Informal regulation of industrial pollution in developing countries : evidence from Indonesia

The authors test a model of supply-demand relations in an implicit market for environmental services when formal regulation is absent. They use plant-level data from Indonesia for 1989-90, before the advent of nationwide environmental regulation. Treating pollution as a derived demand for environmental services, their model relates emissions of biological oxygen demand to the price (expected cost) of pollution; to prices of other inputs (labor,energy, materials); and to enterprise characteristics that may affect pollution demand, including scale, vintage ownership, and efficiency. The price of pollution is determined by the intersection of plant-level demand and a local environmental supply function, enforced by community pressure or informal regulation. Environmental supply is affected by community income, education, the size of the exposed population, the local economic importance of the plant, and its visibility as a polluter. Their results are strongly consistent with the existence of an informal"pollution equilibrium."Pollution intensity declines with increase in plant size, efficiency, and local materials prices. Older plants and publicly owned facilities are more pollution intensive; multinational ownership has no independent effect. The results also suggest that the price of pollution is higher when plants are particularly visible and is far lower in poorer, less-educated communities. Thus the intensity of pollution is far higher in such communities. While it would be premature to generalize from these results, they suggest that the model of optimal pollution control in environmental economics is more relevant for developing countries than many have believed. Community-factory interactions seem to reflect environmental supply-demand considerations even when formal regulation does not exist. In addition, the apparent power of informal regulation implies that cost-effective formal systems should be designed to complement, not supplant, community control. In particular: 1) Local communities should not be forced to rely so heavily on visibility when judging environmental performance. Formal regulation should include publication of audited emissions reports from factories; 2) Environmental injustice may be real and important. Many poor, uneducated communities may need extra support from national regulators.; and 3) However, appropriate regulation should strike the right balance between equity and efficiency. Uniform national standards go too far because they eliminate all the natural and legitimate regional diversity that is also reflected in informal arrangements.