Can payments for ecosystem services schemes mimic markets?

A Payments for Ecosystem Services (PES) scheme can be understood as a mechanism that performs the role of a ‘market’ for Ecosystem Services (ES) in circumstances where such a market would otherwise fail to develop. We investigate the potential for and limits of PES schemes to act in lieu of competitive markets and propose a PES scheme design that mimics markets. This is achieved by applying their underpinning concepts of demand and supply to the determination of ‘market clearing’ prices, while reducing transaction costs of buyer and supplier engagement through the involvement of agents. The proposed design combines economic valuation techniques to estimate ES demand with a novel tendering process that allows the estimation of individual marginal cost curves of potential ES suppliers. Supply actions and ES are linked through ‘conversion factors’ derived from bio-physical models that act as environmental production functions. Demand and supply so estimated enable the determination of a ‘market clearing’ price which, when offered to suppliers, provides static and dynamic incentives for cost-effective supply. Mutually beneficial exchange between buyers and suppliers, as is facilitated under the PES scheme design, improves resource use efficiency while allowing both the buyers and the suppliers to secure surpluses.