With tropical deforestation a major contributor to greenhouse gas emissions, the land use decisions of small-scale farmers at the forest margins have important implications for the global environment. In some tropical forested areas, such as the Zona Bragantina in the Eastern Brazilian Amazon, farmers practice a shifting cultivation system that maintains large amounts of land under forest fallows. This research explores farmers’ incentives for maintaining forest fallows, which provide many of the same environmental services as mature forests, including local externalities such as erosion mitigation and hydrological regulation.

The study addresses three testable research questions: What are the returns to forest fallows in shifting cultivation? Does local forest cover provide economically significant externalities to agricultural production? Do credit constraints hinder farmers from transitioning to more intensive land uses? I empirically estimate the value of ecosystem services provided by forest fallows in agricultural production and test whether local externalities generated by secondary forests are economically significant, using farm survey and GIS data from the Zona Bragantina. I then use the estimated parameters to determine the effect of credit constraints on fallow management efficiency. Implications of a credit constraint for fallow efficiency depend on the magnitude of local forest externalities. Constraints that encourage fallowing may be welfare-improving if forest fallow provides economically significant local externalities. However, credit constraints in the absence of positive local externalities may deter farmers’ expansion of profitable agricultural activities, suggesting that the rate of deforestation is likely to increase as farmers’ access to input and credit markets improves.