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Paper to be presented at SURED 2008 Ascona

Economic Integration, Land Policy and Biodiversity

Christian Bogmans, Tilburg University

April 30th, 2008

Preliminary Version

Abstract

We analyze the effects of capital mobility on biodiversity and welfare. We discuss a simple general equilibrium model with trade in capital between two countries, North and South. Our model contains three factors of production: land, labor and capital. Land and capital are taxed. Biodiversity is introduced using a species-area curve. Positive investment from North to South is conditional on the ‘de-facto’ capital-labour ratio in the South, which depends not only on real endowments but also on policy. This simple framework serves several purposes. First, liberalization might lead to a decrease in global biodiversity if land policy is too lax. Second, strategic interaction between countries adjusting their policies in the face of liberalization depends on biodiversity specifics. If there is no overlap in species across countries, strategic interaction is irrelevant. Third, a social planner would enforce a relatively stringent land policy in a country with relatively high ecosystem productivity. The stringency of a country’s policy also increases if its species are highly valued.

Keywords: Biodiversity, Capital Mobility, Trade and the Environment, Interjurisdictional competition, Land policy. JEL Codes: F180, F210, Q150, Q270, Q560.

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1.1 Introduction: Globalization and Biodiversity Conservation Since the beginning of the 1990’s an increasing number of economists, biologists and other

scientists have paid attention to questions concerning biodiversity conservation and the rate of

species extinction. Although difficult to predict, estimated extinction rates are far higher than

historical rates. There is consensus that the root cause of this and other forms of

environmental degradation is (economic) activity by humans. Habitat loss, over-harvesting,

invasive species and pollution of the environment being the most important causes (see

Polasky et al., 2004; Eppink & van den Bergh, 2006). At the same time, economic growth in

some parts of the world has been higher than ever before, and the world has seen a rapid

increase in trade flows and international investments. Globalisation has taken a new pace at

the same time when many ecosystems face growing pressure from human actions.

According to economist Geoffrey Heal globalisation in itself has not lead to a

decrease in biodiversity (Heal, 2002). Globalisation, as defined by the increase in mobility of

factors of production, the lowering of transport costs and the increase in international trade

and investment, cannot be the prime cause since degradation of the environment happens

worldwide. Heal states that ‘Population growth, habitat loss and biodiversity loss are global

problems, in the sense that they are occurring globally and have global consequences. But

they are not problems of globalization (Heal, 2002)’.

The simple observation that habitat conversion and the resulting loss in biodiversity

occur everywhere in the world is, according to Heal, proof of this statement. Worldwide the

scarcity of land has been greater than ever not just due to globalization, but because of fast

growing populations and enormous boosts in income per capita. These developments imply

that many species, and nature in general, compete with other (economic) activities for scarce

resources. In fact, when valued at the margin many biological assets offer such a low rate of

return that from an economic point of view disinvestment is not irrational at this point in time

(Bulte & Van Kooten, 2000). Even restrictive trade policies can be ineffective at preserving

biodiversity since policies that reduce the terms of trade might also increase the domestic

opportunity cost of preserving habitat areas (Schulz, 1996; Barbier & Schulz, 1997).

Nonetheless, Heal’s remarks can be criticized on several accounts. In sum we argue

that globalization affects patterns of human economic activity with respect to space and time,

and provides for many new opportunities that have no precedent in history. Let us elaborate

more closely on these aspects of globalization. First, Heal neglects the fact that globalization

may be a force of economic growth by itself. Empirically, there is some evidence that

increased openness to trade and factor flows, given the right set of domestic institutions,

increases the rate of economic growth. For example, many have argued that export-led growth

was one of the main drivers behind the East-Asian growth miracle (Rodrik, 2003). So by

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providing for new opportunities of economic growth, reductions in tariffs, quota’s, capital

controls and other restrictions to trade and factor mobility have possibly fuelled a growth

process that endangers global biodiversity. Theoretically, this would imply that the damaging

scale effect from trade outweighs the preserving substitution and technology effects from

trade (Copeland & Taylor, 2003)1.

Second, Heal’s statement ignores the fact that reductions in transport costs have

altered spatial patterns of economic activity. Both biodiversity and economic activity are not

spread uniformly across space. For example, in the European Union there is often a larger

discrepancy in income between different regions within a country than between various

countries itself. Very much comparable to economics similar patterns of spatial heterogeneity

exist in the biological realm. Some ecosystems such as tropical rainforests contain

significantly more species than others. On a global scale, more than 80% of the world’s

biodiversity is contained in 5% of the world’s land area. These areas are called ecological

hotspots. Thus, spatial heterogeneity is an issue in both economics and ecology (Barbier &

Rauscher, 2007; Eppink & Withagen, 2005) and the magnitude by which habitat conversion

occurs is probably less relevant than the location where it takes place.

Third, globalization has affected the speed and scale by which mobile factors of

production can relocate to other, more profitable regions. With less or no detachment to their

original resource base, mobile factors have fewer incentives to acquire a sustainable relation

with their environment. A careful investigation of this aspect seems to be absent in most of

the work on trade, renewable resources and biodiversity (Barbier & Bulte, 2005).

Why Biodiversity and Factor Mobility?

The reasons for studying the relation between factor mobility and biodiversity are many. First,

most work in the economic literature has only focused on the connection between trade and

biodiversity. From an empirical point of view this is somewhat understandable since

international trade and the associated invasion of alien species are among the most important

causes of species decline (Polasky et al., 2004). Nevertheless, other threats to the environment

and biodiversity exist in the form of urbanization, industrialization and eco-tourism. In

particular, the underdevelopment theory of tourism describes the control of ecotourism

resources by multinational enterprises in the developing world. For example, in Zimbabwe of

the 1980’s more than 90% of eco-tourism revenues were expatriated to the parent countries.

Only a small amount was reinvested in the home country causing excessive environmental

1 Note that the work by Copeland and Taylor mainly concerns the relation between environmental pollution and endowment driven trade patters. Assuming biodiversity is also directly affected by pollution, the theoretical framework developed by Copeland and Taylor might apply here as well.

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degradation, among other problems related to sustainable development (Isaacs, 2000; Ziffer,

1989).

Second, from a theoretical perspective globalization is more than just international

trade: factor mobility and foreign direct investment are also part of this phenomenon. In the

related area of internationalisation and environmental pollution theory has focussed on both

models of trade and capital movements (Rauscher, 1997; Copeland & Taylor, 2003; Copeland

& Taylor 1997). We conjecture that when examining environmental amenities theories that

are based solely on trade models are no substitutes for models that include factor mobility

(For models with trade only see Smulders et al. (2004) and Polasky et al. (2004)).

In the literature on tax competition it is readily understood that factor mobility

matters for policymakers. With parts of the tax base becoming increasingly mobile,

interjurisdictional competition in for example environmental regulations might lead to

situations of a ‘race to the bottom’. In addition, underprovision of public goods might occur

since taxes on capital are too low in the Nash equilibrium when compared to the social

optimum (Mieszkowski & Zodrow, 1986; Wilson, 1999). Biodiversity, like many

environmental amenities, is an important example of a public good. The challenge of

attracting capital and fostering economic activity within the borders of its jurisdiction runs

opposite to another need, society’s wish to protect biodiversity by habitat conservation. In

these tax competition models, fiscal externalities and environmental externalities prevent

individual states choosing policies that are optimal from a social point of view.

Most of the economics literature on biodiversity has focused on problems of

economic policy in the context of goods mobility, i.e., models of trade and biodiversity.

Polasky et al. (2004) and Smulders et al. (2004) consider the problem of habitat conversion,

land-use and biodiversity in standard trade models. Polasky et al. (2004) show that, under the

right conditions, trade liberalization leads to specialization of production across countries as

well as specialization in terms of species. Smulders et al. (2004) find that, in contrast to

Brander & Taylor (1997, 1998) and Jinji (2006), trade measures might be beneficial for the

environment in the resource-rich country if the effect of reduced harvesting of natural

resources outweighs the effect of habitat destruction that is the result of agricultural

expansion.

Having said all this capital mobility is obviously an important ingredient in today’s

process of globalization and is therefore a potential source of habitat destruction and

environmental degradation. On a methodological level, a model of factor mobility, be it

capital or labour, is the simplest model of economic integration. Since the global stock of

capital is assumed to be constant, it allows us to isolate the integration effect from pure

growth effects arising from factor accumulation. In that respect the model applied in this

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thesis is convenient, easy to use and adheres to the basic needs when thinking about the

concept of economic integration.

Thus, there exist both theoretical and empirical reasons to study more closely the

relation between factor mobility on the one hand, and biodiversity (conservation) on the other

hand. In the next section we will try to determine whether non-cooperative behaviour can still

lead to situations where global biodiversity is protected, under the pressure of attracting

capital that forms an important part of the tax base.

1.2 A Simple Neoclassical Framework Factor Endowments and Factor Mobility

We consider a model of two (symmetric) regions, North and South. Variables in the South are

denoted by an asterix (*). Capitals denote variables, whereas small letters are used for

functions. Both regions produce a homogenous good under constant returns to scale and

perfect competition. We normalize the price P of the aggregate good, 1=P . The good is

produced using three factors of production: land MT , labour L and capital K . The letter M

is a mnemonic for manufacturing, although the aggregate good can be interpreted as some

appropriate aggregation of various sectors. Our setting is similar to Rauscher (1997) and

Wang (1995), who consider the relation between capital mobility and pollution.

Labour L and land T are immobile factors of production. Capital K is mobile

across regions. Both regions are endowed with a fixed amount of land and labour, a stock T

and L in the North and a stock *T and *L in the South. Capital owned ( 0K ) by Northern

residents differs from capital employed ( K ) in the North. Capital owners are not mobile and

capital earnings are repatriated to the country of origin. The total stock of capital in the North

and South is fixed and either employed at home MK or abroad XK , *XM KKK += and

XM KKK += ** . However, in a two-country model the number of different net capital

allocations is rather limited. Either North or South is a net capital investor. Thus, defining net

investment I as *XX KKI −= , we can classify capital employed as

IKK −= 0 IKK += *0

* (1a),(1b)

In what follows we continue by making use of these definitions for capital.

Ecology and Biodiversity

The ecological part of the model consists of a concave relation between the amount of land

available for habitat purposes TH and the number of local species s, known as the species-area

curve:

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)( HTs , 0,0 <> TTT ss (2)

At times we may use a special functional form for the species-area curve, which includes a

parameter κ for ecosystem productivity:

ϕκ HTs = , 10 <≤ ϕ (3)

The total endowment of land is fixed and is available for either production or habitat area:

HM TTT += . Of course, in reality species do not only survive within protected areas and

there does not need to be a strict separation between economic activity and species

preservation (See Polasky et al. (2005)). The species-area curve first appeared in the island-

biogeography literature. This literature, initiated by ecologists MacArthur and Wilson (1967)

tried to find explanations for the number of species in a particular community. The theory

holds that through migration and extinction the equilibrium number of species in a particular

community or island can be inferred from area size and distance from the mainland. Large

islands are characterized by a larger biological diversity, as are islands close to the mainland

and close to the equator.

We assume that the government owns the property rights of the whole land-area. The

government can protect biodiversity in its region by setting a high, (uniform) tax on land,

thereby limiting the conversion of habitat area in land that is used in production. As a result of

this simple property rights regime, the demand for land MT by firms is a function of the tax

rate Mt , the capital stock K and population size L in a particular country. Alternatively, it

can also set a quota on the use of land.

Production

Production in each country takes place under conditions of constant returns to scale and

perfect competition, ),,( 0 MTLIKfQ −= . The first and second-order derivatives have the

usual signs with diminishing returns to one input and positive cross-order derivatives:

0>if , 0<iif , 0>ijf TLKji ,,, =∀

Producers take factor-prices as given. Government policy consists of either setting the tax-rate

Mt on land or determining the quota MTq = . In addition, the government may also set a tax

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rate on capital, Kt . The profit function of a representative Northern (Southern) producer is

given by

MMK TtwLIKtrQ −−−+−= ))(( 0π (4a),(4b)

Capital is taxed in the country where it is employed. Under conditions of perfect competition

(and no factor market distortions), all factors of production earn their marginal product. Profit

maximization by producers thus leads to the following set of first-order conditions:

KK trf += , wf L = , MT tf = (5a),(5b),(5c)

Using these factor-market conditions for the North and the South, we have a system of 6

equations with 6 exogenous variables ( *** ,,,,, KKMM ttttLL ) which can be used to solve for

the set of 6 endogenous variables ( ** ,,,,, MM TTwwKr ). Note here that the reward to capital

is equalized by the assumption of perfect capital mobility )( *rr = , and that the total stock of

world capital is fixed ( *KKK += ) such that we only have to solve for K . With a quota the

analysis is simplified to a set of 4 equations with 4 unknowns.

Finally, in what follows we will sometimes differentiate between a small open

economy case, taking r as given, or a large country case, with r endogenous and determined

by tax and land policy in both countries. These conditions boil down to respectively W

KMK rtTLKf =−),,( for the small open economy, and the arbitrage condition

***** ),,(),,( KMKKMK tTLKfrtTLKf −==− for the general equilibrium case. These

two assumptions make a big difference for policymaking and biodiversity conservation, since

it is through the interest rate that land policy has a big impact on lending, conservation and

welfare.

Consumption

Utility of the representative consumer is linear additive in full consumption and biodiversity,

where full consumption depends on private and public consumption:

BGCuBGCV η+= ),(),,( , 0>η (8)

where in the absence of savings we have that consumption equals national disposable income

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)(),,( 00

0

IKtTtrITLIKfrKwLC

KMMM −−−+−=+=

(9a)

and similarly for the South

)(),,( *0

******0

*0

****

IKtTtrITLIKfKrLwC

KMMM +−−−+=

+=(9b)

Income of the representative agent consists of net labour income and net capital rents that are

earned from capital employed in production at home and abroad. Consumption C equals the

national product Q plus imports that equal net capital earnings. Consumption of public goods

equals tax revenues: )( 0 IKtTtG KMM −+= and )( *0

**** IKtTtG KMM++= .

Returning to the ecological side of the mode, habitat loss ( HM dTdT −= ) negatively

affects species numbers at home and abroad and the biodiversity index is increasing in local

and foreign species numbers:

))(),((),( ***HH TasTsbssbB == , HM TTT += (10a)

))(),((),( *****HH TsTAsbssbB == , 0, >Aa (10b)

0<−= TST sbb , 0*** <−= TST sbb

Thus, a decrease in land available for habitat purposes means a decrease in local species

numbers, thereby lowering the global biodiversity index. Furthermore, these definitions of

biodiversity include the possibility of different valuation of foreign species and local species

( )0, >Aa .

Welfare

In the absence of public goods )0( =G the indirect utility function is a simple function of

endowments, net investment and land policy. Tax revenues on land and capital are

redistributed to consumers in a lump-sum fashion such that rITLIKfC M +−= ),,( 0 .

Then, welfare in North is determined by the domestic product, the rewards to net foreign

investment and benefits from global biodiversity:

))(),((]),,([ ***0 MMM TTasTTsbrITLIKfuV −−++−= η

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1.3 Autarky

In autarky there is no trade in capital and goods ( 0=I ). As a result, both countries can

produce only with available domestic factors of production. We start out with the most simple

situation where taxes on land are redistributed in a lump-sum fashion and taxes on capital are

zero ( 0,0 == KtG ). Consumption equals the national product:

),,( ***0

*MTLKfC = , ),,( 0 MTLKfC =

Land policy by the government determines the amount of land MT that is available for

production. The government maximizes utility subject to the consumption equation, i.e., the

budget constraint, and a land endowment restriction:

max ))(),(()],,([ ***0 MMM TTasTTsbTLKfuV −−+= η

MT

leading to the following first-order condition for the North:

0=−=∂∂

−∂∂

TSTCMM

sbfudTdB

BV

dTdC

CV η (12)

where the optimal quota is implicitly given by the equation above, ),,( *0 MMM TLKTT = ,

where we have used a notation that separates variables from parameters. The solution for the

optimal land tax Mt^

can be derived by rewriting the first-order condition2:

C

TSTM

usb

ftη

==^

(13)

The optimal tax equates the marginal rate of substitution between land conservation for

biodiversity purposes and consumption. Land policy in autarky is not determined by only

domestic considerations. Optimal land policy in the form of a quota or tax would balance the

benefits from habitat protection and utility derived from consumption, given the quota or tax

set in the other country. In case 0=a or *ssb += , such that the North does not value

Southern species or the ecosystems are characterized by full species endemism, the choice of 2 The second-order condition for an optimum is satisfied by the assumptions with respect to the production function and the biodiversity index.

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the optimal quota is independent of the policy in the other country. It is possible to derive the

‘reaction curves’ of the North and South in autarky by totally differentiating the conditions

for optimal land policy with respect to MT and *MT :

0**

*2***

***2**

**

**

<+++

−=

TTSTSSTTCTCC

TTSS

M

M

sbsbfufussba

dTdT

ηηη

(14a)

022

**

* <+++

−=

TTSTSSTTCTCC

TTSS

M

M

sbsbfufussbA

dTdT

ηηη

(14b)

In autarky land policy in the North and South are strategic substitutes. In a simultaneous

move game each country will take land policy of the other as given. As a result, and

depending on the models’ parameters, both will set an insufficient amount of land aside for

habitat purposes. This can easily be seen by pointing out that the optimal price of land Mt is

equated to local, not social, marginal cost of habitat loss. A sub-optimal equilibrium arises

with quotas (taxes) that are too generous (too low). Here each country has an incentive to

lower its land tax or increase its quota in order to set more land aside for production, while at

the same time expecting the other country to take the burden and to increase habitat

conservation to preserve global biodiversity.

Thus, we have shown that even in autarky with no trade in capital, countries

have an incentive to ‘undercut’ the other country by relaxing its land policy. One of the

questions that arise next is whether capital market integration will increase or diminish the

problems that are associated with providing for an optimal amount of this public good.

Obviously, strategic interaction may quite well lead to under provision of biodiversity even in

the absence of trade.

1.4 Optimal Land Policy (Small Country Case) The optimal autarky tax rate on land relates the benefits of more land usage in the form of

higher consumption against the damage to biodiversity. Thus there is an obvious trade-off

between consumption and biodiversity conservation. Unless an optimal policy is in place a

marginal change in investment does not automatically lead to an improvement in welfare. But

before we analysis the marginal welfare gains/losses from a marginal change in investment

we first consider how changes in some important model parameters affect land policy. To

determine how the marginal valuation of biodiversity and ecological productivity affect the

optimal land policy (tax or quota), we totally differentiate the first-order condition for optimal

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land policy of the South with respect to *MT , MT , κ , *κ and *η and derive the following

comparative statics:

0**

*2***

*2****

**

*

*

<+++

=TTSTSSFCCTTC

TSM

sbsbfufusb

ddT

ηηη(15a)

**

*2***

*2****

2***

**

*

*

* )(

TTSTSSFCCTTC

TSSTSM

sbsbfufusbsb

ddT

ηηη

κκ

++++

= (15b)

0**

*2***

*2****

**

**

≥+++

=TTSTSSFCCTTC

TSSM

sbsbfufussb

ddT

ηηη

κκ (15c)

Countries with a relatively large marginal valuation of biodiversity have a greater incentive to

implement a more strict land policy in the form of a high tax or quota. Somewhat more

complicated is the effect of a country’s ecosystem productivity on its environmental policy.

There are two conflicting forces. First, there is a ‘positive’ effect from increased ecosystem

productivity on the stock of land used in production. Since the biodiversity index is assumed

to be concave, 0** <SSb , the positive effects of increases in carrying capacity eventually ‘die

out’. Thus, there comes a point where greater environmental capacity needs to be ‘traded’ for

more productive land use (income effect). Secondly, there is a negative effect. A higher

carrying capacity increases the returns from ‘existing’ habitat area ( 0* >κTs ) This induces the

country to increase the stock of land devoted to habitat (substitution effect). We can

summarize this in the following proposition.

Proposition 1. If the South attracts foreign capital for other reasons than those concerning

relative endowments, it does so because of relative lax land policy. In turn, lax land policy

itself can be rooted in relatively small preferences for biodiversity and/or relatively large

ecosystem productivity. However, a relatively large ecosystem productivity may actually lead

to a more stringent land policy if the biodiversity index is not very concave and/or the existing

habitat is relatively large.

From this we see that a country may choose to set a tax rate on land that induces

specialization in nature if the ‘substitution effect’ of ecosystem productivity is larger than the

‘income effect’ from ecosystem productivity.

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The last comparative static result, which summarizes the marginal change in the

optimal quota from a marginal change in foreign ecosystem productivity, is unambiguously

positive. Thus, if some exogenous shock negatively affects carrying capacity, thereby

reducing biodiversity abroad, the other country will, ceteris pauribus, definitely reduce land

usage for domestic production. Two important remarks are in order here. First of all, it is not

always realistic to have an exogenous shock that only affects ecosystem productivity in one

country. A global shock would be more plausible, for example as the result of climate change,

that causes a reduction in worldwide ecosystem productivity, 0* <= κακ dd with 0>α .

Second, one would expect both countries to change their land policy in the face of climate

change. The overall optimal changes in land policy can then be given by differentiating both

first-order conditions for optimal land policy:

**

*2***

*2****

**

2***

**

*

*

* )(

TTSTSSFCCTTC

TSSTSSTSM

sbsbfufussbsbsb

ddT

ηηαη

κκκ

+++++

= (16a)

TTSTSSTCCTTC

TSSTSSTSM

sbsbfufussbsbsb

ddT

ηηαη

κκκ

+++++

= 22

**

2 )/((16b)

where we have neglected the impact of foreign ecosystem degradation on land policy at home

( 0// ** == κκ ddTddT MM ), which is in line with the Nash-equilibrium concept, that is, the

country under consideration takes the policy in the other country as given, 0* == MM dTdT .

The derivatives show that, besides the standard income and substitution effects we discussed

in the preceding section, there now is a an extra term that makes the overall effect more likely

to be positive. This implies that compared to a shock that only affects local ecosystems, a

global shock is more likely to increase global land conservation.

1.5. Welfare Effects from Increased Mobility of Capital The welfare effects from increased openness to capital markets depend partially on the type of

land policy that is in place. To analysis this, we evaluate how a marginal inflow of foreign

capital affects welfare. Welfare can decline if habitat area is excessively converted into

productive land area, causing extinction of a large number of local species. If a strict policy,

that is, an enforceable quota ( 0* =MdT ) is in place the welfare effects are unambiguously

positive:

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( ) 0***

**

>−== rfudI

dCudI

dVKCC rf K >⇔ * (17)

A necessary condition for a country with a strict land policy to benefit from increased capital

inflows is capital scarcity. A more interesting policy instrument is that of a land tax. Now, the

amount of land is not fixed and the inflow of capital increases the productivity of land, which

in turn increases the demand for land. As a consequence, habitat area is converted into land

area for production (agriculture, manufacturing etc.) leading to

)()(*

**

**

***

dIdTsb

dIdTsAb

dIdTfrfu

dIdV M

TSM

TSM

TKC +−+−= η (18)

showing that under a tax-policy the total effect on welfare depends on factor market

interactions. Differentiation of the factor market conditions for land in North and South we

get 0// *** >−= TTTKM ffdIdT and 0// <= TTTKM ffdIdT . Substitution of these

derivatives into (eq.18) leads again to ambiguous welfare effects:

)()(

?

*

**

**

0

*

***

*

4444 34444 21444 3444 21 TT

TKTS

TT

TKTS

TT

TKTKC f

fsbffsAb

fffrfu

dIdV

−−−−=

>

η

A marginal increase in investment raises capital productivity in the South and increases the

demand for land. This leads to an increase in consumption that positively affects welfare in

the capital-scarce South. This is the first term. The second term is ambiguous and represents

the global change in biodiversity. On the one hand, in the country where capital is leaving

more land becomes available for habitat purposes. On the other hand production is intensified

in the South and local species are under pressure due to loss of habitat. The overall effect on

welfare from a marginal increase in investment is not clear.

Proposition 2. Under a tax-on-land regime increased openness to foreign capital leads to an

increase in land as a factor of production, an increase in consumption and a decrease

(increase) in local (foreign) biodiversity. If the tax on land is relatively small and/or foreign

biodiversity is not highly valued (small A) and/or the foreign species-area curve is very

concave, then welfare in the capital-poor country may decline.

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Note that with an optimal tax in place, ***

**

TSC

M sbu

t η= , welfare always increases since now

the price of land is set in such a way that at the margin an optimal trade-off between

consumption and habitat loss is assured.

Again, in the absence of an optimal policy trade in capital is not guaranteed to

increase welfare in the capital-poor region. The derivation of the optimal tax was relatively

easy, but in practice it requires a high degree of knowledge of the world’s ecosystems and the

marginal valuation of global biodiversity and consumption. In view of these somewhat

unrealistic information requirements let us consider a country that aims to adjust its policy in

response to increased openness to capital. We assume that the initial policy in place is not

optimal, being either too strict or too lax. A reduction in barriers to capital mobility might

lead to economic and environmental changes that, in the long-run, provide for more

information on the structure of ecological and economic systems. To determine the South’s

(North’s) optimal response to a change in its capital stock recall the first-order conditions for

optimal land policy:

0=−=MM

CM dT

dbdTdCu

dTdV η , 0*

**

*

**

*

*

=−=MM

CM dT

dbdTdCu

dTdV η ,

Totally differentiate these first-order conditions for optimal land-policy with respect to MT ,

*MT and I to obtain the following ‘reaction’ functions for the North and South:

)(

)(2*

***

**2****

**

*****

TSSTTSTCCTTC

MTTSSTKCKTCC

M

sbsbfufudI

dTssbfurffu

dIdT

+++

++−−=

η

η(19a)

)(

)(22

**

*

TSSTTSTCCTTC

MTTSSTKCKTCC

M

sbsbfufudI

dTssbfurffu

dIdT

+++

−+−=

η

η(19b)

these derivatives implicitly contain the reaction functions )( *MTR and )(*

MTR for both

countries under the small country assumption where no one is able to influence the reward to

capital. Simplifying notation such that CdIdTDAdIdT MM /)]/([/ *−= and

**** /)]/([/ CdIdTDAdIdT MM −−= , we can obtain the ‘general equilibrium’ effects of a

marginal change in investment on land policy by substitution:

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**

**

DDCCDAAC

dIdTM

−+=

*)(

*

***

DDCCADCA

dIdTM

−+

−=

since 0<C , 0* <C , 0>A , 0≤D , 0* ≤D but *A ambiguous, we find that both

derivatives are ambiguous; only in case of full species endemism ( 0* == DD ) do we find

some clear-cut results, that is, the North reduces its land usage in production.

When a country recognizes the impact of its own land policy on the other region, then

the sign of this strategic effect is determined by the sign of SSb * , the cross partial of the

global biodiversity index. This derivative considers the effect from a marginal increase in

Northern species numbers on the marginal increase in biodiversity from Southern species

numbers, and vice versa. We consider two extremes (See Polasky et al.(2004) and

Barbier&Rauscher (2007)):

• High Species Endemism, ** ),( ssssbB +==

Ecosystems in the North and South may be completely different and give home to a vast

amount of species that are all country specific. Under this condition we observe that habitat

destruction, which is the result of capital-led growth in industrial or agricultural activity, may

lead to the extinction of a number of species that are unique to the booming region and for

which no ‘substitute’ exists in other regions. High endemism lowers the probability that an

increase in local species numbers makes an additional specie in the other region redundant.

Thus, the cross partial is negative but small in terms of absolute value. For the extreme case

of absolute species endemism, the partial is exactly zero, 0** == SSSS bb .

• High Redundancy, ,max),( ** ssssbB ==

At the other side of the spectrum we may find a situation of high redundancy. Now both

regions have very similar ecosystems and contain a set of local species that is found in the

other region as well. Taken to the extreme, global biodiversity is just the maximum of species

numbers’ living in one of the two regions. Habitat destruction in one region does not

necessarily lead to global extinction of some species. Here we find that the cross partial is

negative and large in absolute value. Under high redundancy an increase in local habitat area

and species numbers most probably makes an additional specie in the other region obsolete,

0** <= SSSS bb .

16

Making use of these various forms of the biodiversity index, we can formulate the

following propositions.

Proposition 3. Without taking into account the other region’s change in land policy, a

resource-rich country should reduce its land quota in response to increased openness. For

the country that is relatively poor in capital the optimal response in land-policy is ambiguous.

Proposition 4. If countries act strategically then the specific functional form of the global

biodiversity index determines the optimal response. Under strict species endemism,

0** == SSSS bb , the aforementioned strategic effect completely disappears. In case of

redundancy of local and foreign species, the optimal response of the capital-poor country to a

change in the other’s regions land policy is negative. For the resource-rich country the

optimal response is negative as well.

In response to the North’s initial reduction in its land quota, the South has an extra incentive

to loosen its land policy even further. First, there is the initial reaction to the inflow of capital

that induces the South to increase (decrease) its quota (tax) up to the point where the marginal

loss of local biodiversity equals the marginal gain in utility from consumption. Second, there

is the increase in habitat area in the North that induces the South to loosen its land policy

further. This positive externality lies at the root of the further conversion of habitat area in the

South; the social gains of habitat protection in the North are larger than the private gains, and

the South is willing to ‘substitute’ some of these gains for extra consumption. The North has a

similar incentive, knowing that further habitat destruction will increase the return to its

investment and increases habitat area at home to make up for the foreign loses in biodiversity.

It remains to be determined though why the strategic effect becomes unimportant or

even disappears completely under high species endemism. One reason might be that the initial

increase in habitat area in the North is now a pure gain: there is no overlap in some of the

species won with existing species in the South. As a result, the South has no incentive to

decrease its habitat area further to get rid of ‘redundant’ species. Thus, high levels of

redundancy increase the strength of the indirect effect and essentially provide a drive towards

specialization: one region as a large reserve site, the other dedicated to production (For

analysis of this issue in a NEG framework, see Barbier & Rauscher, 2007).

17

2. Land Policy in General Equilibrium and Tax Competition

2.1 Interjurisdictional Competition : Cooperative Solution Up to this point we have assumed that the North is relatively well endowed in capital whereas

the South is relatively abundant in nature, i.e., land. In practice, capital mobility might be

even more important in the context of similar countries. In fact, the bulk of foreign direct

investment is between developed countries. Likewise, land policy and habitat conservation

makes sense for similar countries as well.

For this purpose, let us consider symmetric countries. This setting is one that is often

chosen in the literature on interjurisdictional competition (tax competition). Since these

countries are fully symmetric they ex ante fear the outflow of capital but ex post are left with

identical capital stocks. This symmetry in terms of outcomes is the result of the symmetric

Nash equilibrium in tax rates. The analysis in our model involves two possible tax

instruments, a capital tax and a land tax. First, we determine the optimal solution. This social

planner solution will serve as a benchmark for the results of non-cooperative equilibria. We

maximize the sum of welfare with respect to the allocation of land and investment, subject to

a set of consumption and biodiversity conditions:

Max *** )()( BBCuCu ηη +++ (21)

*,, MM TTI

subject to

))(),(( ***MM TTAsTTsbB −−=

))(),(( ***MM TTsTTasbB −−=

IfTLIKfC KM*

0 ),,( +−=

IfTLIKfC KM −+= ),,( ***0

*

),,(),,( 0***

0 MKMK TLIKfTLIKf −=+

],[ 0*0 KKI −∈ , TTM ≤ , ** TTM ≤

After substitution of all conditions into the objective function this becomes an unconstrained

maximization problem with respect to three variables. The stock constraints on land can be

left out: using all land for production would immediately drive the marginal damage from

biodiversity loss to infinity ensuring habitat size is positive under all conditions. Similarly,

18

we can drop the restriction on investment by assuming ∞=→ KKI f0

lim and

∞=−→

**0

lim KKI f , which assures an interior solution. To keep the presentation simple, we

assume that taxes on capital are zero. Maximization yields the following set of first-order

conditions:

*CC uu = (22a),(22b),(22c)

TSKTTC sbaIffu )(][ *ηη +=+

**

**** )(][ TSKTTC sbAIffu ηη +=−

The first equation reveals that net investment should be allocated across regions such that the

marginal utility from consumption in each region is equalized. Stated otherwise, without any

trade frictions the marginal rate of substitution between domestic and foreign consumption

should equal one. The second equation shows that the land quota in the North should take a

value that equalizes the marginal utility from land use to the global marginal benefit from a

marginal increase in biodiversity (eq16.b); the marginal rate of substitution between

consumption and global biodiversity should equal one. This holds for the South as well

(eq.16c).

The benefits from a marginal increase in land use are twofold: the usual direct and

positive effect on production and a capital market effect. This capital market effect consists of

an increase in the world interest rate, an effect that is beneficial (detrimental) for capital

exporters (importers). A marginal increase in species richness has a marginal value η at

home and a marginal value *ηa abroad. In the social optimum both countries recognize the

positive spillovers derived from local biodiversity for the other region. Rewriting the FOC’s

furthermore gives the relation between the productivity of land and the marginal utility of

habitat conservation,

ηηηηA

aIffIff

KTT

KTT

++=

−+

*

*

** (23)

where we have assumed that ** TSTS sbsb = . So if (1) benefits from global biodiversity are

derived equally from local and foreign species numbers ( *SS bb = ) and if (2) local and

foreign ecosystems are equally robust and productive and habitat areas are of equal size

( *TT ss = ), then in the social optimum the ratio of marginal benefits from land must equal the

19

ratio of global preferences for biodiversity in the North and the South. Rewriting this

condition once more yields some further insights:

PP

PPT

KT

T

PP

PP

KT

T

tttt

ff

tttt

ffI

+−Ω

=+

−Ω= *

*

*

*

/11/

where MMTTT ttff // ** =≡Ω

TSC

P sbu

at*ηη +=

***

**

TSC

P sbu

At ηη +=

Where we used *KTKT ff = and the fact that the right-hand side of eq.(23) can be written as

**

**

*

*

*

)/()/(

TS

TS

C

C

sbsb

uAua

Aa

ηηηη

ηηηη

++

=+

+. In addition we have the defined the land-tax ratio TΩ

and Pigovian taxes for the North and South, Pt and *Pt . A sufficient and necessary condition

for net investment to be positive in this model is *PP tt >Ω . More formally this can be stated

as

0>I for *PP tt >Ω ⇔ PPMM tttt // ** >

if the relative land tax of the South exceeds the optimal relative Pigovian tax then investment

is positive. In the social optimum capital flows from the North to the South if for some reason

actual land policy in the South is relative stringent. This seems counterintuitive but is

plausible from a global point of view: with a scarce supply of land in the South this country

can overcome its resource scarcity by substitution with capital. The North on the other hand

can rely on its relative abundant supply of land. Global production is maximized by moving

mobile factors of production to these regions where immobile factors are in short supply. In

other words, if the relative demand for habitat in the South is smaller than the relative supply

investment is positive.

Note that this investment-condition is different in a two-country market economy.

Here, using Cobb-Douglas functional forms, the investment equation is given by

Ω

Ω

Ω

Ω

+−=

+−

=tl

Lkkttl

lKKtI )( **00

20

where */ LLl ≡ is the North-South population ratio, */ MM ttt ≡ is the North-South land-tax

ratio, LKk /0≡ , **0

* / LKk = and αχαβα //)1( =−−≡Ω is the ratio of the share of

land in production over the share of labor in production. Equilibrium investment is increasing

in the initial Northern capital stock )( 0K and decreasing in the Southern capital stock )( *0K .

In a market economy, a necessary condition for I to be positive, that is, to have

capital flowing from the North to the South, is the denominator being positive, 0>+ Ωtl ,

which is always guaranteed. Thus, a sufficient and necessary condition in a market economy

for positive investment in equilibrium is a positive nominator, that is, 0*00 >−Ω lKKt .

Rewriting gives us the intuitive condition that the Northern capital-labor ratio LKk /0≡ ,

must be larger than the Southern capital-labor ratio, **0

* / LKk ≡ , controlled for the land-tax

ratio:

kkt

*

>Ω or 1* >Ωtkk

With identical land policies in North and South, this condition boils down to a standard

factor-endowment result where the capital-rich country exports capital: 0* >⇔> Ikk .

With land-policy being exogenous in this exercise, the fundamental determinant in this model

is the North-South capital-labor ratio. It also shows that with land policy sufficiently stringent

even a capital-poor country under market conditions can become an exporter of capital since

land is de-facto scarce.

Returning back to our model of a social planner, we find that shifts in preferences for

biodiversity can alter the flows of investment. For example, a marginal change in North’s

preference for biodiversity leads to

2*

**

0 )())(1())(1(

|/PP

PPPP

KT

Tdt tt

ttAttAffI

M +−+−+−

=∂∂ =η (24)

where 0/ >∂∂ ηI for T

KT

fIf

AA >

+−

11

, which means that a positive preference shift for

biodiversity result in more investment if and only if North’s preference for Southern species

is sufficiently low. If a change in preference affects the land tax as well, as they should when

policy makers are concerned with implementation of optimal taxes, then an extra effect is

added:

21

0|/|// 00 >∂∂>∂∂+∂∂

=∂∂ == MM dtdtT

M IIfItI ηη

ηη (25)

where the first term is positive as long as the North is an exporter of capital. The general

equilibrium effect is larger than the original effect deduced above, because the indirect effect

(i.e. a more stringent land policy) works in the same direction as the direct effect of a

preference shift. Note that the derivative η∂∂ /Mt is based on a optimal policy formulation,

to which we will turn next.

Finally, we can derive the optimal taxes in the North and South that are consistent

with the social optimum by rewriting the FOC’s:

Ifu

sbatf KTC

TsMT −

+==

)( *ηη(26a)

Ifu

sbAtf KTC

TsMT

**

**** )(

++

==ηη

(26b)

The optimal tax on land in both regions is the sum of two effects. First, there is the Pigovian

tax part that measures the global marginal willingness to pay for biodiversity. We call this a

‘global’ effect because the Pigovian tax in the North (South) also incorporates the marginal

willingness to pay from the South (North) for species in the North (South). The second effect

is a capital market, i.e., a rent effect. By loosening environmental policy the return to foreign

investment is increased. For a capital exporter (importer) an increase in the world interest rate

is beneficial (detrimental) and it can spend more (less) on consumption. Comparing these

taxes with those from autarky, TsCAUT

M sbut )/(η= , leads us to conclude that the socially

optimal taxes are unambiguously higher than those in autarky if countries are fully symmetric

(net investment 0=I ).

Proposition 5. In the social optimum taxes for symmetric regions ( 0=I ) are

unambiguously higher than those in autarky and are equal to a pigovian tax.. Therefore

global consumption in the social optimum is lower, whereas biodiversity is larger than in

autarky. Social welfare is greater than in autarky. For asymmetric regions the optimal taxes

on land diverge from pigovian taxes due do a capital market effect. The global allocation of

capital is improved and social welfare is increased, but the effect on consumption and

biodiversity are not a priori clear.

22

The question remains how the global effect on biodiversity turns out in the social optimum if

we are dealing with asymmetric regions. For countries that differ in terms of endowments or

preferences, investment is positive and the global allocation of capital is improved. Due to

this improved capital allocation, the optimal tax on land in the North (South) becomes

increasingly smaller (greater) for increases in investment. In fact for CTsKT usbaIf /)( *η>

we find that the autarky tax for the North is larger than the optimal tax in the social optimum.

However this does not necessarily mean that local biodiversity declines, since one would still

have to determine the combined effect of a lower land tax and the reduced amount of capital

that is employed locally on total habitat area. The total effect on global biodiversity is even

more difficult to determine.

Nevertheless, the fact remains that if (1) much is to be gained from factor

reallocation, i.e., countries are not very similar and/or (2) countries do not care about foreign

biodiversity (a, A close to zero) then it is likely that increases in welfare are caused mainly by

increases in consumption and only marginally due to improvements in biodiversity.

2.2 Interjurisdictional Competition: Non-Cooperative Solution Now that we have determined the cooperative solution for land policy let us evaluate the non-

cooperative solution as well. If countries are of significant importance in world markets, as in

the case when we consider a two-country model, then their actions might alter the

remuneration (interest rate) to capital. So to be able to consider capital market interactions,

we repeat the following ‘location condition’ of capital:

KMKKMK tTLIKftTLIKf −−=−+ ),,(),,( 0****

0 (7)

Both countries are able to influence the location of capital by either setting an attractive tax

on capital or a lax policy with respect to the land quota or land tax. In what follows next we

first determine the non-cooperative solution under the assumptions that both countries take

the other’s tax policies as given (Nash) and can only change the tax on land. Thus, we

consider a non-cooperative game with one instrument. The necessary first-order conditions

are:

0=+=∂∂

MMC

M dTdb

dTdCu

TV η

M

MC

dTdCdTdbu

//

−=⇔η

23

0*

**

*

**

*

*

=+=∂∂

MMC

M dTdb

dTdCu

TV η *

*

* //

M

MC

dTdCdTdbu

−=⇔η

where we have set 0* == KK tt to make a comparison with the social solution more

straightforward. Substitution of these various derivatives into the FOC for optimal land policy

then gives:

***

****** ])()[( TS

KKKK

KTKKKKTTC sb

ffftIfIffu η=+

−+−

TSKKKK

KTKKKKTTC sb

ffftIfIffu η=+

+−+ ])()[( *

rewriting yields

C

TS

KKKK

KTKKT

NCM u

sbff

Iffft η+

+−

== *

*

,C

TS

KKKK

KTKKT

NCM u

sbff

Iffft**

*

*** η

++

== (27a,b)

whereas

*

*

KKKK

KKKT

C

TsNCM

CM ff

Iffu

sbatt

+−+=

η(28a)

and for the South

(28b)

NCM

KKKK

KKKT

C

TsNCM

CM t

ffIff

usbA

tt **

***** >

+++=

η

As shown, the cooperative tax is unambiguously higher than the non-cooperative tax in the

case of symmetric countries ( 0=I ), that is, NCM

CM tt > and NC

MC

M tt ** > .

Proposition 6. For symmetric regions the Nash-equilibrium of non-cooperative policy yields

unambiguously higher land taxes in both countries when compared to the cooperative setting.

As a result of these lower taxes biodiversity is underprovided in the non-cooperative setting.

For the case of asymmetric countries, the non-cooperative equilibrium yields taxes that

become increasingly larger (smaller) for the North (South). In the end, the total effect on

global biodiversity may be ambiguous for countries that are sufficiently asymmetric.

24

The underprovision of public goods when jurisdictions compete in taxes is a well-known

result in the literature on optimal taxation (Oates&Schwabb, 1988; Flatters et al., 1974). A

difference is that in the problem analysed here, regions compete in taxes set on a cooperative

factor of production, and not on capital itself. Other differences with Oates&Schwabb (1988)

are the possible asymmetry of regions and the inclusion of a capital market effect as a result

thereof.

With tax competition, countries do not internalise the positive externalities of a higher

tax on land. Local habitat protection benefits the other country as well, although to a lesser

extent. If countries are asymmetric for any of the reasons mentioned in the first proposition

(preferences, endowments), then there is an extra externality involved. This externality

represents the beneficial effects of a better factor allocation for both countries (capital market

effect). For the South this implies that the gap between the non-cooperative and cooperative

solutions becomes greater: large net investments in the South produce increasingly larger

taxes in the South in the social optimum. Welfare is unambiguously higher in the social

optimum, but for more asymmetric countries the gains from integration might come at the

cost of losing biodiversity. For the non-cooperative setting the Nash equilibrium yields

unambiguously lower taxes for countries that are ‘sufficiently symmetric’ and underprovision

of global biodiversity results.

2.3 Environmental Kuznets Curve for Biodiversity and Land Regulation? Increasing awareness of environmental problems and risks such as those associated with

global warming, industrial pollution and the emission of CFC’s have caused numerous

governments to respond in various ways to these threats. For example, today various climate

agreements exist with the Kyoto protocol probably being the most famous. Enforced since

2005, the Kyoto protocol is an amendment to the United Nations framework convention on

Climate Change with the objective to limit emissions of carbon dioxide and other greenhouse

gasses. In the area of biodiversity agreements exists as well, the most notable probably the

convention on biological diversity (Biodiversity Treaty).

In our model environmental policy is modelled in a relatively simply manner: the

government either sets a land tax or a quota. In addition, we have assumed that land policy is

set exogenous. To model an endogenous policy response to capital market liberalization, we

take a small open economy facing an exogenous world interest rate Wr and analyze how

investment growth affects land-use. Since investment unambiguously raises income, we use a

logarithmic utility function to emphasize the role of income gains in environmental policy:

))(),(()ln( *****MM TsTAsBCV η+= (29)

25

with IrQYC **** −== . Equating demand and supply for land by differentiating

respectively firm’s profits and the welfare function we obtain

*********

0** )())(),((),,( YTsTsTsBATIKLf MTMMSMT η=+ (30)

which shows that the right-hand side is rising in income. Since the right-hand side represents

marginal damage of habitat loss, this implies that high income per se increases the damage

from biodiversity loss. Note that this land equilibrium equation can be rewritten as

),,(),,( *****0

** YTTMDBTIKLf MMMT =+ (31)

where YTsTsTsBAMDB MTMMS )())(),(( ******* η≡ , the marginal damage to biodiversity

from a decrease in habitat area. Differentiation with respect to I and *MT yields the following

effect of a change in the world interest rate on land-use under an endogenous policy response:

∆

−=

*,

*,

*,

**ItMIYYMDBM

WM

It

drdT εεε

(32)

where )//()/(, YtdYdMDB MYMDB ≡ε , the elasticity of marginal damage to biodiversity

with respect to income, )//()/( ***, IYdIdYIY ≡ε , the elasticity of national income with

respect to investment and ***, / MTKItM tIf≡ε , the elasticity of inverse land demand with

respect to a change investment, ***** / TMMYTT MDBdTdYMDBf −−=∆ .

In general the sign of the derivative is ambiguous, since the sign of both the

nominator and denominator are not clear. For *,

*,

*, ItMIYYMDB εεε − to be positive, we must have

*,

*,

*, ItMIYYMDB εεε > , which depends not only on preferences such as *η , but also on the size of

the investment I and the strength of an increase in investment on the demand for land *TKf .

Furthermore, 0>∆ if and only if ***** / MBYTT

BT dTdYMDfMD −> . Thus, a decrease in

the world interest rate is likely to raise the demand for land if the marginal damage from

biodiversity loss is low, the size of total foreign direct investment is low and the share of land

in production is small.

26

Note that it is also possible for the derivative to change signs, that is, for sufficiently

large reductions in the world interest rate, the demand for habitat area increases. The intuition

is that since the marginal damage from biodiversity is increasing in income, large enough

gains in investment may raise income sufficiently to increase the demand for biodiversity at

the cost of land usage in production.

Figure 1: Biodiversity Underprovision

Figure 2: Possibly too much global habitat area

27

Conclusions

In this paper we described a simple model of economic integration where consumers care

about both local and global levels of biological diversity. Since biodiversity and aggregate

production both depend on the use of land, there is an inherent trade-off in this economy

between habitat conservation one the hand and consumption on the other hand. We discussed

issues of optimal land policy, capital market liberalization and changes in biodiversity.

A small open economy that takes the world interest rate as given attracts capital from

abroad if it is relatively poor in capital and/or its land policy is relatively lax. Liberalization

improves production, increases utility from consumption and improves overall welfare if land

policy is optimal. Only with a strict quota on land is the original size of habitat maintained. If

there is a tax on land use, then biodiversity unambiguously declines but this may be desirable

in terms of overall welfare if the tax rate itself is optimal.

Next, we discussed some strategic issues concerning land policies. It was found that a

global drop in ecosystem productivity, for example due to climate change, is more likely to

increase habitat area than a purely local shock. Furthermore, we found that ecological

characteristics play an important role in setting land policies as well. If there is a high level of

redundancy, implying that many species inhabit both North and South, there is more room for

strategic interaction. Under these circumstances, governments weaken their land policies if

there is a marginal increase in habitat area abroad, since governments calculate that now more

species at home are redundant from a global point of view.

In the second section we strengthened our intuition regarding the condition required

for positive capital investment from North to South. A relatively land abundant country can

‘de-facto’ be a relatively land scarce country if its land policy in the form of a quota or tax is

sufficiently stringent. This ‘de-facto’ endowment condition was found before by Rauscher

(1997) in the context of trade and pollution. It basically entails a combination of the ‘pollution

haven hypothesis’ and the ‘factor endowment hypothesis’. If the land-tax ratio is equal to one,

we obtain the classic factor endowment result.

In the second section we also raised questions concerning social welfare. When

ecosystems in the North and South are similar, quotas are set in such a way that in the social

optimum the ratio of marginal benefits from land use must equal the ratio of global

preferences for biodiversity in the North and South. This also implies that if, for example,

species in the South are highly valued by both countries then a social planner would set aside

more habitat area in the South. As a result, more economic activity would be located in the

North. This result is strengthened if ecosystems in the South are more productive, for example

due to reasons related to geography.

28

In the social optimum factors of production move to regions where they are in short

supply. For symmetric regions we find that global consumption in the social optimum is

lower, whereas biodiversity is larger than in autarky. Social welfare is greater than in autarky.

For asymmetric regions the optimal taxes on land diverge from Pigovian taxes due to a capital

market effect. The global allocation of capital is improved and social welfare is increased, but

the effects on consumption and biodiversity are not a priori clear. In addition, a positive

preference shift for biodiversity by the North results in more investment in the South if and

only if North’s preferences for species in the South are sufficiently low.

Furthermore, we investigated the possibilities of an environmental Kuznets curve for

biodiversity. To do so, we derived comparative statics for capital market liberalization under

endogenous land policy. By taking a simple log-linear functional form for utility, the land-tax

or quota was shown to be increasing in income. Our thought experiment assumed a drop in

the world interest rate that would give rise to a surge of international investment in the South.

Even though this rise in income is associated with an immediate increase in the stringency of

land policy, the effect on local habitat conservation and biodiversity is ambiguous. The

chance of an improvement in biodiversity increases with (1) the elasticity of marginal damage

from biodiversity loss and decreases with (2) the share of land in production, among other

factors.

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