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Tropical moist forests provide a range of goods and services to society. Traditionally, decisions regarding tropical forest land use have been made on the basis of major direct uses of forest land that generate local and national benefits. Typically, this has meant timber extraction and the conversion of forest to agricultural or livestock uses. In recent years increasing attention has been given to the important economic role non-market benefits may play in providing incentives for the conservation of tropical forests. A number of studies have explored the local, national and global benefits generated by non-timber forest products, ecotourism, pharmaceutical prospecting and carbon storage.
Another important ecological service that is often cited as an economic justification of conservation activities is the watershed protection function provided by tropical forests. Soil and water conservation may yield benefits to land-owners and alleviate damage to downstream economic activities. Nevertheless efforts to conserve watersheds are plagued by the difficult nature of the externalities involved. The off-site nature of many of the benefits of conservation activities makes both valuation and internalization of these externalities difficult, thereby preventing the development of 'sustainable' watershed protection programs. This is even the case in areas where pristine, mountainous forests provide downstream national benefits to hydroelectricity and irrigation schemes. The establishment of incentive systems that solve market, policy and institutional failures impeding watershed protection in such areas remains a vexing problem for policy-makers, scientists and communities in developing countries. Drawing on the literature and on-going research in Costa Rica, the paper outlines a collaborative research project investigating the potential for economic incentives for watershed protection in the Arenal region of Costa Rica.