China has implemented a strategy of classified forest management to achieve sustainable forest development. As part of this strategy, a large amount of non-public forestland has been designated for ecological purposes, depriving farmers of the management and use rights. Without adequate compensation, however, this policy could dampen their interest in managing commercial as well as ecological forests, hampering the long-term forestry development itself. We assess the impact of designating ecological forests on farmers' forest investments using a cutting-edge econometric approach, coupled with survey data gathered from a typical region in southern China that reflect farmers' forestry activities before and after ecological forests were designated. It is found that this policy indeed reduced the probabilities and levels of overall investments in both ecological and commercial forests, as well as specific investments in afforestation and forest management and protection. Moreover, these negative effects were more pronounced on small-scale holdings. These findings have major policy implications to not just China but also many parts of the world.