Forest Policy and Economics 5 (2003) 39–56

Extending the boundaries of forest economics Shashi Kant* Faculty of Forestry, University of Toronto, 33 Willcocks Street, Toronto, Ont., Canada M5S 3B3 Received 25 June 2001; received in revised form 1 March 2002; accepted 5 April 2002

Abstract The existing forest economic models, rooted in sustained yield timber management systems and neo-classical economic framework, are subject to many limitations. Social, economic, and ecological features of sustainable forest management (SFM) are different than that of sustained yield timber management. Hence, the economics of SFM will be based on different economic principles. The two main requirements of the economics of SFM are the economics of multiple equilibria, and a consumer choice theory that incorporates heterogeneity of agents, context specific and dynamics of preferences, distinction between needs and wants, and the subordination of needs. These requirements will need the extension of the boundaries of forest economics. Five basic principles—principles of ‘both–and’, ‘existence’, ‘relativity’, ‘uncertainty’, and ‘complementarity’ will work as a foundation, and the economic principles, developed by evolutionary, institutional, ecological economists and economists from other new streams of economics, will be the useful tools to extend these boundaries. 䊚 2002 Elsevier Science B.V. All rights reserved. Keywords: Ecological economics; Evolutionary economics; Institutional economics; Heterogeneous agents; Multiple equilibria; Sustainable forest management

1. Introduction The complexities of economic problems associated with forest management have troubled economists since the beginning of the nineteenth century. The conclusions of many great economists, such as Boulding, Fisher, Goundry, Hotelling, Kaldor, von Thunen, and Wicksell, on forest rotation are questionable (Samuelson, 1976). The correct solution of optimal forest rotation is based on the maximization of forest value (or soil expectation value) that was first calculated correctly by Faustmann (1849). Even though Faustmann did not calculate the necessary conditions for optimal forest rotation, he was aware of the usefulness of *Tel.: q1-416-978-6196; fax: q1-416-978-3834. E-mail address: [email protected] (S. Kant).

his forest value formula for the assessment of the most advantageous silvicultural system and forest rotation (Faustmann, 1849). Ohlin (1921) provided the mathematical conditions for optimal forest rotation, and their economic interpretation. Later, Gaffney (1960) and Pearse (1967) analyzed the necessary conditions for optimal forest rotation using marginal (neo-classical) techniques, and concluded these to be identical with the conditions obtained from Faustmann’s formulation. In the last three decades, modified economic rotation formulations, that incorporated uncertainty of factors and prices, market imperfections, and multiple values, have dominated forest economics literature; and these models can be termed as single-stand and single-criterion models. Multi-stand and multi-criteria models and valuation of ecological and envi-

1389-9341/03/$ - see front matter 䊚 2002 Elsevier Science B.V. All rights reserved. PII: S 1 3 8 9 - 9 3 4 1 Ž 0 2 . 0 0 0 4 5 - X

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ronmental goods and services have been other main features of forest economics during this period. All these dominant features of forest economics, in general, have followed neo-classical economic thought,1 characterized by the utility (or profit) maximizing rational (Homo-economicus) agent and the ‘invisible hand’ leading to an efficient general equilibrium. In this framework, people’s preferences are static, society is a mathematical aggregation of homogeneous rational agents, public inputs are through market signals, and there is no role for any institution other than the market. Forest economic models based on the neoclassical framework are subject to serious limitations. The emergence of a new forest management paradigm in the last two decades has further amplified these limitations (Toman et al., 1996). The new forest management paradigm has transformed forest management from timber management to forest ecosystem management, from sustained timber yield management to sustainable forest management (SFM), and from forest management by exclusion to management by inclusion of user groups, and is commonly known as SFM. The limitations of forest economic models have resulted in the severance of links between these models and social perceptions and practices of forest management.2 1 Neo-classical economic thought refers to the rejuvenation of the classical economics of Smith, Malthus, and Ricardo by marginalists, such as Jevon, Menger, and Walras, and to the theoretical framework developed by Marshall and Samuelson (Dugger, 1977). Hamilton (1970), suggests that neo-classical economics is based on a Newtonian conception, while some economists are uncomfortable with the term ‘neo-classical’ (Dahlman, 1980, p. 219). 2 There is evidence that even the simplest financial analysis models are not applied in forest management (Hyde, 1980; Repetto, 1988). Many studies, such as Kearney et al. (1999), Dennis (1998) and Karppinen (1998), have demonstrated the diversity and evolution of stakeholder perspectives on appropriate forest management against the fundamental assumption of the same and stable preferences used in the models of forest economics. Similarly, ‘Volvo effect’ discussed by Johansson and Lofgren (1985), will not lead to a general (competitive) equilibrium, a basic premise of the neo-classical economics. Nautiyal (1996), realised this gap between theory and practices, and observed that people have lost faith in professionals simply because professionals seem to have lost touch with reality and cannot see the forest for the trees.

The gap between theoretical models and practices has roots in mainstream economics itself. Many economists have observed multi-dimensional limitations of the neo-classical paradigm resulting in low ‘evidence theory ratio’ (Holmstrom and Tirole, 1989, p. 126). However, the economics profession, as a whole, has been re-examining and challenging almost every basis of the neo-classical thought to reduce this gap. For example, experimental economists, such as Camerer (1997), Rabin (1998) and Camerer and Thaler (1995), have been working to get a clear picture of decision making by ‘Homo-sapiens’ as against ‘Homo-economicus’ agents. Many economists have proposed alternative economic frameworks that overcome some of the limitations of the neo-classical paradigm and incorporate some features of behavioral patterns of ‘Homo-sapiens’ observed by experimental economists. Evolutionary economics has challenged the concepts of maximization in an uncertain environment and a single competitive equilibrium; institutional economics has incorporated institutions in economic analysis; many branches of economics, such as ecological economics, socio-economics and post-Keynesian economics, have challenged the concept of mono-utility, static preferences, and a maximizing rational agent. Game-theoretic models have been developed to understand and explain co-operative, non-cooperative and strategic behaviors of people in diverse settings, and agent-based models have incorporated heterogeneous agents, changing preferences, and non-maximizing behaviors in economic models. However, no significant attempt has been made in the field of forest economics to incorporate the concepts and principles emerging from these new economic thoughts. Thus, it is now the turn of forest economists to respond to new challenges of forest management by extending the boundaries of forest economics beyond neo-classical economics. This paper has two main objectives: (i) to demonstrate basic limitations of the models, dominant in forest economics, and usefulness of emerging economic thoughts to overcome these limitations; and (ii) to establish the relevance of emerging economic thoughts to the economics of SFM, and to provide some basic principles for the economics of SFM.

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Because the literature on forest economics is enormous, we have focused on dominant themes including: single-stand and single-criterion forest rotation models; multi-stand and multi-criteria models; some forest policy discussions; and nonmarket valuation techniques. Although, an overview of the literature on forest economics and on emerging economic thoughts is necessary, our aim here is to provide the context and not to review the literature in great detail. The main underlying motivation behind this paper is to expose professionals and students of forest economics to emerging economic thoughts and their relevance to the economics of SFM. We are not proposing any new economic model for SFM but are suggesting some basic principles that may be used as a foundation to built economic models of SFM. The paper is divided in eight sections. First, an overview of single-stand and single-criterion forest rotation models, and their limitations are discussed. Second, multi-stand and multi-criteria models are examined, and the relevance of evolutionary economics to these models is established. Third, forest policy discussions and their linkages with institutional economics are discussed. Fourth, issues related to non-market valuation and related features of ecological economics and some other emerging economic thoughts are highlighted. Fifth, the evolution of forest management is summarized. Sixth, linkages between the main features of SFM and emerging economic thoughts are established. Seventh, some basic principles for the economics of SFM are proposed. Finally, we conclude with an argument to extend the boundaries of forest economics. 2. Single-stand and single-criterion forest rotation models Faustmann’s optimal rotation formula is for a single stand and single criterion. Many economists, such as Samuelson (1976), Anderson (1976) and Reed (1984), have confirmed the correctness of this formula. However, this confirmation is conditional on explicit and implicit assumptions of the model. Lofgren (1995), identified four explicit assumptions of the model belonging to two main

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categories—deterministic nature (of timber prices, timber yields, and interest rates) and perfect markets (of capital and forestland). In the last 20 years many scholars3 have extended Faustmann’s insight to more complex settings (Brazee, 2001). The assumptions related to the nature of the elements of the model such as, the stochastic nature of prices and costs (Brazee et al., 1999; Fina et al., 2001), interest rates (Ollikainen, 1990), timber yield (Buongiorno, 2001), and a generalised model that incorporated uncertainty in all factors (Chang, 1998) have been the focus of these works. Some economists have addressed the assumption of perfect markets in forestland markets (Sandhu, 1991) and capital markets (Ollikainen, 1996; Abildtrup et al., 1997)4. The incorporation of non-timber values in a singlecriterion (maximization of net present value) framework has been the other dimension of these modifications (Hartman, 1976; Calish et al., 1978)5. These modifications have focused on stochastic elements and addressed these by maximizing the expected value of bare land, expected profits, or expected utility. However, maximization is only meaningful in a certainty environment (Tintner, 1941; Alchian, 1950). In a stochastic (either risky or uncertain) environment, each action that may be chosen is identified with a probability distribution of potential outcomes, not with a unique outcome. Each possible action has a probability distribution of potential outcomes, of which only one will materialise, and that one outcome cannot (Tintner, 1941). The use of the mean or expected 3 Newman (2001), notes that through 1999, 278 identifiable works on the optimal rotation problem have been published (85% of these have been published since 1979), and provides a review of these papers. 4 Some economists, such as Montgomery and Adams (1995), used a two-period utility maximizing framework to incorporate people’s consumption preferences in forest rotation models. Other economists, such as Koskela and Ollikainen (1997), have used expected utility model to analyze the impact of stochastic elements. 5 We have cited only one or two references from each category. An extensive literature review is available in Newman (1988) and Newman (2001), and special issues of the Journal of Forest Economics 6(3), 2000, Forest Science 47(4), 2001, and Forest Policy and Economics 2(2001).

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value completely begs the question of stochasticity by disregarding the variance of a distribution, while a certainty equivalent assumes the answer (Alchian, 1950). Hence, in a stochastic environment, the task is converted into making a decision whose potential outcome—distribution—is preferable, that is, choosing the action with the optimum distribution, since there is no such thing as a maximizing distribution (Alchian, 1950). Therefore, while these modifications may have increased the understanding of forest economists, their outcomes are questionable. The solution to stochastic problems lies in evolutionary economics discussed in Section 3. Similarly, models, that incorporated non-timber values in a single criterion, are subject to many theoretical limitations. A key assumption of these models is that non-timber values can be regenerated with forest growth; there are no absolute irreversibilities (Toman et al., 1996). The addition, rather than inclusion, of both private and public goods and services in a single objective function is questionable. These two different types of economic goods are not additive; if they were there would have been no need to develop two separate economic theories for private and public goods. This addition also results in changes in harvest and non-harvest values and the costs of harvest can have ambiguous effects on the rotation, in contrast to Faustmann’s solution (Toman et al., 1996). The inclusion of non-timber values can introduce non-concavities into the maximization problem that will give rise to multiple local maxima and discontinuous responses to changes in economic conditions (Swallow et al., 1990; Toman et al., 1996). The inclusion of religious, spiritual, and Aboriginal forest values into a single utility function is also questionable. These problems are also addressed by evolutionary economics (Section 3), ecological economics, socio-economics, and post-Keynesian economics (Section 5). In addition to these limitations, there are at least three implicit assumptions concealed within the market-driven neo-classical paradigm that have not been explicitly discussed in the literature. First, forest (timber) production is independent (insen-

sitive) of resource regime arrangements6 or the transaction cost is assumed to be zero. Second, the values of all goods and services available from forests are additive, and natural capital and manmade capital are perfect substitutes. Third, the rate of time preference is exogenous and is equal to the real rate of interest. These assumptions further deepen the limitations of the optimal economic rotation models. The implications of these assumptions are discussed in the following sub-sections. 2.1. Resource-regime independence of forest production Coase (1960), argued that the traditional concept of factors of production, usually thought of as a physical entity (a unit of land or labour), is a faulty concept, and a right to perform certain physical actions is also a factor of production.7 Nautiyal and Williams (1990), recognised the limitation of the Faustmann model in terms of a single factor (time) and included management intensity as another factor of production. But Faustmann’s model and its modifications have ignored the ‘right to perform’ (resource regime arrangements) as one of the factors of production which makes forest production independent of resource regime arrangements. Results of these models, therefore, are valid only for a given resource regime or a resource regime is not a decision variable in this formulation. Hence, the solution of Faustmann’s model can provide only a local optimum, not a global optimum. Kant (1996) and Kant (2000), argued that the forest production process is complete only when 6 A resource regime is a structure of rights and duties characterizing the relationship of individuals or decision units to one another with respect to resource (Bromley, 1991). Rights and duties do not have only two situations—either no right or full right. There are situations of partial rights and partial duties. Hence, resource regime arrangements vary continuously from open-access to private resource regimes (Kant, 2000). 7 Please refer to ‘The Problem of Social Cost’ by Coase (1960), for the full exposition of the ‘right to perform certain physical actions’ as one of the factors of production. The incorporation of the ‘right to perform’, as one of the factors of production in forest management decisions, is available in Kant (2000) and Kant and Berry (2001).

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the produced physical output is available to the legal right holder. Hence, the forest production process comprises a transformation process (conversion of physical inputs into physical outputs) and a transaction process (making the physical output available in full or in part to the legal right holder). The transformation process depends mainly upon conventional physical inputs—land, labour, and man-made capital—while the transaction process depends upon the resource regime arrangements (right to perform) and socio-economic characteristics of user groups. In the case of forest resources, these two processes are inseparable. Hence, Faustmann’s formulation captures only part of the production process—the transformation process. In the simplest specification of the total production process, based on time and the right to perform (resource regime arrangements) as factors of production, simultaneous satisfaction of two marginal conditions—the marginal condition with respect to time and the marginal condition with respect to resource regime8—will be necessary for optimal rotation. Therefore, even in a certainty environment, optimal rotation will, normally, be different from Faustmann’s outcome. Costs associated with the transformation process are called transformation costs (conventional costs of land, labour, and capital) and costs associated with the transaction process are transaction costs (costs of designing, implementing, and monitoring resource regime arrangements). Faustmann’s formulation is valid only for zero transaction costs, which is a common feature of neo-classical production models but not of the real world.9 The 8 Resource regime is a continuous variable ranging from open access to private regime, and as such the marginal condition of the resource regime will require marginal cost equal to marginal benefit due to incremental change in resource regime. Detailed discussion of all the issues in this section is available in Kant (1996, 2000) and Kant and Berry (2001). 9 Some forest economists argue that the Faustmann model includes provision for all costs including transaction costs. This argument is similar to the argument of neo-classical economists that transaction costs can be included in conventional production models but none of them included or even realized before strong arguments of Coase and others. In the Faustmann’s modifications, which include transaction cost, ‘right to perform’ is not an input factor, and transaction cost is not a function of resource regime. Hence, transaction cost is treated in a narrow sense.

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transaction function and transaction costs depend on the socio-economic conditions of the user group that have spatial and temporal variations. Hence, the optimal rotation and optimal resource regime arrangement will, likewise, have spatial diversity and will evolve with temporal variations in the socio-economic factors of user groups (Kant, 2000). Therefore, analysis of the complete production process will require an economic framework that is compatible with multiple equilibria, a framework based on evolutionary economics (Section 3) and institutional economics (Section 4). 2.2. Addition and substitution of forest values Multiple-use models include timber and nontimber products and services in their objective functions, and use either an aggregate price for all non-timber products and services, or assign some arbitrary prices for non-timber goods. Many services from forests, such as aesthetic, symbolic, and spiritual, are public goods, and it is problematic to put a market price on a public good. In addition, many non-timber forest products, which have properties of private goods are critical for local forestdependent community subsistence but are never traded in the market (Kant et al., 1996; Kant, 1997) and therefore, cannot be assigned a market price. In the last three decades, resource and environmental economists have developed valuation methods for non-market goods and services. They have grouped values as use and non-use values, and have suggested some valuation methods (discussed in Section 5) for these two categories. A major problem in assessment of non-use values is the bias toward values more amenable to monetary estimation, such as commodity-based values of forests. Ecological, aesthetic, and spiritual values do not easily lend themselves to economic measurements. Hence, valuation by these non-market techniques is always subjective, contrary to the basic objectivity premise of neo-classical economics. In addition, an aggregation of private and public goods is problematic. Conversion of all values into a single currency facilitates analysis but at the cost of realistic outcomes. The addition of diverse values through common currency means

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that one value, for example, spiritual value, can be substituted by another value, for example, timber value. However, different values are different, and if they were substitutable, what is the need of having different values. In addition, this notion also implies that man-made capital and natural capital are perfect substitutes. Costanza and Daly (1992), point out that: (i) man-made capital is derived from natural capital; and (ii) if both capitals are perfect substitutes, why develop manmade capital. Alternatively, man-made capital and natural capital are complementary and not substitutes. Similarly, many forest values such as spiritual, aesthetic, and symbolic are complementary and not substitutes to consumptive or monetary values. Hence, an economic framework, in which all forest values are treated as additive, is unable to capture the reality. The solution lies in a different consumer choice framework provided by the emerging fields of ecological economics, socioeconomics, and post-Keynesian economics (Section 5). 2.3. Exogenous rate of time preference Generally, in the neo-classical framework, the rate of time preference is assumed to be exogenous to an individual’s decision-making, and equal to the real rate of interest determined by the market and not by the decision maker. However, the observations of many economists and empirical evidence do not support this idea. Bohm-Bawerk (1891, p. 257), observed that impatience would manifest in extremely different degrees in different individuals and even in the same individual at different times. Similar elements of the endogenous nature of the rate of time preference are observed in the writings of Jevons (1931). More recently, Ciriacy-Wantrup (1963), observed that due to imperfections in the physical asset, labour, and capital markets, the planning agents of flow resources, such as forests, take their own timepreference rates, rather than market interest rates for resource conservation decisions. Becker and Mulligan (1997), also observed the endogenous nature of the rate of time preference. The economic theory of a rational and consistent choice also suggests the same rate of time preference across

situations, as well as for different time horizons; otherwise it would result in dynamic inconsistency. However, Thaler (1981), and Loewenstein and Thaler (1989), have demonstrated that the rate of time preference depends on the magnitude and the sign of award and on the time horizon. In the context of forest resources, Kant (1999), argued that: (i) an individual may have different rates of time preference for different objects of hisyher utility bundle; (ii) the rate of time preference for an object will depend upon the role of the object in the economic and other necessities of the individual; and (iii) the influence of the individual’s personal factors on the rate of time preference will be object and context specific. In the context of multiple-use resources, the use of market rate of interest as a discount rate for non-financial values is an invalid perception of modelling experts (Price, 2000). In addition, the argument of nonsubstitutability of natural capital by man-made capital jeopardises the common practice of equating the rate of time preference to the real rate of interest. In support of the Faustmann model it can be argued that it does not assume that the real rate of interest is the best or the only option. However, the recognition of the endogenous nature of time preference and its variability with time horizon and across situations will result in multiple equilibria, contrary to the single competitive equilibrium of neo-classical economics. Evolutionary economics addresses these challenges and is discussed in the following section. 3. Multiple-stands and multi-criteria models and evolutionary economics The single-stand model of Hartman (1976), has been extended to multiple stands by Bowes and Krutilla (1989), but their amenity production function is not explicitly spatial. Swallow and Wear (1993), and Wear and Swallow (1993), developed a more explicit spatial framework but their focus is on single-stand rather than forest-level analysis. Hof and Joyce (1992), incorporated spatial configuration of land allocations to determine a statically optimal configuration. The single-stand single-criterion model has also been extended by the incorporation of multiple criteria. The most common

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approaches in multi-criteria decision making (MCDM) are goal programming (Field et al., 1980), fuzzy multi-criteria models (Bare and Mendoza, 1992), and interactive multi-criteria models (Liu and Davis, 1995). In the case of forest management, different tools of operations research, such as linear programming (Weintraub et al., 1994), mixed integer programming (Hof et al., 1994), dynamic programming (Gong, 1992), goal programming (Mendoza, 1987), multiple objective linear programming (Gong, 1992), and the analytical hierarchy process (Kangas, 1993) have been used to address multiple-criteria decision problems.10 However, the solution provided by MCDM models need not to be ‘true’ optimum outcome (Diaz-Balteiro and Romero, 1997). The determination of real optimum would entail the assessment of a multiple-attribute utility function involving all the relevant criteria, and this task is full of conceptual and operational difficulties (Rehman and Romeo, 1993). Diaz-Balteiro and Romero (1997), used multiple-goal programming and compromise programming to avoid the difficulties associated with the assessment of multipleattribute utility models, but encountered many problems with regard to the single optimum outcome. The models of multiple (interrelated) stands (forest-level analysis) are approached through dynamic programming, and their analysis is hindered by the complicated dynamics, such as nonconcavities, of the system leading to the possibility of multiple steady states. Similarly, in multiplecriteria models, the number of extreme efficient points can easily surpass a thousand points, which leads to the uselessness of such solutions to decision makers (Diaz-Balteiro and Romero, 1997). In addition, the ‘user first—technology second’ approach is not used and these systems still remain strongly technology driven (Angehrn, 1991). While, these mathematical models do provide some useful outputs they are not supported by theoretical forest economic foundations. In the neo-classical paradigm, there is no theoretical 10 An extensive review of the literature on applications of MCDM to forestry problems is available in Tarp and Helles (1995).

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foundation for more than one efficient point, the selection of one optimal point out of many efficient points, or the movement from one efficient point to another efficient point. Alchian (1950), provided the foundation for evolutionary economics. He proposed an approach which embodies the principles of biological evolution and natural selection to select a posteriori the most appropriate action according to the principle of ‘realised positive profits’. Alchian argued that in an uncertain environment a firm’s behavior is characterized by adaptive, imitative, and trialand-error features in the pursuit of ‘positive profits’, rather than the individualistic rational pursuit of ‘maximized profits’. These arguments have been further developed by Winter (1964), Farrell (1970), Dunn (1971), Winter (1971), and Nelson and Winter (1973, 1982). According to Nelson and Winter’s (1982), evolutionary theory of economic change, firms are motivated by profit and engage in a search of ways to improve their profits, but their actions are not for profit maximization. Firms are modelled as having certain capabilities and decision rules; all regular and predictable behavioral patterns of firms are called ‘routines’. These ‘routines’ play the same role that genes play in biological evolutionary theory. Over time, these capabilities and rules are modified, and the economic analogue of biological natural selection operates which tends to winnow out unprofitable firms. In the neo-classical framework, the available techniques are a constant, and decision rules are the consequence of maximization, in evolutionary theory, they are simply a reflection of the historically given ‘routines’ governing the action of a firm. Hence, in evolutionary economics, history plays a critical role while rational agents of the neo-classical paradigm do not have any memory of their past. Similarly, there is no hypothetical single equilibrium in which all the unprofitable firms are no longer in the industry and profitable ones are at their optimum size, but there may be multiple equilibria. Another source of the economics of multiple equilibria is found in the economic theory of increasing returns. Conventional economic theory is built on a strong assumption of diminishing returns, negative feedback, and a predictable equi-

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librium for prices and market shares. However, in many real life situations, positive feedback magnifies the effects of small economic shifts and moves them away from any single equilibrium. This possibility was noticed by Marshal as early as 1890, when he noted that if a firm’s production costs fall as its market share increases, a firm that simply by good fortune gained a high proportion of the market early on would be able to beat its rivals. Similarly, economists such as Gunnar K. Myrdal and Nicholas Kaldor, in the 1940s and 1950s, observed mechanisms of positive-feedback in some sectors that did not involve technology (Arthur, 1994, p. 4). In the 1980s and 1990s, Arthur gave a new impetus to the economics of increasing returns. Arthur (1994, p. 3), argues that the parts of the economy that are knowledge-based are largely subject to increasing returns. Economic models of increasing returns differ from conventional neo-classical models in at least four ways: (i) multiple equilibria—a number of solutions are possible and the outcome is indeterminate; (ii) possible inefficiencies—it is not guaranteed that the particular outcome selected from among the many alternatives will be the ‘best’; (iii) lock-in— once reached, a solution is difficult to exit from; and (iv) path dependence—the consequence of small events and chance circumstances can determine solutions that, once they prevail, lead one to a particular path (Arthur, 1988). This theory of increasing returns has many common elements, such as absence of profit maximization, relevance of history in decision making, and multiple equilibria, with evolutionary economics. 4. Forest policy analysis and institutional economics Forest policy is a complex balance between economic, social, and political objectives in an environment where the forests and the institutions continuously change. Hence, a wide variety of policy models exist across various forestry jurisdictions, and policy discussions include a wide range of topics, such as timber supply, timber sale and pricing, forest taxation, international trade, forest management standards, carbon sequestration, tropical deforestation, forest ownership, property

rights, and policy reforms. While it is not possible to review this literature to a full extent, in general, this literature is either based on neo-classical economic tools, or on institutional economics. Neoclassical economic tools have been used to analyze the issues related to timber supply (Kuuluvainen, 1990; Koskela and Ollikainen, 1999), timber pricing and sale (Baldwin, 1997; Paarsch, 1997), forest taxation (Koskela, 1989; Koskela and Ollikainen, 1997), international trade of forest products (Zhu et al., 2001), forest certification (Swallow and Sedjo, 2000; Koskela and Ollikainen, 2001), carbon sequestration (Parks and Hardie, 1995; Huang and Kronard, 2001), deforestation (Angelsen, 1999; Sandler, 1993), and policy reforms (Grebner and Amacher, 2000; Zhang et al., 2000). The other aspect of the policy literature is ‘institutions’, and one of the emerging consensuses among economists is that ‘institutions matter’ even in a capitalist economy. The concept of institutional economics goes back to Veblen (1875–1929). The publication of Institutional Economics (Commons, 1934) marked the formation of institutional economics as a distinct school of thought. The main features of this school, which is now termed as Old Institutional Economics (OIE), are the holistic and interdependent nature of processes within the whole social system and absence of equilibrium (Myrdal, 1978). ‘New Institutional Economics’ (NIE), a term coined by Oliver Williamson to distinguish it from OIE (Coase, 1998) comes from both OIE and neo-classical economics. In essence, the NIE is concerned with property rights (Alchian, 1961; Alchian and Demstez, 1973), transaction costs (Williamson, 1979, 1985; Coase, 1937, 1960), and increasing returns and market imperfections (North, 1994). The first two aspects—property rights and transaction costs—do not depart far from the neo-classical framework. Forest economists have used these two concepts, property rights and transaction costs, to analyze various policy issues such as forest tenures and their impacts (Zhang, 1996; Zhang and Pearse, 1997), global deforestation (Mendelsohn, 1994), silvicultural contracting (Wang and van Kooten, 1999), and changes in forest regimes (Zhang, ¨ and Bisang, 2001). 2001; Kissling-Naf

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North (1994), recently included increasing returns and market imperfections, as a source of institutional change, in NIE. North (1994), acknowledges the presence of multiple equilibria when he argues that all four of Arthur’s selfreinforcing mechanisms of technological change, namely, initial setup costs, learning effects, coordination effects, and adaptive expectations, apply to institutional changes. Similarly, when Coase (1998) stated, ‘the costs of exchange depend on the institutions of a country: its legal system, its political system, its social system, its educational system, its culture and so on’, he acknowledges, at least indirectly, the presence of multiple equilibria. However, forest economists have yet to explicitly incorporate these aspects into forest policy analysis. 5. Non-market economics

valuation

and

ecological

As discussed in Section 2.2, non-market valuation of ecological goods and services has attracted a major attention from forest economists in the last 30 years. Economists have suggested direct techniques—stated preference analysis techniques (contingent valuation)—and indirect techniques— revealed preference analysis techniques (travel cost method and hedonic pricing) for valuation. The travel cost method, which was originally conceptualised by Hotelling, is in its current operational and popular form due to Clawson (1959) and Knetsch (1964). In the 1980s, two important variants of the basic travel cost model—varyingparameter travel cost model (Maddala, 1983) and hedonic travel cost model (Brown and Mendelsohn, 1984) were developed to analyze quality changes. These methods have been used mainly for the valuation of recreation sites. A hedonic price model was first used by Griliches (1971), and it was further developed and refined by Rosen (1974). Ciriacy-Wantrup (1947), suggested the use of direct interviews (contingent valuation) to measure non-traditional values of natural resources. Davis (1963), first used this method to estimate the benefits of outdoor recreation. In the 1980s and 1990s, it has been used extensively to determine values of a wide range of non-conven-

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tional forest values, including ecological and environmental goods and services. Cummings et al. (1986), and Mitchell and Carson (1989), provide a detailed discussion on theoretical and applied aspects of contingent valuation. Recently, choice modelling has been used to value ecological and environmental services (Adamowicz et al., 1998; Rolfe et al., 2000).11 However, the theoretical validity of non-market valuations depends directly on the validity of the neo-classical axioms of consumer choice theory.12 But, these axioms do not confirm the accepted models of human behavior, and have been challenged by ecological economists (Georgescu-Rogen, 1971; Gowdy and Mayumi, 2001), socio-economists (Etzioni, 1988), post-Keynesian economists (Lavoie, 1993), humanistic economists (Lutz and Lux, 1979), and economists working with agent-based models (Epstein, 1999). Neo-classical consumer choice theory assumes the invariance of preferences, non-satiation, a smooth and continuous utility function (ruling out lexicographic preferences), no distinction between needs and wants, and reducibility of all wants into money. But, in reality, choices are reference (time, place, and immediate past experiences) dependent (Tversky and Kahneman, 1991; Knetsch, 1992; Hanemann, 1994; Bateman et al., 1997; Bohnet and Frey, 1999), there is satiation with almost every good and service, except perhaps with money (Gowdy and Mayumi, 2001); lexicographic preferences are ubiquitous, such that food cannot substitute for sex, bread cannot save someone dying of thirst (Georgescu-Rogen, 1954; Lavoie, 11 Some other economic issues, such as valuation of biodiversity, externalities, sustainability, and green accounting, have also attracted the attention of forest economists in the last 30 years. As stated in the first section, while we do not intend to review the whole literature on forest economics, most of this literature and literature on environmental economics in general, is within the boundaries of neo-classical economics, and is subject to the limitations discussed in this paper. 12 In addition, the incongruity problem (Vatn and Bromley, 1994), discounting the future (Arrow et al., 1995), the existence of pure uncertainty (Bishop, 1979; Gowdy and McDaniel, 1995), and equal marginal utility of income (Medin et al., 2001) are other limitations of these methods. Hence, the CV is a deeply flawed methodology for measuring nonconsumptive values (Diamond and Hausman, 1994).

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1993), and wants are distinct from needs (Lutz and Lux, 1979; Lavoie, 1993). In view of these limitations, ecological economists and economists from other streams of economics mentioned above have suggested an alternate consumer choice theory. The main principles of this theory are the principles of procedural rationality, satiable wants, non-independence, subordination of needs, irreducibility of needs, and growth of needs. Procedural rationality consists of means to avoid complex calculations and considerations and of procedures of decision-making even in the absence of full or accurate information. Some of these procedures are rules and habits. The principle of satiation implies that eventually more of one good or more of a characteristic will bring less supplementary satisfaction. Satiation often arises with positive prices and finite income while in neo-classical economics, it arises only if prices are null or incomes are infinite. Following the principle of non-independence, decisions and preferences are not made independently of those of other agents. The principle of the subordination of needs is related to hierarchy of needs. The principle of irreducibility states that some needs cannot be substituted for others, and as a consequence, everything does not have a price. Finally, the principle of the growth of needs means that the growth of real incomes will induce new needs. In addition to consumer choice theory, ecological economics has some other main features. For example, ecological economists are extending the material balance and energetic paradigm of ecology to economic questions (Ayres, 1978; Costanza and Herendeen, 1984), and are using biological evolutionary theory to understand co-evolution of natural and social systems (Norgaard, 1981). Ecological economics recognises the problem of decision-making in an uncertain environment and warns that even the precautionary principle sets the first stage of this approach. One of the main features of ecological economics is the integration of natural and social systems. These distinct features of ecological economics, and other related streams of economics, also indicate towards the presence of multiple equilibria.

6. Evolution of forest management In nineteenth century, central Europe, forestry was a profitable activity, and forest was to be managed in a manner to ensure continued profit. Faustmann was much concerned about these practicalities, and his formulation was a direct result of these conditions. In this way, Faustmann’s formulation was a true depiction of a realistic situation, where the main objective was financial gain. Elsewhere, including Britain and the British colonies, the early nineteenth century was characterized by large-scale deforestation. This was followed by the initiation of forest management activities throughout Britain and the British colonies, in the late nineteenth and early twentieth century. However, in these countries also, profit from timber and timber yield regulation were the main concerns of forest management, and Faustmann’s formulation was relevant in those social conditions. In the postSecond World War era, (1945–1970), forests were treated as catalytic agents for industrialization and economic development (Westoby, 1987), and the main emphasis remained on profit from timber. During this period, the other main feature of forest management was the exclusion of local people from forests. In the 1970s, when the fulfillment of the basic needs of the rural poor became an ingredient of rural development, the critical role of forests in the life of forest-dependent rural communities, which had been excluded from forest use, was reestablished (Barraclough and Ghimire, 1995; Poffenberger and McGean, 1996). The United Nations Conference on Human Environment (1972) brought environmental issues to the forefront, and since this time environmental movements have been strengthening in the developed as well as the developing world. In the developing world, during the last 30 years, forest management has been transforming from the forest regimes installed by colonial rulers to forest regimes that are the result of activism of new pressure groups that have emerged due to freedom of thought, expression, and action (Kant and Berry, 2002). Similarly, in the developed world, the activism of environmental groups has forced national governments to include non-timber returns in their forest management

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regimes. The World Commission on Environment and Development (1987), brought further attention to the deteriorating health of forests and emphasised ‘sustainable development’, defined as the ability to meet ‘the needs of the present without compromising the ability of future generations to meet their own needs.’ In view of these developments, the concept of sustained yield has been replaced by the concept of SFM, and many international initiatives have marked the process of defining SFM, for example the Helsinki Process for European forests, the Montreal Process for non-European temperate and boreal forests, the International Tropical Timber Organisation process for tropical forests (Rametsteiner, 2000). World leaders attending the Earth Summit (1992) acknowledged the social, cultural, recreational, and spiritual values of forests, and viewed these benefits as fundamental to successful SFM. The basic elements of SFM are the maintenance and enhancement of forest ecosystems and their contribution to global ecological cycles, the conservation of biodiversity, soil, and water resources, multiple benefits from forests, and participatory forest management (CCFM, 1995).13 Hence, the main features of SFM, which distinguish it from the sustained yield forest management, can be grouped into social and ecological aspects.14 On the social side, SFM includes people in decisionmaking, and incorporates multiple values (value pluralism) and intergeneration equity. On ecological side, it recognises the holistic nature of interactions among components of forest ecosystems on different temporal and spatial scales, and focuses on long-term ecosystem sustainability. The recognition of these features brings to the fore the potential conflict between these obligations and 13 Many other terms, such as multi-resource management, multiple-values management, and ecosystem management, have been used to express the same concept as of SFM. However, the concept of SFM is much broader and integrative than that of the existing concept of multiple-use management in the USA which emerged as an outcome of the Endangered Species Act of 1973 and National Forest Management Act of 1976. 14 Detailed discussion of the differences between two forest management paradigms is available in Bengston (1994) and Behan (1990).

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the neo-classical economic framework (Toman et al., 1996). 7. Emerging economic thoughts and emerging issues in forest management These two categories of the features of the new paradigm of forest management—social and ecological—have direct linkages to emerging economic thoughts. In the traditional forest management by exclusion of people, preferences were fixed and stationary; other factors such as the value system and the rate of time preference were exogenous and were decided either by the government or by the market. Institutions were exogenous, and the role of institutions in economically optimal outcomes was neglected.15 The decision criterion was based on single-dimensional utility (profit) maximization. However, in the case of inclusion of people in forest management, preferences, values, and other factors will become endogenous, and these will vary across the range of stakeholders and will also change with time. Multiple forest values will satisfy different levels of needs. For example, the needs that are being satisfied by use values will be either physiological needs or safety needs of Maslow’s pyramid (lower-level needs), while the needs satisfied by existence values and spiritual values, will be the social needs of the pyramid (higher-level needs). The utilities, then, derived from different forest values for different levels of needs cannot be aggregated into a single number. The decision criterion will also vary with stakeholders: in some cases, such as Aboriginal and environmental groups, normative factors will be dominant while economic factors will be dominant in industrial groups. Hence, an appropriate economic analysis will require the use of alternate consumer choice theory, discussed in Section 5. Heterogeneity among agents (due to variation in preferences and other factors) and interaction among these agents will require the use of agent15 Regulations to exclude local people from forest use were thought of as necessary and sufficient institutions to take care of economic efficiency in forest management, and it was assumed that these institutions could be designed, implemented, and monitored at zero cost.

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based models to understand and explain the outcomes of forest management practices. Forest management institutions, due to inclusion of people, will become sensitive to social, political, cultural and other institutions of user groups. Informal institutions of stakeholders will become an integral part of institutions, and the optimal institutions will vary across diverse socio-economic conditions. The evolutionary nature of social, cultural, and other institutions will lead to evolution in optimal forest management regimes over a period. Hence, the real outcome will be dynamic multiple equilibria. In addition, inclusion of institutions in the total production process will probably change the nature of the production function itself. Because institutions are information based they have demonstrated increasing returns (North, 1990, p. 92–104). Hence, the inclusion of institutions in the total production process will likely transform production from decreasing returns to increasing returns, at least in situations where there are no well-established institutions or institutional arrangements are in an infancy stage. This will also lead to multiple equilibria outcomes instead of a single equilibrium outcome. Hence, the economics of SFM has to be based on the economics of multiple equilibria. The holistic nature of SFM demands the study of interactions within natural systems and between natural systems and human systems, and it requires a shift from the neo-classical approach to the ecological economics approach. The depth of ecological uncertainty is much more intense than the uncertainties associated with human systems, and our knowledge of diffuse ecosystem services is far poorer than the knowledge of timber products (Toman et al., 1996). Non-concavities have already been reported in the joint production functions of two goods, timber and wildlife. Production functions and value functions for more than two goods will likely contain non-concavities leading to the non-feasibility of a single equilibrium. In addition, the concept of maximization becomes irrelevant, theoretically as well as practically, in the case of multiple objective management. The positive value of all objectives is the only viable alternative that is similar to Alchian’s argument of positive profits. All interactions within natural systems and many

interactions between natural systems and human systems do not take place through markets, but various institutions play a critical role in these interactions. Hence, economically-efficient equilibrium will not be determined by the market. Instead, the ‘routines’ (as discussed in Section 3) of forest stakeholders and management organisations will determine the choice of one optimal point out of many optimal points. Overtime, as these routines (capabilities and rules) are modified, a path of selection of optimal points will emerge. But, in the case of forest resources, this path will be an outcome of interactive (between social systems and natural systems) evolutionary process, in which both routines and genes will be important elements. The path of movement from one optimal point to another point will partially depend (from the perspective of human systems) upon selfreinforcing mechanisms.16 In these circumstances, the existing institutions and the dynamics of institutions17 will become critical for SFM. Therefore, the existing multiple-use and multiple criteria models, which are insensitive to institutions, will not be sufficient to address the issue of SFM. Clearly, the holistic nature of SFM will require the development of a new economic theory of multiple equilibria that will integrate biological and economic evolution, and the concepts of evolutionary, institutional, and ecological economics. 8. Basic principles of the economics of sustainable forest management The discussion in the previous sections highlights two necessary elements of the economics of SFM—multiple equilibria and new consumer choice theory. However, as illustrated in Section 16 Arthur (1988), identified four generic sources of selfreinforcing mechanisms: large set-up or fixed costs, learning effects, coordination effects, and adaptive expectation to explain technological change. North (1990) used these mechanisms to explain the path-dependent nature of institutional change. 17 Kant (2001), found that the evolution of forest regimes in India and China (two culturally, historically, and politically different countries) is path-dependent, and the four selfreinforcing mechanisms, identified by Arthur and used by North, play an important role in the path-dependence of forest regimes.

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7, the economics of SFM will require encompassing and integrating the concepts from different streams of emerging economic thoughts. This integration cannot be achieved in a single mathematical model, and SFM will require a complete new economic framework. Readers who may have expected to find another model for the economics of SFM in this paper may be disappointed. However, the five principles discussed below may become the foundations of the economics of SFM and readers may see many models in future. The basic idea behind SFM is to manage forests in such a way that the needs of the present are met without compromising the ability of future generations to meet their own needs. This idea demands elements of altruistic and cooperative behavior among social agents in contrast to the self-interest-maximizing rational agent of neo-classical economics. Everyone is selfish as well as altruistic, and everyone tends to be more of one than the other at a given time, but everyone is capable of both selfishness and altruism in different frames of reference. Uphoff (1992), argues that an individual’s value dispositions are similar to probability distributions that may be normal with the mean in the centre or skewed towards selfishness or altruism. As long as there is even a small chance that one will be selfish (or altruistic), one may act this way. But, neo-classical economics, based on Newtonian equilibrium guided by the ‘either–or’ principle, is unable to incorporate such probabilistic behavior of social agents. Incorporation of such behavior may be possible in economic models that are based on the ‘both–and’ principle that has been accepted by post-Newtonian physicists of the twentieth century.18 Under the umbrella of the ‘both–and’ principle, four subprinciples—principles of existence, relativity, uncertainty, and complementarity—will be of par18 In nineteenth century physics, the universe was made up of billiard-ball type atoms that followed the Newtonian law of motion. Hence the relationship between matter and energy was of ‘either–or’. In the twentieth century, Einstein’s two concepts—the theory of relativity and the dual nature of a particle—brought new dimensions to physics. According to the theory of relativity, two apparently mutually exclusive conditions may co-exist from different perspectives (frames of reference) (Uphoff, 1992, p. 307). Similarly, the dual nature of particle supports the ‘both–and’ principle.

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amount importance to guide the evolution of the economics of SFM.19 The ‘principle of existence’ suggests that we cannot ignore the existing situations because these conditions have survived for a long time. Hence, we should start from the economic analysis of the existing situations in human-forest interactive systems, to examine the effects of proposed changes, and to attempt to decide whether the new situations would be, in total, better or worse than the existing situations. The choice of forest rotation based on annual allowable cut, also known as forester’s rotation, which has dominated the forestry practices all over the world for centuries against all economic arguments of forest economists, is a good example of this principle. It is possible that due to many uncertainties in forest production, positive profit rather than maximum profit is a viable and economically optimal alternative, or the transaction cost of changing from forester’s rotation to Faustmann’s rotation may be higher than the benefits from this change, or use of forester’s rotation may be the case of increasing returns. Forest economists have never examined these possible economic explanations of forester’s rotation. The ‘principle of relativity’ suggests that an optimal solution is not an absolute but rather a relative concept. Hence, optimal solutions will be situation specific, and in many cases will be beyond market forces. For example, two different models of forest management, the co-management of forests for Aboriginal values and private management of forest for industrial values can be economically optimal in the frame of reference of Aboriginal people and forest industries, respectively. However, comanagement may be economically inefficient in the frame of reference of forest industries and similarly private management in the frame of reference of Aboriginal people. The ‘principle of uncertainty’ suggests that due to uncertainties in natural and social systems, a social agent may never be able to maximize his outcomes, but will always search for positive outcomes, and therefore, resource allocation will be improved by adaptive 19 Some of these principles are similar to the principles discussed by Uphoff (1992).

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efficiency20 and not by allocative efficiency. The ‘principle of complementarity’ suggests that human behavior may be selfish as well as altruistic, people can have economic values as well as moral values, and people need forests to satisfy their lower level needs as well as higher level needs. Hence, the economics of SFM should be based on complementarity, as against the principle of substitution, which is dominant in forest economics. 9. Conclusions The concept of SFM is the reflection of social, economic, and environmental conditions of the late twentieth and early twenty-first century, which are quite different from the conditions of nineteenth and early twentieth century. Management principles and silviculture of SFM are quite different than the management principles and silviculture of forest management based on timber-yield regulation. Similarly, the economic principles of SFM need to be reflective of social, economic, and environmental conditions of twenty-first century and management principles and silviculture of SFM. The silviculture of the Faustmann formula continues to have a direct application for plantation forestry, but not to the SFM. As demonstrated in this paper, existing forest economic models, including Faustmann’s formulation, must be refined, and some new economic theories and models must be developed to incorporate the features of SFM. The two dominant requirements of the economics of SFM are the economics of multiple equilibria, and a consumer choice theory that incorporates context specific and dynamic preferences, heterogeneous agents, distinction between needs and wants, and subordination of needs. These two requirements are beyond the boundaries of neo-classical economics. The boundaries of forest economics will have to be extended. The 20 Adaptive efficiency is concerned with the kinds of institutions that shape the way an economy evolves over time. It includes the willingness of a society to acquire knowledge and learning, to induce innovation, to undertake risk and creativity, and to resolve problems of society through time (North 1990, p. 80). A detailed discussion of adaptive efficiency in forest management in available in Kant and Berry (2001).

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