Designing Contracts for Reducing Emissions from Deforestation and Forest Degradation

Reduction of carbon emissions from
deforestation and forest degradation has been identified as
a cost effective element of the post-Kyoto strategy to
achieve long-term climate objectives. Its success depends
primarily on the design and implementation of a financial
mechanism that provides land-holders sufficient incentives
to participate in such scheme. This paper proposes
self-enforcing contracts (relational contracts) as a
potential solution for the constraints in formal contract
enforcement derived from the stylized facts of the
implementation because relational contracting relies upon
mutual private self-enforcement in a repeated transaction
framework. The paper derives an opportunity cost function
for land use and characterizes the optimal self-enforcing
contract as well as provide the parameters under which
private enforcement is sustainable. The optimal payment
scheme suggests that all payments should be made contingent
on the carbon offsets delivered, that is, at the end of the
contracting period. Thus, the optimal contract does not
observe any ex ante payment. Self-enforcement is more
difficult to sustain the higher the opportunity cost of
forest conservation is relative to the value of the carbon
offsets from the contract. Necessary extensions to the
relational contracting model are also discussed.