Extending the boundaries of forest economics

Forest Policy and Economics 5(2003) 39–56

1389-9341/03/$ - see front matter� 2002 Elsevier Science B.V. All rights reserved.PII: S1389-9341Ž02.00045-X

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-classicaleconomic framework, are subject to many limitations. Social, economic, and ecological features of sustainable forestmanagement(SFM) are different than that of sustained yield timber management. Hence, the economics of SFM willbe based on different economic principles. The two main requirements of the economics of SFM are the economicsof multiple equilibria, and a consumer choice theory that incorporates heterogeneity of agents, context specific anddynamics of preferences, distinction between needs and wants, and the subordination of needs. These requirementswill 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.� 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 associ-ated with forest management have troubled econ-omists since the beginning of the nineteenthcentury. The conclusions of many great econo-mists, such as Boulding, Fisher, Goundry, Hotell-ing, Kaldor, von Thunen, and Wicksell, on forestrotation are questionable(Samuelson, 1976). Thecorrect solution of optimal forest rotation is basedon the maximization of forest value(or soil expec-tation value) that was first calculated correctly byFaustmann(1849). Even though Faustmann didnot calculate the necessary conditions for optimalforest 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 themost advantageous silvicultural system and forestrotation (Faustmann, 1849). Ohlin (1921) provid-ed the mathematical conditions for optimal forestrotation, and their economic interpretation. Later,Gaffney (1960) and Pearse(1967) analyzed thenecessary conditions for optimal forest rotationusing marginal (neo-classical) techniques, andconcluded these to be identical with the conditionsobtained from Faustmann’s formulation. In the lastthree decades, modified economic rotation formu-lations, that incorporated uncertainty of factors andprices, market imperfections, and multiple values,have dominated forest economics literature; andthese models can be termed as single-stand andsingle-criterion models. Multi-stand and multi-cri-teria models and valuation of ecological and envi-

40 S. Kant / Forest Policy and Economics 5 (2003) 39–56

ronmental goods and services have been othermain features of forest economics during thisperiod. All these dominant features of forest eco-nomics, in general, have followed neo-classicaleconomic thought, characterized by the utility(or1

profit) maximizing rational (Homo-economicus)agent and the ‘invisible hand’ leading to an effi-cient general equilibrium. In this framework, peo-ple’s preferences are static, society is amathematical aggregation of homogeneous rationalagents, public inputs are through market signals,and there is no role for any institution other thanthe market.Forest economic models based on the neo-

classical framework are subject to serious limita-tions. The emergence of a new forest managementparadigm in the last two decades has furtheramplified these limitations(Toman et al., 1996).The new forest management paradigm has trans-formed forest management from timber manage-ment to forest ecosystem management, fromsustained timber yield management to sustainableforest management(SFM), and from forest man-agement by exclusion to management by inclusionof user groups, and is commonly known as SFM.The limitations of forest economic models haveresulted in the severance of links between thesemodels and social perceptions and practices offorest management.2

Neo-classical economic thought refers to the rejuvenation1

of the classical economics of Smith, Malthus, and Ricardo bymarginalists, such as Jevon, Menger, and Walras, and to thetheoretical framework developed by Marshall and Samuelson(Dugger, 1977). Hamilton (1970), suggests that neo-classicaleconomics is based on a Newtonian conception, while someeconomists are uncomfortable with the term ‘neo-classical’(Dahlman, 1980, p. 219).

There is evidence that even the simplest financial analysis2

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 thediversity and evolution of stakeholder perspectives on appro-priate forest management against the fundamental assumptionof the same and stable preferences used in the models of foresteconomics. Similarly, ‘Volvo effect’ discussed by Johanssonand 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 practic-es, and observed that people have lost faith in professionalssimply because professionals seem to have lost touch withreality and cannot see the forest for the trees.

The gap between theoretical models and practic-es has roots in mainstream economics itself. Manyeconomists have observed multi-dimensional lim-itations of the neo-classical paradigm resulting inlow ‘evidence theory ratio’(Holmstrom and Tiro-le, 1989, p. 126). However, the economics profes-sion, as a whole, has been re-examining andchallenging almost every basis of the neo-classicalthought to reduce this gap. For example, experi-mental economists, such as Camerer(1997), Rabin(1998) and Camerer and Thaler(1995), have beenworking to get a clear picture of decision makingby ‘Homo-sapiens’ as against ‘Homo-economicus’agents. Many economists have proposed alterna-tive economic frameworks that overcome some ofthe limitations of the neo-classical paradigm andincorporate some features of behavioral patternsof ‘Homo-sapiens’ observed by experimental econ-omists. Evolutionary economics has challenged theconcepts of maximization in an uncertain environ-ment and a single competitive equilibrium; insti-tutional economics has incorporated institutions ineconomic analysis; many branches of economics,such as ecological economics, socio-economicsand post-Keynesian economics, have challengedthe concept of mono-utility, static preferences, anda maximizing rational agent. Game-theoretic mod-els have been developed to understand and explainco-operative, non-cooperative and strategic behav-iors of people in diverse settings, and agent-basedmodels have incorporated heterogeneous agents,changing preferences, and non-maximizing behav-iors in economic models. However, no significantattempt has been made in the field of foresteconomics to incorporate the concepts and princi-ples emerging from these new economic thoughts.Thus, it is now the turn of forest economists to

respond to new challenges of forest managementby extending the boundaries of forest economicsbeyond neo-classical economics. This paper hastwo main objectives:(i) to demonstrate basiclimitations of the models, dominant in forest eco-nomics, and usefulness of emerging economicthoughts to overcome these limitations; and(ii) toestablish the relevance of emerging economicthoughts to the economics of SFM, and to providesome basic principles for the economics of SFM.

41S. Kant / Forest Policy and Economics 5 (2003) 39–56

Because the literature on forest economics is enor-mous, we have focused on dominant themesincluding: single-stand and single-criterion forestrotation models; multi-stand and multi-criteriamodels; some forest policy discussions; and non-market valuation techniques. Although, an over-view of the literature on forest economics and onemerging economic thoughts is necessary, our aimhere is to provide the context and not to reviewthe literature in great detail.The main underlying motivation behind this

paper is to expose professionals and students offorest economics to emerging economic thoughtsand their relevance to the economics of SFM. Weare not proposing any new economic model forSFM but are suggesting some basic principles thatmay be used as a foundation to built economicmodels of SFM.The paper is divided in eight sections. First, an

overview of single-stand and single-criterion forestrotation models, and their limitations are discussed.Second, multi-stand and multi-criteria models areexamined, and the relevance of evolutionary eco-nomics to these models is established. Third, forestpolicy discussions and their linkages with institu-tional economics are discussed. Fourth, issuesrelated to non-market valuation and related featuresof ecological economics and some other emergingeconomic thoughts are highlighted. Fifth, the evo-lution of forest management is summarized. Sixth,linkages between the main features of SFM andemerging economic thoughts are established. Sev-enth, some basic principles for the economics ofSFM are proposed. Finally, we conclude with anargument to extend the boundaries of foresteconomics.

2. Single-stand and single-criterion forest rota-tion models

Faustmann’s optimal rotation formula is for asingle stand and single criterion. Many economists,such as Samuelson(1976), Anderson(1976) andReed (1984), have confirmed the correctness ofthis formula. However, this confirmation is con-ditional on explicit and implicit assumptions ofthe model. Lofgren(1995), identified four explicitassumptions of the model belonging to two main

categories—deterministic nature(of timber prices,timber yields, and interest rates) and perfect mar-kets (of capital and forestland). In the last 20years many scholars have extended Faustmann’s3

insight to more complex settings(Brazee, 2001).The assumptions related to the nature of theelements of the model such as, the stochasticnature of prices and costs(Brazee et al., 1999;Fina et al., 2001), interest rates(Ollikainen, 1990),timber yield (Buongiorno, 2001), and a generali-sed model that incorporated uncertainty in allfactors(Chang, 1998) have been the focus of theseworks. Some economists have addressed theassumption of perfect markets in forestland mar-kets (Sandhu, 1991) and capital markets(Ollikai-nen, 1996; Abildtrup et al., 1997) . The4

incorporation of non-timber values in a single-criterion (maximization of net present value)framework has been the other dimension of thesemodifications (Hartman, 1976; Calish et al.,1978) .5

These modifications have focused on stochasticelements and addressed these by maximizing theexpected value of bare land, expected profits, orexpected utility. However, maximization is onlymeaningful in a certainty environment(Tintner,1941; Alchian, 1950). In a stochastic(either riskyor uncertain) environment, each action that maybe chosen is identified with a probability distri-bution of potential outcomes, not with a uniqueoutcome. Each possible action has a probabilitydistribution of potential outcomes, of which onlyone will materialise, and that one outcome cannot(Tintner, 1941). The use of the mean or expected

Newman(2001), notes that through 1999, 278 identifiable3

works on the optimal rotation problem have been published(85% of these have been published since 1979), and providesa review of these papers.

Some economists, such as Montgomery and Adams4

(1995), used a two-period utility maximizing framework toincorporate people’s consumption preferences in forest rotationmodels. Other economists, such as Koskela and Ollikainen(1997), have used expected utility model to analyze the impactof stochastic elements.

We have cited only one or two references from each5

category. An extensive literature review is available in New-man (1988) and Newman(2001), and special issues of theJournal of Forest Economics 6(3), 2000, Forest Science 47(4),2001, and Forest Policy and Economics 2(2001).


value completely begs the question of stochasticityby disregarding the variance of a distribution,while a certainty equivalent assumes the answer(Alchian, 1950). Hence, in a stochastic environ-ment, the task is converted into making a decisionwhose potential outcome—distribution—is prefer-able, that is, choosing the action with the optimumdistribution, since there is no such thing as amaximizing distribution(Alchian, 1950). There-fore, while these modifications may have increasedthe understanding of forest economists, their out-comes are questionable. The solution to stochasticproblems lies in evolutionary economics discussedin Section 3.Similarly, models, that incorporated non-timber

values in a single criterion, are subject to manytheoretical limitations. A key assumption of thesemodels is that non-timber values can be regener-ated with forest growth; there are no absoluteirreversibilities(Toman et al., 1996). The addition,rather than inclusion, of both private and publicgoods and services in a single objective functionis questionable. These two different types of eco-nomic goods are not additive; if they were therewould have been no need to develop two separateeconomic theories for private and public goods.This addition also results in changes in harvestand non-harvest values and the costs of harvestcan have ambiguous effects on the rotation, incontrast to Faustmann’s solution(Toman et al.,1996). The inclusion of non-timber values canintroduce non-concavities into the maximizationproblem that will give rise to multiple local max-ima and discontinuous responses to changes ineconomic conditions(Swallow et al., 1990; Tomanet al., 1996). The inclusion of religious, spiritual,and Aboriginal forest values into a single utilityfunction is also questionable. These problems arealso addressed by evolutionary economics(Section3), ecological economics, socio-economics, andpost-Keynesian economics(Section 5).In addition to these limitations, there are at least

three implicit assumptions concealed within themarket-driven neo-classical paradigm that have notbeen explicitly discussed in the literature. First,forest (timber) production is independent(insen-

sitive) of resource regime arrangements or the6

transaction cost is assumed to be zero. Second, thevalues of all goods and services available fromforests are additive, and natural capital and man-made capital are perfect substitutes. Third, the rateof time preference is exogenous and is equal tothe real rate of interest. These assumptions furtherdeepen the limitations of the optimal economicrotation models. The implications of these assump-tions are discussed in the following sub-sections.

2.1. Resource-regime independence of forestproduction

Coase(1960), argued that the traditional con-cept of factors of production, usually thought ofas a physical entity(a unit of land or labour), isa faulty concept, and a right to perform certainphysical actions is also a factor of production.7

Nautiyal and Williams (1990), recognised thelimitation of the Faustmann model in terms of asingle factor (time) and included managementintensity as another factor of production. ButFaustmann’s model and its modifications haveignored the ‘right to perform’(resource regimearrangements) as one of the factors of productionwhich makes forest production independent ofresource regime arrangements. Results of thesemodels, therefore, are valid only for a givenresource regime or a resource regime is not adecision variable in this formulation. Hence, thesolution of Faustmann’s model can provide only alocal optimum, not a global optimum.Kant (1996) and Kant(2000), argued that the

forest production process is complete only when

A resource regime is a structure of rights and duties6

characterizing the relationship of individuals or decision unitsto one another with respect to resource(Bromley, 1991).Rights and duties do not have only two situations—either noright or full right. There are situations of partial rights andpartial duties. Hence, resource regime arrangements vary con-tinuously from open-access to private resource regimes(Kant,2000).

Please refer to ‘The Problem of Social Cost’ by Coase7

(1960), for the full exposition of the ‘right to perform certainphysical actions’ as one of the factors of production. Theincorporation of the ‘right to perform’, as one of the factorsof production in forest management decisions, is available inKant (2000) and Kant and Berry(2001).


the produced physical output is available to thelegal right holder. Hence, the forest productionprocess comprises a transformation process(con-version of physical inputs into physical outputs)and a transaction process(making the physicaloutput available in full or in part to the legal rightholder). The transformation process depends main-ly upon conventional physical inputs—land,labour, and man-made capital—while the transac-tion process depends upon the resource regimearrangements(right to perform) and socio-eco-nomic characteristics of user groups. In the caseof forest resources, these two processes are insep-arable. Hence, Faustmann’s formulation capturesonly part of the production process—the transfor-mation process. In the simplest specification of thetotal production process, based on time and theright to perform (resource regime arrangements)as factors of production, simultaneous satisfactionof two marginal conditions—the marginal condi-tion with respect to time and the marginal condi-tion with respect to resource regime —will be8

necessary for optimal rotation. Therefore, even ina certainty environment, optimal rotation will,normally, be different from Faustmann’s outcome.Costs associated with the transformation process

are called transformation costs(conventional costsof land, labour, and capital) and costs associatedwith the transaction process are transaction costs(costs of designing, implementing, and monitoringresource regime arrangements). Faustmann’s for-mulation is valid only for zero transaction costs,which is a common feature of neo-classical pro-duction models but not of the real world. The9

Resource regime is a continuous variable ranging from8

open access to private regime, and as such the marginalcondition of the resource regime will require marginal costequal to marginal benefit due to incremental change in resourceregime. Detailed discussion of all the issues in this section isavailable in Kant(1996, 2000) and Kant and Berry(2001).

Some forest economists argue that the Faustmann model9

includes provision for all costs including transaction costs.This argument is similar to the argument of neo-classicaleconomists that transaction costs can be included in conven-tional production models but none of them included or evenrealized before strong arguments of Coase and others. In theFaustmann’s modifications, which include transaction cost,‘right to perform’ is not an input factor, and transaction costis not a function of resource regime. Hence, transaction costis treated in a narrow sense.

transaction function and transaction costs dependon the socio-economic conditions of the user groupthat have spatial and temporal variations. Hence,the optimal rotation and optimal resource regimearrangement will, likewise, have spatial diversityand will evolve with temporal variations in thesocio-economic factors of user groups(Kant,2000). Therefore, analysis of the complete produc-tion process will require an economic frameworkthat is compatible with multiple equilibria, aframework based on evolutionary economics(Sec-tion 3) and institutional economics(Section 4).

2.2. Addition and substitution of forest values

Multiple-use models include timber and non-timber products and services in their objectivefunctions, and use either an aggregate price for allnon-timber products and services, or assign somearbitrary prices for non-timber goods. Many serv-ices from forests, such as aesthetic, symbolic, andspiritual, are public goods, and it is problematic toput a market price on a public good. In addition,many non-timber forest products, which have prop-erties of private goods are critical for local forest-dependent community subsistence but are nevertraded in the market(Kant et al., 1996; Kant,1997) and therefore, cannot be assigned a marketprice.In the last three decades, resource and environ-

mental economists have developed valuation meth-ods for non-market goods and services. They havegrouped values as use and non-use values, andhave suggested some valuation methods(discussedin Section 5) for these two categories. A majorproblem in assessment of non-use values is thebias toward values more amenable to monetaryestimation, such as commodity-based values offorests. Ecological, aesthetic, and spiritual valuesdo not easily lend themselves to economic meas-urements. Hence, valuation by these non-markettechniques is always subjective, contrary to thebasic objectivity premise of neo-classical econom-ics. In addition, an aggregation of private andpublic goods is problematic. Conversion of allvalues into a single currency facilitates analysisbut at the cost of realistic outcomes. The additionof diverse values through common currency means


that one value, for example, spiritual value, canbe substituted by another value, for example,timber value. However, different values are differ-ent, and if they were substitutable, what is theneed of having different values. In addition, thisnotion also implies that man-made capital andnatural capital are perfect substitutes. Costanza andDaly (1992), point out that:(i) man-made capitalis derived from natural capital; and(ii) if bothcapitals are perfect substitutes, why develop man-made capital. Alternatively, man-made capital andnatural capital are complementary and not substi-tutes. Similarly, many forest values such as spiri-tual, aesthetic, and symbolic are complementaryand not substitutes to consumptive or monetaryvalues. Hence, an economic framework, in whichall forest values are treated as additive, is unableto capture the reality. The solution lies in a differ-ent consumer choice framework provided by theemerging fields of ecological economics, socio-economics, and post-Keynesian economics(Sec-tion 5).

2.3. Exogenous rate of time preference

Generally, in the neo-classical framework, therate of time preference is assumed to be exogenousto an individual’s decision-making, and equal tothe real rate of interest determined by the marketand not by the decision maker. However, theobservations of many economists and empiricalevidence do not support this idea. Bohm-Bawerk(1891, p. 257), observed that impatience wouldmanifest in extremely different degrees in differentindividuals and even in the same individual atdifferent times. Similar elements of the endoge-nous nature of the rate of time preference areobserved in the writings of Jevons(1931). Morerecently, Ciriacy-Wantrup(1963), observed thatdue to imperfections in the physical asset, labour,and capital markets, the planning agents of flowresources, such as forests, take their own time-preference rates, rather than market interest ratesfor resource conservation decisions. Becker andMulligan (1997), also observed the endogenousnature of the rate of time preference. The economictheory of a rational and consistent choice alsosuggests 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 andThaler (1989), have demonstrated that the rate oftime preference depends on the magnitude and thesign of award and on the time horizon. In thecontext of forest resources, Kant(1999), arguedthat: (i) an individual may have different rates oftime preference for different objects of hisyherutility bundle; (ii) the rate of time preference foran object will depend upon the role of the objectin the economic and other necessities of the indi-vidual; and(iii ) the influence of the individual’spersonal factors on the rate of time preference willbe object and context specific. In the context ofmultiple-use resources, the use of market rate ofinterest as a discount rate for non-financial valuesis an invalid perception of modelling experts(Price, 2000). In addition, the argument of non-substitutability of natural capital by man-madecapital jeopardises the common practice of equat-ing the rate of time preference to the real rate ofinterest. In support of the Faustmann model it canbe argued that it does not assume that the real rateof interest is the best or the only option. However,the recognition of the endogenous nature of timepreference and its variability with time horizonand across situations will result in multiple equi-libria, contrary to the single competitive equilibri-um of neo-classical economics. Evolutionaryeconomics addresses these challenges and is dis-cussed in the following section.

3. Multiple-stands and multi-criteria modelsand evolutionary economics

The single-stand model of Hartman(1976), hasbeen extended to multiple stands by Bowes andKrutilla (1989), but their amenity production func-tion is not explicitly spatial. Swallow and Wear(1993), and Wear and Swallow(1993), developeda more explicit spatial framework but their focusis on single-stand rather than forest-level analysis.Hof and Joyce(1992), incorporated spatial config-uration of land allocations to determine a staticallyoptimal configuration. The single-stand single-cri-terion model has also been extended by the incor-poration of multiple criteria. The most common


approaches in multi-criteria decision making(MCDM) are goal programming(Field et al.,1980), fuzzy multi-criteria models(Bare and Men-doza, 1992), and interactive multi-criteria models(Liu and Davis, 1995). In the case of forestmanagement, different tools of operations research,such as linear programming(Weintraub et al.,1994), mixed integer programming(Hof et al.,1994), dynamic programming(Gong, 1992), goalprogramming(Mendoza, 1987), multiple objectivelinear programming(Gong, 1992), and the analyt-ical hierarchy process(Kangas, 1993) have beenused to address multiple-criteria decisionproblems. However, the solution provided by10

MCDM models need not to be ‘true’ optimumoutcome(Diaz-Balteiro and Romero, 1997). Thedetermination of real optimum would entail theassessment of a multiple-attribute utility functioninvolving all the relevant criteria, and this task isfull of conceptual and operational difficulties(Rehman and Romeo, 1993). Diaz-Balteiro andRomero(1997), used multiple-goal programmingand compromise programming to avoid the diffi-culties associated with the assessment of multiple-attribute utility models, but encountered manyproblems with regard to the single optimumoutcome.The models of multiple(interrelated) stands

(forest-level analysis) are approached throughdynamic programming, and their analysis is hin-dered by the complicated dynamics, such as non-concavities, of the system leading to the possibilityof multiple steady states. Similarly, in multiple-criteria models, the number of extreme efficientpoints can easily surpass a thousand points, whichleads to the uselessness of such solutions to deci-sion makers(Diaz-Balteiro and Romero, 1997). Inaddition, the ‘user first—technology second’approach is not used and these systems still remainstrongly technology driven(Angehrn, 1991).While, these mathematical models do providesome useful outputs they are not supported bytheoretical forest economic foundations. In theneo-classical paradigm, there is no theoretical

An extensive review of the literature on applications of10

MCDM to forestry problems is available in Tarp and Helles(1995).

foundation for more than one efficient point, theselection of one optimal point out of many efficientpoints, or the movement from one efficient pointto another efficient point.Alchian (1950), provided the foundation for

evolutionary economics. He proposed an approachwhich embodies the principles of biological evo-lution and natural selection to select a posteriorithe most appropriate action according to the prin-ciple of ‘realised positive profits’. Alchian arguedthat in an uncertain environment a firm’s behavioris characterized by adaptive, imitative, and trial-and-error features in the pursuit of ‘positive prof-its’, rather than the individualistic rational pursuitof ‘maximized profits’. These arguments have beenfurther developed by Winter(1964), Farrell(1970), Dunn (1971), Winter (1971), and Nelsonand Winter (1973, 1982). According to Nelsonand Winter’s(1982), evolutionary theory of eco-nomic change, firms are motivated by profit andengage in a search of ways to improve their profits,but their actions are not for profit maximization.Firms are modelled as having certain capabilitiesand decision rules; all regular and predictablebehavioral patterns of firms are called ‘routines’.These ‘routines’ play the same role that genes playin biological evolutionary theory. Over time, thesecapabilities and rules are modified, and the eco-nomic analogue of biological natural selectionoperates which tends to winnow out unprofitablefirms. In the neo-classical framework, the availabletechniques are a constant, and decision rules arethe consequence of maximization, in evolutionarytheory, they are simply a reflection of the histori-cally given ‘routines’ governing the action of afirm. Hence, in evolutionary economics, historyplays a critical role while rational agents of theneo-classical paradigm do not have any memoryof their past. Similarly, there is no hypotheticalsingle equilibrium in which all the unprofitablefirms are no longer in the industry and profitableones are at their optimum size, but there may bemultiple equilibria.Another source of the economics of multiple

equilibria is found in the economic theory ofincreasing returns. Conventional economic theoryis built on a strong assumption of diminishingreturns, negative feedback, and a predictable equi-


librium for prices and market shares. However, inmany real life situations, positive feedback mag-nifies the effects of small economic shifts andmoves them away from any single equilibrium.This possibility was noticed by Marshal as earlyas 1890, when he noted that if a firm’s productioncosts fall as its market share increases, a firm thatsimply by good fortune gained a high proportionof the market early on would be able to beat itsrivals. Similarly, economists such as Gunnar K.Myrdal and Nicholas Kaldor, in the 1940s and1950s, observed mechanisms of positive-feedbackin some sectors that did not involve technology(Arthur, 1994, p. 4). In the 1980s and 1990s,Arthur gave a new impetus to the economics ofincreasing returns. Arthur(1994, p. 3), argues thatthe parts of the economy that are knowledge-basedare largely subject to increasing returns. Economicmodels of increasing returns differ from conven-tional neo-classical models in at least four ways:(i) multiple equilibria—a number of solutions arepossible and the outcome is indeterminate;(ii)possible inefficiencies—it is not guaranteed thatthe particular outcome selected from among themany alternatives will be the ‘best’;(iii ) lock-in—once reached, a solution is difficult to exit from;and (iv) path dependence—the consequence ofsmall events and chance circumstances can deter-mine solutions that, once they prevail, lead one toa particular path(Arthur, 1988). This theory ofincreasing returns has many common elements,such as absence of profit maximization, relevanceof history in decision making, and multiple equi-libria, with evolutionary economics.

4. Forest policy analysis and institutionaleconomics

Forest policy is a complex balance betweeneconomic, social, and political objectives in anenvironment where the forests and the institutionscontinuously change. Hence, a wide variety ofpolicy models exist across various forestry juris-dictions, and policy discussions include a widerange of topics, such as timber supply, timber saleand pricing, forest taxation, international trade,forest management standards, carbon sequestration,tropical deforestation, forest ownership, property

rights, and policy reforms. While it is not possibleto review this literature to a full extent, in general,this literature is either based on neo-classical eco-nomic tools, or on institutional economics. Neo-classical economic tools have been used to analyzethe issues related to timber supply(Kuuluvainen,1990; Koskela and Ollikainen, 1999), timber pric-ing and sale(Baldwin, 1997; Paarsch, 1997),forest taxation(Koskela, 1989; Koskela and Olli-kainen, 1997), international trade of forest prod-ucts (Zhu et al., 2001), forest certification(Swallow and Sedjo, 2000; Koskela and Ollikai-nen, 2001), carbon sequestration(Parks and Har-die, 1995; Huang and Kronard, 2001),deforestation(Angelsen, 1999; Sandler, 1993), andpolicy reforms (Grebner and Amacher, 2000;Zhang et al., 2000).The other aspect of the policy literature is

‘institutions’, and one of the emerging consensusesamong economists is that ‘institutions matter’ evenin a capitalist economy. The concept of institution-al economics goes back to Veblen(1875–1929).The publication ofInstitutional Economics (Com-mons, 1934) marked the formation of institutionaleconomics as a distinct school of thought. Themain features of this school, which is now termedas Old Institutional Economics(OIE), are theholistic and interdependent nature of processeswithin the whole social system and absence ofequilibrium (Myrdal, 1978). ‘New InstitutionalEconomics’(NIE), a term coined by Oliver Wil-liamson to distinguish it from OIE(Coase, 1998)comes from both OIE and neo-classical economics.In essence, the NIE is concerned with propertyrights (Alchian, 1961; Alchian and Demstez,1973), transaction costs(Williamson, 1979, 1985;Coase, 1937, 1960), and increasing returns andmarket imperfections(North, 1994). The first twoaspects—property rights and transaction costs—donot depart far from the neo-classical framework.Forest economists have used these two concepts,property rights and transaction costs, to analyzevarious policy issues such as forest tenures andtheir impacts(Zhang, 1996; Zhang and Pearse,1997), global deforestation(Mendelsohn, 1994),silvicultural contracting(Wang and van Kooten,1999), and changes in forest regimes(Zhang,2001; Kissling-Naf and Bisang, 2001).¨


North (1994), recently included increasingreturns and market imperfections, as a source ofinstitutional change, in NIE. North(1994),acknowledges the presence of multiple equilibriawhen he argues that all four of Arthur’s self-reinforcing mechanisms of technological change,namely, initial setup costs, learning effects, coor-dination effects, and adaptive expectations, applyto institutional changes. Similarly, when Coase(1998) stated, ‘the costs of exchange depend onthe institutions of a country: its legal system, itspolitical system, its social system, its educationalsystem, its culture and so on’, he acknowledges,at least indirectly, the presence of multiple equili-bria. However, forest economists have yet toexplicitly incorporate these aspects into forest pol-icy analysis.

5. Non-market valuation and ecologicaleconomics

As discussed in Section 2.2, non-market valua-tion of ecological goods and services has attracteda major attention from forest economists in thelast 30 years. Economists have suggested directtechniques—stated preference analysis techniques(contingent valuation)—and indirect techniques—revealed preference analysis techniques(travel costmethod and hedonic pricing) for valuation. Thetravel cost method, which was originally concep-tualised by Hotelling, is in its current operationaland popular form due to Clawson(1959) andKnetsch (1964). In the 1980s, two importantvariants of the basic travel cost model—varying-parameter travel cost model(Maddala, 1983) andhedonic travel cost model(Brown and Mendel-sohn, 1984) were developed to analyze qualitychanges. These methods have been used mainlyfor the valuation of recreation sites. A hedonicprice model was first used by Griliches(1971),and it was further developed and refined by Rosen(1974). Ciriacy-Wantrup(1947), suggested the useof direct interviews (contingent valuation) tomeasure non-traditional values of naturalresources. Davis(1963), first used this method toestimate the benefits of outdoor recreation. In the1980s and 1990s, it has been used extensively todetermine values of a wide range of non-conven-

tional forest values, including ecological and envi-ronmental goods and services. Cummings et al.(1986), and Mitchell and Carson(1989), providea detailed discussion on theoretical and appliedaspects of contingent valuation. Recently, choicemodelling has been used to value ecological andenvironmental services(Adamowicz et al., 1998;Rolfe et al., 2000). However, the theoretical11

validity of non-market valuations depends directlyon the validity of the neo-classical axioms ofconsumer choice theory. But, these axioms do12

not confirm the accepted models of human behav-ior, and have been challenged by ecological econ-omists (Georgescu-Rogen, 1971; Gowdy andMayumi, 2001), socio-economists(Etzioni, 1988),post-Keynesian economists(Lavoie, 1993),humanistic economists(Lutz and Lux, 1979), andeconomists working with agent-based models(Epstein, 1999).Neo-classical consumer choice theory assumes

the invariance of preferences, non-satiation, asmooth and continuous utility function(ruling outlexicographic preferences), no distinction betweenneeds and wants, and reducibility of all wants intomoney. 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; Bohnetand Frey, 1999), there is satiation with almostevery good and service, except perhaps with mon-ey (Gowdy and Mayumi, 2001); lexicographicpreferences are ubiquitous, such that food cannotsubstitute for sex, bread cannot save someonedying of thirst (Georgescu-Rogen, 1954; Lavoie,

Some other economic issues, such as valuation of biodiv-11

ersity, externalities, sustainability, and green accounting, havealso attracted the attention of forest economists in the last 30years. As stated in the first section, while we do not intend toreview the whole literature on forest economics, most of thisliterature and literature on environmental economics in general,is within the boundaries of neo-classical economics, and issubject to the limitations discussed in this paper.

In addition, the incongruity problem(Vatn and Bromley,12

1994), discounting the future(Arrow et al., 1995), the exis-tence of pure uncertainty(Bishop, 1979; Gowdy and Mc-Daniel, 1995), and equal marginal utility of income(Medinet al., 2001) are other limitations of these methods. Hence,the CV is a deeply flawed methodology for measuring non-consumptive values(Diamond and Hausman, 1994).


1993), and wants are distinct from needs(Lutzand Lux, 1979; Lavoie, 1993). In view of theselimitations, ecological economists and economistsfrom other streams of economics mentioned abovehave suggested an alternate consumer choice the-ory. The main principles of this theory are theprinciples of procedural rationality, satiable wants,non-independence, subordination of needs, irreduc-ibility of needs, and growth of needs. Proceduralrationality consists of means to avoid complexcalculations and considerations and of proceduresof decision-making even in the absence of full oraccurate information. Some of these proceduresare rules and habits. The principle of satiationimplies that eventually more of one good or moreof a characteristic will bring less supplementarysatisfaction. Satiation often arises with positiveprices and finite income while in neo-classicaleconomics, it arises only if prices are null orincomes are infinite. Following the principle ofnon-independence, decisions and preferences arenot made independently of those of other agents.The principle of the subordination of needs isrelated to hierarchy of needs. The principle ofirreducibility states that some needs cannot besubstituted for others, and as a consequence, eve-rything does not have a price. Finally, the principleof the growth of needs means that the growth ofreal incomes will induce new needs.In addition to consumer choice theory, ecologi-

cal economics has some other main features. Forexample, ecological economists are extending thematerial balance and energetic paradigm of ecolo-gy to economic questions(Ayres, 1978; Costanzaand Herendeen, 1984), and are using biologicalevolutionary theory to understand co-evolution ofnatural and social systems(Norgaard, 1981). Eco-logical economics recognises the problem of deci-sion-making in an uncertain environment andwarns that even the precautionary principle setsthe first stage of this approach. One of the mainfeatures of ecological economics is the integrationof natural and social systems. These distinct fea-tures of ecological economics, and other relatedstreams of economics, also indicate towards thepresence of multiple equilibria.

6. Evolution of forest management

In nineteenth century, central Europe, forestrywas a profitable activity, and forest was to bemanaged in a manner to ensure continued profit.Faustmann was much concerned about these pract-icalities, and his formulation was a direct result ofthese conditions. In this way, Faustmann’s formu-lation was a true depiction of a realistic situation,where the main objective was financial gain. Else-where, including Britain and the British colonies,the early nineteenth century was characterized bylarge-scale deforestation. This was followed by theinitiation of forest management activities through-out Britain and the British colonies, in the latenineteenth and early twentieth century. However,in these countries also, profit from timber andtimber yield regulation were the main concerns offorest management, and Faustmann’s formulationwas relevant in those social conditions. In the post-Second World War era,(1945–1970), forests weretreated as catalytic agents for industrialization andeconomic development(Westoby, 1987), and themain emphasis remained on profit from timber.During this period, the other main feature of forestmanagement was the exclusion of local peoplefrom forests.In the 1970s, when the fulfillment of the basic

needs of the rural poor became an ingredient ofrural development, the critical role of forests inthe life of forest-dependent rural communities,which had been excluded from forest use, was re-established(Barraclough and Ghimire, 1995; Pof-fenberger and McGean, 1996). The United NationsConference on Human Environment(1972)brought environmental issues to the forefront, andsince this time environmental movements havebeen strengthening in the developed as well as thedeveloping world. In the developing world, duringthe last 30 years, forest management has beentransforming from the forest regimes installed bycolonial rulers to forest regimes that are the resultof activism of new pressure groups that haveemerged due to freedom of thought, expression,and action(Kant and Berry, 2002). Similarly, inthe developed world, the activism of environmentalgroups has forced national governments to includenon-timber returns in their forest management


regimes. The World Commission on Environmentand Development(1987), brought further attentionto the deteriorating health of forests and emphasi-sed ‘sustainable development’, defined as the abil-ity to meet ‘the needs of the present withoutcompromising the ability of future generations tomeet their own needs.’ In view of these develop-ments, the concept of sustained yield has beenreplaced by the concept of SFM, and many inter-national initiatives have marked the process ofdefining SFM, for example the Helsinki Processfor European forests, the Montreal Process fornon-European temperate and boreal forests, theInternational Tropical Timber Organisation processfor tropical forests(Rametsteiner, 2000). Worldleaders attending the Earth Summit(1992)acknowledged the social, cultural, recreational, andspiritual values of forests, and viewed these bene-fits as fundamental to successful SFM. The basicelements of SFM are the maintenance andenhancement of forest ecosystems and their con-tribution to global ecological cycles, the conser-vation of biodiversity, soil, and water resources,multiple benefits from forests, and participatoryforest management(CCFM, 1995). Hence, the13

main features of SFM, which distinguish it fromthe sustained yield forest management, can begrouped into social and ecological aspects. On14

the social side, SFM includes people in decision-making, and incorporates multiple values(valuepluralism) and intergeneration equity. On ecologi-cal side, it recognises the holistic nature of inter-actions among components of forest ecosystemson different temporal and spatial scales, and focus-es on long-term ecosystem sustainability. The rec-ognition of these features brings to the fore thepotential conflict between these obligations and

Many other terms, such as multi-resource management,13

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 integrativethan that of the existing concept of multiple-use managementin the USA which emerged as an outcome of the EndangeredSpecies Act of 1973 and National Forest Management Act of1976.

Detailed discussion of the differences between two forest14

management paradigms is available in Bengston(1994) andBehan(1990).

the neo-classical economic framework(Toman etal., 1996).

7. Emerging economic thoughts and emergingissues in forest management

These two categories of the features of the newparadigm of forest management—social and eco-logical—have direct linkages to emerging econom-ic thoughts. In the traditional forest managementby exclusion of people, preferences were fixed andstationary; other factors such as the value systemand the rate of time preference were exogenousand were decided either by the government or bythe market. Institutions were exogenous, and therole of institutions in economically optimal out-comes was neglected. The decision criterion was15

based on single-dimensional utility(profit) maxi-mization. However, in the case of inclusion ofpeople in forest management, preferences, values,and other factors will become endogenous, andthese will vary across the range of stakeholdersand will also change with time. Multiple forestvalues will satisfy different levels of needs. Forexample, the needs that are being satisfied by usevalues will be either physiological needs or safetyneeds of Maslow’s pyramid(lower-level needs),while the needs satisfied by existence values andspiritual values, will be the social needs of thepyramid (higher-level needs). The utilities, then,derived from different forest values for differentlevels of needs cannot be aggregated into a singlenumber. The decision criterion will also vary withstakeholders: in some cases, such as Aboriginaland environmental groups, normative factors willbe dominant while economic factors will be dom-inant in industrial groups. Hence, an appropriateeconomic analysis will require the use of alternateconsumer choice theory, discussed in Section 5.Heterogeneity among agents(due to variation inpreferences and other factors) and interactionamong these agents will require the use of agent-

Regulations to exclude local people from forest use were15

thought of as necessary and sufficient institutions to take careof economic efficiency in forest management, and it wasassumed that these institutions could be designed, implement-ed, and monitored at zero cost.


based models to understand and explain the out-comes 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 becomean integral part of institutions, and the optimalinstitutions will vary across diverse socio-econom-ic conditions. The evolutionary nature of social,cultural, and other institutions will lead to evolu-tion in optimal forest management regimes over aperiod. Hence, the real outcome will be dynamicmultiple equilibria. In addition, inclusion of insti-tutions in the total production process will proba-bly change the nature of the production functionitself. Because institutions are information basedthey have demonstrated increasing returns(North,1990, p. 92–104). Hence, the inclusion of institu-tions in the total production process will likelytransform production from decreasing returns toincreasing returns, at least in situations where thereare no well-established institutions or institutionalarrangements are in an infancy stage. This willalso lead to multiple equilibria outcomes insteadof a single equilibrium outcome. Hence, the eco-nomics of SFM has to be based on the economicsof multiple equilibria.The holistic nature of SFM demands the study

of interactions within natural systems and betweennatural systems and human systems, and it requiresa shift from the neo-classical approach to theecological economics approach. The depth of eco-logical uncertainty is much more intense than theuncertainties associated with human systems, andour knowledge of diffuse ecosystem services is farpoorer than the knowledge of timber products(Toman et al., 1996). Non-concavities have alreadybeen reported in the joint production functions oftwo goods, timber and wildlife. Production func-tions and value functions for more than two goodswill likely contain non-concavities leading to thenon-feasibility of a single equilibrium. In addition,the concept of maximization becomes irrelevant,theoretically as well as practically, in the case ofmultiple objective management. The positive valueof all objectives is the only viable alternative thatis similar to Alchian’s argument of positive profits.All interactions within natural systems and many

interactions between natural systems and humansystems do not take place through markets, butvarious institutions play a critical role in theseinteractions. Hence, economically-efficient equilib-rium will not be determined by the market. Instead,the ‘routines’(as discussed in Section 3) of foreststakeholders and management organisations willdetermine the choice of one optimal point out ofmany optimal points. Overtime, as these routines(capabilities and rules) are modified, a path ofselection of optimal points will emerge. But, inthe case of forest resources, this path will be anoutcome of interactive(between social systemsand natural systems) evolutionary process, inwhich both routines and genes will be importantelements. The path of movement from one optimalpoint to another point will partially depend(fromthe perspective of human systems) upon self-reinforcing mechanisms. In these circumstances,16

the existing institutions and the dynamics ofinstitutions will become critical for SFM. There-17

fore, the existing multiple-use and multiple criteriamodels, which are insensitive to institutions, willnot be sufficient to address the issue of SFM.Clearly, the holistic nature of SFM will require thedevelopment of a new economic theory of multipleequilibria that will integrate biological and eco-nomic evolution, and the concepts of evolutionary,institutional, and ecological economics.

8. Basic principles of the economics of sustain-able forest management

The discussion in the previous sections high-lights two necessary elements of the economics ofSFM—multiple equilibria and new consumerchoice theory. However, as illustrated in Section

Arthur (1988), identified four generic sources of self-16

reinforcing mechanisms: large set-up or fixed costs, learningeffects, coordination effects, and adaptive expectation toexplain technological change. North(1990) used these mech-anisms to explain the path-dependent nature of institutionalchange.

Kant (2001), found that the evolution of forest regimes17

in India and China(two culturally, historically, and politicallydifferent countries) is path-dependent, and the four self-reinforcing mechanisms, identified by Arthur and used byNorth, play an important role in the path-dependence of forestregimes.


7, the economics of SFM will require encompass-ing and integrating the concepts from differentstreams of emerging economic thoughts. This inte-gration cannot be achieved in a single mathemati-cal model, and SFM will require a complete neweconomic framework. Readers who may haveexpected to find another model for the economicsof SFM in this paper may be disappointed. How-ever, the five principles discussed below maybecome the foundations of the economics of SFMand 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 aremet without compromising the ability of futuregenerations to meet their own needs. This ideademands elements of altruistic and cooperativebehavior among social agents in contrast to theself-interest-maximizing rational agent of neo-clas-sical economics. Everyone is selfish as well asaltruistic, and everyone tends to be more of onethan the other at a given time, but everyone iscapable of both selfishness and altruism in differ-ent frames of reference. Uphoff(1992), arguesthat an individual’s value dispositions are similarto probability distributions that may be normalwith the mean in the centre or skewed towardsselfishness or altruism. As long as there is even asmall chance that one will be selfish(or altruistic),one may act this way. But, neo-classical econom-ics, based on Newtonian equilibrium guided bythe ‘either–or’ principle, is unable to incorporatesuch probabilistic behavior of social agents. Incor-poration of such behavior may be possible ineconomic models that are based on the ‘both–and’principle that has been accepted by post-Newto-nian physicists of the twentieth century. Under18

the umbrella of the ‘both–and’ principle, four sub-principles—principles of existence, relativity,uncertainty, and complementarity—will be of par-

In nineteenth century physics, the universe was made up18

of billiard-ball type atoms that followed the Newtonian law ofmotion. Hence the relationship between matter and energy wasof ‘either–or’. In the twentieth century, Einstein’s two con-cepts—the theory of relativity and the dual nature of aparticle—brought new dimensions to physics. According tothe theory of relativity, two apparently mutually exclusiveconditions may co-exist from different perspectives(frames ofreference) (Uphoff, 1992, p. 307). Similarly, the dual natureof particle supports the ‘both–and’ principle.

amount importance to guide the evolution of theeconomics of SFM.19

The ‘principle of existence’ suggests that wecannot ignore the existing situations because theseconditions have survived for a long time. Hence,we should start from the economic analysis of theexisting situations in human-forest interactive sys-tems, to examine the effects of proposed changes,and to attempt to decide whether the new situationswould be, in total, better or worse than the existingsituations. The choice of forest rotation based onannual allowable cut, also known as forester’srotation, which has dominated the forestry practic-es all over the world for centuries against alleconomic arguments of forest economists, is agood example of this principle. It is possible thatdue to many uncertainties in forest production,positive profit rather than maximum profit is aviable and economically optimal alternative, or thetransaction cost of changing from forester’s rota-tion to Faustmann’s rotation may be higher thanthe benefits from this change, or use of forester’srotation may be the case of increasing returns.Forest economists have never examined these pos-sible economic explanations of forester’s rotation.The ‘principle of relativity’ suggests that an opti-mal solution is not an absolute but rather a relativeconcept. Hence, optimal solutions will be situationspecific, and in many cases will be beyond marketforces. For example, two different models of forestmanagement, the co-management of forests forAboriginal values and private management of for-est for industrial values can be economically opti-mal in the frame of reference of Aboriginal peopleand forest industries, respectively. However, co-management may be economically inefficient inthe frame of reference of forest industries andsimilarly private management in the frame ofreference of Aboriginal people. The ‘principle ofuncertainty’ suggests that due to uncertainties innatural and social systems, a social agent maynever be able to maximize his outcomes, but willalways search for positive outcomes, and therefore,resource allocation will be improved by adaptive

Some of these principles are similar to the principles19

discussed by Uphoff(1992).


efficiency and not by allocative efficiency. The20

‘principle of complementarity’ suggests thathuman behavior may be selfish as well as altruistic,people can have economic values as well as moralvalues, and people need forests to satisfy theirlower level needs as well as higher level needs.Hence, the economics of SFM should be based oncomplementarity, as against the principle of sub-stitution, which is dominant in forest economics.

9. Conclusions

The concept of SFM is the reflection of social,economic, and environmental conditions of thelate twentieth and early twenty-first century, whichare quite different from the conditions of nine-teenth and early twentieth century. Managementprinciples and silviculture of SFM are quite differ-ent than the management principles and silvicul-ture of forest management based on timber-yieldregulation. Similarly, the economic principles ofSFM need to be reflective of social, economic,and environmental conditions of twenty-first cen-tury and management principles and silvicultureof SFM. The silviculture of the Faustmann formulacontinues to have a direct application for plantationforestry, but not to the SFM. As demonstrated inthis paper, existing forest economic models,including Faustmann’s formulation, must berefined, and some new economic theories andmodels must be developed to incorporate thefeatures of SFM.The two dominant requirements of the econom-

ics of SFM are the economics of multiple equili-bria, and a consumer choice theory thatincorporates context specific and dynamic prefer-ences, heterogeneous agents, distinction betweenneeds and wants, and subordination of needs.These two requirements are beyond the boundariesof neo-classical economics. The boundaries offorest economics will have to be extended. The

Adaptive efficiency is concerned with the kinds of insti-20

tutions that shape the way an economy evolves over time. Itincludes the willingness of a society to acquire knowledge andlearning, 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 forestmanagement in available in Kant and Berry(2001).

five basic principles suggested in Section 8 of thispaper and the economic principles, developed byevolutionary, institutional, ecological economistsand economists from other new streams of eco-nomics, will be the tools to extend these bounda-ries in appropriate directions.

Acknowledgments

Some parts of this paper were presented at theInternational Symposium—150 years of the Faust-mann Formula: The Consequences for Forestryand Economics in the Past, Present and Future—held at Darmstadt, Germany, October 3–6, 1999.The author is thankful to participants who madetheir valuable comments and suggestions duringthe presentation. Financial support from the SocialScience and Humanities Research Council(SSHRC), Canada(Grant Number 410990343)and Natural Science and Engineering ResearchCouncil (NSERC), Canada (Grant Number203032-98) are also acknowledged.

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Extending the boundaries of forest economics

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