# **_2. Land speculation_**

While some may call land races a form of speculation, _land speculation_ is actually a different phenomenon. It refers to a situation where land is cleared (and property rights established) to capture expected profits through later sales, and land prices are not solely a function of the land rent but also contain a speculative element.

The simple capital asset pricing theory suggests that land prices reflect the discounted value of future land rents. In booming frontier areas with active land markets, land prices may reflect the expectations about being able to sell the land at even higher land prices later. This form of “rational bubbles” is similar to what can be observed in other asset market, e.g., stock and real estate markets.

A study based on US data for the period 1910-1990 by Clark et al. (1993) suggests that land prices rose faster than land rents when both are rising. In other words, during boom periods the land prices seem to increase more than the land rent increase would dictate. Expectations created about future land price increases make farmers willing to pay a higher price. Thus the expectations become selffulfilling, but the bubble – even if rational – will eventually bust when farmers start doubting that this can continue.

We are not aware of any quantitative studies of the importance of this phenomenon for tropical deforestation, although anecdotal evidences from booming frontiers may point in this direction. But they will typically work in tandem with other forces to expand the agricultural frontier, and the relative importance remains unknown.

# **_3. Games and strategic squeezing_**

When property rights are established by converting forest to agriculture, there is a third effect termed “strategic squeezing” that can lead to deforestation beyond the outcome of the basic von Thünen model of section 2.1. The key elements of this effect are described below. A more elaborate discussion is given in Alston et al. (1999), Alston et al. (2000) and Angelsen (2001), and the following discussion is a simplified version of the game model of the latter.

Consider two competing land users: a local community and the state. Both agents derive benefits from both converting forest (to agricultural land) and – unlike what we assumed above – from maintaining forest cover. The latter could be in the form of environmental services and various forest products. Thus deforestation by one agent is costly as it reduces forest benefits to the other. Additionally, deforestation by the other agent is costly as it reduces own opportunity for forest conversion in the future.

The two players will take the others’ response into account when they decide on how much land to clear, i.e., they think strategically. The normal response for both players would be to clear less land when the other increases its forest clearing for at least two reasons: the marginal costs of forest conversion has gone up (less suitable forest land for agricultural conversion), and the marginal value of the remaining forest is higher (higher forest scarcity).

In this context there are incentives for both players to try and squeeze the other: increasing own deforestation has an additional benefit beyond the agricultural rent obtained; it squeezes (reduces) the other players’ forest clearing, which is costly to them.

We can formalize these arguments as follows:<sup>28</sup> The players get two types of benefits: agricultural income from forest conversion, and forest products and forest environmental services ( _ei_ ). The latter is a function of the forest area, i.e., they decline with the amount of forest converted by the two

> 28 For simplicity, we only include the argument about benefits from standing forest in the model, and not the effect of increasing costs of conversion.

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