chapter 2 engaging the private sector in forest...

Sustainable forest management (SFM) requires sub-stantial financial resources. Developing countriesneed to explore and encourage all sources and mech-

anisms of funding for the forest sector to achieve SFM. Theprivate sector is expected to play the lead role in global eco-nomic and production activities. Private investment in theforestry sector in developing countries and countries intransition is estimated at US$15 billion per year, or up tonine times more than current official development assis-tance flows.1

To date, private investment in SFM has been concen-trated in developed countries. Although this trend is chang-ing, the need remains to motivate similar investment indeveloping countries to maximize the full potential of SFM,because investments required for harvesting and processingcan be large (for example, establishing a modern pulp millcan cost the better part of US$1 billion). Investments on thisscale can only come from global corporations or joint ven-tures involving local partners and development banks will-ing to cover the risk. Furthermore, ensuring that these largeinvestments are made in a socially and environmentallyresponsible manner is essential to preventing destructiveuse of forest resources.

When discussing the need to attract investment to theforest sector in developing countries, many organizationsand governments tend to focus on large-scale internationalinvestors. However, the majority of the markets are domes-tic: For example, as much as 86 percent of the wood har-vested in the Brazilian Amazon is consumed within Brazil,

and log exports from West and Central Africa account foronly 20 percent of the 25 million cubic meters harvested peryear. Although developed countries now consume approxi-mately 70 percent of industrial roundwood, consumptiongrowth in developing countries is narrowing the gap: Theconsumption of industrial roundwood in developing coun-tries grew by 3.2 percent per year in 1996–97, in contrast todeveloped countries, where it grew by only 0.6 percent peryear (Victor and Ausubel 2000). In the forest sector, it wouldbe logical for much of the new global private investment totry to capture the financial gains from these rising domesticmarkets in developing countries, where the majority of theworld’s natural tropical forests are located. This aligns withglobal trends that show that while foreign direct investmentremains important in developing countries for foreignexchange earnings and skills and technology transfer, thebulk of private investment remains domestic across all sec-tors (ITTO 2006).

The forest products industry supplies a wide range ofessential products—from construction materials, paper,sanitary products, and specialty chemicals to watershed andsoil conservation—from a renewable resource. It providesmillions of jobs and supports thousands of local communi-ties with an annual production of about US$750 billion(WBCSD 2006).

Considerable potential exists in these investments todeliver benefits to farmers, small forest owners, local com-munities, and Indigenous Peoples. Forest investment caninvolve small- and large-scale investments and can bring

63

Engaging the Private Sector in Forest Sector Development

C H A P T E R 2

together communities and companies through partnershiparrangements, build small and medium enterprises (SMEs),or enable socially responsible corporate investments. SMEsare a major potential source for off-farm employment inrural areas (Molnar et al. 2006).

PAST ACTIVITIES

The International Finance Corporation (IFC), the privatesector arm of the World Bank Group, promotes sustainableprivate sector investment to foster economic developmentand reduce poverty. The IFC finances investments with itsown resources and by mobilizing capital in the internationalfinancial markets. In addition to equity and loan financing,IFC also provides technical assistance to its clients, eitherfunded by grants or by the clients themselves.

Between fiscal2 2003 and fiscal 2006, the IFC invested morethan US$1 billion to help finance 25 forestry sector projectswith a total cost of about US$4 billion (figure 2.1). The size ofprojects fluctuated between US$3 million (a packaging projectin the Kyrgyz Republic) and US$500 million (a paper millproject in China). The pulp and paper industry accounted for56 percent of the total, while 33 percent was directed at thewood-based panel and engineered-wood products industries,with some small investments made in sawmilling and furni-ture production. The share of forestry projects in private sec-tor financing was 11 percent and on the increase. The IFC hasnot invested in projects requiring raw material from naturaltropical moist forests. During this period, about half of IFC

projects included an integrated forestry component. IFC tech-nical assistance was mostly targeted at specific projects butsome sector work was also carried out.3

Geographically, Europe and Central Asia (ECA) attractedmost IFC financing during the 2003–06 period followed byEast Asia and the Pacific (EAP), Latin America and theCaribbean (LAC), South Asia (SAR), and the Middle Eastand North Africa (MENA) (figure 2.2). Only one Africancountry appears in the IFC portfolio during the period.4

IFC projects concentrated in 16 countries, and the Bank hadforestry lending activities in 10 of them, indicating a con-siderable geographic overlap.5

The relatively high proportion of IFC investment chan-neled to the ECA region reflects the importance of the Russ-ian Federation’s forest industries and the emerging forestindustrial investment opportunities in Eastern Europeantransition countries. In both EAP and LAC, the IFC’s maininvestments have been in rapidly expanding pulp and paperindustries in China, India, and Brazil.

Although the link to poverty alleviation may not bedirect in most IFC investments, the project companies oftengenerate significant employment, ranging from a few hun-

64 CHAPTER 2: ENGAGING THE PRIVATE SECTOR IN FOREST SECTOR DEVELOPMENT

The IFC has a Global Manufacturing and ServicesDepartment, within which there is a Forest Prod-ucts Sector. The portfolio of projects from this sec-tor spans a diverse group of pulp, paper, and con-verted products, ranging from linter and strawpulp to tissue, sacks, and various kinds of packag-ing. The sector involves dealing with sensitivepolitical, social, and environmental issues. Amongthe greatest risks are severe environmental andhuman health impacts associated with antiquatedtechnology and poor forest practices.

Subsector categories in this sector include plan-tations, wood fiber, and woodworking.

Source: http://www.ifc.org/ifcext/gms.nsf/Content/Forest_Products_Overview.

Box 2.1 IFC Projects in the Forest Products Sector

45111

41

348

443

205

1000

200300400500

2001 2002 2003 2004 2005 2006

Fiscal year

US$

mill

ion

Figure 2.1 IFC Forest Sector Investments

SAR13%

MENA4%

LAC21%

ECA37%

EAP25%

Figure 2.2 IFC Forest Investments Regional Distribution,2003–06

dred to tens of thousands of new jobs. Indirect employmentimpacts can be many times higher than direct employment,in particular when considering the forestry component.

While almost all the investments to date relate to largeindustrial projects, the IFC has a particular interest in sup-porting the expansion and sustainable management ofupstream fiber sources. Greater IFC involvement in forestrycan enhance the positive impacts of industrial developmentin environmental conservation, economic development,and poverty alleviation while possible negative impacts canbe better mitigated.6

The International Development Association and Inter-national Bank for Reconstruction and Development arms ofthe World Bank Group have invested in enabling privatesector engagement in the forest sector in different ways. InFY05, the Bank financed the Cameroon Forest and Environ-ment development policy loan to help consolidate and scaleup recent successful forest sector policy reforms, supportcapacity building, and strengthen forest and environmentinstitutions. In this loan, a prior action for release of the sec-ond tranche included signed contracts with companiesmeeting requirements and implementation of appropriatemeasures, including the withdrawal of concession, if appro-priate, for companies failing to meet requirements. Simi-larly, in the Lao People’s Democratic Republic poverty sup-port reduction credit, there were prior actions that includedcompleting requirements for independent certification ofsustainable forest management and establishing a forest sec-tor monitoring system. The World Bank has also beeninvesting in activities enabling payments for environmentservices (see details in note 2.3, Innovative MarketingArrangements for Environmental Services).

In addition to lending, since 2004, the World WildlifeFund (WWF) Global Forest and Trade Network (GFTN)has been involved in World Bank–WWF Global ForestAlliance activities by building up enterprise-level capacityfor certification and linking responsible suppliers with buy-ers (for example in Ghana, Indonesia, Nicaragua, Peru, Rus-sia, and Vietnam). In Nicaragua, the cooperation of theGFTN resulted in IFC support for local companies toachieve certification. A financing mechanism for forest con-cessionaires was developed in Peru. Development of timbertracking systems has been supported in Cambodia,Nicaragua, Peru, and in the Congo Basin countries. To pro-mote responsible investment in forest management, PRO-FOR (Program on Forests) and the World Bank–WWFAlliance for Forest Conservation and Sustainable Use haveorganized three investment forums (a global forum in 2004,and regional forums in East Africa in 2004 and in South

Africa in 2006) that have focused on the development of theSME sector in forest-based activities within the frameworkof poverty reduction.

KEY ISSUES

Numerous private sector actors. A variety of privatesector actors, all with different interests, capabilities, andconstraints, influence the forest sector, including

■ large multinational companies,■ local companies of varying sizes,■ individual private investors (for example, conservation

investments by philanthropists),■ community or cooperative enterprises applying SFM,

and ■ small-scale forest owners.

Primary manufacturers might include chainsaw opera-tors or small sawmills, in addition to large corporationswhose annual sales might be larger than the gross domesticproduct (GDP) of many developing countries. All have thepotential to invest productively, create jobs, and expand—thereby contributing to economic growth and povertyreduction. Each type of business (or investment opportu-nity) can be affected differently by changes in internationaland domestic markets, as well as by changes in governmen-tal policies and the general in-country business and invest-ment environments (ITTO 2006).

Factors influencing private sector investment. Factorsthat influence private sector decisions about forest-relatedinvestments include the following:

■ Returns. Sufficient returns are a prerequisite; therefore,any factors that reduce the returns or profits from theinvestment can act as a deterrent.

■ Risks. Weighing returns against risks, private investorsgenerally demand much higher returns (typically 15 per-cent to 30 percent) from developing countries whererisks are (or can be perceived as being) high.

■ Transaction costs. High transaction costs can makeinvestments less attractive. For example, evidence indi-cates that small investors in particular find it difficult tomeet the additional costs associated with SFM (see note3.2, Forest Certification Systems).

Elements of an enabling environment. To encouragethe private sector to invest in SFM with full confidence and

CHAPTER 2: ENGAGING THE PRIVATE SECTOR IN FOREST SECTOR DEVELOPMENT 65

commitment, an enabling environment has severaldimensions, both national and international. Some of thefactors may be outside the forest sector’s control, yet theyneed to be addressed to promote investment in SFM. Keyenabling actions include the following:

■ Reducing domestic policy and institutional problemsthat restrain or discourage private sector engagement inSFM—for example, avoiding excessive and inappropriateregulations and bureaucracy that contribute to undulyhigh costs of registering companies and undertakingmanagement.

■ Seeking ministerial commitment for legislative and otherpolicy reforms that will help to contain illegal loggingand create a level playing field for responsible companiesthat are willing to invest in SFM (see chapter 5, Improv-ing Forest Governance, and associated notes). The will-ingness of high-level political leaders and more responsi-ble companies to engage in supporting such initiatives asthe European Union– and World Bank-supported ForestLaw Enforcement and Governance Program has beenencouraging.

■ Facilitating political stability necessary to assure in-vestors.

■ Assisting governments to engage private sector compa-nies and local communities in dialogue regardingreforming timber allocation processes, achieving equi-table revenue sharing, taxation and revenue collectionsystems, encouraging value added processing, and ensur-ing a secure supply of raw material.

■ Assisting governments to develop transparent timberallocation procedures and concession policies that willhelp to ensure a secure supply of raw material for poten-tial client companies, thus reducing the perception ofrisk for investors. Lack of security threatens the continu-ity of manufacturing operations.

■ Ensuring stable and clear policies, institutions, and oper-ating environments, including those related to tenureand concessions.

■ Developing instruments or drawing upon existinginstruments to hedge against excessive market fluctua-tions and seek mechanisms for better prices in interna-tional markets, and seeking ways to deter major marketsfrom buying low-priced supplies from unsustainablesources that unfairly undermine responsible suppliersseeking to achieve SFM (see note 3.2, Forest CertificationSystems).

■ Ensuring relevant training and skills development andresearch for the forestry sector.

■ Helping to expand the profit base of SFM investmentsthrough environmental services (see note 2.3, Small andMedium Enterprises).

Potential for relationships between companies andcommunities in the forest sector. With time and effort,some of the existing relationships between companies andcommunities could mature from superficial deals into realpartnerships (Mayers and Vermeulen 2002; Howard et al. 2005;Nawir and Santoso 2005; Vermeulen and Walubengo 2006).These cover the full range of forest goods and services and awide variety of partnership models, including the following:

■ In outgrower schemes and sales or purchase contracts,small-scale farmers grow trees or NTFPs on their ownplots with support from the company (such as technicaladvice, seed stock, fertilizers, pesticides, tools, harvest-ing) and with guaranteed purchase, sometimes at guar-anteed prices.

■ In joint ventures, companies and communities makecapital coinvestments in goods or service projects, possi-bly sharing management. Often the community’s capitalinvestment is land or labor. In simpler lease models, thecompany pays a fee for use rights on community landover a fixed period and the community plays no part inmanagement.

■ In multiple land-use arrangements on land under com-pany freehold or leasehold, communities are grantedaccess rights and management rights to noncore goodsand services, typically NTFPs in forest areas managedprimarily for timber production.

■ In social responsibility contracts, the forestry companynegotiates a social license to operate within environmen-tal and cultural limits set by the community; in return,the company receives the benefit of local investments,usually infrastructural. Globally, SMEs represent one ofthe faster growing industrial sectors in the world. Forest-based SMEs (SMFEs) account for 80–90 percent of all theforest enterprises in many countries (box 2.2). For manycountries, more than 50 percent of total forest-relatedemployment is in SMFEs, with approximately 20 millionpeople employed worldwide. SMFEs generate a grossvalue added of about US$130 billion per year (Macqueenand others 2006). Greater awareness of the potential ofSMFEs to contribute to essential subsistence needs and topoverty alleviation and economic growth is needed (seenote 2.2, Small and Medium Enterprises). Such awarenessshould inform both forest policies and policies regardingmarket access, credit, and other relevant macro policies.


MARKETS FOR FOREST ENVIRONMENTAL SERVICES. Markets for environmental services need further development andmay require the creation of an enabling environment forprivate sector investment in this area. This could be facilitatedby providing greater clarity on the potential financial benefitsof environmental services and greater certainty regarding theassociated markets (see note 2.3, Innovative MarketingArrangements for Environmental Services).

Consensus is growing that investment in the sector has tooccur within a credible framework of safeguards and envi-ronmental assessment procedures. These have to motivateresponsible investment and deter unsustainable anddestructive activities. There is a need to address such issuesas the identification and protection of forests that are a highpriority for biodiversity conservation, protection of rightsand resource interests of Indigenous Peoples and otherforest-dependent people, certification and other systems ofindependent verification of forest management perfor-mance, and establishment and management of forest andagricultural tree-crop plantations (see note 1.3, IndigenousPeoples and Forests, and section II, Guide to Implementing,Forests Policy OP 4.36). The various safeguard initiativesalso need to be harmonized and extended to a broader rangeof investing groups.

FUTURE PRIORITIES FOR ACTIVITIES

Increasing demand for forest products, especially in devel-oping countries, indicates that investment in the forest sec-tor will likely expand. Major prospects are in Brazil, China,

India, and Russia. To ensure that the growing private invest-ment generates benefits for a wide range of forest users andforest-dependent households, some priority actions mustbe taken:

Increase availability of and access to financing forsmall-scale forestry and wood processing.Opportunities that would provide funding for small-scaleenterprises and mechanisms that would strengthen thesupply chain for SMEs should be explored.

Provide incentives for the private sector to manage(rather than solely log) natural forests, to adopt a longer-term and broader view of forests (even for plantationforestry and the timber processing industry), take onemerging opportunities, and reduce perceptions of risk.

Remove constraints related to investments insustainable management of natural tropicalforests. This should be done by the internationalcommunity (the Bank and the IFC in cooperation withother donors and intergovernmental organizations [such asITTO], nongovernmental organizations [NGOs], and theprivate sector) in collaboration with governments. Theobjective should be to enable policy reform to improve theinvestment environment and strengthen the policy andregulatory frameworks for responsible investment.

Continue providing support to the establishment, andon-the-ground implementation, of environmentallysound legal and regulatory standards and capacity,which are essential to creating the necessary preconditions forthe sustainable operation of the predominantly downstreamprivate operators. Because forest-based investments areusually made with a long-term time horizon, all means tomitigate risks are particularly important for private investors.Risk mitigation through enabling conditions is key in thedecision making of responsible private investors.

Build capacity at all levels to address the lack ofcapacity in many developing countries to adequatelyimplement environmental assessment procedures andsafeguards. This increased capacity would developmultistakeholder institutional mechanisms for monitoringforest harvesting and management, especially where theseare weak. The presence of visible and strong institutionalmechanisms to implement monitoring of environmentalprocedures and safeguards can substantially contribute toproject risk mitigation and would both encourage and


Since 1995, Brazilian small and medium enter-prises have grown annually by 2.8 percent and 4.7percent, respectively—much faster than largerenterprises—despite having a higher failure ratethan larger companies, with 39 percent failing inBrazil within the first year (a reasonably averagefailure rate globally for small and medium enter-prises (May, Da Vinha, and Macqueen 2003)). Log-ging by SMFEs in Guyana contributes almost asmuch to the revenue of the Guyana Forestry Com-mission as do large enterprises (Thomas et al.2003). In China, more than 90 percent of the totalvalue of wood products is generated by SMFEs(Sun and Chen 2003).

Source: ITTO 2006.

Box 2.2 The Prevalence of SMFEs

support socially and environmentally responsiblecompanies.

Continue further collaboration between the Bankand the IFC. IFC investments in an environmentallysustainable private company can demonstrate profitabilitywithin the framework of a Bank-supported regulatorystructure (supply response), and it is at this intersection thatthe benefits of collaboration are strongest. Areas where theBank and the IFC should increase collaboration include thefollowing:

■ promotion of investment in forest-based, small-scaleenterprises;

■ increased exchange of information at the country,regional, global, and research levels;

■ further cooperation in areas where engagement hasalready been demonstrated to be beneficial (for example,the IFC could enhance the use of the GFTN of the WorldBank–WWF Alliance in linking its investments withresponsible buyers); and

■ additional Bank economic and sector work and analyti-cal and advisory activities, especially those related to gov-ernance reform, that can help create enabling conditionsfor IFC investment projects.7

NOTES

1. In 2002 the World Bank estimated that total forest sectorprivate investment in developing countries and countries intransition was about US$8 billion to US$10 billion per year.This may underestimate actual private sector investment.According to the FAO (2005), the plantation area in develop-ing countries is increasing at about 1.8 million hectares peryear. This represents investments of US$3 billion to US$4 bil-lion per year. Improvements in existing forest managementshould be added to this, but reliable estimates do not exist. Inplantation-based projects, industrial investments represent80–90 percent of the total. Applying this coefficient—withplantation investments being 20 percent of the total—totalforest investment in developing countries should be at leastUS$15 billion.

2. The World Bank operates according to a fiscal year thatbegins July 1 and ends June 30.

3. As an example, there is ongoing work to prepare astrategic plan for the pulp and paper industry in Ukraine.

4. This appears to be due to the scarcity of companies thatcan meet IFC criteria for support.

5. The regional analysis is based on the projects with a totalvalue of US$800 million. In two countries without the

Bank’s forest lending, there are practically no productionforests.

6. The upstream forestry activities have significant poten-tial for rural poverty reduction. As an example, IFC projectsin India have engaged 135,000 farmers or families in coop-erative arrangements with pulp and paper companies, cov-ering a total area of 128,000 hectares. Each family typicallyallocates 1 to 2 hectares to forest plantation to increase theirincome, demonstrating that primarily poor households areinvolved in these schemes. Similar arrangements are alsobeing supported by IFC-financed projects in Brazil. IFC hasalso provided technical assistance to small-scale, forest-based operations in Central America through the LAC Pro-ject Development Facility in collaboration with the GFTN.The future impact of these investments can be significantfor employment and local income, if such efforts movebeyond technical assistance.

7. Several economic and sector work and analytical andadvisory activity products developed under the WorldBank’s forest partnerships are directly related to this issue(see annex 2A to this chapter for a list of some products).

SELECTED READINGS

FAO (Food and Agriculture Organization of the UnitedNations). 2005. “Global Forest Resources Assessment2005: Progress Towards Sustainable Forest Manage-ment.” FAO Forestry Paper 147, FAO, Rome.

Mayers, James. 2006. “Poverty Reduction Through Com-mercial Forestry. What Evidence? What Prospects?” TFDPublication No. 2, School of Forestry and EnvironmentalStudies, Yale University, New Haven, CT.

Mayers, J., and A. Vermeulen. 2002. Company-CommunityPartnerships in Forestry: From Raw Deals to MutualGains? Instruments for Sustainable Private SectorForestry series. London: International Institute for Envi-ronment and Development.

Pagiola, S., and G. Platais. 2007. Payments for EnvironmentalServices: From Theory to Practice. Washington, DC: WorldBank.

REFERENCES CITED

ITTO (International Tropical Timber Organization). 2006.Tropical Forest Update 16 (2).

Howard, M., P. Matikinca, D. Mitchell, F. Brown, F. Lewis, I.Mahlangu, A. Msimang, P. Nixon, and T. Radebe. 2005.Small-Scale Timber Production in South Africa: What Rolein Reducing Poverty? Small and Medium Forest Enter-prise Series 9. London: International Institute for Envi-ronment and Development.


Macqueen, D., N. Armitage, M. Jaecky, 2006. Report of ameeting of participants of the UK Tropical Forest Forumon small enterprise development and forests RoyalBotanic Gardens, Kew 26 September 2006. IIED, London.

May, P. H., V. G. Da Vinha, and D. J. Macqueen. 2003. “Smalland Medium Forest Enterprise in Brazil.” Grupo Econo-mia do Meio Ambiente e Desenvolvimento Sustentável(GEMA) and International Institute for Environmentand Development (IIED), London.


Molnar, A., M. Liddle, C. Bracer, A. Khare, A. White, and J.Bull. 2006. “Community-Based Forest Enterprises inTropical Forest Countries: Status and Potential.” Reportto the ITTO. Forest Trends/Rights and Resources Group,Washington, DC.

Nawir, A. A., and L. Santoso. 2005. “Mutually BeneficialCompany-Community Partnerships in PlantationDevelopment: Emerging Lessons from Indonesia.” Inter-national Forestry Review 7 (3): 177–92.

Sun, C., and X. Chen. 2003. “Small and Medium ForestryEnterprises in China: An Initial Review of Sustainabilityand Livelihood Issues.” Research Center of Ecological andEnvironmental Economics (RCEEE) and IIED, London.

Thomas, R., D. J. Macqueen, Y. Hawker, and T. DeMen-donca. 2003. “Small and Medium Forest Enterprises inGuyana.” Guyana Forestry Commission (GFC) and IIED,London.

Vermeulen, S., and D. Walubengo. 2006. “Developing Part-nerships for Sustainable Management of Forests inKenya: Review of Existing Models and Set of Options forFurther Support.” Report prepared for the ForestryDepartment, Government of Kenya, and PROFOR (Pro-gram on Forests), World Bank. International Institute forEnvironment and Development, London.

Victor, D.G., and Jesse H. Ausubel 2000. “Restoring theForests.” Foreign Affairs 79(6):127-144, November/December 2000.

WBCSD (World Business Council for Sustainable Develop-ment). 2006. “Forest Products Industry.” http://tinyurl.com/36fcrw.

CROSS-REFERENCED CHAPTERS AND NOTES

Note 1.3: Indigenous Peoples and Forests

Notes following chapter 2: Engaging the Private Sector inForest Sector Development

Note 3.2: Forest Certification Systems

Chapter 5: Improving Forest Governmance, and associatednotes


Blaser, J., A. Contreras, T. Oksanen, E. Puustjarvi, and F.Schmithusen. 2005. “Forest Law Enforcement and Gov-ernance (FLEG) in Europe and North Asia (ENA).” Ref-erence paper prepared for the Ministerial Conference, St.Petersburg Russia, Nov. 22–25, 2005.

Chen, H. K. 2006. The Role of CITES in Combating IllegalLogging: Current and Potential. Cambridge: TRAFFICInternational.

China National Forestry Economic Development Center.2006. “A Background Paper on Forest Law Enforcementand Governance in China.” Draft.

Colchester, M. 2006. Justice in the Forest: Rural Livelihoodsand Forest Law Enforcement. CIFOR Forest Perspectives3. Bogor, Indonesia: CIFOR.

Contreras-Hermosilla, A. 2002. Law Compliance in theForestry Sector: An Overview. WBI Working Papers.World Bank Institute, The World Bank 2002. Also avail-able at: http://lnweb18.worldbank.org/eap/eap.nsf/2500ec5f1a2d9bad852568a3006f557d/c19065b26241f0b247256ac30010e5ff?OpenDocument.

Dykstra, D. P., G. Kuru, R. Taylor, R. Nussbaum, W. B.Magrath, and J. Story. 2003. “Technologies for WoodTracking: Verifying and Monitoring the Chain of Cus-tody and Legal Compliance in the Timber Industry.”Environment and Social Development East Asia and thePacific Region Discussion Paper, The World Bank, Wash-ington, DC, 2003.

ECSSD/PROFOR. 2005. Forest Institutions in Transition:Experiences and Lessons from Eastern Europe. TheWorld Bank, Washington, DC, February 2005.

Gray, J. 2002. Forest Concession Policies and Revenue Sys-tems: Country Experience and Policy Changes for Sus-tainable Tropical Forestry, World Bank Technical PaperNo. 522, The World Bank, Washington, DC, 2002.

International Union for the Conservation of Nature andNatural Resources (IUCN). 2006. Illegal Logging: A Com-mitment to Change Through Tripartite Action. Gland,Switzerland: IUCN.

Kishor, N. 2004. Review of Formal and Informal Costs andRevenues Related to Timber Harvesting, Transportingand Trading in Indonesia. World Bank informal note.2004.

Magrath, W. B., R. Grandalski, J. Stuckey, G. Vikanes, and G.Wilkinson. Forthcoming. Timber Theft Prevention andForest Resource Security. Washington, DC: World Bank.

PAF. 2004. Benchmarking Public Services Delivery at theForest Fringes in Jharkhand, India. Public Affairs Foun-dation, Bangalore, India, October 2004.

Puustjarvi, E. 2006a. “Proposal for Typology of Illegal Log-ging.” Draft. Savcor Indufor Oy, Helsinki

———. 2006b. “Guidelines for Formulating and Imple-menting National Action Plans to Combat Illegal Log-ging and Other Forest Crime.” Draft. Savcor Indufor Oy,Helsinki.

Rosenbaum, K. L. 2005.Tools for civil society action toreduce forest corruption: Drawing lessons from Trans-parency International. PROFOR/FIN, The World Bank,Washington, DC, 2005

Savcor Indufor Oy. 2005a. “Ensuring Sustainability ofForests and Livelihoods Through Improved Governanceand Control of Illegal Logging for Economies in Transi-tion: World Bank Discussion Paper.” Helsinki.

———. 2005b. “Action Plan to Combat Illegal Activities inForest and Wood Processing Sectors in Bosnia andHerzegovina.” Draft. Savcor Indufor Oy, Helsinki.

World Bank. 2003. Reforming Forest Fiscal Systems: AnOverview of Country Approaches and Experiences.PROFOR, The World Bank, Washington, February 2003.

———. 2005a. “Going, Going, Gone: The Illegal Trade inWildlife in East and Southeast Asia.” Discussion Paper.Environment and Social Development, East Asia andPacific Region, World Bank, Washington, DC.

———. 2005b. East Asia Region Forestry Strategy. Washing-ton, DC: World Bank.

———. 2006a. Strengthening Forest Law Enforcement andGovernance: Strengthening a Systemic Constraint toSustainable Development. Report No. 36638-GLB, WorldBank, Washington, DC.

———. 2006b. Forest Law: Manual for Sustainable Develop-ment. Washington, DC: World Bank.


ANNEX 2A WORLD BANK ANALYTICAL AND ADVISORY ACTIVITIES AND ECONOMIC AND SECTOR WORK RELATED TO GOVERNANCE REFORM

71

COMPANY-COMMUNITY PARTNERSHIPS

N OT E 2 . 1

Company-community partnerships in forestry areactive agreements for the production of forestgoods and services in which the parties share ben-

efits, costs, and risks with the expectation of a mutuallybeneficial outcome. Companies are formal entities organ-ized for making a profit, and range from large multinationalcorporations to small-scale local businesses. Communitiesinclude local farmers, households, and community-levelunits of social organization, such as producer groups or vil-lage councils.

Most partnerships to date have formed around produc-tion of industrial pulpwood (outgrower, joint venture, andlease schemes) and high-quality timber (mainly leaseschemes). NTFP-based partnerships are most important inthe case of high-value NTFPs (such as certain resins andmedicinal plants). A niche is now growing for partnershipsaround forest ecosystem services, including carbon seques-tration, watershed management, biodiversity, and eco-tourism (see note 2.3, Innovative Marketing Arrangementsfor Environmental Services). The variety of partnershipmodels are covered in table 2.1.

Both company and community partners have a varietyof motives for entering into agreements. Immediate eco-nomic motives include access to niche markets, access to

Table 2.1 Company-Community Partnership Models for Different Forest Goods and Services

Partnership modelJoint venture Multiple land

Outgrower or or lease on use on Social responsibility Forest good or service sales contract community land company land contract

Timber and wood fiber ✓ (see box 2.3) ✓ — ✓ (see box 2.4)Nontimber forest products ✓ (see box 2.5) — ✓ (see box 2.6) ✓

Ecosystem services — ✓ (see box 2.7) ✓ ✓

Source: Vermeulen 2006.Note: ✓ = Such partnerships are feasible. — = Not applicable.

The company Xylo Indah Pratama manufacturespencils for sale through Faber Castell, Germany.Because of wood supply shortages and the need toaccess wood from certified sources, the companyset up an outgrower scheme in 1995 with localfarmers, using low-value uncultivated land togrow Alstonia scholaris. Grower contracts over 11years are based on a 50:50 profit-sharing ratio,with the company providing most inputs, butland-owning farmers free to sell to other buyers ifthe company is unable to absorb the harvest atcurrent market prices. Farmers have benefitedfrom early revenues through trimming, and at fullharvest (from 2005 onward) returns are aboutUS$450 per hectare to both company andcommunity.

Sources: LATIN 2000; Nawir and Santoso 2005.

Box 2.3 Outgrower Contract for Wood Production:Xylo Indah Pratama, Indonesia


Vegext processes and exports wattle tannin, but itsfactory is currently working far below capacity as aresult of short supplies of wattle bark (Acaciamearnsii). Hence, the company, in partnershipwith a forestry NGO, has developed purchaseagreements with wattle farmers. Vegext agrees tocollect bark from any farm within 70 km of its col-lection yard at Eldoret and to pay a higher pricethan competitors; indeed, one of the company’sobjectives is to raise wattle prices so that farmersconsider wattle an attractive alternative to othertree crops and seasonal crops. The NGO connectsfarmers with traders who will buy the debarkedlogs for charcoal production, further raisingreturns to wattle production.

Sources: Vermeulen and Walubengo 2006.

Box 2.5 Purchase Agreement for Nontimber ForestProducts: Vegext Limited, Kenya

In 1996 the company Rainforest Expeditionssigned a 20-year joint venture agreement with theEse’eja community of Tambopata in southeasternPeru. The company and community agreed tojointly manage 9,600 hectares of land (to whichthe community has legal title) and a tourist lodge,sharing profits 60:40 between the community andthe company, to reflect relative investments ofland, labor, and finance. The company agreed tohand over all assets to the community at the end ofthe joint venture. The agreement came to an earlyclose, satisfactory to both sides, when the commu-nity bought out the company’s share using aninternational grant. The community has sincebuilt on its strengths, opening a research center atthe site and winning the Conservation Interna-tional ecotourism award in 2000.

Sources: Stronza 2000; Landell-Mills and Porras 2002;http://www.wildland.com.

Box 2.7 Joint Venture for Ecosystem Services:Posada Amazonas Ecotourism, Peru

Mondi Fine Paper SA has an arrangement whereby40 beekeepers from local communities are allowedto keep hives in Mondi-operated forests in the PortDunford, Umfolozi, and Melmoth areas. Mondihas paid for each beekeeper to receive technicaland business training. One beekeeper running 20hives realizes about 12,000 South African rand(US$1,700) per season (February–July) throughthe sale of honey to local buyers. Mondi runs thisscheme partially via the consortium SiyaQhubekaForests, which is the first Black Economic Empow-erment company to acquire significant shares inSouth African forestry, having successfully bid for26,450 hectares of privatized forest land in Kwa-Zulu Natal.

Sources: www.siyaqhubeka.co.za; www.mondi.co.za.

Box 2.6 Multiple Land Use on Company Land:Beekeeping and Mondi, South Africa

Ghanaian legislation requires logging companiesto negotiate social responsibility agreements withcommunities as a condition for granting conces-sions. The agreement between Bibiani LumberCompany and the Stool of the Omanhene, Ghana,signed in 2000, requires the company to constructboreholes, latrines, and roads; to avoid all cultur-ally significant sites and taboo days; to consult thecommunity over planned logging routes and sid-ings; and to restore any accidental damage. Theagreement also spells out terms for payment ofstumpage fees and royalties to the community, forcontinued NTFP access and sale by the commu-nity and for dispute settlement.

Source: Yeboah 2001.

Box 2.4 Social Responsibility Contract for TimberProduction (with Lease of Use Rights andan NTFP Agreement): Bibiani LumberCompany and the Stool (Chief) of theOmanhene, Ghana

NOTE 2.1: COMPANY-COMMUNITY PARTNERSHIPS 73

inputs (communities), and cost savings (companies), whilelonger-term motives include social responsibility and secur-ing land tenure or long-term use rights.

Company-community forestry partnerships have thepotential to contribute to Bank objectives of SFM and ruraldevelopment. A recent international review (Vermeulen andWalubengo, 2006) concluded that these partnerships canhelp communities reduce risk, achieve better returns onland use, diversify income sources, access paid employment,develop new skills, upgrade infrastructure, and enhanceecosystem management. They are also a mechanism forcompanies to practice SFM on their own land (Brody et al.2006). However, company-community partnerships havenot yet proved sufficient to lift people out of poverty andremain supplementary rather than central to incomegeneration.

OPERATIONAL ASPECTS

Context and conditions for partnerships. Experienceshows that company-community forestry partnerships canemerge under a wide range of political and economicconditions. In considering whether partnerships may beappropriate—and what kinds of partnerships are likely towork—some important conditions to consider include thefollowing:

■ Production and markets– Sound business. Artificial promotion of partnerships

for social gains will not work—an internationallycompetitive ratio of benefits to costs and risks mustbe demonstrated for specific forest products at the sitelevel.

– Integrated land use. Trees for fiber and fuel competewith food crops and grazing land and may or may notprovide differential environmental services—partnerships will only work where a locally appropri-ate balance is achieved.

– Multiple use. Opportunities for multiple land use atone site favor the use of partnerships (such as com-bining timber production, NTFP production, andecosystem functions).

– Market maturity. New production systems and newmarkets favor tight contractual partnerships whiledeveloped, open markets favor looser arrangements.

– Access to technology and information. Insufficient tech-nical and market knowledge among communities is amajor disincentive to formation of partnerships.

■ Policy and governance– Land tenure. Changes in land and resource tenure

(such as the privatization of state forests or securingof collective land title) often precipitate partnershipsbecause partners need new deals to access forestproduction.

– Forest sector incentives. In some countries, specific pol-icy statements encourage partnerships (such as thecomanagement requirements for state forest land).

– Extra-sectoral incentives. Some policies are generally pro-partnership, such as those that encourage decentraliza-tion (see note 5.1, Decentralized Forest Management) orprovide incentives to indigenous or small-scale business,while particular policies encourage different types ofpartnership (for example, environmental tax breaksfavoring ecosystem service partnerships).

– Governance. Implementation and survival of partner-ships require considerable backstopping, includingfunctional courts and efficient systems for legal recog-nition of representative bodies (see note 5.4, Strength-ening Fiscal Systems in the Forest Sector).1

– Private-sector policy. Multinational corporate policiescan precipitate transfer of partnership modelsinternationally.

Contractual arrangements. Partnership models may bebased on successful arrangements elsewhere—and initialnegotiations often depend on an external moderator. Typicalagreements, verbal or written, include terms for financialand technical inputs, loan repayments, and benefit-sharing.Partners involved can benefit from advice and oversight oncontractual terms (see Mayers and Vermeulen [2002] forguidance), and options for making the most of externalincentive schemes should be explored, including carboncredits, certification, or business compacts.

Time requirement for forming partnerships. It takescontinual investment over long periods to buildpartnerships. Experience to date reveals three broadscenarios for the development of company-communityforestry relationships: (i) little constitutive change over longperiods, with the company partner taking the lead indirecting the partnership; (ii) strengthening of thecommunity partner’s position, such as renegotiation ofbenefit sharing or the community forming a company; and(iii) dissolution of the partnership (see “Ending aPartnership” below). A move toward tighter partnerships isnot always desirable—in buoyant, competitive forest

product markets, looser arrangements that are sensitive todemand and price trends will be much more sustainable.

Importance of Risk and operational flexibility.Partnerships are a means to share risks, particularly thoseassociated with production and markets. Adaptability hasproved to be key to the success of company-communitypartnerships. Best practices include allowance in contractsfor flexible technical features (for example, partial earlyharvesting of timber, annual reassessments of NTFP offtake,variable levies for tourism or other ecosystem services),flexible loan repayment terms, provisions for alternativeavenues for marketing in the event of over- or under-harvest, well-defined terms for managing any disputes, andrenegotiating the contract on a regular basis.

Transaction costs and power sharing. Dealing with alarge number of scattered farmers or groups is a majorchallenge, not only for technical reasons (extension,harvesting, transport) but also for collective decision making.Power sharing is critical for both equity and resilience ofpartnerships (Ashman 2001). For communities, the solutionis to create economies of scale and raise bargaining power byjoining or forming farmers’ groups, cooperatives, and othercoalitions. Even small associations have been successful insaving costs and improving marketing—but so far there arefew examples of communities improving partnership termsthrough collective bargaining.

Ending a partnership. Some partnerships havedisintegrated amid bad faith and litigation. However,termination does not necessarily mean failure, andconversely, close partnerships may outlive their utility. Aspriorities and market opportunities shift, partners maymake strategic choices away from formal collaborationtoward looser working relations. For the community, thepartnership may be a steppingstone to developing viableindependent enterprises, while for the company, theincreased business acumen within the community providesreliable new opportunities (to develop and supply high-quality products and services, for instance).

LESSONS LEARNED AND RECOMMENDATIONSFOR PRACTITIONERS

Company-community partnerships take a long time toestablish—they are built on trust gained through experi-ence. The World Bank and other third parties can play a cru-

cial role in enabling and supporting company-communitypartnerships for the benefit of local livelihoods and SFM.

■ Existing local organizations are an important route tobuilding deal-brokering capacity in communities. Theselocal organizations often have the institutional flexibilityto service community needs independent of externalinfluences and the potential to provide equitable repre-sentation and a forum for equitable negotiation.

■ Empowerment must be an explicit objective of partner-ship schemes. Often the poorest people are only partici-pants as contractors to those with land. To enable com-munity empowerment, arrangements for revenuesharing, sharing ownership in downstream processing,and other broader joint ventures are important. Empow-erment must be an objective if partnerships are to sub-stantively raise people out of poverty.

■ Greater attention must be given to forming enterprisepartnerships with entities other than limited liabilitycompanies. Partnership structures, such as cooperatives,should also be explored.

■ The details of benefit sharing and cost and risk sharingshould be examined closely to ensure that the term “part-nership” describes arrangements that are equitable for allparties.

■ Local communities may often need legal assistance toclarify their land ownership rights and in negotiatingsuch rights.

■ There is a risk that benefits may only accrue to a smallsection of the community (for example, outgrowerhouseholds) while the community at large may sufferloss of land rights and resource access (livestock house-holds, for instance), leading to a need to examine bothbusiness projection and local tenure arrangements (legaland customary) to ensure such outcomes are avoided.

Explore current options and future scenarios forpartnerships. This includes supporting work towardincreasing understanding of practical arrangements forefficient and equitable community-company partnerships.It is important to build understanding in the community ofpractice of the impacts of corporate social responsibilityand the cooperative movement. Equally important is toexploit the willingness of companies to network oncompany-community partnerships (for example, inIndonesia and South Africa). Leading companies cancontinue to exchange experiences and to experiment withinnovative tools that promote equitable company-


NOTE 2.1: COMPANY-COMMUNITY PARTNERSHIPS 75

community arrangements, such as ethical supply chainmanagement and transparent corporate reporting. Thesecompanies lead the way by going beyond legislativerequirements to explore pioneering partnership models.

Promote access to insurance, credit, and legal andbusiness services. Community partners would gain muchfrom mechanisms to mitigate risk independently, outsidethe partnership. Such mechanisms can be developed byinvesting in insurance schemes that explore alternativepolicies for small-scale producers and strengthening safetynets for community members who may lose if a partnershipends. Communities involved in partnerships would alsobenefit from independent arbitration and assistance withlegal aid in the event of legal actions. There have beenadvancements in small-scale finance schemes, yet moresupport is needed. Business information and advisoryservices for partners also still need support.

Support capacity building for business skilldevelopment. The performance of community partnerswould improve further through support to capacity-building in business (for example, understandingorganizational and contractual models, market niches andmarket standing, technology and innovation, managementof costs, and future trends). The capacity of communityinstitutions and individuals needs to be strengthened innegotiation skills, negotiation of contractual terms, andbusiness development. Greater support for development ofcommunity entrepreneurship is also important.

Ensure policy coherence and accessibility. Partnershipsare influenced by government policy and service provisionacross several sectors (for example, land, tax, trade,agriculture, forestry). Companies, communities, and theirsupporters repeatedly raise the need for national and localgovernments to coordinate and clarify relevant incentives,regulations, and agencies (Howard et al. 2005; Vidal 2005a,2005b). While industry standards can help, governments andinternational bodies need to guard against stringency thatfavors the largest players in the industry at the expense ofsmaller, locally owned companies. To ensure this, members ofrepresentative community bodies should be included inpolicy dialogue at the national level. Governments would gainfrom support in development of complementary oralternative partnership facilitation services.

Support the development of value added productsand services. Few company-community partnerships go

beyond production or site management. Communitypartners can reap far greater benefits if they are able tocapture a share of value added operations, such as timbersawmills, downstream processing of NTFPs, or add-ons toecosystem management (tailored tourism facilities, forinstance; see box 2.5 and box 2.7 for examples). Supporterscould also facilitate new business links that helpcommunities secure a larger share of the value chain (forexample, Fair Trade). New initiatives that include multipleroles for the community can help to bring benefits to thepoorest members of the community who are otherwiseexcluded (by providing employment to landless people, forinstance).

Support community networks and theirrepresentation. Associations and coalitions continue tobe the most effective routes for communities to raisebargaining power. Support to networks and associations ofcommunity interests and emerging small businesses willhelp, as will efforts to increase meaningful representation bysmall-scale providers of forest goods and services in existingplatforms for the forestry industry. Existing bodies thatrepresent community interests are both legitimate anddynamic and may be forest specific or formed aroundagriculture.

NOTE

1. An ongoing IIED-supported program currently opera-tional in 10 countries is supporting strengthening of bar-gaining power of local communities that are in the course ofnegotiating fair prices and legally enforced safe workingconditions.

SELECTED READINGS: REVIEWS


Nussbaum, R. 2002. “Group Certification for Forests: APractical Guide.” ProForest, Oxford.

Scherr, S., A. White, and D. Kaimowitz. 2003. “Making Mar-kets Work for Forest Communities.” InternationalForestry Review 5 (1): 67–73.

Vermeulen, S., A. A. Nawir, and J. Mayers. Forthcoming.“Rural Poverty Reduction Through Business Partner-ships? Examples of Experience from the Forestry Sector.”Environment, Development and Sustainability.

Wunder, S. 2005. “Payments for Environmental Services:Some Nuts and Bolts.” CIFOR Occasional Paper No. 42,Center for International Forestry Research, Indonesia.

SELECTED READINGS: COUNTRY CASES

Ashley, C., and Z. Ntshona. 2003. “Transforming Roles butnot Reality? Private Sector and Community Involvementin Tourism and Forestry Development on the WildCoast.” Overseas Development Institute, U.K., and Uni-versity of Western Cape, South Africa.

Howard, M., P. Matikinca, D. Mitchell, F. Brown, F. Lewis, I.Mahlangu, A. Msimang, P. Nixon, and T. Radebe. 2005.“Small-Scale Timber Production in South Africa: WhatRole in Reducing Poverty?” Small and Medium ForestEnterprise Series, Discussion Paper No. 9. London: Inter-national Institute for Environment and Development.

Mayers, J. 2006. “Poverty Reduction Through CommercialForestry. What Evidence? What Prospects?” TFD Publica-tion No. 2, School of Forestry and Environmental Stud-ies, Yale University, New Haven, CT.

Vermeulen, S., and D. Walubengo. 2006. “Developing Part-nerships for Sustainable Management of Forests inKenya: Review of Existing Models and Set of Options forFurther Support.” Report prepared for the Forest Depart-ment Kenya and PROFOR (Program on Forests), WorldBank. International Institute for Environment andDevelopment, London.

Vidal, N. 2005. “Forest Company-Community Agreementsin Mexico: Identifying Successful Models.” Forest Trends,Washington, DC.

REFERENCES CITED

Ashman, D. 2001. “Civil Society Collaboration with Busi-ness: Bringing Empowerment Back.” World Develop-ment 29: 1097–1113.

Brody, S. D., S. B. Cash, J. Dyke, and S. Thornton. 2006.“Motivations for the Forestry Industry to Participate inCollaborative Ecosystem Management Initiatives.” ForestPolicy and Economics 8: 123–34.

Howard, M., P. Matikinca, D. Mitchell, F. Brown, F. Lewis, I.Mahlangu, A. Msimang, P. Nixon, and T. Radebe. 2005.“Small-Scale Timber Production in South Africa: WhatRole in Reducing Poverty?” Small and Medium ForestEnterprise Series Discussion Paper No. 9. London: Inter-national Institute for Environment and Development.

Landell-Mills, N., and I. T. Porras. 2002. Silver Bullet orFools’ Gold? A Global Review of Markets for Forest Envi-

ronmental Services and Their Impacts on the Poor. Instru-ments for Sustainable Private Sector Forestry series. Lon-don: International Institute for Environment andDevelopment.

LATIN (Lembaga Alam Tropika Indonesia). 2000. “Corpo-rate Community Partnership Between PT Xylo IndahPratama and the Local Community in Musi Rawas Dis-trict, South Sumatera, Indonesia.” LATIN, Bogor,Indonesia, and International Institute for Environmentand Development, London.


Nawir, A. A., and L. Santoso. 2005. “Mutually BeneficialCompany-Community Partnerships in PlantationDevelopment: Emerging Lessons from Indonesia.” Inter-national Forestry Review 7 (3): 177–92.

Stronza, A. 2000. “‘Because It is Ours’: Community-BasedEcotourism in the Peruvian Amazon.” Unpublished the-sis, University of Florida at Gainesville.

Vermeulen, S. 2006. “Company-Community Partnerships.”Note submitted to World Bank as input to Forests Source-book. Unpublished. World Bank, Washington, DC.

Vermeulen, S., and D. Walubengo. 2006. “Developing Part-nerships for Sustainable Management of Forests inKenya: Review of Existing Models and Set of Options forFurther Support.” Report prepared for the Forest Depart-ment Kenya and PROFOR (Program on Forests), WorldBank. International Institute for Environment andDevelopment, London.

Vidal, N. 2005a. “Forest Company-Community Agreementsin Brazil: Current Status and Opportunities for Action.”Forest Trends, Washington, DC.

———. 2005b. “Forest Company-Community Agreementsin Mexico: Identifying Successful Models.” Forest Trends,Washington, DC.

Yeboah, R. 2001. “Short Report on Social ResponsibilityAgreements in Ghana.” International Institute for Envi-ronment and Development, London.


Note 2.3: Innovative Marketing Arrangements for Environ-mental Services

Note 5.1: Decentralized Forest Management

Note 5.4: Strengthening Fiscal Systems in the Forest Sector


77

SMFEs are business operations aimed at making profitfrom forest-based activity. They are commonlydefined by employment (between 10 and 99 full-time

employees), by annual turnover (US$10,000–US$30,000,000),or by annual roundwood consumption (3,000–20,000 cubicmeters) (Macqueen and Mayers 2006).

SMFEs can offer a trajectory out of poverty. SMFEs playa critical role in securing poor people’s basic needs, spread-ing wealth locally, enabling local innovation, and preservingcultural identity and practices (Macqueen 2005; Macqueenand Mayers 2006). SMFEs grouped together in clusters orassociations can reduce transaction costs for the poor,develop strategic alliances, and shape the policy environ-ment through lobbying on behalf of the poor (Macqueen,Figueiredo et al. 2005; Macqueen, Vermeulen et al. 2005).

SMFEs are diverse and complicated to deal with. SMFEdiversity is linked to a number of factors, including thatthey span both timber and NTFPs, and include rural pro-ducers, suppliers to large firms, primary and secondaryprocessors, and forest service providers. It is difficult tomake generalizations regarding SMFEs; thus, it is importantto consider the following:

■ how supportive the policy and institutional environ-ments are toward SMFEs (Macqueen 2005)

■ whether the market structure offers real opportunity ormerely options of last resort

■ whether the business structures adopted by SMFEs arethose of profit-driven companies, democraticallyaccountable social cooperatives, or something inbetween (Macqueen 2006)

■ whether SMFEs are isolated entities or an integral part ofa broader network

SMFEs tend to be underrepresented in policy initiativesand development programs. This could be on account ofthe following:

■ the complexity of linking with diverse SMFEs in multi-ple locations—even when they are grouped into associa-tions (there are 2,000–3,000 forest-based associations inUganda; Kazoora et al. 2006)

■ the constitutional diversity of these enterprises, whichdiminishes the likelihood of common agendas, lessonlearning, and diffusion of relevant solutions (Saigal et al.2006)

■ the small individual scale of each enterprise, whichreduces both per unit impact (that is, the perceived ben-efit to the development agency) and comparative humanand financial costs of compliance (that is, the perceivedbenefits to the enterprise)

■ The lack of formal incorporation and collateral throughwhich SMFEs become visible to public bodies and privatesector investors. For example, the informal economy makesup 41 percent of gross national income in developing coun-tries (Schneider 2002) and is highest where incomes andassets are not evenly distributed (Becker 2004)

Despite their potential, it can be challenging to makeSMFEs sustainable. Exploitative SMFEs can easily gounchecked. Informality, insecure tenure, low investment,and low profitability may reduce scope for social or envi-ronmental benefits. Lack of management capacity inSMFEs may lead to resource depletion. Risks are highestin “distress diversification,” where SMFEs seek refuge inlow-skill activities and seasonal migration for productswithout long-term prospects. High risks often lead policymakers and decision makers to marginalize SMFEs, butperhaps because of this, many self-help solutions haveevolved around local enterprise associations and net-works. Responsive support to these local institutions inareas such as market information, secure resource access,sustainable management, design and technology, andfinancial and business administration can make all thedifference.

Small and Medium Enterprises

N OT E 2 . 2


Due consideration should be given to the different valuesrecognized by different types of SMFEs. The diversity ofSMFEs is paralleled by a diversity of values. For example,profit-driven SMFEs may place economic values abovesocial or environmental concerns (Macqueen 2006), whilelocal or indigenous forest groups attribute up to 13 differentvalues to forests (Brown and Reed 2000), of which “com-mercial values” used by economists in cost-benefit analysisor internal rate of return calculations represent only 6 per-cent of the sum of scaled forest values (Rowcroft, Studley,and Ward 2006).

SMFEs have variable social impacts. Depending onenterprise type, management disposition, and circum-stances, SMFEs may differ in their social impact. Distressdiversification or “SMFEs of last resort” often fail to deliverincreasing social welfare. Particular care is required whereoutsourcing to SMFEs is prevalent (Clarke and Isaacs 2005),and greater benefits are evident in “upwardly mobile”SMFEs (Arnold and Townson 1998; Belcher, Ruiz-Perez,and Achdiawan 2005). For some products and services,market opportunities expand with the SMFE’s increasingincome, and the economic distance between SMFEs andlarge enterprise technologies, and employment standards,start to fall. Identifying which is which—whether the SMFEis of last resort or upwardly mobile—is a critical first stepfor appropriate intervention.

SMFEs have variable environmental impacts; enterprisetype, management disposition, and the policy environmentlargely determine environmental impacts. SMFEs may cutenvironmental corners in the search for economic competi-tiveness, especially if the underlying legal and regulatoryframework and government capacity for implementationare weak. Informality of operations, insecure tenure, inade-quate investment, and low profitability may reduce environ-mental benefits. For example, SMFEs face great difficultywith third-party certification (Higmann and Nussbaum2002) despite group schemes designed to accommodatethem (Forest Stewardship Council 2004). For many SMFEs,local accountability for environmental impacts can enhanceenvironmental quality, especially at the landscape level(Clay, Alcorn, and Butler 2000; Scherr, White, andKaimowitz 2004; Durst and others 2005).

OPERATIONAL ASPECTS

Annex 2.2A to this note provides a checklist of key issues toconsider to determine SMFE program direction and feasi-bility. This section discusses some of these issues in moredetail.

Strengthen transparent access to land andresources for SMFEs. There are no cure-alls that willensure transparent access to land and resources, andneither individual title, nor, conversely, community forestmanagement, strengthens SMFEs in all cases. In somecases, clear land titling helps. In others, it is the democraticinvolvement of marginalized groups in decisions overcommon land that is critical. A priority is to identify andaddress, jointly with SMFEs, ill-developed or poorlyunderstood codes and institutions that govern these rights(see note 1.4, Property and Access Rights). Many forestproducts or services with SMFE potential come fromcommon property resources, which cannot be privatized,thus collective rather than individual decisions arerequired.

Support local sovereignty and orient SMFEsprimarily to local product or service markets.SMFEs can flourish in situations where they respond to civilsociety concerns about where products are originating, howthey are produced, and who is profiting.1 With regard towider applicability, it is worthwhile to support SMFEs inidentifying demand in local markets that are not yet highlycompetitive, local skills that can be used, options forspecialization over time, and nonperishable products,unless excellent infrastructure exists. See box 2.8 forexamples from India and Guyana.

Identify “superior” products or services for whichdemand rises with increasing income. Products that areonly useful as subsistence safety nets or seasonal gap fillers

In India, the Madhya Pradesh Minor Forest Pro-duce Cooperative has successfully developed a taskforce on ayurvedic herbal medicines with a retailoutlet and consultations to support primary NTFPmedicinal plant collection and processing societies(Saigal and others 2006). In Guyana, the SuramaEco-tourism Enterprise has developed a tourismpackage to showcase Makushi cultural identity andnatural resources—a win-win combination forculturally sensitive development and the environ-ment (Ousman and others 2006). An importantlesson is that, unless ethical market niches or aunique world-class resource exists, it can beunwise to target export markets.

Box 2.8 Local Sovereignty, Markets, and SMFEs inIndia and Guyana

NOTE 2.2: SMALL AND MEDIUM ENTERPRISES 79

must be distinguished from products and services that canbe critical steppingstones out of poverty.

Improve information flows. SMFEs generally sufferfrom poor market information, and global communicationtechnology and market access favor large multinationals,often to the detriment of SMFEs. Timely marketinformation, through local radio networks or electronicmedia, can shift the balance back in their favor. For someproducts, local cultural tastes and the origin of productionstill count, which gives SMFEs local competitiveadvantages.

Help break up market monopolies. Market monopoliestend to exclude SMFEs—especially where large enterprisesand government officials collude. In India, for example, thenegative impact on small-scale producers of governmentmarketing corporations has been well documented.Systematic attempts to break up monopolies (andassociated collusion and corruption) require action at manylevels. Mobilizing local legal support groups or independentforest monitoring can be useful tactics.

Support appropriate economic incentives orcampaigns against unreasonable subsidies and tradebarriers—depending on circumstances. Free trade canbe biased toward larger enterprises because of inequities inpower and scale efficiencies. Depending on the context, itmay be necessary to ensure that trade reforms andeconomic incentives do not result in accumulation ofpower in the hands of a few, marginalizing small-scaleproducers.

Strengthen the capacity of SMFEs to attractinvestment. Building capacity for accurate riskassessments, installing policy interventions to underwritecollateral, and developing financial administration all canserve to attract investment. Transaction costs hamper theattempts of financial institutions to reach SMFEs—whooften rely on their own savings (Spantigati and Springfors2005). In some cases, group forest certification has been auseful tool for unlocking credit (see note 3.2, ForestCertification Systems).

Strengthen the capacity to negotiate financialdeals with investment agencies and big business. Thepotential often exists to combine financial capacitydevelopment, group lending schemes, and marketdevelopment (see box 2.9 for an example from Guatemala).

Seeking support through local institutions deserves widerapplication. Also, risk assessments should better reflectforest timeframes, seasonality, returns, and constraints sothat banks are better able to do business with SMFEs.

Build capacity in product or service design.Specialization is often critical to ongoing success.Information about what customers want can be obtainedthrough training courses in design, trade fairs, pooled marketresearch within an association, benign middlemen, orspecialized information services, such as market chainworkshops. Consumer concerns for fairer trade and moresustainable forest management drive networks thatspecifically target SMFEs and build their entrepreneurialcapacity—even if all of the final product or service is notdistributed through such channels.

Develop economic incentives or grants to supportthe needs of forest enterprise associations. Forestenterprise associations can help shape the policyenvironment, reduce transaction costs, and invest inadaptive strategies to take advantage of new opportunities.Specific administrative, financial, and technical trainingcan be extremely useful if properly targeted throughexisting associations (see box 2.10 for an example fromBrazil).

Devolve control over forest management to localSMFEs to reduce the risk of forest conflicts, whichare endemic to many forested areas.2 Insecure rights andinequitable resource use in remote forest areas breed

In Guatemala, community forest enterprises in theheavily forested Petén region managed to obtaincredit from two banks, Banrural and Bancafé. Thisachievement was based heavily on (i) support forclear tenure rights, such as the legal establishmentof a community concession system; (ii) technicalsupport from business development providers;(iii) strong partnerships (including advance pay-ments) with the timber industry and a dedicatedjoint marketing company (Forescom); and (iv) anassociation, Forest Communities of Petén, thatprovided bridging loans.

Source: Macqueen 2006.

Box 2.9 Building SMFE Negotiating Capacity

grievances—in more extreme cases providing the motiveand means for financing conflict (Kaimowitz 2005). Incertain circumstances, putting local resources into localhands may be most appropriate. Local SMFEs generallyhave a greater understanding of local social and politicalcontexts, stronger links with local civil society, and a greatercommitment to operating in a specific area than do large-scale enterprises. Inappropriate forest land allocation tolarge players (even if justified by more sustainable forestmanagement) may undermine local control and its “silentsocial responsibility” and generate conflict (Ozinga 2004).


Invest in understanding SMFEs and, if appropriate,initially work with pilots. Information on SMFEs indeveloping countries is often inadequate, especially forNTFPs (Thomas and others 2003), and it takes time to collectinformation and assess the impact of policies on SMFEs inthe field (Johnstone, Cau, and Norfolk 2004; Johnstone andothers 2004). SMFE staff are also usually heavily time-constrained and risk averse. Hidden constraints can preventexpansion of forest product activities. Available time, cultural

roles, social priorities, and misconceptions or mistrust of thelanguage of economic development can affect outcomes.Tools to get to know entrepreneurs are essential (Mangal andForte 2005). Smaller trial interventions with a long timeframe may be necessary for initial implementation.

Ensure that interventions are based on demand-drivenapproaches rather than approaches to supplyingcapacity. Trying to make what sells is invariably better thantrying to sell what can be made. Too often the focus of SMFEprograms is supply driven—for example, trying to createemployment or raise income levels (Artur and Kanji 2005).

Partnerships between large firms and SMFEs can helpto overcome some of the capacity deficits that constrainvertical adaptation and specialization. Fair deals that balanceresource supply with technological exchange from the largefirm is a model that has worked in instances where it is in theinterest of both sides. However, it must be assumed thatnegotiations are stacked in favor of large firms; thus, specifictools and processes should be used to equip SMFEs fornegotiating (Joaquim, Norfolk, and Macqueen 2005).

Work with existing enterprise associations. The vastmajority of SMFEs link themselves in some way toassociations that help to shape the policy environment,reduce transaction costs, and invest in adaptive strategies totake advantage of new opportunities. Good information canbe found about what makes associations work well (forexample, Agrawal 2001). Working with trusted intermediariesto support the specific training needs identified byassociations is fundamental to SMFE support (Macqueen,Figueiredo et al. 2006; Macqueen, Vermeulen et al. 2005).

Give preferential support to forms of enterprisethat are designed to achieve progressive social andenvironmental objectives. For some enterprises, such asassociations, cooperatives, and nonprofit companies linked tomarginalized groups, these objectives are as important asprofit, and it is worth providing preferential support to orprocurement policies for such aims (Macqueen 2006). Toolssuch as Fair Trade already exist that favor cooperative formsof enterprise or particular marginalized groups (for example,black economic empowerment procurement policies inSouth Africa or equivalents for First Nations in Canada).

Establish cross-agency coordination to simplify,stabilize, and implement pro-SMFE policies andsupport programs. In many countries, the burden of


In Brazil, the National Institute for Colonisationand Land Reform requires settlers to register anassociation to access government titles to land,housing, and infrastructure. Many of these associ-ations became dormant after this obligationpassed, but some, such as the Association of theSettlement Project California, have gone on toconsolidate their associations and pursue mem-bers’ interests, and having a representative bodyhas allowed potential partners to engage.

For example, the NGO GTA (Amazon WorkingGroup) has built milk and pork agro-industry facil-ities and fruit and honey processing units. Electric-ity was supplied through a government programcalled “Light in the Countryside.” Adult educationwas supplied through a government education pro-gram. Association members experimented withoutgrowing soybeans, but are now looking for gov-ernment support for biofuel production.

Source: Figueiredo and others 2006.

Box 2.10 Supporting Forest Enterprise Associationsin Brazil


overregulation falls most heavily on smaller enterprises (seebox 2.11 on South Africa). Experience has shown that SMFEsrequire a range of policy and support services and thatexternal intervention can help to ensure that there is somedegree of dialogue between such services, both to optimizewhat exists and to identify gaps.

Institutionalize mechanisms to coordinate SMFEactivities across multiple government authorities.Multiple overlapping authorities with varying responsibilitiescan often tie up the SMFE sector in red tape. Developing strongand clear advocacy messages within broad coalitions can shiftpolicies and institutions. For example, depending on thecontext, it may be useful to establish a cross-ministerial SMEdevelopment council or administrative body to coordinatepolicies. This might be linked with sector-specific SME centers,including forestry. In turn, these might interact with SMEinvestment companies and banks or technical and businesssupport companies, including cooperatives and credit unions.

Support for SMFEs can be channeled through leadersof local enterprise associations and cooperatives.Dynamic individuals (often necessary to the establishment ofan enterprise association) can serve as useful contact pointsabout how to channel support to SMFEs. Associations work

best when they arise independently without politicalpatronage; this should be supported rather than creating newinstitutions (Agrawal 2001).

Track and support extension networks of localactivists who support SMFEs. Experience has shownthat SMFE support programs run by local groups andactivists with long track records of community engagementcan be successful and overcome the problems of centralizedextension and support services that often bypass SMFEs(see box 2.12). Local networks can build administrative andtechnical capacity. It is vital that such local institutions, andthe SMFEs they support, are known and understood; thus,data on SMFEs and their supporting institutions need to becollected. Such data could inform the option of catalyzingand rolling out programs area by area.

NOTES

1. While this is the starting point for most communitiesand for many this is the market focus that remains, somecommunities and some products could have export oppor-tunities, especially for some commercially valuable NTFPs.

2. Reduction of forest conflicts through devolution of con-trol is partly contingent on efficient land and forest tenure.

SELECTED READINGS

Auren, R., and K. Krassowska. 2003. “Small and MediumForestry Enterprises in Uganda: How Can They be Prof-itable, Sustainable and Poverty Reducing?” UgandaForestry Sector Coordination Secretariat (FRSCS) andInternational Institute for Environment and Develop-ment (IIED), London.

In many countries the burden of overregulationfalls most heavily on smaller enterprises. Forexample, in South Africa the paperwork involvedwith value-added tax management, contributionsto the Unemployment Insurance Fund, districtmunicipality levies, and training levies can stretchsmall firms. Many useful support programs exist.For example, the Centre for Small Business Pro-motion (policy), the Ntsika Enterprise PromotionAgency (nonfinancial services), Khula EnterpriseFinance Limited (financial services), and the For-est Industry Education and Training Association(training) all provide useful services. However,overall leadership and coordination is lacking andmight be provided by some cross-ministerial SMEdevelopment council or brokering bodies thatcould coordinate policies, interact with investmentsources, and provide business support.

Source: Lewis and others 2003.

Box 2.11 South African SMFEs and the Burden of Bureaucracy

In Guyana the North Rupununi District Develop-ment Board has successfully supported a range oflocal initiatives, including a logging cooperative,an agricultural producers association, a revolvingdevelopment fund, a women’s revolving loanscheme, a credit and development trust, commu-nity natural resources management projects, andthe Bina Hill Training Institute (Ousman, Roberts,and Macqueen 2006). Local development of theseinitiatives followed methods documented else-where (Tilakarnata 1980; Albee and Boyd 1997).

Box 2.12 Supporting Local Activists Who SupportSMFEs in Guyana

Boyd, G. 2001. “Guidelines for a Poverty Focused Commu-nity Assistance Service.” Caledonia, Edinburgh, Scotland.

Carter, J.. and J. Gronow. 2005. “Recent Experience in Col-laborative Forest Management: A Review Paper.” CIFOROccasional Paper No. 43, CIFOR, Bogor, Indonesia.

FAO. 2005. State of the World’s Forests 2005. Rome: FAO.

Global Witness. 2005. “Independent Forest Monitoring: ATool for Social Justice?” Power Tools Series, Global Wit-ness, London, and International Institute for Environ-ment and Development, London.

Fisseha, Y. 1987. “Basic Features of Rural Small-Scale Forest-Based Processing Enterprises in Developing Countries.”In Small-Scale Forest-Based Processing Enterprises, ed.FAO. Rome: FAO.

IIED (International Institute for Environment and Devel-opment). 2004. Making Land Rights More Secure: Pro-ceedings of an International Workshop. Ouagadougou,March 19–21, 2002. London: IIED.

ILO (International Labour Organisation). 2001. Globaliza-tion and Sustainability: The Forestry and Wood Industrieson the Move. Geneva: ILO.

Lecup, I., and K. Nicholson. 2000. “Community-Based Treeand Forest Product Enterprises: Market Analysis andDevelopment.” FAO and RECOFT, Rome.

Macqueen, D. J., S. Bose, S. Bukula, C. Kazoora, S. Ousman,N. Porro, and H. Weyerhaueser. 2006. “WorkingTogether: Forest-Linked Small and Medium EnterpriseAssociations and Collective Action.” Gatekeeper series,IIED, London.

May, P. H., V. G. Da Vinha, and D. J. Macqueen. 2003. Smalland Medium Forest Enterprise in Brazil. London: GrupoEconomia do Meio Ambiente e Desenvolvimento Susten-tável (GEMA) and IIED.

Opoku, K., and E. Yaw Danso. 2005. “People’s Law: Ideas forResource Rights Campaigners.” Power tools series, ForestWatch Ghana, Accra, Ghana, and IIED, London.

Phi, L. T. 2005. “Better Business: Market Chain Workshops.”Power tools series, Non-timber Forest Products ResearchCentre, Hanoi, Vietnam, and IIED, London.

Redfern, A., and P. Snedker. 2002. “Creating Market Oppor-tunities for Small Enterprises: Experiences of the FairTrade Movement.” SEED Working Paper No. 30, Interna-tional Labour Office, Geneva, Switzerland.

Salafsky, N., B. Cordes, J. Parks, and C. Hochman. 1999.“Evaluating Linkages Between Business, the Environ-ment, and Local Communities: Final Analytical Resultsfrom the Biodiversity Conservation Network.” Biodiver-sity Support Program, Washington, DC.

Scherr, S. J., A. White, and D. Kaimowitz. 2004. “A NewAgenda for Forest Conservation and Poverty Reduction.”Forest Trends, Washington, DC.

Schreckenberg, K., E. Marshall, A. Newton, J. Rushton, and D.W. te Velde. 2006. “Commercialization of Non-TimberForest Products: Factors Influencing Success.” UNEPWorld Conservation Monitoring Centre, Cambridge, U.K.

Sun, C., and X. Chen. 2003. “Small and Medium ForestryEnterprises in China: An Initial Review of Sustainability andLivelihood Issues.” Research Center of Ecological and Envi-ronmental Economics (RCEEE) and IIED, London.

Vantomme, P. 2004. “Extraction of Nonwood Forest Prod-ucts.” In Challenges in Managing Forest GeneticResources for Livelihoods: Examples from Argentina andBrazil, ed. B. Vinceti, W. Amaral, and B. Meilleur, 51–69.Rome: International Plant Genetic Resources Institute.

REFERENCES CITED

Agrawal, A. 2001. “Common Property Institutions and Sus-tainable Governance of Resources.” World Development29 (10):1649–72.

Albee, A. and Boyd, G. 1997. “Doing it differently - networksof community development agents.” Caledonia, Edin-burgh, Scotland.

Arnold, J. E. M., and I. Townson. 1998. “Assessing the Poten-tial of Forest Product Activities to Contribute to RuralIncomes in Africa.” Natural Resource Perspectives No. 37,Overseas Development Institute, London.

Artur, L., and N. Kanji. 2005. “Satellites and Subsidies:Learning from Experience in Cashew Processing inNorthern Mozambique.” IIED, London.

Becker, K. F. 2004. “The Informal Economy. Fact FindingStudy.” Sida, Stockholm. http://www.sida.se/publications.

Belcher, B. M., M. Ruiz-Perez, and R. Achdiawan. 2005.“Global Patterns and Trends in the Use and Managementof Commercial NTFPs: Implications for Livelihoods.”World Development 33 (9):1435–52.

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Clarke, J., and M. Isaacs. 2005. “Forestry Contractors inSouth Africa: What Role in Reducing Poverty?” IIED,London.

Clay, J. W., J. Alcorn, and J. Butler. 2000. “Indigenous Peo-ples, Forest Management and Biodiversity Conserva-tion.” World Bank, Washington, DC.

Durst, P. B., C. Brown, H. D. Tacio, and M. Ishikawa, eds.2005. In Search of Excellence: Exemplary Forest Manage-ment in Asia and the Pacific. FAO and RECOFT, Bangkok,Thailand.

Figueiredo, L.D., Porro, N. and Pereira, L.S. 2006. “Associa-tions in Emergent Communities at the Amazon ForestFrontier, Mato Grosso.” Instituto de Pesquisa Ambiental



da Amazônia (IPAM) and the International Institute forEnvironment and Development (IIED), London.

FSC (Forest Stewardship Council). 2004. “SLIMF Stream-lined Certification Procedures: Summary.” FSC-POL-20-101. http://www.fsc.org/slimf/docs/FSC-POL-20-101%20SLIMF%20streamlined%20certification%20procedures.PDF.

Higman, S., and R. Nussbaum. 2002. “How Standards Con-strain the Certification of Small Forest Enterprises.” Pro-Forest, Oxford. http://www.proforest.net/ index3.htm.

Joaquim, E., S. Norfolk. and D. Macqueen. 2005. “Avanteconsulta! Effective consultation.” Power Tools Series,Terra Firma, Maputo, Mozambique, and IIED, London.

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Johnstone, R., B. Cau, S. Norfolk, and D. J. Macqueen. 2004.“The Good Average Bad (GAB) Framework for Scrutin-ising and Improving Legislation.” Terra Firma, Maputo,Mozambique.

Kaimowitz, D. 2005. “Forests and Armed Conflict.” EFTRN[European Tropical Forest Research Network] News43–44: 5–7.

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Lewis, F., J. Horn, M. Howard, and S. Ngubane. 2003. “Smalland Medium Enterprises in the Forestry Sector in SouthAfrica: An Analysis of Key Issues.” Institute of NaturalResources, Forestry South Africa and Fractal Forests, andIIED, London.

Macqueen, D. J. 2005. “Small Scale Enterprise and Sustain-able Development: Key Issues and Policy Opportunitiesto Improve Impact.” IIED, Edinburgh, U.K.

———. 2006. “Governance Towards Responsible ForestBusiness: Guidance on Different Types of Forest Businessand the Ethics to Which They Gravitate.” IIED, Edin-burgh, U.K.

Macqueen, D. J., L. Figueiredo, F. Merry, and N. Porro. 2005.“Stronger by Association: Small and Medium Scale For-est Enterprise in the Brazilian Amazon.” ParticipatoryLearning and Action 53: 31–36.

Macqueen, D. J., and J. Mayers. 2006. “Forestry’s Messy Mid-dle: A Review of Sustainability Issues for Small andMedium Forest Enterprises.” Unpublished, IIED, Edin-burgh, U.K.

Macqueen, D. J., S. Vermeulen, C. Kazoora, F. Merry, S.Ousman, S. Saigal, S. Wen, and H. Weyerhaeuser. 2005.“Advancement Through Association: Appropriate Sup-

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Saigal, S., S. Bose, P. Lal, M. Verma, and P. S. Pareek. 2006.“Small and Medium Forest Enterprise Associations inIndia: A Brief Overview.” IIED, London.

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Schneider, F. 2002. “Size and Measurement of the InformalEconomy in 110 Countries around the World.”Presented ata workshop of the Australian National Tax Centre, 17 July2002, Australian National University, Canberra, Australia.

Spantigati, P., and A. Springfors. 2006. Microfinance andForest-Based Small-Scale Enterprises. FAO Forestry PaperNo. 146. Rome: FAO.

Thomas, R., D. J. Macqueen, Y. Hawker, and T. DeMen-donca. 2003. “Small and Medium Forest Enterprises inGuyana.” Guyana Forestry Commission (GFC) and IIED,London.

Tilakarnata, S. 1980. “Organisation of the Poor. Lessonsfrom Sri Lanka.” http://www.caledonia.org.uk/siritila.htm.


Note 1.4: Property and Access Rights

Note 3.2: Forest Certification System


ANNEX 2.2A CHECKLIST OF KEY ISSUES TO DETERMINE SME PROGRAM DIRECTION ANDFEASIBILITY

Checklist of Key Issues

Key issue Possible intervention

Resource and infrastructure 1. Natural forest resources are insufficient to support Consider alternative investment programs or options linked to

enterprise development. cultivation.2. Natural forest resource ownership and access rights are not Consider support for land and natural resource reform programs,

secure, nor accessible to SMFEs. including education and awareness raising of current land tenure 3. Basic business infrastructure does not exist (telecommunications, anomalies and potential for remedial reforms.

energy, transport). Consider infrastructure development (bearing in mind potential environmental consequences).

Market structure issues4. Baseline diagnostics of SMFEs have not been carried out in-country. Start by commissioning an adequate baseline survey.5. An entrepreneurial target group has yet to be selected for Conduct a selection process, drawing on criteria from Poverty

further assistance. Reduction Strategy Papers, national strategic plans, and so forth.6. Specific market surveys for potential products or services have Identify specialized products and services whose demand rises

yet to be carried out. with increasing income.7. No overseas ethical market niches or unique world-class products Focus on developing products and services tailored to the local

suited to export have been identified. market.Social and environmental safeguard issues

8. There is a lack of information about the sustainable management Consider investing in baseline biological and ecological research of the natural resource in question. and in associated education and awareness raising.

9. Target groups are not using business forms that guarantee Actively support such enterprises—or strengthen local governance distribution of benefits (for example, cooperatives). enforcement.

Business structure issues10. Products or services are not specialized (beyond subsistence or Start by short-listing possible products or services for

seasonal gap-filler activities). specialization (for example, using FAO’s MA&D).11. There is a lack of business capacity within the target group. Ensure that capacity is developed and disseminated over a

specified period.Financial and technological issues12. Target groups are unaware of market trends, design, technology, Catalyse an information system that meets these needs (for

and the like. example, buy trade magazines).13. Target groups have inadequate financial services and lack Organize a mutual loan facility or develop forest-aware bank credit

collateral to take out loans. guarantee systems.Networking issues14. Target groups lack the organization needed to collectively reduce Introduce the idea of creating an association, based around

costs, adapt strategically, and lobby. principles of group success.15. There are no small enterprise support networks that connect Develop a communication platform to link SMFEs with support

SMFEs with service providers. services and customers.16. Specific product-based market support networks for the Consider support networks, such as Fair Trade, or push for

entrepreneurial targets do not exist. government procurement contracts.Policy and institutional issues17. SMFEs are not formally constituted (or evidence regarding Analyze the major bureaucratic and cost implications of formality,

this is inadequate). and simplify legislation.18. Surveys of policy and institutional constraints for SMFEs have Invest in an analysis of the main policy constraints.

yet to be carried out.19. Subsidies to small and large enterprises are inequitable. Lobby for judicious subsidies or a level playing field.20. Laws are not developed and/or enforced in a transparent Bring in independent monitors to expose corrupt practices and

and equitable manner. strengthen judicial capacity.

85

Forests can provide a wide variety of benefits outsidetheir boundaries. The main categories of such benefitsare as follows:

■ Watershed protection. Forests play an important role in reg-ulating hydrological flows and reducing sedimentation.Changes in forest cover can affect the quantity and qualityof water flows downstream, as well as their timing, in bothpositive and negative ways. A clear understanding of theseimpacts is crucial for ecologically sound forest land useplanning.

■ Biodiversity conservation. Forests harbor an importantpart of the world’s biodiversity. Loss of habitat (such asforests) is a leading cause of species loss.

■ Carbon sequestration. Forests and forest soils containlarge stocks of carbon, sequestering it from the atmo-sphere and playing a vital role in climate regulation.

Because these are benefits enjoyed by people outside the

forests, forest managers—whether local communities orlogging companies—have no external financial incentive totake them into account in forest management decisions.

Forest loss or degradation can cause adverse impacts onthose who benefit from these forest services—creatingscope for arrangements in which the users of the servicescompensate forest managers for managing forests in waysthat generate the desired services. This is the basis of thePayments for Environmental Services (PES) approach.

The PES approach is a market-based approach to conser-vation financing based on the twin principles that those whobenefit from environmental services (such as users of cleanwater) should pay for them, and that those who contributeto generating these services should be compensated for pro-viding them. The approach thus seeks to create mechanismsto arrange for transactions between service users and serviceproviders that are in both parties’ interests, thus internaliz-ing what would otherwise be an externality. The basic logicof the approach is illustrated in figure 2.3.

Innovative Marketing Arrangements:Payments for Environmental Services

N OT E 2 . 3

Conversion to pasture Conservation

Payment for service

$/ha

Benefits toforest managers

Costs to downstreampopulations

Conservation withservice payment

Source: Pagiola and Platais (2007).

Figure 2.3 The Simple Economics of Payments for Environmental Service


The PES approach is attractive in that

■ it generates new financing, which would not otherwisebe available for conservation;

■ it is likely to be sustainable because it depends on themutual self-interest of service users and providers andnot on government or donor funding; and

■ it is likely to be efficient, in that it conserves serviceswhose benefits exceed the cost of providing them anddoes not conserve services when the opposite is true.

PES programs are not limited to forests and can be used,in principle, to help induce the adoption of any land usethat generates external benefits. The majority of PES pro-grams to date have focused on forests or agroforestry,however.

There has been considerable experimentation with PESand other market-based approaches in recent years. LatinAmerica has been a particularly fertile ground for suchexperimentation. Costa Rica established an elaborate,nationwide PES program, the Pago por Servicios Ambientales(PSA) Program, in 1997. Mexico created a similar program,the Pago por Servicios Ambientales Hidrológicos (PSAH) Pro-gram, in 2003. Both of these programs focus on forests.There have also been a wide range of subnational initiatives,with municipal water supply systems, hydropower produc-ers, irrigation water user associations, bottlers, and otherwater users paying for the services they receive, eitherthrough national programs, such as Costa Rica’s PSA orthrough self-standing PES mechanisms. Pilot efforts are alsoemerging in other regions.

The World Bank has been active in supporting PES pro-grams. In fiscal 2007, several projects had explicit PES com-ponents under implementation or preparation (table 2.2).

The prospect for implementation of PES projects variesacross the main services generated by forests:

Hydrological services. Water services are often the mostpromising for actually generating payment streams. Theusers of water services are typically easy to identify, receivewell-defined benefits, and stand to suffer substantially ifwater services were to be curtailed. However, water servicesare very site specific, meaning that some areas will havesubstantial potential for payments, and others almost none.Water users do not use generic “water services”; they areinterested in very specific ones. Depending on the nature ofthe user, some will be primarily concerned about waterquality, others about dry-season flow, and others aboutflood risk or sediment loads. This often eases the task of

understanding service provision in individual cases becauseefforts can focus on the specific dimensions of interest.

Biodiversity conservation. The potential for PES forbiodiversity conservation is limited because of the difficulty ofidentifying service users and of charging them. Nevertheless,biodiversity conservation has been a major theme of many PESprojects, usually with support from the Global EnvironmentFacility (GEF). This has usually taken the form of helpingfinance the up-front costs of establishing PES mechanisms thatwill then depend on payments by water users, as suchmechanisms are also likely to generate biodiversity benefits.Although GEF cannot provide the long-term funding streamthat is necessary for PES, in some cases it has supported theestablishment of trust funds that can generate such funding.

Carbon sequestration. Carbon sequestration has limitedpotential, because of the restrictions imposed on land-useand land-use change (LULUCF) projects under the currentrules of the Clean Development Mechanism (CDM). TheBank’s BioCarbon Fund has been working to develop CDM-compliant LULUCF projects, as well as emerging and newapproaches. Carbon sequestration projects will not bediscussed further in this note, but are addressed thoroughlyin a separate sourcebook on the topic (World Bank CarbonFinance Unit, n.d.).

Scenic beauty. Payments for scenic beauty may potentiallybe generated from “users,” such as the tourism industry, butthis has not been done to date. This potential is beingexplored in the Mexico PES project.

OPERATIONAL ASPECTS

The process of designing a PES mechanism for forests canbe broken into several steps:

■ identifying and quantifying environmental services ■ charging service users ■ paying service providers ■ creating an appropriate organizational and institutional

structure

Identifying and quantifying environmental services

Implementing PES approaches requires that the servicesthat are desired are clearly identified and that the effect ofdifferent land uses on these services be understood andquantified to the extent possible.

NOTE 2.3: INNOVATIVE MARKETING ARRANGEMENTS: PAYMENTS FOR ENVIRONMENTAL SERVICES 87

Hydrological services. While forests are widely believed toprovide a variety of hydrological services, the evidence is oftenfar from clear (see box 2.13). This partly reflects the diversityof conditions encountered: hydrological services, for example,depend on the rainfall regime, on the type of soil, and ontopography. Deforestation and afforestation can havemultiple, often contradictory impacts, making the net impacton water services hard to determine. For example, infiltrationcan be reduced, but water use can also be reduced throughevapotranspiration. The net impact of these changes (both intotal and within a year) depends on the balance between theseeffects. Moreover, much depends on post-logging land use.The objectives also influence the analysis: Efforts to regulatewaterflows to avoid flooding and dry season deficits mayrequire different interventions than efforts to maximize totalwater volume, and the measures required to conserve

biodiversity may be different from either. Moreover, even if thekind of benefit that a forest generates is known, one must alsoknow how much of that benefit is being generated.Maintaining or regenerating forest cover imposes opportunitycosts from the forgone land use and may also impose directcosts (for example, for reforestation). Without estimates of theamounts of benefits that would be generated, determiningwhether these costs are worth bearing is difficult.

Biodiversity conservation. Although in some waysbiodiversity is much harder to measure than water services,adequate indicators can be developed relatively easily inpractice. These can include, for example, counts of thenumber of species of conservation interest, or of speciesthat are particularly sensitive to ecosystem conditions, andof the number of individuals within these species.

Table 2.2 World Bank Projects with Explicit PES Components

Total cost World Bank loan GEF grantCountry, project (US$ million) Main features

Completed projectsCosta Rica: Ecomarkets 49.2 32.6 8.0 Effective 2001–05. Supported the country’s

PSA program.Projects under implementationColombia/Costa Rica/Nicaragua: 8.45 — 4.5 Effective 2002. Piloting the use of PES to Regional Integrated Silvopastoral encourage adoption of silvopastoral Ecosystem Management practices.South Africa/Lesotho: Maloti-Drakensberg 33.1 — 15.2 Effective 2003 (separate but coordinated Transfrontier Conservation and Development projects). Includes a PES pilot.South Africa: Cape Action Plan for the 49.6 — 9.0 Effective 2004. Uses PES to encourage Environment (CAPE) conservation in the Cape Floristic Region.Mexico: Environmental Services 156.6 45.0 10.0 Effective 2006.Will consolidate and ensure

long-term financial sustainability of country’s PES program.

Costa Rica: Mainstreaming Market-based 90.3 30.0 10.0 Approved 2006.Will consolidate and ensure Instruments for Environmental Management long-term financial sustainability of

country’s PES program.Kenya: Natural Resources Management 78.0 68.5 — Approved 2007.Will explore the potential

for PES mechanisms to contribute to improved water and forest resource management.

Projects under preparationBrazil: Espirito Santo Biodiversity and 12.5 — 4.2 Will use PES as part of package of Watershed Conservation and Restoration Project measures to improve watershed

management.Kenya: Agricultural Productivity and Sustainable 12.4 — 10.0 Will pilot use of PES for watershed Land Management protection.Panama: Rural Poverty and Natural Resource 50.0 36.4 6.0 Will include pilot PES program for local Management II communities and specific watersheds.República Bolivariana de Venezuela: 24.5 — 6.0 Will develop PES mechanism with Canaima National Park hydropower producer to protect Río

Caroni watershed.

Sources: Pagiola 2006.Note: — = Not available. Projects noted as under preparation if PCN has been approved; other projects are in identification.Amounts shown for projects under preparation are preliminary and subject to change; for projects with PES components, amounts reflect overallproject costs, not PES-specific costs.

Charging service users

It is sometimes asserted that water users will never pay forservices. This assertion is manifestly false. In Costa Rica, avariety of water users (hydroelectric producers, bottlers,municipal water supply systems, agribusinesses, hotels)are paying to conserve the watersheds from which theydraw their water, generating about US$500,000 annuallyin payments. Other examples exist throughout Centraland South America, and in South Africa. In Kenya, theNairobi Water Company has indicated its willingness inprinciple to pay for watershed protection. The principalchallenge is to demonstrate to users that they will, in fact,benefit from making such payments, by reducing oravoiding costs from reduced water services. NairobiWater, for example, is currently spending aboutUS$150,000 a year in additional water treatment anddesilting costs at its Sasumua treatment plant as a result ofupstream degradation.

In general, the primary interlocutors in such discus-sions are not the ultimate consumers of the water servicesbut the companies and public agencies that generatehydropower, provide domestic water services, or distributeirrigation water. In many cases, funding for paymentscomes from the existing budgets of these agencies. Thus,Nairobi Water would finance payments for upstream con-servation from the savings resulting from reduced costs atits treatment plant. Only in rare instances is it necessary toincrease fees to consumers to pay for PES. In thoseinstances, experience has shown that this can be achievedwith public support if the need for and use of the revenueare clearly explained.

As noted above, charging biodiversity users is difficult ifnot impossible. Most available funding from biodiversity

users (for example, from the GEF) is short term, limiting itsuse to paying for the up-front costs of PES mechanismestablishment or to capitalization of a trust fund.

Paying service providers

For PES to have the desired effect, the payments must reachthe land users and do so in a way that motivates them tochange their land use decisions. This is not easy. The histor-ical record is replete with examples of efforts to induce landusers to adopt particular land use practices, for a variety ofreasons and using a variety of payment mechanisms. Mosthave very little to show for their efforts.

In general, several principles are clear:

Payments need to be ongoing. The benefits being soughtare generally ongoing benefits, which will be enjoyed yearafter year as long as appropriate land uses are maintained.For this to occur, land users must receive payments as longas they maintain the land use. All too often, payments havebeen frontloaded into a few years. Predictably, however,when payments cease, any leverage over land users’ behavioralso ceases.

Payments need to be targeted. Environmental servicesdepend on both the kind of land use and its location. Anundifferentiated payment system that pays everyone thesame will be much more expensive than a targeted scheme.It will also make it difficult to tailor interventions to theparticular requirements of given situations.

Perverse incentives need to be avoided. Particular careneeds to be taken to avoid perverse incentives. For example,


Claim Reality

Forests slow runoff TrueForests increase total annual water flow Because of increased evapotranspiration, forests usually

reduce total annual water flowException: Cloud forests

Forests increase dry season water flow UnclearForests increase precipitation Minor effect, except at continental scaleForests reduce flooding True at small scales, not at large scalesForests reduce erosion Depends on use that is made of deforested areas

Sources: Bruijnzeel 2004; Calder 1999; Chomitz and Kumari 1998.

Box 2.13 Water Services Provided by Forests: Claims and Reality


payments for reforestation can encourage land users to cutdown standing trees so as to qualify.

Creating the institutional framework

Scale of project. A critical initial question concerns thescale of the PES mechanism. There are, in principle, threebroad scales at which PES could be implemented: (1)nationwide, (2) at the scale of a river basin, and (3) locally,usually at the scale of a microwatershed. In practice,although there are some high-profile national systems (inCosta Rica and Mexico), almost all existing mechanisms areat the local scale. There are no river basin–scale programs.Nationwide systems may appear attractive because they cancover large areas quickly and can have relatively low costsbecause of economies of scale. Experience has shown thatsuch systems tend to be very inefficient, however. They areeasily distorted by political considerations and exhibit lowtransaction costs mainly because they sidestep the difficultquestions. Local initiatives are more likely to be efficientbecause they tend to be closely tailored to local needs andconditions. However, they often are constrained by limitedlocal capacity. The El Salvador Environmental ServicesProject is exploring an intermediate approach, in whichlocal mechanisms are being developed under a nationwideumbrella.

Legal framework. PES programs are often thought torequire a specific legal framework. They only do so if theyare to be based on public financing, in which case a legalframework is desirable so that the payment program is notwholly at the mercy of annual budgetary decisions. Relyingon public financing is, however, generally an undesirableapproach to PES. PES programs that are based on paymentsfrom service users do not require any specific law, otherthan general contract law. There may be a need for legalreform to remove obstacles, however. For example, publicutilities may be restricted in their ability to chargeconsumers for the costs of conservation, or in their ability touse available funding in PES mechanisms.

Functions to be accomplished. Systems of payments forenvironmental services require a supporting institutionalinfrastructure. This can take many forms, but several commonfunctions must be accomplished (see figure 2.4).Organizationally, the most complex task to be undertaken ispaying service providers because agents must be sent into thefield, with all the logistical issues that entails. This task canoften be subcontracted to NGOs or other agencies that already

have a field presence, but sometimes it may be necessary toestablish new organizations to undertake this task.

Ensuring the poor benefit

PES programs are not poverty-reduction instruments, butgiven the often high spatial correlation between areas thatprovide environmental services and areas of high poverty,PES programs may contribute to poverty reduction, at leastlocally. Guidelines are available on how to design PES pro-grams to maximize their positive impact on the poor andminimize any potential negative impacts. For example, insome countries, even within a community, benefits may becaptured by local elites at the expense of the poor. Toaddress this issue, capacity needs to be built to empower thepoor and vulnerable groups in the community.

Because some participants may be indigenous groups, itmay be necessary to prepare an Indigenous Peoples Plan(IPP) or an Indigenous Peoples Planning Framework(IPFP). However, because PES programs are largely volun-tary, these safeguards are triggered mainly in cases with col-lective decision making on land use and the use of PES rev-enues (see chapter 12, Applying OP 4.10 on IndigenousPeoples, in section II of this sourcebook).

Other operational considerations

Project type. PES projects can generally take two forms:

■ Projects entirely dedicated to PES, which typically workon a nationwide basis (as in Costa Rica and Mexico).

■ PES components within a broader project. Such PEScomponents could be part of a variety of projects. Obvi-ous examples include watershed management and sus-tainable land management projects (as in the KenyaKAPSLM (Kenya Agricultural Productivity and Sustain-able Land Management), but there is also significantpotential to undertake PES as part of institutional reformprojects or water infrastructure projects (the BrazilEspirito Santo Project is partially blended with a domes-tic water supply project in the town of Vitoria).

Avoiding perverse incentives. PES projects do notsupport any clearing or degradation of forests or othernatural habitats. On the contrary, they are intended topromote the conservation and restoration of forests andother natural habitats. PES projects, therefore, are usuallyfully compatible with both the World Bank’s NaturalHabitats OP/BP 4.04 and the Forests OP/BP 4.36.

The main risk is of unintended, perverse consequences,such as land users clearing forest to qualify for reforestationpayments or moving into previously intact ecosystems toclaim payments for managing them correctly. These prob-lems can generally be avoided by instituting appropriate eli-gibility criteria for participation, setting appropriate condi-tions for payments, and instituting effective monitoringsystems (see box 2.14).


PES programs are not a universal answer to all forest con-servation problems. Even when PES approaches are war-ranted, the details of their application will differ substan-

tially from case to case, in light of local technical, economic,and institutional conditions.

Identifying the services sought is critical, and mosteffectively done by focusing on the demand for servicesand asking how best to meet it, rather than on the supply.Beginning from the supply side carries the risk of devel-oping mechanisms that supply the wrong services, in thewrong places, or at prices that buyers are unwilling topay.

The land uses that can generate the services sought mustthen be identified and their impact quantified to the extentpossible.

Monitoring effectiveness is essential to documenting tobuyers that they are getting what they are paying for and toadjusting the functioning of the mechanism should prob-lems arise. At the same time, excessively burdensome moni-toring requirements can discourage potential supplierswithout necessarily further reassuring buyers. Finding theright balance between information and compliance costs isan ongoing concern, as seen in the case of markets for certi-fied timber and agricultural products.

PES mechanisms must also be sufficiently flexible torespond to changing demand and supply conditions andimprovements in knowledge about how forests generateservices.

SELECTED READINGS

Pagiola, S., A. Arcenas, and G. Platais. 2005. “Can Paymentsfor Environmental Services Help Reduce Poverty? AnExploration of the Issues and the Evidence to Date fromLatin America.” World Development 33: 237–53.

Pagiola, S., and G. Platais. 2007. Payments for EnvironmentalServices: From Theory to Practice. Washington, DC: WorldBank.


Figure 2.4 Institutional Elements of a PES Mechanism

Governance structure

Beneficiary Land userLand userLand userLand userLand userLand userLand user

BeneficiaryBeneficiaryBeneficiaryBeneficiaryBeneficiaryBeneficiary

Paymentmechanism

Financingmechanism

Environmental services

Contracts under the Regional Silvopastoral Projectspecify that land users who switch any of their landto less environmentally desirable uses (as meas-ured using the project’s environmental servicesindex) will not receive payment. Induced perverseincentives outside project areas may be more sub-tle. The Regional Silvopastoral Project hadintended to only pay for improvements over base-line conditions, but ultimately decided to makenominal payments for preexisting baseline servicesto encourage current nonparticipants to under-take such improvements even before they were for-mally in the PES program.

Source: Pagiola 2006.

Box 2.14 Avoiding Perverse Incentives in PES


Wunder, S. 2005. “Payments for Environmental Services:Some Nuts and Bolts.” CIFOR Occasional Paper No. 42,CIFOR, Bogor, Indonesia.

REFERENCES CITED

Bruijnzeel, L. A. 2004. “Hydrological Functions of TropicalForests: Not Seeing the Soil for the Trees?” Agriculture,Ecosystems and Environments 104 (1): 185–228.

Calder Ian R., 1999. The Blue Revolution: Land Use and Inte-grated Water Resource Management. London: Earthscan.

Chomitz, K. M., and K. Kumari. 1998. “The Domestic Ben-efits of Tropical Forests: A Critical Review EmphasizingHydrological Functions.” World Bank Research Observer13 (1): 13–35.

ITTO. 2006. Guidebook for the Formulation of Afforestationand Reforestation Projects Under the Clean DevelopmentMechanism. ITTO technical series No. 25. Yokohama:International Tropical Timber Organization.

Pagiola, S. 2006. “Innovative Marketing Arrangements forEnvironmental Services.” Note submitted to World Bankas input to Forests Sourcebook. Unpublished. World Bank,Washington, DC.

Pearson, T., S. Walker, and S. Brown. 2005. Sourcebook forLand Use, Land-Use Change and Forestry Projects. Wash-ington, DC: Winrock International.

WBCFU (World Bank Carbon Finance Unit). n.d. “Opera-tions Handbook.” http://carbonfinance.org/Router.cfm?Page =DocLib&ht=34&dl=1. World Bank, Washington, DC.

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