Risk and Markets for Ecosystem Services

Market-based environmental regulations (e.g., cap and trade, “payments for ecosystem services”) are increasingly common. However, few detailed studies of operating ecosystem markets have lent understanding to how such policies affect incentive structures for improving environmental quality. The largest U.S. market stems from the Clean Water Act provisions requiring ecosystem restoration to offset aquatic ecosystems damaged during development. We describe and test how variations in the rules governing this ecosystem market shift risk between regulators and entrepreneurs to promote ecological restoration. We analyze extensive national scale data to assess how two critical aspects of market structure – (a) the geographic scale of markets and (b) policies dictating the release of credits – affect the willingness of entrepreneurs to enter specific markets and produce credits. We find no discernible relationship between policies attempting to ease market entry and either the number of individual producers or total credits produced. Rather, market entry is primarily related to regional geography (the prevalence of aquatic ecosystems) and regional economic growth. Any improvements to policies governing ecosystem markets require explicit evaluation of the interplay between policy and risk elements affecting both regulators and entrepreneurial credit providers. Our findings extend to emerging, regulated ecosystem markets, including proposed carbon offset mechanisms, biodiversity banking, and water quality trading programs.