Game theory techniques and regarding pollution control as infrastructure could end haze over Indonesia’s palm oil industry.
By Euston Quah and Joergen Oerstroem Moeller*
Despite political pressures over many years and various enforcement measures, palm oil producers in Indonesia continue to slash and burn to clear land, harassing neighboring countries with transboundary pollution.
Simple economics may offer a new approach for slash-and-burn agriculture, which if successful might also have relevance for similar environmental encroachments. Farmers and plantations must find it profitable to ditch slash and burn, and those demanding a haze-free life must contribute financing. Benefits and costs must be designed in such a way that no alternative exists making countries better off – creating a win/win situation for everybody taking part.
Palm oil is the world’s most competitive vegetable oil with global production more than doubling since 2000 and expected to grow even more as advanced economies favor natural oils over artificial trans-fats for health reasons. The palms, native to Africa, were transferred to Malaysia in the 20th century and later to Indonesia.
Today, that region produces more than 80 percent of the world’s palm oil.
Economic losses in health, tourism and canceled flights along with school and business closures are an indisputable consequence of haze, but do not hit those responsible. The Asian Development Bank estimated the 1997 costs of haze to be US$9 billion, and that does not include the negative images of deforestation and pollution, highlighted by activists and in turn leading to decreased foreign direct investment. Often, the burning of fields gets out of control, triggering wildfires with impacts that are difficult to estimate.
The cost of switching to non-burning methods is estimated at US$1.2 billion.
The only way to change producers’ behavior is bridging the cost difference between slash-and-burn versus non-burning methods. Those who resent the pollution must invest $1.2 billion to avoid the $9 billion in costs.
Uniform cross-the-board measures won’t work. About 40 percent of the haze originates from plantations run by large corporations and 60 percent from small landholders including subsistence and indigenous farmers. The large corporations have the financial resources to ditch slash-and-burn methods, but the small operators do not and cling to traditions.
Market forces won’t work. Slash-and-burn is less costly than environmentally friendly methods relying on manpower, heavy machinery or new technologies. Under current market conditions – low prices due increasing supply amid falling demand as well as currency volatility and competition from soybean oil – the initial investment will, at best, be profitable only in the long run and burden the producer with a short-term cash drain.
If forced to switch to expensive methods and if the governments could enforce regulations, small operators would close. Lacking coordination or influence, small farmers cannot easily hike the market price for palm oil and they resist pressure, legislation and rules. Politicians are understandably reluctant to target a major contributor to the domestic economy, estimated at about 5 percent of Indonesia’s GDP.
Governments and environmentalists could disrupt the economic calculus by paying rewards or subsidies to small landholders that use haze-free methods. Such a system anchored in financial rewards or subsidies, aiming to improve methods and increase enforcement, would change the economic calculus. High rewards for those who act swiftly could create a group of pioneers who demonstrate the advantages. New technologies and synergies might eventually reduce cost differences and the need for subsidies, but development of new technology is held back by a lack of economic incentives. Such a system would not avoid payouts to large corporate plantations, and organizers could borrow from methods in European countries that encourage collecting waste to generate energy.
The large corporations could do more to reduce haze, but many hide behind the small farmers and the government is lenient. Media reports this year disclosed fires in concession areas managed by six companies.
The only solution is to finance the costs for small stakeholders to switch methods of land clearance. It may seem unfair – like extortion – to ask the victims to pay out to avoid being harmed. But realistically, many in Southeast Asia may be willing to pay to end the annual choking haze that can last three to four months. Such a policy conforms with welfare economics: A policy enhances welfare if those who are better off can compensate those who lose and still be better off.
If such a policy were left to countries directly involved in financing, then the amount should be distributed according to relative negative impact. A 2004 study suggests that about 94 percent of the victim damages are in Indonesia, 5 percent in Malaysia and 1 percent in Singapore. Game theory economics suggests that if victims share the costs of controlling pollution in proportion to their damages then no country would be worse off, no country should be better off by leaving the agreement and no alternatives exist that make some countries better off.
But political realities rarely work as smoothly as economic theory. Haze has so far been classified as an environmental problem, relevant only for those producing the pollution and those suffering from the effects. Such a narrow focus might be replaced by classifying such haze as an element in economic and social development. As such, preventing the burning and the economic consequences belongs among the many activities undertaken by developed countries as well as international institutions like the World Bank, the Asian Development Bank and the newly born Asian Infrastructure Investment Bank under the label of development assistance.
Lending expertise and financial support would improve environmental conditions in Southeast Asia, saving the region’s countries billions of dollars while modernizing production methods used primarily by small landholders. The benefits of transforming this agricultural sector in Malaysia and Indonesia might deliver spinoffs to other sectors in the economy including agricultural machinery. And over the long term, the health benefits might be considerable as is the case for switching to a more modern production structure and obliterating the image of a sector mired in outdated methods. Another substantial if nontangible benefit: Accusations by activists about the sector not being a good corporate citizen would no longer be warranted.
The world is trying to get a handle on climate change and environmental problems with limited success. Agreements to limit carbon dioxide emissions as a result of the Paris agreement, to go in effect in November, are encouraging but not enough.
A rewards system for small stakeholders in economies may serve as a template for similar cross-border environmental problems to analyze production methods, technology and market structure and develop financing and enforcement systems, making it profitable for polluters to switch into cleaner production methods.
The underlying assumptions include that people are willing to pay for not enduring pollution, small stakeholders will respond to economic incentives, and international financial institutions are prepared to classify reduction of pollution as infrastructure improvements and therefore eligible for support. If so, the world may have a much-needed tool to act against global pollution.
*Euston Quah is professor and head of economics with Nanyang Technological University, Singapore. He is also president of the Economic Society of Singapore. Joergen Oerstroem Moeller is visiting senior fellow, ISEAS Yusof Ishak Institute, Singapore. He is also adjunct professor with the Singapore Management University and Copenhagen Business School and an honorary alumni of the University of Copenhagen.