October-- December 1996
Volume 7, Number 4
The environmental performance of factories in developing countries varies enormously. Even in the poorest countries some plants would satisfy the best OECD emissions standards—and in industrial countries some plants fall well short of those standards.
Conventional thinking about controlling industrial pollution says that plants in countries with weak environmental regulation are likely to treat the environment as a free input and make no effort to control emissions, while plants in countries with stronger regulation are likely to comply with regulatory standards. Since neither view is consistent with the facts, a new approach is necessary. World Bank experience in partnership with environmental agencies in six big developing countries—Brazil, China, India, Indonesia, Mexico, and the Philippines—sheds light on this problem. It shows that the traditional assumptions of optimal regulation theory—full information and no transactions costs—are not met in practice. And regulators are not the only source of pressure on plants to improve environmental performance. Communities and markets also play important roles. Fortunately, the traditional theoretical view has an alternative—one that links the plant, the state, the community, and the market.
The law and regulators traditionally set and enforce the rules of environmental behavior. In keeping with this, traditional policy analysis has focused on regulation (legal or market-based) as the control instrument and liability claims by injured parties as the principal means of enforcement. The regulatory problem in this traditional world is straightforward: Having determined the optimal amount of pollution with full information, regulators seek to attain it through command and control—by mandating factories not to pollute above a determined level—or through market-based instruments—by setting a price for pollution or allowing factories to trade pollution permits.
Prices and tradable permits can be effective under the right conditions. But research and field experience show that conventional regulation pays too little attention to defining the right conditions.
In the six developing countries environmental agencies are plagued by problems with:
Information. Monitoring is often so poor that compliance is difficult to assess. When collected, data on factory emissions are often held by separate agencies with different responsibilities. Information on abatement costs is rarely available.
Bureaucracy. Agencies responsible for monitoring air and water quality rarely talk with each other or with those responsible for monitoring emissions.
Human and technical resources. Agencies generally have little capacity for assessing the benefits of alternative programs and using the results to establish priorities for allocating scarce resources. Few trained inspectors are available.
Political support. Serious enforcement often meets political resistance.
Under these conditions it is hard to implement pollution control, including market-based measures. It would be pointless—indeed, counterproductive—to advocate pollution charges or tradable permits under conditions that guarantee failure and risk discrediting these potentially powerful regulatory tools.
Near-term policy problems are more pressing and should be addressed first:
These steps will lay the foundation for more sophisticated pollution control strategies.
The traditional view of regulation is misguided because its focus is too narrow. Conventional policy has focused almost solely on the state and the plant. But there are potentially powerful roles for the community and the market.
Evidence from Asia, Latin America, and North America suggests that neighboring communities can have a powerful influence on plant emission levels. Communities that are richer, better educated, and more organized find ways to enforce environmental norms. The agents of informal regulation vary from country to country—religious groups, social organizations, community leaders, and politicians. But the pattern is similar: Factories negotiate directly with local communities, responding to explicit or implicit threats of social, political, or physical sanctions if they fail to reduce pollution. In countries as far apart as Brazil, China, Indonesia, and the United States, much of the variation in factories' environmental performance is explained by variation among communities in income, education, and bargaining power.
Factories operate in local, national, and international markets, where many agents can affect revenues and costs. Many of these agents take environmental considerations into account in making decisions. In both industrial and developing countries environmentalism is a big factor in consumer decisions. Investors also scrutinize environmental performance, weighing the potential for financial losses from regulatory penalties and liability settlements. For similar reasons, international and local suppliers of financing, industrial equipment, and engineering services, too, pay close attention to firms' environmental performance. Public certification of good or bad performance can translate into large expected gains or losses.
Once the community and the market are introduced, variations in factory pollution are more easily explained. Clean factories are possible in poor countries, and polluting plants in rich countries. Under this new view of regulation the traditional model—in which the state and the factory are the sole players—is replaced by a regulatory triangle (figure 1).
In this world of multiple agents and multiple incentives, it is necessary to rethink the regulator's role, which no longer needs to be confined to producing, monitoring, and enforcing rules and standards. Instead, regulators can use nontraditional programs that harness the power of communities and markets. But what does this new view of regulation mean in practice? Let's look at experience in China and Indonesia.
China's Environmental Protection Law says that "in cases where the discharge of pollutants exceeds the limit set by the state, a compensation fee shall be charged, according to the quantities and concentration of the pollutants released." Roughly 300,000 factories are monitored and potentially subject to the levy.
Case studies have suggested that the system is poorly administered and that enforcement is largely arbitrary and ineffective. But the results of econometric analysis are more positive. The analysis sought to explain variations in two province-level measures—industrial emissions of biological oxygen demand (a common measure of organic water pollution) and the effective water pollution levy rate (the ratio of provincial levy collections for wastewater discharge above standard to total provincial wastewater discharge above standard).
Although the national government sets an official levy rate that applies uniformly across China, the effective levy rate varies significantly across provinces, reflecting differences in monitoring and enforcement. The variation is not random: effective levies are much higher in urbanized and industrialized provinces. Differences in enforcement and large increases in the official levy have also led to a varied pattern of pollution intensities across provinces and over time. Between 1987 and 1993 provincial levels of biological oxygen demand fell at a median rate of 50 percent, and total discharges at a median rate of 22 percent. The results suggest that China's water pollution levy has been neither arbitrarily administered nor ineffective.
Two local factors largely explain variations in the effective levy. The first, local valuation of pollution damage, has three components—total pollution load, size of exposed population, and local income. The second is community capacity to understand and act on local environmental problems. Lacking adequate information for determining optimal pollution levels in each province, the national government sets the official levy at a reference level and allows officials in each province to trade off costs and benefits in effective implementation. The implications are clear: Uniform implementation of uniform standards or levy rates is not optimal. Local conditions determine what these should be.
Manufacturing in Indonesia is growing at more than 10 percent a year, and though formal regulation is weak, the government recognizes the risk of severe pollution. Indonesia's National Pollution Control Agency decided to initiate a program for rating and disclosing the environmental performance of factories. It hopes that this will provide a low-cost substitute for formal regulations and create incentives for cleaner technologies.
The agency gives a blue rating to factories that comply with national regulatory standards. Gold is reserved for world-class performers, and black for factories that have made no attempt to control pollution and are causing serious damage. Intermediate ratings are red, for factories that have some pollution control but fall short of compliance, and green, for factories whose procedures significantly exceed those needed for compliance.
How could such a system have an impact on pollution? Informal regulation, or community influence on polluters' behavior, is widespread, but information problems may distort public perceptions of the problem. It is often easy to see or smell organic water pollution or sulphur oxide air pollution. But metals and other toxins are likely to go unnoticed. Even where pollutants are visible, communities often cannot gauge the long-run impact. And communities downstream from polluting plants may have difficulty identifying the culprits. Armed with government-certified performance ratings, communities are in a stronger position to negotiate pollution control agreements with neighboring factories.
Indonesia's program also provides a novel application of incentive regulation. Regulators need reliable data about a firm's performance, but firms have incentives to withhold such information. Like traditional regulation, Indonesia's program penalizes noncompliance. But it also rewards superior performance with green and gold ratings. The hope is that firms will conclude that the value of this status will more than offset the costs of cleaner production.
In the pilot phase Indonesia's program rated 187 plants but publicized the names of only five green plants when it was officially launched in June 1995. The 121 plants rated red or black were privately notified and given until December 1995 to cut back on pollution. Before full disclosure on December 29 half the black plants and many red plants had upgraded their status.
Although the state can (and should) have a role in regulating pollution, the importance of the community and the market must be recognized. The environmental performance of factories is determined by the interactions of multiple agents, with multiple incentives. Regulators should be relegated to their proper place. Five features are key for effective pollution regulation in developing countries:
The conventional policy discussion on pollution is too shallow and too narrow—too shallow because it ignores the preconditions for applying any instrument effectively, and too narrow because it focuses on the interaction between state and factory as the sole determinant of environmental performance.
There is a less heroic approach—a broader model that includes the community and the market in determining the environmental performance of factories, along with the five key principles of information intensity, information leveraging, community control, structured learning, and adaptation.
Drawn from Shakeb Afsah, Benoît Laplante, and David Wheeler, "Controlling Industrial Pollution: A New Paradigm," Policy Research Working Paper 1672,World Bank, Policy Research Department, Washington, DC, 1996.