Epsilon Open Archive

Abstract

The free market economy, to which East European countries are increasingly being exposed, implies that classical budgeting techniques in the form of the Faustmann approach present themselves as the tools of choice for forest investment analysis. One implication is that the choice of a proper discount rate (r) must be made as part of the basis for formulating a harvest policy. The paper discusses this choice in the light of practice as well as theory, and, using Lithuania as a case, examines the potential economic and political impact of softening the current restrictions on forest management. A review of the debate on discounting in forestry is provided. A statistical analysis of the relation between reported rs and internal rates of return (IRR) from numerous studies on forestry investments reveals a strong correlation between r and IRR. Possible explanations are provided. Analysis reveals that application of any positive r will significantly change forestry practice in Lithuania. Setting r = 3 per cent, slow growing species are to be replaced by fast growing species, and rotation periods should be substantially shortened. The standing volume of (over-) mature forests is about 160 million m3, as compared with the currently harvestable volume of about 40 million m3 according to the minimum allowable rotation age. The macroeconomic perspectives of cashing some of the mature forest for the small transition economy are discussed, taking into account the effects of externalities of forests. Consequently we suggest an alternative formulation of the normal forest. Finally, based on these considerations, a real r of 0-2 per cent is suggested for State forestry in Lithuania. A post-tax r of 2 per cent is advocated for private forestry, with potential project specific deviations downward to 0 or upward to 4 per cent. It is stressed that discount rate is viewed as one of important decision parameters and due regard should be given to non-timber forest outputs, social and institutional settings and other factors.