The clearing of forests for agricultural land and other marketable purposes is a well-trodden path of economic development. With these private benefits from deforestation come external costs: emissions from deforestation currently account for 12 per cent of global carbon emissions. A widespread intervention in reducing emissions from deforestation will affect the paths of agricultural expansion and economic growth of lower income nations. To investigate these processes, this paper presents a general, dynamic, stochastic model of deforestation and economic growth. The model is shown to generate unique deforestation and investment paths and a model without reduced deforestation policy is shown to have a stationary distribution of income and landholdings. There are three main findings. First, in the short run national output growth falls with compensation for reduced deforestation. Second, deforestation rates are reduced through compensating either reduced deforestation directly or the stock of forests; however, compensating the stock of forests is likely to be prohibitively expensive. Finally, by offering a fixed compensation rate, as opposed to a compensation rate tied to a stochastic carbon price, further reductions in deforestation can be achieved.
