25 Feb 2017

Indonesia's palm oil: the other side

Imane writes:*

Imagine you planned a trip to Jakarta and are all excited about the pleasant temperatures of Indonesia. You try Googling ‘Jakarta’ and you see impressive skylines. You try again, but this time you add ‘haze’ to it. Suddenly, Jakarta became a lot less interesting and the comfortable temperatures do not matter as much anymore. You probably do remember the large media coverage of the expanding forest fires in 2015, caused by the unsustainable use of palm oil fields, but did not realize what environmental impact this actually had. While being the world’s largest supplier of palm oil, Indonesia has been struggling with the negative externalities of this strongly demanded commodity. The government has been put in the spotlights, while being accused not to take action in order to correct for the externalities. But what could and should the government do?

Whereas Friedrich Hayek would argue that the market will solve for the externalities, few people think the Indonesian government should not take action. The benefits of supplying and exporting palm oil are quite clear: it has contributed 4.5% to Indonesia’s GDP in 2010, and was nearly 7% of total export value. However, these benefits are not as equally divided over the cost bearers. Besides the regular costs that are calculated into the price of palm oil, negative externalities often fall upon other people that do not enjoy these benefits. Such negative externalities can be the damage to surrounding lands, the health implications from breathing the smoke, and the well-known haze: an environmental pollution that refers to the accumulation of small particles in the air, usually resulting from human activities such as deliberate forest burnings (Othman, 2006). Moreover, the Indonesian people are not the only ones who bear the costs: neighboring countries bear many of the environmental costs as well. In 2015, Malaysia had to close their schools for a few days because of the dangerous smoke that came from Indonesia. This example shows the far-extending externalities of burning forests to increase the yield of palm oil, while the benefits and costs are far from distributed fairly.

The demand for palm oil has been increasing over the years, which is why it is attractive to Indonesian palm oil producers to continue their production, as long as their benefits outshine the costs. However, the government could redistribute the burdens by increasing the tax for palm oil producers in order to increase their costs. This will allow the price of palm oil to go up, which will lead to less demand, less usage and therefore less negative externalities. Moreover, the money raised from this behavioral tax could be used to cover the externality costs. Another option could be the implementation and enforcement of stricter rules that will prevent as many negative externalities as possible. The ASEAN (Association of South East Asian Nations) has formulated a Regional Haze Action Plan (RHAP), but due to game theoretical perspectives, this plan has not been successful. It is therefore a challenge to recommend either governmental or market solutions to correct for the negative externalities of palm oil in Indonesia, but by distributing the benefits and costs as fairly as possible, possible solutions could be approached.

Bottom Line: The government of Indonesia should correct for the negative externalities of burning palm oil fields. Increasing tax or implementing stricter rules should allow the benefits and costs to be distributed more fairly.

* Please comment on these posts from my environmental economics students, to help them with unclear analysis, alternative perspectives, better data, etc.


  1. First of all, I very much enjoyed your blogpost and agree with the overall line of your argumentation. The palm oil industry in Indonesia is obviously a considerable environmental issue that is accompanied with numerous domestic and international externalities. However, I have some questions about your proposed solutions. You mainly focus on the possibility of a tax (I assume a Pigouvian tax?) to both decrease demand and raise revenue to distribute amongst the parties bearing the costs of the externalities. These two goals might be mutually exclusive, as the former pertains to behavioral taxes and the latter pertains to fiscal taxes. You mention in the post that the tax would be behavioral, I doubt how realistic this is. Palm oil is an ingredient for many ‘basic’ goods and alternatives are few, so I would assume that demand is rather inelastic. As a result, a Pigouvian tax would lead to the burden falling on consumers and have little effect on the cost function of producers. Treating it as a fiscal tax would still be possible, as would the compensation off the effected persons. However, the environment will continue to carry the same burden of degradation. Therefore, I would look more into regulatory possibilities, for example a cap and trade system.


  2. Hello,
    First, I wonder if you completely understand the Hayekian view of negative externalities, which is that they exist because government has failed to protect the property rights of those affected. The court system could provide a form of remedy if people affected by the pollution are allowed to sue polluters. See here for more: https://www.quora.com/How-does-Austrian-Economics-approach-negative-externalities

    Second, the chain of events that leads to the pollution is not exactly clear. I am not familiar with palm oil production. But the question I guess I have is what specific activities related to palm oil production cause damage? Because then perhaps those activities that, say, produce pollution could be taxed. In other words, can you tax the pollution directly and not the end product? This might encourage producers to improve their processes.

  3. Hi, well-written article but I see areas that you might want to comment on further. 1. https://orangutan.org/rainforest/the-effects-of-palm-oil/ and 2. the large literature on public health cost of small-particle pollutants. Keep up the good work.

  4. The demand for palm oil skyrocketed after the German government mandated the increase in biodiesel while penalizing other forms of generating electricity and auto power.

    Classic broken window fallacy committed by the German government.

    This increase in haze which made Indonesia the third largest polluter in the planet and emitting more than 100* the oil sands in Canada is the unintended consequence of mandating biodiesel, the reduction in coal and nuclear energy in Europe.

    Hayek would say that the fatal conceit of government policies being unable to foresee the unintended consequences caused this problem.

    You seemed to leave out a very important part of the story. Why the palm oil demand is booming. Maybe a new regulation will switch the negative externality to another nation...And repeat.

  5. The tax solution reminds me of the following Simpson's exchange:

    Skinner: Well, I was wrong; the lizards are a godsend.

    Lisa: But isn't that a bit short-sighted? What happens when we're overrun by lizards?

    Skinner: No problem. We simply release wave after wave of Chinese needle snakes. They'll wipe out the lizards.

    Lisa: But aren't the snakes even worse?

    Skinner: Yes, but we're prepared for that. We've lined up a fabulous type of gorilla that thrives on snake meat.

    Lisa: But then we're stuck with gorillas!

    Skinner: No, that's the beautiful part. When wintertime rolls around, the gorillas simply freeze to death.


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