Creating incentives to control pollution An innovative program in Indonesia, developed with assistance from World Bank researchers, set out to tap the power ofpublic opinion andfinancial mar- kets to encourage factories to reduce pollution. The programs success has inspired a similar program in the Philippines and evoked serious interest in LOCAL Colombia and Mexico. COMMUNITIES, Environmental agencies in developing coun- radin tries often face an uphill battle in regulating Gfactories THE MEDIA, AND industrial pollution. While the agencies usu- The idea behind PROPER was simple: by pro- MARKET FORCES ally set standards for maximum allowable viding information about pollution in a form pollution levels, monitoring and enforcing that nonspecialists could understand, the ini- CAN BE compliance with these standards can be tiative sought to tap the growing power of the POWERFUL extremely difficult. BAPEDAL, Indonesia's media and public opinion to promote cleaner Environmental Impact Management Agency, industry. Specifically, BAPEDAL hoped that ALLIES I THE faced such a problem in the late 1980s. public performance ratings would attract two STRUGGLE Having promulgated regulations to counter major allies to the pollution reduction effort: rapidly increasing pollution from a booming local communities, which would pressure manufacturing sector, the agency found that nearby factories with poor ratings to improve; INDUSTRIAL its limited monitoring and enforcement and the financial markets, which might react capacity meant it often had to settle for vol- adversely to firms with low ratings. POLLUTION untary agreements, out-of-court settlements, By mobilizing these agents, BAPEDAL and other ad hoc approaches. hoped to strengthen the regulatory "stick" Because none of these approaches was faced by heavy polluters. The program also entirely effective, BAPEDAL started experi- included a "carrot": by recognizing excellent menting with alternatives. In 1993 Deputy environmental performance, BAPEDAL for Pollution Control Nabiel Makarim began hoped to give factories an incentive to be developing the Program for Pollution cleaner than the regulations required. The Control, Evaluation, and Rating, now known agency decided to focus on water pollution as PROPER. The new program was designed first, since it already had significant data on to receive pollution data from factories, ana- factories' compliance with water regulations lyze and rate their environmental perfor- from previous enforcement efforts and from a mance, and disseminate the ratings to the Clean Rivers Program in which firms agreed public. to meet specified standards. FROM THE DEVELOPMENT ECONOMICS VtCE PRESIDrNCY OF THE WORLD BANK NO. 31 JULY 1997 The initiative reflected growing international The color rating system, and the data analysis recognition of public disclosure as a regulatory that underpinned it, met several objectives. tool. Commonly known as public performance First, by collapsing complex data into a single audits, such programs develop and disclose per- rating, the system made it possible to compare formance indicators to create incentives for bet- the water pollution performance of very differ- ter performance. A well-designed public perfor- ent firms. Second, the final ratings were simple mance audit can increase the transparency and and their implications easily understood by the accountability of public institutions. It can also public. Third, the system clearly distinguished induce improvements from private agents whose between firms in compliance with the regula- poor performance would otherwise require cost- tions and those not in compliance. Finally, the ly enforcement activity or litigation. Of course, system created incentives for firms to become such systems are only as good as the information cleaner than the regulations require. on which they are based. Initial impact Data integrity BAPEDAL decided to disclose the results in From the outset it was clear that PROPER's suc- stages, first publicly recognizing the best per- cess would depend on the integrity of its data. If formers and giving the others a chance to factory ratings were perceived as being unrea- improve before their bad ratings were revealed. For more details on sonable or inconsistent, the entire initiative This approach gave the business community PROPER and on the could be undermined. BAPEDAL had relatively adequate time to adjust to the new program, little experience with collecting, verifying, and thereby increasing the likelihood of improved research the Policy analyzing large amounts of data. Thus the compliance. Moreover, it generated support Research agency sought assistance from the environment from the firms whose good performance was Department's team in the Environment, Infrastructure, and publicly recognized. Finally, and perhaps most Agriculture Division of the World Bank's Policy critically, it allowed BAPEDAL to gauge the Research Department. Arrangements were made. potential for extreme reactions in communities Infrastructure, and for a team member to work with the PROPER where plants with red and black ratings were Agriculture Division development team in Jakarta. located. is performing on Over the next several months the PROPER The first partial announcement of results, in team prepared a data management system for June 1995, was extensively covered in the the economics of the program. The system incorporated informa- national press. Five factories were awarded the industrial tion on each factory's economic activities, emis- green rating (no factories were rated gold). Of pollution... sions control equipment, and in-house pollution the remaining 182 plants, only the distribution monitoring. The system was designed so that of the color ratings was disclosed: 61 were blue, field teams could readily organize and quantify 115 were red, and 6 were black. This announce- the results of on-site inspections and monitoring ment was, in itself, a remarkable exercise in self- activities. criticism. By announcing that almost two-thirds In February 1995 the team sent survey ques- of the plants were not in compliance, tionnaires to about 350 factories. The pilot BAPEDAL was confessing its own previous inef- group that eventually emerged included 187 fectiveness to the Indonesian public. plants from thirteen provinces and covered each BAPEDAL gave plants rated red or black of the fourteen industrial sectors that had efflu- until December 1995 to improve their perfor- ent discharge standards. The team supplement- mance before their names and ratings were pub- ed the surveys with rigorous on-site inspections. licly disclosed. Under the threat of public dis- Using a computerized model developed for closure, ten factories managed to improve their this purpose, the team collapsed information on rating to red or blue within six months. each factory into a single performance rating. Conversations with plant owners and other evi- They then assigned the plants to one of five cat- dence suggest that the primary force driving egories (table 1). these improvements was concern about poten- Table 1. PROPER's five-color rating scheme for pollution Compliance status Color rating Performance criteria Compliant Gold Al requirements of the green rating, plus similar pollution control for air and hazardous waste. Polluter achieves high intemational standards by making extensive use of clean tech- nology, minimizing waste, preventing pollution, recycling, and so on. Green Pollution level is significantly lower than the discharge standard. Polluter also disposes of sludge properly, ensures good housekeeping, keeps accurate pollution records, and main- tains the wastewater treatment system. Blue Polluter applies effort sufficient only to meet the standard. Non-compliant Red Polluter makes some effort to control pollution, but not enough to achieve compliance. Black Polluter makes no effort to control pollution, and causes serious environmental damage. tially strong negative responses from local com- Although reputational incentives were obvi- munities and markets. ously at work, the PROPER team discovered In December 1995 full disclosure got under that the program was often the means by which way; information was released gradually to factory owners had first learned about the envi- encourage continued media coverage. Disclosure ronmental performance of their plants. Thus included plants' color ratings, names and loca- PROPER is also performing a valuable educa- tions, managers, and parent companies. A fresh tional function, increasing the awareness of round of ratings, announced in September 1996, owners, managers, and employees and providing revealed additional improvements. The changing guidelines for better performance. status of the 187 factories that initially partici- PROPER also has had an important impact P as s pated is shown in table 2. on BAPEDAL. The need for accurate ratings has New Ideas in The movement of firms from non-compli- compelled the agency to increase its factory Pollution Regulation ance to compliance is impressive. In June 1995, inspections and to improve the quality and reli- Web site at 65 percent of the factories were rated black or ability of its data collection and verification. The red. By September 1996 non-compliant plants information collected through PROPER also http:/Iww.NlPR.org accounted for just 47 percent of the total. provides BAPEDAL with solid evidence on a Moreover, the number of firms in compliance factory's compliance status, supporting stronger increased by 50 percent during this period. action in cases where conventional enforcement Since it is unlikely that other Indonesian pol- action is appropriate. luters improved at the same rate, this response suggests that PROPER is creating powerful Next steps incentives for pollution control. In addition, between June 1995 and December 1995 the PROPER's record in its first two years suggests number of factories volunteering to participate that firms internalize reputational effects at very in PROPER doubled, from 11 to 23. These different rates. The program has been effective factories apparently expected rating by in moving some poor performers toward com- BAPEDAL and disclosure of their environ- pliance and in motivating some firms to control mental performance to enhance their market pollution beyond the required level and invest position. in pollution prevention equipment. Many fac- Table 2. PROPER's impact June 1995 December 1995 September 1996 (first announcement) (first full disclosure) (second full disclosure) Share of Share of Share of Rating Number total (percent) Number total (percent) Number total (percent) Gold 0 0 0 Green 5 3 4 2 5 3 Blue 61 32.5 72 38.5 94 50 Red 115 61.5 108 58 87 46.5 Black 6 3 3 1.5 1 0.S tories, however, still have red ratings, and there The regulator's role certainly does not vanish in has been no significant increase in green ratings. this system. However, it evolves from adopting During the next year collaborative research by and policing rules toward empowering other BAPEDAL and the environment team of the agents through the provision of appropriate infor- Bank's Policy Research Department will address mation. In circumstances where the agents' inter- several questions: Which characteristics of action cannot produce satisfactory results, the reg- plants, firms, sectors, markets, and local com- ulator must retain its traditional enforcement role. munities affect plants' responsiveness to public Public disclosure appears to be contributing disclosure? By what channels is pressure to lower industrial pollution in Indonesia. brought to bear on firms, and what are the Encouraged by PROPER's results, BAPEDAL is effects? How have firms assessed the incremen- preparing to rate 2,000 plants by the year 2000. tal costs and benefits of improved ratings? What Other countries have also been inspired by this cost has BAPEDAL incurred in implementing example of public information in action. PROPER, and how does it compare with the Drawing on advice from the Bank researchers cost of conventional regulation? who helped with the project in Indonesia, the Philippines launched a similar program (called Conclusion EcoWatch) in April 1997. In addition, Colombia and Mexico are moving rapidly This new approach to regulation in Indonesia is toward developing public disclosure programs. Regulators move showing that local communities, the media, and -Shakeb Afsah, Benoit Laplante, from enforcing market forces can be powerful allies in the strug- David Shaman, and David Wheeler gle against industrial pollution. PROPER's rat- toward empowering ings are designed to reward good performance Further reading and to call public attention to polluters who are not in compliance with the regulations. Armed Afsah, Shakeb, Benoit Laplante, and David Wheeler. 1996. with this information, local communities can "Controlling Industrial Pollution: A New Paradigm." negotiate better environmental arrangements Policy Research Working Paper 1672. World Bank, ngtaebetter enlomna ragmns Washington, D.C. with neighboring factories, firms with good per- formance can advertise their status and earn Dasgupta, Susmita, and David Wheeler. 1997. "Citizen Complaints as Environmental Indicators: Evidence from market rewards, investors can accurately assess China." Policy Research Working Paper 1704. World environmental liabilities, and regulators can Bank, Washington, D.C. focus their limited resources on the worst per- Lanoie, Paul, Benoit Laplante, and Maite Roy. 1997. "Can former.s. Transparency is also increased because Capital Markets Create Incentives for Pollution the environmental agency is subject to public Control?" Policy Research Working Paper 1753. World scrutiny. Bank, Washington, D.C. This DECnote was prepared by Shakeb Afsah, Benoit Laplante, David Shaman, and David Wheeler in the Policy Research Departrnent of rhe World Bank. DECnotes transmit key research findings to Bank Group managers and staff. They are drawn from the work of individ- ual Bank researchers and do not necessarily represent the views of the World Bank and its member countries-and therefore should not be attributed to the World Bank or its affiliates. DECnotes are produced by the Research Advisory Staff. We welcome your questions and comments; please e-mail them to the authors or to Evelyn Alfaro, RAD. Prepared for World Bank staff