Ecosystem complementarities: Evidence from over 700 U.S. watersheds

This paper demonstrates how the slope of a production possibilities frontier (PPF) can be used to empirically identify the presence of an ecosystem externality. Complementarity between non-market ecosystem services implies the PPF between these services may be upward sloping. In contrast, private landowners that ignore these complementarities will treat non-market ecosystem services as competing products thereby ensuring a downward sloping PPF. Using data from 738 U.S. watersheds, we compare the slope of PPFs on predominately private and predominately public watersheds. We find evidence that private markets are failing to internalize complementarities between forest habitat and two other non-market ecosystem services: instream flows and grazing. In addition, we show how three-stage least squares regression can be used to reduce endogeneity bias associated with more common approaches to estimating ecosystem service relationships.