Land Use Policy 27 (2010) 489–496 Contents lists available at ScienceDirect Land Use Policy journal homepage: www.elsevier.com/locate/landusepol Land speculation and interest rate subsidies as a cause of deforestation: The role of cattle ranching in Costa Rica Peter C. Roebeling a,b,∗ , Eligius M.T. Hendrix c,d a Development Economics Group, Department of Social Sciences, Wageningen University, 6706 KN, Wageningen, The Netherlands b Centre for Environmental and Marine Studies (CESAM), Department of Environment and Planning, University of Aveiro, 3810-193 Aveiro, Portugal c Operations Research and Logistics Group, Department of Social Sciences, Wageningen University, 6706 KN, Wageningen, The Netherlands d Department of Computer Architecture, University of Málaga, 29017, Málaga, Spain article info Article history: Received 12 November 2008 Received in revised form 1 July 2009 Accepted 5 July 2009 Keywords: Investment theory Dynamic optimization Land speculation Cattle ranching Deforestation abstract Land speculation by cattle ranchers is considered a principal cause of deforestation in Latin America, in particular in combination with (previously) widely provided interest rate subsidies. Proof for the hypoth- esis that land speculation leads to inflated rates of investment in land is, however, relatively limited and invariably related to the question of whether land prices tend to rise over time. Based on the Neoclassical investment theory with adjustment costs we develop a stochastic cattle ranching model in which land prices are modelled as geometric Brownian motion, to evaluate the effect of expected fluctuations in land prices on land investment decisions by cattle ranchers in Latin America. For a case study in the Atlantic Zone of Costa Rica, results show that the expected rate of investment is almost 35% underestimated in case land prices are assumed constant instead of fluctuating according to the standard deviation, while abolition of interest rate subsidies leads to an almost 15% decrease in the expected rate of investment. Consequently, it is shown that variability in land prices alone is a sufficient condition for land speculation, inflated rates of investment in land, larger farm sizes and, thus, higher rates of deforestation in agrarian frontier areas, while this process is further promoted by subsidized livestock credit or any other form of agricultural subsidy that increases the marginal production value of land. © 2009 Elsevier Ltd. All rights reserved. Introduction Forest clearing and subsequent conversion to pasture for livestock production has been one of the most profound land trans- formations in Latin America over the past decades (Hecht, 1992; Kaimowitz, 1996; Laurence et al., 2004). Between 1961 and 1999, permanent pastures accounted for no less than 80% of the agri- cultural area, while the share of permanent pastures in the total area increased from about 25% in 1961 to almost 30% in 2005 (FAO, 2008). The increase in pasture area was largely facilitated by a decrease in forest and woodland area, which implies a rate of defor- estation of up to 2.2 million hectare per year (0.2% of the total forest and woodland area). As a result, Latin America accounts for more than 42% of global deforestation. Small farmers, traditional ranchers and investment ranchers are generally considered the key agents of forest-to-pasture conver- ∗ Corresponding author at: Centre for Environmental and Marine Studies (CESAM), Department of Environment and Planning, University of Aveiro, 3810-193 Aveiro, Portugal. Tel.: +351 234 370 387; fax: +351 234 370 309. E-mail addresses: peter.roebeling@ua.pt (P.C. Roebeling), eligius.hendrix@wur.nl (E.M.T. Hendrix). sion in Latin America (Faminow, 1998). In this paper we focus on the share of deforestation attributed to large scale cattle ranching operations, which is estimated to account for about 25–35% of total deforestation in Latin America (Faminow, 1998; Walker et al., 2000; Fearnside, 2005)—we do not consider deforestation by small farm- ers, plantations, mining, logging and infrastructure developments, which account for the remaining 65–75% of deforestation. Factors explaining the expansion of cattle ranching at the agrarian frontier in Latin America, include the characteristics of cattle ranching, the increased demand for beef products, govern- ment policies, land speculation and resource degradation (for an overview, see Kaimowitz, 1996; Faminow, 1998; Roebeling, 2003; Fearnside, 2005). As pasture based beef production is character- ized by low labour and input requirements while cattle provides goods, services and collateral, cattle ranching can be developed over large and remote areas where markets are imperfect or fail- ing altogether. The increased local, Latin American and, over the last decade, global export demand for beef products, required a structural increase in the supply of beef products despite the decrease in real beef prices since the mid-1970s. Input subsi- dies, tax advantages, subsidized livestock credits, infrastructure developments, land titling and migration programs are, amongst others, government policies that promoted the expansion of cattle 0264-8377/$ – see front matter © 2009 Elsevier Ltd. All rights reserved. doi:10.1016/j.landusepol.2009.07.002