Pollution Haven in the Making

Photo by Viktor Lysenko on Unsplash

Newly passed Undang-Undang Cipta Kerja/UU Cipta Kerja (Job Creation Law of 2020) in Indonesia recently become a hot topic on every platform (it incited hashtag war on Twitter and “celebrated” with days-long protest in several cities). It is the first omnibus legislation in Indonesia; the one-for-all legislation aims to push Indonesia out of the middle-income trap marked by low investment, slow growth of manufacturing activity, limited industrial diversification, and low labor market conditions. The leading indicators used to justify the bill are Indonesia’s Ease of Doing Business (EoDB) index and Global Competitive Index (CGI), which are stunted by neighboring countries. The bill revolves around how investment regulations became a red tape, so deregulations and bureaucratic efficiency are needed to make investment more desirable in Indonesia. Deregulations are done by amending many previous laws; the most visible regulations amended are labor and environmental protection.

Based on ICEL’s policy analysis, environmental deregulation in UU Cipta Kerja loosen the ecological impact analysis requirement for business prerequisites, depriving citizens’ constitutional rights to healthy environments and access to information and equal treatment under the law. UU Cipta Kerja also weakens environmental mitigation in spatial planning consideration by the local government for the sake of national strategic projects. Many civil organizations worry that Indonesia’s race to the bottom would be faster under UU Cipta Kerja, creating more harm to the environment (other than how constitutionally-ill the bill crafting process was). The questions have to be asked: Does environmental deregulation create a more favorable climate for investment, which conceives new jobs? What is the antidote to an incoming ecological crisis from UU Cipta Kerja’s deregulations and, at the same time, not sacrificing new jobs?

How economics meets the environment.

There is a lot of evidence of how economic activity is directly linked to environmental health. Grossman and Kruger (1991) in their National Bureau of Economic Research report, offers a systematic approach towards trade and environment relationship into three independent effects; scale, composition, and technique effect.

Scale effect in the simpler terms explains how economic growth correlates with pollution level increase. If economic expansion increases market access while its mechanisms remain unchanged to meet the market access, the amount of pollution released must increase. A more expanse economic scale would emit more pollution and consume more natural resources to fill the expanded demand.

The composition effect is caused by changes in economic policy towards a more liberal position. Economic specialization happens faster in the sector, accepting comparative advantage from government policies, such as unregulated business practices or more lenient oversight on industrial standards. If this advantage originates from environmental regulation differences, the economic specialization will be focused on natural resource exploitation and further harm the environment. This policy-based reason explains the pollution haven hypothesis (PHH) discussed later.

The technique effect explains changes in production techniques pushed by liberalized trade policy through two different schemes. First, the free market may induce new demand for environmentally responsible products constructed from cleaner production technologies and stronger environmental regulations. Second, the free market may increase general income and national wealth, which pushes the government to adopt stricter pollution standards. Better environment quality is achieved to reflect its economic status. These notions are used to explain the environmental Kuznets curve (EKC). Adapted from Simon Kuznet’s economy vs. inequality hypothesis, its inverted U-shaped graph resembles a bell, based on the hypothesized correlation between economic and environmental performance.

The main idea from the environmental Kuznets curve (EKC) is that environmental degradation and pollution also increase in the early stages of economic growth. Still, on one point, the trend will reverse so that at later degrees, higher levels of economic growth lead to environmental improvement. The bell graph created a turning point of an economic indicator, which dictates when environmental performance begins to improve faster than its deterioration. In the early years, the EKC hypothesis created a misleading discourse that economic growth would be the means to eventual and definite environmental improvement in the future, giving a possibility of achieving sustainability without a significant change from business-as-usual the economy has been.

The environmental Kuznets curve suggests: “the solution to pollution is economic growth.”

There is a lot of debate on how EKC models the environmental improvement would happen. Several studies found mixed empirical evidence, so a causal link between income and environmental quality cannot be consistently explained. The most interesting critic is how the EKC failed to account for globalization. Cole (2004) described a trade pattern, shows a reduction of pollution in developed countries with its reverse happening in developing countries. This trade pattern is caused by a particular comparative advantage where environmental regulations differences between developed and developing countries come into play. Developing countries that often have a more permissive stance towards environmental standards now serve as pollution-intensive output for developed countries. This practice implies a pollution reduction for a developed country- thus the EKC turning point achieved by developed countries- but in reality, it’s solely a “transfer of pollution from North to South”.

“Transfer of pollution” between countries caused by comparative advantage due to regulation differences holds a principal concept for the pollution haven hypothesis (PHH). The PHH conveys that country with lax environmental regulation will attract pollution-intensive industries relocating from more rigorous ones, hence becoming a pollution haven. Another way to address PHH is that environmental policies in developed countries created emission leakage to developing countries. In an international setting, the economic indicator used to characterize PHH is Foreign Direct Investment (FDI). Partially based on Grossman and Krueger’s scale effect, FDI is often used by developing countries to expand their economy at the first stage and should lead to more pollution generation. Without changes in the economic mechanism, more pollution generation just create more environmental damages. The PHH predicted an ecological disaster in developing countries that had a comparatively, ineffective environmental policy.

Several studies around environmental policy and FDI shows the mixed result on PHH validity. Direct studies on policy (US Clean Air Act of 1963 and its amendments) show an increase in foreign assets owned by the dirty-multinational industry due to stricter environmental regulations, from an increase in compliance cost, which in part supports the PHH. On the other hand, Letchumanan and Kodama (2000) criticized how comparative advantage in PHH is embedded in neoclassical theory that treats the environment cost as the sole factor worked on PHH. It should be more dynamic since comparative advantage also comes from innovation, technology, market access, and partnership opportunity that significantly affect competitiveness.

Studies on how PHH works in Indonesia are already discussed by several papers. Merican et al. (2007) compare the PHH in ASEAN-5 countries, including Indonesia, using FDI and CO2 emission per capita data from 1970–2001. Their findings show pollution halo effect-opposite of pollution haven- in Indonesia, indicating international investment does not seem to intensify the pollution. Newer studies by Guzel and Okumus (2020), using data from 1981–2014, found the PHH and EKC hypotheses are valid in ASEAN-5 countries, including Indonesia. Their report implying FDI is the main propeller of economic growth, and policies to encourage FDI in these countries may lead to an increase in pollution-intensive industries. They found that these policies may contradictory, based on SDG 1 and 8 (economic growth) and SDG 13 (environmental sustainability). The study also implies EKC validity, which predicts CO2 emission lowers after the threshold point of income per capita is achieved, and how FDI can reach the threshold point faster.

Remedy to decelerate Indonesia’s race to the bottom.

In practice, another factor such as broader market access, labor cost, and productivity plays more critical determinants than environmental policy when it comes to investment patterns, so environmental deregulation on UU Cipta Kerja may insufficient to induce new investment. This insufficiency was covered by other deregulation provisions in UU Cipta Kerja due to labor-related amendments and tax incentives programs, which the government hopes could boost FDI. But there even additional solutions to curb the environmental deterioration from deregulation. Market-based solution (MBS) offers several initiatives on downstream activity to prevent pollution generation, such as waste deposit, permit trading, and subsidy deduction. MBS allows industries and their technologies to be more competitive and even create new businesses to provide MBS’s auxiliary market.

Associated with potential pollution haven, stringent regulation surrounding environmental standards and oversight still deems the most effective solution to pollution generation. Even indirect policies such as energy and resource conservation help reduce emissions. Most studies reviewing environmental economics refer to the sustainable development framework to be adopted as a standard of how the industries should working. Still, Guzel and Okumus (2020) offer justice and policing institution improvement (SDG 16) to ensure strong enforcement of remaining regulation. A review by Gill et al. (2018) stated that investors from developed countries more unlikely to invest in countries with a flawed legal system and ineffective enforcement institution.

In the end, Indonesia had to make sure the incoming FDI should be invested in all things that support national environmental targets (compliance to emission reduction agreement, for example), import greener and cleaner technology, improve labor and managerial skill, and adheres to international industrial standard practices. So that UU Cipta Kerja may reach its noble goal to enhance national productivity, competitiveness, and livelihood for all, with additional perks on work safety and environmental health, not only provide a tropical pollution haven for richer countries.

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Oka Pradhita

Oka Pradhita

Emotionally invested in environmental issues, current affairs, books and tv shows.

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