Wednesday, March 28, 2012

Looking for the right incentive

Below is an excerpt of my talk in the International Conference on Adaptation to Climate Change, Brussels, February 28, 2012. I think this has some relevance to the ongoing debate on fuel subsidy in Indonesia. In particular, as I have talked much about infrastructure, now it's time for the environment. Cheers. Aco.

Cooperation in Adaptation and Mitigation - Southeast Asia
by Arianto A. Patunru (University of Indonesia)

Managing the climate change is a public good issue. That is, it is not economically attractive to any private party to do it alone, despite the fact that the benefits of doing it will spread out to many parties. Therefore, it is prone to the problem of free riding.  On the other hand, what one does will affect the others, such that if left uncompensated the latter will be forced to move down to a lower utility, hence the negative externality. Furthermore, climate change problem is not contained only in one isolated place. It is almost impossible to localize the problem within a small range neighborhood. Due to these characteristics of climate change problem, it is imperative for all the parties affected to cooperate.

The idea behind many internationally arranged cooperation in terms of environmental causes such as climate change mitigation and adaptation is how developed countries help developing countries to reduce emission levels by proper compensation. One of the important aspects of international cooperation is that the fund involved often times requires a loop process where assistance is given with conditionalities. This is normal and in fact can be used to help the recipient country developing its own structure or system to support global initiative of green economy.  Cooperation for environmental cause can also be conducted using the already existing organization. In fact many of these organization already have initiatives addressing environmental problems in a coordinated way. In addition to developed-developing countries cooperation, there needs to be cooperation system between developing countries. Most naturally this would be formed on the basis of geographical proximity e.g Southeast Asian countries, for each country is prone to the externality originated from any other country in the region (for example on NOx and SOx pollution).

One of the areas that need cooperation especially among developing countries is clean energy. It is a fact that energy demand is always rising in a developing country. But the demand is often times met with a supply of energy that produces negative externality to the economy. That is, the supply of clean energy has been limited. Many Southeast Asian economies are victim of high oil prices, but they continue to pervasively subsidize energy. Countries spend even up to 25% on energy subsidies, for example Malaysia (USD 15 billion in 2009), and Indonesia (USD 15 billion in 2010). In 2008 the overall fossil fuel consumption subsidies amounted to USD 557 billion, of which non-OECD countries responsible for USD 400 billion.  These energy subsidies distort prices, and have negative effects on the environment as it can support pervasive activities that lead to environmental degradation or encourage overconsumption.  Although in developing countries energy is subsidized for economic development and poverty alleviation, subsidies for oil and other energy sources mainly benefit higher income groups and capital-intensive industries.

While pursuing cooperation with other countries, each individual country should continue improving its own domestic policies and development practices. For example, in Indonesia agriculture is still the most important sector in terms of the large share of population working in it, as well as the high concentration of the poor. Hence any policy regarding this sector should take poverty issue into account. Simply requesting a low carbon agricultural practices might not tackle the root of the problem. The fact that many poor Indonesians are stuck in agriculture sector is also related to the rigidity of the labor market where the movement across sectors (for example for agriculture to more value-adding manufacturing) is relatively hindered. Furthermore, the ratio of land per farmer is very small (currently majority of Indonesian farmers are landless peasants and farmers who own less than 0.5 hectare of land) – and keeps reducing due to fixed resource of land versus increasing labor force in the sector. This leads to the problem of low productivity and sustainability. Therefore, it would be more logical if the policy in this sector aims to increase productivity (in a more sustainable manner) and to improve farmers’ access to wider opportunities like manufacturing. This also applies to peat and forestry sector.

With regards to energy and transportation, the governments' attempt to reduce dependency on fossil fuel and instead move towards renewables is commendable. However, the key culprit of the dependence of fossil fuel is the heavily subsidized price. The cheap price of gasoline has made riding private vehicles is far more attractive than using public transportation. On the other hand, the availability and reliability of mass transportation are still low. Therefore, the incentives for consumers to reduce their use of private vehicles (and hence fossil fuel) are scarce. On the producer and business side, the same incentive problem takes place. Because the fossil fuel is heavily subsidized, there is little incentive for business to develop renewables for their product will not be able to compete against the subsidized fuel.


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