Natural Capital Externalities: Evidence from Over 700 U.S. Watersheds

This paper develops a theoretical model of how an externality can make tradeoffs between natural capital stocks more common, and provides evidence by comparing natural capital relationships between public and private lands. An externality arises because joint production relationships between natural capital stocks are internal to the ecosystem but external to the economy. We find evidence that private markets are failing to internalize synergistic biophysical relationships between forests and two other natural capital stocks: water for municipal use and forage for 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.