Stream ecosystem service markets under no-net-loss regulation

We analyze interactions between economics and ecology for ecosystem service markets under no-net-loss regulation. Previous studies of no-net-loss regulation address the ecological efficacy and valuation of restoration but largely ignore the effects of market dynamics. We link an economic model of free-entry equilibria with an ecological model that includes returns to scale and inefficiency of restored ecosystems and apply the result to stream mitigation banking in North Carolina. Intuition from ecology alone must be modified to account for economic processes, and vice versa. To implement no-net-loss regulation, one must not only account for ecological differences between restored and natural ecosystems, but also consider the effect of market entry on the number and size of restoration projects. In a purely economic model, free-entry equilibria are characterized by excess entry: the equilibrium number of firms is greater than the welfare maximizing number. Ecological considerations may exacerbate or ameliorate this, so that either excess entry or insufficient entry may occur, depending on the specific ecosystem services sought.