ecosystem service values • Costanza, R., R. d’Arge, R. de Groot, S. Farber, M. Grasso, B. Hannon, K. Limburg, S. Naeem, R.V. O’Neill, J. Paruelo, et.al. 1997. The value of the world’s ecosystem services and natural capital. Nature 387:253-260 • The value of ecosystem services from 17 global ecosystems = 2 times of global GDP • Problems?

7. Motivations (2) • Costanza et al. (1997)raised awareness • But • Can we pay more than we make? • God forbidden…. • Demand side only (but can not be used to do tradeoff) • Area under the whole demand curve? • Methods questioned (being called “reckless”)

8. Motivations (3) • Economic methods • Contingent valuation • Travel cost • Hedonic pricing • Replacement cost (cost avoided) • Most of them are demand-side/used for specific service (design/double counting?) • None can be used to estimate the aggregate value of all the environmental services from all forests in a country, not from the supply-side

9. Motivations (4) • What is the amount of environmental values, in aggregation, that a country (the U.S.) sacrifices by harvesting the amount of timber it produces annually? • How is the tradeoff between timber production and environmental service is made, explicitly or perhaps more inexplicitly, in economic term?

10. Methods Assumptions/Arguments Supporting evidences Calculations Results

11. Two Primary Forest Goods • Timber • Environmental services • Water/air quality + climate mitigation • Biodiversity/habitat • Recreation • Spiritual/cultural • Non-timber forest products (hunting, fruits, mushroom)

12. Argument 1: Timber & Environmental Service Are Competing Uses • Timer and environmental services are competing uses, at least in a large scale • Some of these environmental services are complementary to timber production, and therefore need not to be compensated (not to be “studied”?) in economic sense • In other cases, simply produce one of them (either…. or….)

13. Theory on multiple/combinations of Uses • See pages 175-182 in Zhang and Pearse. 2011. Forest Economics. UBC Press

14. A Cubic metres of timberper year T Competing uses 0 R Recreation days per year T B T C Mutually exclusive uses Highly conflicting uses 0 0 R R D E F Constantly substitutable uses T T T Complementary uses Independent uses 0 0 0 R R R Figure 6.4: Types of production possibilities for two products on a tract of land

15. Resource allocation (1) • For mutually exclusive, highly conflicting and, in most case, constant substitutable uses (Figure 6.4B, 6.4C, 6.4F): Always produce one of these uses • Some forests, because the environmental services they produce are so significant, need to be reserved/protected, and only used for producing these service • For example, Yellowstone, Yosemite…

16. Resource allocation (2) • For independent and complementary uses (Figure 6.4E, 6.4F): Always produce both • Some environmental services produced by private landowners need not to be compensated (Onecan value them, but compensation is not necessary, not efficient, and not fair)

17. Resource allocation (3) • For competing use (timber and ecosystem services): the allocation of resource depends on the relative value/price • But most environmental services are not priced • There is little incentive to supply them • Yet, a growing population and rising personal income increase the demand for these services (environmental Kuznets curve?)

18. Argument 2: With One Exception, The Market For Environmental Services Largely Works • The imbalance of supply and demand suggests a need of government intervention • When this imbalance grow over time, government: • Land set-aside (e.g., Yellowstone…) • Regulations (forest practice law/cap and trade): try to limit the negative externality Reduce land base for timber production/raise its price • Tax adjustment/subsidy/contract/payment

19. A Political Market For Environmental Services • Supplier---politicians • Demanders---the public • Is the political market for environmental services effective and efficient? • Can it meets the demand of the public for these services? • Can it restrict the negative externality in a efficient way? • YES, NO, Maybe. What is the better alternative other than this political market?

20. Summary for my first 2 arguments • Efficient allocation of competing uses is based on the relative value/price • Even though most environmental services are not priced, and their supply mostly depend political process, their demand/supply is affected by the development of timber side of the forest sector • Human demand for environmental services influencethe supply/price of timber • Through market and mostly politics, society decides how much forests are used to produce timber and environmental services, either exclusively or jointly

21. Argument 3: There Is A Tradeoff • These environmental services be valued from the supply-side • Tradeoff is made at the margin • Thus, the focus of this paper is “marginal benefits”, not total benefit

22. P • P • DES • DT • PES • PT • QTimberland OA • OB

23. Argument 4: These Environmental Services Can Valued In Aggregation and At The Margin • Can these environmental services be valued in aggregation? • Yes/no/maybe, yes if we want to study about the tradeoff at the margin and from the supply side

24. I Argue They Can Be Aggregated • All are produced from forests; vary with forest age + structure • Often not priced • Demand: increase with income • Supply: • A lot of public good in nature (non-exclusiveness + non-rivalry) • Some aspect of private good, which is taken care of in the market • There is nothing wrong to think them as one, theoretically

25. If so, we have a joint production problem with 2 goods Environmental Services A - B is the shadow price of environmental services X Y Price ratio Timber B A

26. Dynamics In The Forest Sector In The Long-run And Large Scale • Timber/Environmental services • Joint production of timber and environmental services from forests in a country • Estimating Shadow price of environmental services • Let us think about timber only at first

27. Faustmann Formula: Timber Only • Price P(t) is a function of time • land expectation value of a typical old-growth forest • long-term balance relationship • Adding an afforestation cost (or reforestation cost, C) will only modify the RHS term slightly

28. Timber Production In The U.S. • European settlement: • timber was harvested for building materials and fuel wood • land was cleared for pasture and agriculture • As timber inventory declines, timber becomes increasingly scarce and prices increase • Price rise is not limitless as • shifts in extensive margin • forest protection • plantation forests • Technology change in manufacturing • Substitution

30. Now Adding Environmental Services • Demand is increasing, but most are not priced • Likely (undersupply) in a market economy • Government steps in periodically to reflect society’s desire • Governmental means • Public ownership –land set-aside; less timber harvesting • Regulations of private forestry – BMPs • Subsidy – Conservation Reserve Program • Tax --- lower tax for timber income/reforestation tax credits • Private means • Private demand (thus supply through private means) increases along with income • All government + private means change the price and volume…

31. Family Forest Ownership ObjectivesUnited States, 2006 U.S. Forest Service, National Woodland Owner Survey

32. Family Forest Ownership ObjectivesUnited States, 2006 U.S. Forest Service, National Woodland Owner Survey

33. Faustmann Formula: timber+ Environmental services • F(t) is the value of environmental services flowing from a standing forest at age t • land expectation value of a typical old-growth forest • long-term balance relationship • Adding an afforestation cost (or reforestation cost, C) will only modify the RHS term slightly

34. The Marginal Value Of Environmental Services The above equation can be re-arranged as • Forests are capital goods • This is a long-run relationship • What about net imports? (U.S. net imports of forest products=10-12% of its consumption)

36. U.S. Forest Service, National Woodland Owner Survey

37. Softwood And Hardwood Growing Stock Volume, Net Growth And Growth Rate, 1977 To 2002

38. Alabama Stumpage Prices For Sawtimber And Pulpwood $/mbf, Scribner

39. Average Stumpage Prices For Selected Sawtimber Species Sold From National Forests

40. Average Stumpage Prices For Selected Sawtimber Species Sold From Private Lands In Louisiana

41. Average Stumpage Prices For Pulpwood Of Louisiana And Northern New Hampshire

42. The Weighted Average Rate Of Annual Change in Stumpage Priceis 0.88% (in real terms) In The U.S. South From 1956 to 2005

43. Prime and 10-year T-bill Interest Rates

44. From 1956 to 2005 The Average Annual (Real) Rate Of 10-year U.S. T-bill = 3.59% The Real Rate Of Return in the Stock Market (S&P 500) = 7.39%

45. So, We found Growth rate = 2.8 Price change 1956-2005= 0.88 Interest rate =11.48-4.09=7.39 Assuming average rotation age =40-50 year The RHS of equation 4 is 7.39

46. Long term (im)balance Equation 4 Left-hand-side=2.8%+0.88%=3.68% Right-hand-side=7.39% 7.39% - 4.68%=3.71% • This 3.71% represents the disparity (margin) between managing the forests for timber and environmental services, and managing the forests for timber alone

47. Shadow price of environmental services • margin = 3.71% • average stumpage price in Alabama in 2005 = $1.03/ft3 • U.S. forest growing stock in 2005 = 856 billion ft3 $33.25 billon of environmental services (Forest Sector’s contribution to US GDP = 1.0% or $121 billion in 2005)

48. Discussion (1) • Is this a valid method? • Based on marginal analysis from the supply-side • Consistent with economic theory (tradeoff) • Using a stand-level model to the whole forest sector in a country? • Results does not fluctuate much in the long-run, but it does not work in the short-run (r and P fluctuate too much) or a small region (Q fluctuate too much) • What interest rate to use? • The MBES may become negative! • Cannot assume all timber growth is for the value of timber! There is an environmental service component in it

49. Discussion (2) • Does society/political + economic markets behave efficiently? • In the long-run, maybe • Can we aggregate all environmental services? • What about the total value of environmental services in other forests (not timberland)? • If the method is valid, I plan to ….

50. Summary • Purpose/Motivations • Methods • Assumptions: 1 good (timber) / 1 service ( all environmental services in aggregation) • The political market for environmental services influence the timber market /production and vise versa (there is a tradeoff) • Dynamic Faustmann formula • Results • Discussion