AnalysisMarket Redirection Leakage in the Palm Oil Market
Introduction
Reducing tropical deforestation and forest degradation (DD) in developing countries is essential to limit global warming and preserve biodiversity (Stern, 2007; Seymour and Busch, 2016; Giam, 2017). Clearing for export-oriented agricultural commodities is a driver of tropical deforestation. Curtis et al. (2018) estimate that globally about 27% of all forest disturbance between 2001 and 2015 was commodity driven. Palm and soybean production are examples that are implicated in countries such as Malaysia, Indonesia and Brazil (Carlson et al., 2018; Curtis et al., 2018).
Developing countries often lack the capacity or motivation to curb DD on their own. Assistance and/or pressure from regulations imposed by developed country importers can help, but diverse application across jurisdictions offers fragmented coverage, leaving leakage channels through which DD can be maintained. The forestry literature has emphasized the competitive leakage channel; differential imposition of regulations on suppliers of forest products, promoting the geographical displacement of DD implicated production from more to less strictly regulated jurisdictions (Murray et al., 2004; Gan and McCarl, 2007; Lim et al., 2017). It can be avoided by uniform application of regulations across all sources of supply. We focus on a leakage channel not well recognized for forest products, the market redirection channel that occurs when regulations are applied differentially across markets. Producers need not move, but instead create leakage by rerouting their sales to less selective markets. In energy markets it is known as the energy market channel (Bohm, 1993; Larch et al., 2018).
Using the example of palm oil as the product, and a DD embodied tariff as the main regulatory instrument, we develop a model in which not all importers are concerned about the forest loss embodied in their imports, nor willing to impose embodied DD tariffs. We also allow that, due to transaction costs, not all developing country exporters respond to importing country tariffs by switching to forest friendly production practices. In the unlikely event that all importers imposed tariffs, market redirection leakage would be avoided. Contrary to a unilateral ban, or tariff, on unsustainable imports, which creates market redirection leakage, the second best optimum combines the unilateral damage based tariff with an output subsidy. The output subsidy encourages exports to the tariffed market. If transaction costs are sufficiently low the exports to the tariffed market will also be sustainably produced.
The next section provides background on the palm oil market. Section 3 discusses the literature on leakage. Section 4 models four importing or exporting entities in the palm oil market; an embodied DD tariff imposing oil importer, an importer that does not impose the tariff, an exporter who always responds to the tariff by producing sustainably, and a competing exporter who, depending on the transaction costs of certifying sustainable production, will produce all or a portion of its production unsustainably. Section 5 presents policy recommendations.
Section snippets
The Palm Oil Market
Palm oil is traded globally and accounts 34% of world vegetable oil production. Soybean oil, at 29%, is its closest competitor (United States Department of Agriculture, 2017). Along with rapeseed and sunflower oils they are effectively interchangeable for edible (e.g. sweets, baked goods, margarine, cereals), non-edible (e.g. detergents, and cosmetics) and biofuel uses (Corley, 2009).
Indonesia and Malaysia account for about 56% and 35% of all palm oil exports (United States Department of
Leakage
Leakage occurs when there is an incomplete regulatory framework for pollution, with unregulated market segments providing channels that allow polluting economic activities to avoid the regulation (Holland, 2012; Lim et al., 2017). It is defined as pollution levels different from, usually in excess of, what would occur with no response in unregulated market segments to restrictions in the regulated segments. Because forests provide global public goods such as biodiversity and carbon
Model With Market Redirection Leakage
We use a simple model with two representative palm oil importing jurisdictions, r and n, and two representative palm oil exporting firms, x and y, in a different jurisdiction(s). There may be other domestic production and consumption within these jurisdictions. For simplicity, we assume that all other consumption, production and associated pollution is fixed, and that for both importing regions willingness to pay is additively separable in palm oil and any other products consumed. The market
Palm Oil Policies
We have shown that a DD tariff imposed unilaterally by an importer causes market redirection leakage to non-tariffed markets that may well prevent much reduction in unsustainable production. We have also shown that an output subsidy can be used to reduce leakage from tariffed to non-tariffed markets, but that it may not be very effective in reducing unsustainable production if transaction costs prevent unsustainable producers from switching to sustainable production. If transaction costs can be
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