Afforestation subsidy under asymmetric information and transaction cost in developing countries: does rural capital market imperfection matter?

This paper deals with the design of voluntary contract of afforestation subsidy in developing countries, where there are substantial variations among farmers in terms of land value. The dispersion in the land value is due to critical difficulty in capital market, where the rate of return to land is determined by household rate of time preference. Farmers&rsquo; rate of time preference is not observed by public agency that intends to regulate land use through subsidy, which is a 'lack of information' problem.<br /><br />The paper notes that countries differ in terms of the additional-costs related to afforestation, and consequently attain different afforestation level for the same amount of subsidy expenditure. The main findings of the paper are:<br /> in general, such critical dificulties in capital market undermines the efficiency of subsidy measures in developing countries afforestation level under 'lack of information' circumstances is lower as compared to the other scenario particularly, the information problem resulted from inability to observe farmer&rsquo;s rate of time preferences limits the efficiency of subsidy policy for afforestation under Payment for Environmental Services (PES) the efficiency loss is also further compounded by the additional-costs related to the policy for that reason, there is no guarantee that a subsidy without information problems would result in first best afforestation level also the absence of the related additional-costs of subsidy doesn&rsquo;t necessarily guarantee the first best solution in the presence of critical problems in capital market The paper concludes that the lower are the related additional-costs, the closer is the afforestation level to the first best world afforestation level for such farmers. Furthermore, as a policy implication, the paper suggests that development of credit markets in rural areas of developing countries can complement PES scheme of afforestation.<br /><br />