Deforestation and credit instability in Latin American countries Deforestation and credit instability in Latin American countries

This paper highlights the link between deforestation and credit instability in Latin American countries which exhibit strong deforestation rates as well as macroeconomic instability that is often rooted in the alternating episodes of credit booms and crunches. Pieces of explanation establishing a causal link between credit instability and deforestation driven by agricultural expansion are put forward. A key ingredient of the model is the existence of two sectors: a labour intensive agricultural sector and a capitalintensive one, the former relying only on land and labour and the latter using three production factors: capital, labour and land. Land is a specific factor within each sector. Land increases are deemed to be mainly an irreversible deforestation process; land decreases barely coincide with forest cover increases. Deforestation occurs in response to changes in the opportunity cost of capital, primarily because of the irreversible character of forest conversion. Econometric tests are performed on the 1948-2005 period and on a sample of Latin American countries. Controlling for the effects of macroeconomic policies and usual deforestation determinants, a positive and significant impact of credit instability on deforestation is found. Robustness checks including different specifications do not contradict this result. Sound macroeconomic policies have also significant positive environmental effects.