Performance Payments for Environmental Services: Lessons from Economic Theory on the Strength of Incentives in the Presence of Performance Risk and Performance Measurement Distortion
Institute for Environmental Decisions (IED) Working Paper 7, ETH Zurich
22 Pages Posted: 9 Aug 2009
Date Written: June 1, 2009
Payments for environmental services (PES) schemes have become an increasingly accepted and popular mode for governmental and non-governmental agencies to use in addressing local and regional declines in ecosystem services. A defining characteristic of performance payments, a sub-category of PES schemes, is the linking of individual payments to environmental outputs themselves rather than to the inputs that affect the production of environmental services. Such a focus raises several practical issues during implementation. We review and translate key aspects of the economic theory of incentives into the context of performance payments schemes with special attention paid to two practical issues. The first is that of structuring individual incentives to account for risks outside the individual’s control such as weather that can affect the level of environmental services generated. The second deals with the possibility of distortion in the measurements of environmental services used to determine individual payments under PES schemes. Each challenge is accompanied by a discussion of advice based upon economic theory and a discussion of examples from different countries where such implementation issues arise.
Keywords: optimal incentive contracts, payments for environmental services, performance incentives, distortion
JEL Classification: Q2
Suggested Citation: Suggested Citation