Water purification might be the most frequently invoked example of an economically valuable ecosystem service, yet the impacts of upstream land use on downstream municipal water treatment costs remain poorly understood. This is especially true in developing countries, where rates of deforestation are highest and cost-effective expansion of safe water supplies is needed the most. We present the first econometric study to estimate directly the effect of tropical forests on water treatment cost. We exploit a rich panel dataset from Malaysia, which enables us to control for a wide range of potentially confounding factors. We find significant, robust evidence that protecting both virgin and logged forests against conversion to nonforest land uses reduced water treatment costs, with protection of virgin forests reducing costs more. The marginal value of this water purification service varied greatly across treatment plants, thus implying that the service offered a stronger rationale for forest protection in some locations than others. On average, the service value was large relative to treatment plants' expenditures on priced inputs, but it was very small compared to producer surpluses for competing land uses. For various reasons, however, the latter comparison exaggerates the shortfall between the benefits and the costs of enhancing water purification by protecting forests. Moreover, forest protection decisions that appear to be economically unjustified when only water purification is considered might be justified when a broader range of services is taken into account.

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