Environmental Regulation and Public Disclosure

The Case of PROPER in Indonesia

Shakeb Afsah, Allen Blackman, Jorge H. Garcia, Thomas Sterner

• Publisher: RFF Press
• Year: 2013
• ISBN:
  9781135127084
• Edition: 1
• Topic: Business
• Subtopic: Sustainability in Business
• Index: Business

This book is a remarkable case study of an environmental policy initiative for a national environmental regulatory system in the information age. In 1995 the Indonesian Ministry of Environment took the bold step to launch an environmental disclosure initiative called the Program for Pollution Control, Evaluation and Rating (PROPER). Under PROPER, environmental performance of companies is mapped into a five-color grading scale – Gold for excellent, Green for very good, Blue for good, Red for non-compliance, and Black for causing environmental damage. These ratings are then publicly disclosed through a formal press conference and posted on the internet. Not only did this simple rating scheme create a major media buzz and enhanced environmental awareness of the general public, but it also unleashed a wide range of performance incentives that showed how markets with environmental information could function in a developing country setting.

The authors provide a multidisciplinary analysis of how the PROPER program harnessed the power of public disclosure to abate the problem of industrial pollution. They describe how the program has successfully improved the average environmental compliance rate from close to thrity per cent in 1995 to as high as seventy per cent in 2011. This improvement was driven primarily by information disclosure, which avoided expensive and unpredictable legal enforcement through the court system of Indonesia.

The combination of institutional history and detailed economic and analyses sheds light on the role of policy entrepreneurs who laid the foundation for disclosure and transparency, despite the constraints of the Suharto regime. The PROPER program is now internationally recognized and continues to serve as a model for many developing countries.

1 Introduction

Nabiel Makarim did not know he would one day be Minister of the Environment, but back in 1993 he took the initiative to create a system of public environmental pollution ratings. In an interview for this book, he told us that the Ministry of Environment was desperate to find some policy that would work. Industry had little respect for their regulations and always had better lawyers. Makarim told us that the industry did not even believe it when the Ministry announced its intentions with the Program for Pollution Control Evaluation and Rating (PROPER); they probably did not think that Indonesia’s environmental enforcement agency, BAPEDAL, would have the necessary capacity. Thus, they were taken by surprise when confronted, quietly and carefully, with the first private disclosure of ratings and saw to their dismay that BAPEDAL had amassed serious amounts of technical information. Some managers even commented that the regulator appeared to know more about the plants than the engineers and managers themselves.

The PROPER program was launched in June 1995 and was the quiet but purposeful beginning of a small revolution—or at least one battle in the struggle for supremacy in the information market. For over two decades, public disclosure of pollution has appeared as a new instrument aimed at reducing industrial pollution. One of the first and most notable examples of information disclosure was the US Toxic Release Inventory program of 1988. PROPER in Indonesia can claim to be the first large-scale program in the developing world. Other important examples include Canada’s National Release Inventory (started in 1993), the UK’s Pollutant Inventory (1998), and Australia’s National Pollutant Inventory (1998). In the developing world we find several that were modeled on PROPER, such as the Philippines’ EcoWatch (1998), Chinese Green Watch (1999), and most recently Ghana’s Akoben (2010). Although the programs vary widely in structure, they share the common principle of information disclosure.

Within just a few years of its launch, PROPER was dealt a severe blow: In 1998, Indonesia and other countries of the region were hit by a severe recession coupled with other structural and political problems. This “Asian financial crisis” occasioned considerable political and administrative turmoil, and the PROPER program ceased to function in practice. As we will see, however, sufficient elements of the scheme were kept alive, so that the program could be resuscitated in 2001 and expanded in scope in the following year.

The economic development of Indonesia during the 1980s and early 1990s had been impressive—annual Gross Domestic Product grew at sustained and unprecedented rates that often reached 10 percent. The country managed to swiftly transition from an import substitution economy (mainly agricultural products) fuelled by oil exports in the 1970s to a more liberal and export-oriented path. The manufacturing sector became the most important engine of economic growth, and international observers such as the World Bank classified Indonesia as one of the “Asian miracle economies” (World Bank 1993). Although the manufacturing sector boom benefitted millions of Indonesians, it was accompanied by industrial pollution and resource degradation. Estimates in 1994 indicated that industrial pollution accounted for 25 to 50 percent of the total pollution load in rivers of Java, the country’s main island (World Bank 1994). Industrial contamination had become a serious health problem in one of the most densely populated regions on earth. The first serious attempt of the Ministry of Population and Environment to control industrial pollution was the semi-voluntary Clean River program, begun in 1989. The Clean River program (PROKASIH) was based on pollution reduction agreements between provincial vice-governors and polluting firms. The agreements were not legally binding, however, and their details were kept secret. Unsurprisingly, it seemed to have had limited impact on environmental quality.

The PROPER program, targeting water pollution, was launched in June 1995. Its distinctive feature was the disclosure of information via a five-color code, in which each participating firm was assigned a color according to its environmental status. The grading is primarily built on polluters’ compliance with existing regulation: The scheme included both compliant (gold, green, and blue grades), and non-compliant firms (red and black grades). The presence of environmental management practices and clean technology were used as secondary criteria. Plants that self-reported information on analysis of the effluent were viewed as cooperative and were, to some limited extent, rewarded in the grading process. Thus, black was awarded to facilities that did not meet the legal standards and made virtually no efforts to control pollution. Red facilities had made some effort to reduce emissions but failed to meet legal standards and had insufficient reporting. Blue was given to facilities that met legal standards and produced reasonably frequent reports. Green was intended for the “proactive” companies and was awarded if pollution was 50 percent or less than the required standards and the firm conducted good equipment maintenance, reporting, and environmental work. Gold would reward firms who were below 5 percent of the legal standard and met international standards of environmental excellence, which in addition to the green requirements implied the use of clean production technology, waste minimization, and pollution prevention activities. Besides releasing the ratings, BAPEDAL issued a simple one-page checklist on the environmental performance of the participating firms.

With the introduction of PROPER, Indonesia became the first country in the world that had mapped regulations into easy-to-understand color codes. The five colors became the symbols for this program to foster good environmental behavior of industries—a novel method for building environmental awareness, rewarding good environmental behavior, and improving regulatory performance. PROPER has grown considerably since its inception in the mid 1990s and is now firmly institutionalized. PROPER ratings, which initially targeted water effluents, now also include air pollution and hazardous waste. The coverage of industries has been expanded from manufacturing to include agriculture, mining, and oil and gas sectors, and the number of participating firms has increased fivefold to a total of 1,002 in 2011.

The introduction of the PROPER program marked the beginning of what has been characterized as the “third wave” of instrument choice (after regulation and market-based instruments) in the environmental economics literature (Tietenberg 1998). But, as revealed in our background chapters, what is not well known is that the origin of information disclosure in environmental management in Indonesia could be traced back almost a decade before the PROPER program was introduced in 1995: The success of PROPER partially derived from the fact that Indonesia’s environmental regulators had already gained experience and public credibility using informational-oriented approaches in earlier programs.

Information Disclosure and Certification

It is an overused cliché to say that we live in the information age but clearly the demand for information is increasing and the costs of supply are falling. It seems that one of the main functions of policy making in this area is to provide the structure for information flows and maybe this function is becoming successively more important over time. However, a closer look at the demand for and supply of information reveals a fascinating and fundamental area of research—but far from simple and far from unique to the environment (Stiglitz 2002).

In fact, asymmetric information pervades the economy and there are many areas where consumers or other agents in the economy are presumed to be “fully” informed—but where in fact information may be both difficult to acquire and even more difficult to evaluate. An example of this is to think of the complexities of buying a car or any other piece of modern machinery: its technical properties are usually past the comprehension of most consumers. Buying healthcare (or insurance programs that are supposed to deliver future healthcare) or choosing schooling or university education is equally difficult. The same goes again for financial investments in stocks or bonds: evaluating quality, prospects, or risks is extremely difficult. Almost by definition the customer or client is at a considerable information disadvantage in making an informed choice. The multitude of feedback and evaluation sites on the web testifies to the perceived need of consumers. “Trip advisor” is one of many websites that allows you to rate hotels, resorts, and trip packages thus providing a form of feedback and indirect advice to fellow travellers. Amazon allows you to rate numerous services ranging from books to salesmen, video games and so forth. There are literally billions of hits for words such as “rating” on Google.

Financial investments are another area where there is high demand for information and where rating can and does play a major role—as witnessed perhaps most clearly in those instances where such information fails. It is widely thought that the credit ratings agencies grades, such as Standard and Poor, played a very big— maybe decisive—role in creating the conditions that led to the financial crisis. These agencies are at the very heart of the richest and most affluent sectors in our Western societies. Their willingness to hand out (sell) Triple A ratings on all kinds of Wall Street engineered mortgage packages was enormously lucrative for the raters themselves, but their “expert” advice turned out to be completely misguided and to harbor disaster for the global economy.

Dranove and Jin (2010) provide an overview of both the theoretical debate and some empirical literature on quality disclosure and certification. They define quality disclosure as “an effort by a certification agency to systematically measure and report product quality” and focus mainly on third-party disclosure (later referred to as Type 1 disclosure). Among the examples they discuss are the Leapfrog Group’s hospital quality ratings, Moody’s bond ratings, Consumer Reports’ evaluation of consumer products, and U.S. News & World Report’s ranking of colleges. One of the reasons consumers need systematically collected and processed information rather than word of mouth or anecdotal evidence is that some services are not only complicated but also “purchased” very rarely; the example given is that of heart surgery. To some extent, branding and reputation built up by the producers may fulfill this purpose but they may also be insufficient on their own. They can then be supplemented by other mechanisms such as warranties or licensing schemes or disclosure—the latter may be voluntary, third party, or legally required by authorities.

The history of market brands dates back for more than a century and is important, for instance, in the marketing of foods and wines in France. Third-party disclosure also has a fairly long history with ratings of bonds by Poor and Moody going back just over a century. The theoretical literature focuses very much on the incentives for the producers (sellers) of goods to voluntarily disclose information to consumers (with or without the collaboration of third-party disclosure). One of the main results in the theoretical literature is the so-called “unraveling result,” which predicts that the best quality firm will have a strong incentive to first disclose his quality to distinguish himself from lower quality competitors. Once this happens, the second-best firm has the same incentive and so forth. This theoretical result requires a number of strict assumptions for its proof: Among other assumptions there is the absence of oligopolistic or monopolistic competition that is so common, as well as assumptions concerning the availability of public information, homogeneous consumers who are willing to pay for quality, and so forth. In reality there are many markets where it seems that firms do not have a sufficient incentive to disclose quality.

Additionally, there is also a literature on the incentives of the third-party certifiers. The very raison d’être of the third party is to remove the obvious bias that can occur if the sellers provide information about themselves. However, one cannot be naïve about the objectivity, ability, or impartiality of the “third party” either. One must ask, for instance, if their interests are aligned with the interests of the consumers. Typically the firms to be rated have to pay for the rating service. If the rating is complex (as is typically the case when numerous environmental, safety, or quality aspects must be aggregated) then fees may be high and the whole process is not necessarily very transparent. Thus the third-party rating agency may well feel a temptation to “sell high ratings.” This could potentially be remed ied by competition among rating agencies, but the effect of such competition could in some circumstances also be the opposite (increased temptation to give good ratings in order to attract more customers). One could also imagine that reputation effects or certification of the certifiers could be mechanisms to discipline them, but clearly they are not necessarily foolproof. If the unregulated markets fail to deliver quality disclosure automatically, it may be optimal for governments to intervene to force some degree of disclosure. This will however, as usual with second-best situations, depend on a delicate balance of pros and cons with the publicly required programs. Naturally public agencies may also be imperfect and there might be both inefficiencies and corruption of interest or impartiality present in public agencies also.

Dranove and Jin (2010) summarize their review by saying, “The theoretical literature casts some doubt on the ability of third-party certifiers to accurately measure quality and, on occasion, their incentives to truthfully disclose it.” They also review some empirical experiences from, for instance, the health care, education, and financial sectors. In these cases the empirical literature shows that information disclosure does have effects, but also points to considerable practical difficulties in assessing such complicated services. For instance, average mortality or test results can be reported from hospitals or schools. However, there are numerous problems: mortality is unusual, so the number of cases is small and differences tend not to be statistically significant. Also there are biases due to non-random selection effects and reverse causality. It is quite obviously inappropriate to compare a top university hospital with well-motivated and well-informed patients who seek medical care early, with a hospital catering for patients who per haps have much fewer resources in several vital dimensions. Also, if simple rankings focus on just a limited set of variables then providers can “play” the system by undertaking measures that improve scores as measured on these variables while perhaps neglecting other aspects that are not measured and reported or that are only important for small numbers of consumers and thus do not carry a big weight in aggregation. On the other hand, when more information is added to an analysis and comparison, it becomes more difficult for the consumers to understand and digest, and empirical research already shows that many consumers do not use the ratings that are available. There may be a trade-off concerning the stability of the criteria used. On the one hand, the firms to be rated want predictability; on the other hand, this may lead to the sub-optimizing just described and a proactive rating agency may therefore want to vary criteria.

Of particular relevance for this book is the evidence on public certification. Public certifiers should not be subject to the same commercial pressure to distort results as might afflict private certifiers but they naturally face problems of their own. They may not have strong incentives to put sufficient work into analyzing all the complexities of a case precisely because there is no financial incentive that would reward this extra effort. There could also be the risks of corruption or personal prejudice at the level of the individual inspector (Prendergast 2007). As an example, empirical studies have found that the probability of detecting violations in nuclear safety varied considerably among inspectors, and detection rates increased sharply after the Three Mile Island accident (Feinstein 1989).

When the PROPER program first decided to disclose ratings, they seemed to have realized intuitively that any error in the ratings would adversely affect the reputation of the regulators, and they could not afford to make such mistakes. It was not a coincidence that when PROPER was first introduced, every company that participated was also inspected to ensure the accuracy of the final ratings. Compared to 34 inspections in 1994, the PROPER team conducted 278 inspections in 1995 and 222 in 1996. Such a dynamic shows that PROPER had a disciplining effect not just on companies but on the regulators too.

Two conditions emerged as critical elements of the overall rating methodology and its implementation system. First, the ratings had to be reliable and technically defensible. Second, the public would trust these ratings only if the environmental disclosure was recurrent and predictable. This implied that the rating methodology and the underlying data collection and communications system had to be quite comprehensive. The rating also had to be fast—to maintain a level of interest, and because otherwise data might be out of date.

Environmental Product Labeling and Certification

In environmental policy making, information is of course a pre-requisite for other instruments, and public disclosure of information is now seen as an instrument in its own right (Sterner & Coria 2012). It has become a hot topic in the search for effective policy instruments in settings where for one reason or another (complex technology and ecology, unequal balance of power between polluters and victims, ideology etc.) traditional policies fail. This applies particularly to the area of the environment where information disclosure takes a number of different forms depending on the degree of interpretation/aggregation of information as well as on the character of the organization that is accountable for certification. Two common classes of certification that are rather different from PROPER but nonetheless interesting points of comparison are 1) labels that apply to products and are intended to help consumers in their choices, and 2) voluntary certification schemes. We might also distinguish between the certification of products, firms, processes, or management procedures.

Product labeling schemes are often divided into different types, where Type 1 is carried out by independent agencies who set criteria and evaluate the products of the applying company. Type 2 is “in-house” labeling by the companies themselves without fixed criteria or independent review. Type 3 is the provision of raw data, without interpretation or judgment but sometimes aggregated and including all indirect effects in the form of Life Cycle Analysis (LCA). As such it is a form of qualified product information without ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Table of contents
• List of tables
• List of figures
• Preface
• 1. Introduction
• 2. Public disclosure in developing countries
• 3. Institutional history of Indonesia’s environmental rating and public disclosure program
• 4. Rating methodology and implementation
• 5. The effectiveness of PROPER
• 6. Which firms were more sensitive to PROPER?
• 7. How does PROPER work?
• 8. The impact of the financial crisis on PROPER
• 9. Current status of PROPER (2001–12)
• 10. Summary and conclusions
• References
• Index