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ECOLABELING OF TROPICAL TIMBER:
Linking Consumer Awareness and Sustainable Forest Utilization

By

Mubariq Ahmad

A DISSERTATION
Submitted to
Michigan State University

in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY
Department of Agricultural Economics

1 997

ABSTRACT

ECOLABELING OF TROPICAL TIMBER:
Linking Consumer Awareness and Sustainable Forest Utilization

By

Mubariq Ahmad

This study examines ecolabeling initiative as an economic instrument to
mitigate externality problems in renewable resource extraction. Ecolabeling of
tropical timber - which is based on a third party independent certification system
- is chosen as an application area. With timber certification and ecolabeling,
the mitigation of externalities is achieved through the adoption of better logging
and forest management practice that will results in sustainable yield and less
damage in the forests.

Support from economics literature on the working of ecolabeling can be
based on the theory of economics of information. With asymmetry of information
between producers and consumers on sustainability characteristics of the wood,
product certification and labeling is one way to provide warranty to prevent
adverse selection in the market. The certified ecolabel guarantees that the wood
product to which it is attached originates from a well-managed forest.

The theoretical and empirical analyses show that market becomes

segmented as ecolabeled product is introduced. Taking the total demand in the

market as given, demand for ecolabeled wood, and its share in the total market,
become smaller as the price premium increases, and vice versa. The increases
in the share of ecolabeled segment become larger as the price premium
decreases. At any particular quantity demanded, consumer surplus is higher if
consumers buy ecolabeled product instead of the conventional one. This gain in
consumer surplus becomes smaller as the price premium for ecolabeled wood
increases. Part of the gain in consumer surplus can be attributed to the value of
information contained in the ecolabel because it helps consumers make the “pro-
sustainability choice” at the time of purchase.

From the business perspective, however, adoption of timber certification
and ecolabeling is not always a viable option. Using break-even net present
value analyses, the study shows that the viability of the adoption depends
largely on: (1) yield of the forest concession area; and (2) the cost of conducting
proper silviculture effort to comply with certification and ecolabeling
requirements.

Based on the results, two policy implications can be identified. First,
there emerges a possibility of selectively promoting timber certification and
ecolabeling on a regional basis based on forest condition. Second, potentially
large social and environmental benefits of sustainable logging and forest
management may justify some public initiative to cover part of the cost borne by
the private forest concessionaires when implementing sustainable logging and

forest management.

To my beloved wife
Raina Nurhayati
and children

Tiara, Tisya, and Tania

ACKNOWLEDGEMENT

I thank everyone who helped me with this dissertation although I will not
be able to name them all in the space provided.

I am especially grateful to Dr. John Hoehn, my primary advisor, who
contributed so much of his valuable thought and time on the economics aspects
of the topics; Dr. James Stevens, who helped me a great deal on the empirical
analysis and with whom I enjoyed working; Dr. Sandra Batie and Dr. Jake Ferris
who asked tough questions to help me build the integrity of the analysis; and Dr.
Theodore Tomasi who convinced me that ecolabeling is a topic worth studying
and helped at the earlier stage of the dissertation works. Thank you also to Dr.
Eric Crawford, Sherry Rich and all staff of MSU Agricultural Economics
Department for all the support I received from the department.

My deepest feelings of sympathy and gratefulness extend to my wife,
Ratna Nurhayati and my daughters Tiara Rinjani, Tisya Andhini and Tani Anjani,
for all their strength, sacrifices, patience and perseverance while having the man
of their house living through a period that no one would ever want to do it twice. I
owe my mother and mother-in-law for their support, prayers and patience.

My highest appreciation goes to Frances Seymour, a friend with a great

heart, who helped make it possible for me to start my Ph.D. program, and the

Ford Foundation that provided financial support for my study and my family
during our stay in Michigan.
I thank the Indonesian and Greater Lansing Muslim Communities that had
helped make our stay in East Lansing a wonderful and enjoyable experience.
Thank you all for being there for me. May GOD reward you with the best

of HIS blessing and help me use this knowledge in HIS way.

vi

 

TABLE OF CONTENTS

LIST OF TABLES ............................................................................................. x
LIST OF FIGURES .......................................................................................... xii

LIST OF ABBREVIATIONS xiv

Chapter I
ECOLABELING AS AN ECONOMIC INSTRUMENT ............................................ 1
Introduction ....................................................................................................... 1
1.1 Research Problem ....................................................................................... 1
1.2 Objectives and Scope of the Study ............................................................. 2
1.3 Organization ................................................................................................ 3
Chapter II
LITERATURE REVIEW2ECONOMICS PERSPECTIVE ON ECOLABELING ....... 6
Introduction ....................................................................................................... 6
2.1 Development of General Ecolabeling Initiatives ......................................... 7
2.2 The Emergence of Timber Certification and Ecolabeling Initiative ........... 12
2.2.1 Externalities in Timber Production ................................................... 13
2.2.2 Problems in the Implementation of the First Best Economic
Policy Instrument ............................................................................. 14
2.2.3 The Rise of Green Consumerism ..................................................... 18
2.3 Timber Certification and Ecolabeling under F SC System ......................... 21
2.4 Views on Timber Certification and Ecolabeling ......................................... 24
2.4.1 Initiatives and Views of International Organizations ........................ 24
2.4.2 Initiatives and Views of Importing Countries ................................... 27
2.4.3 Initiatives and Views of Exporting Countries . ................................. 32
2.5 Costs, Price Premium and Willingness to Pay for Ecolabeled Wood ....... 35
2.6 Consumer Utility and Product Information ................................................. 40

2.7 Asymmetry of Information and the Role of Certification and Ecolabeling .45

vii

 

Chapter III
SITUATION IN INDONESIA AS A MAJOR TIMBER SUPPLIER AND IN THE
UNITED STATES INTERMEDIATE WOOD INPUT MARKET ............................ 53
Introduction ..................................................................................................... 53
3.1 Indonesia's Forest, Timber Production and Deforestation Issue .............. 54
3.1.1 Forest Land Use Plan and Timber Extraction Policy ....................... 54
3.1.2 Current Situation and Problems in Timber Production .................... 57
3.2 The Emergence of Ecolabeling Issue In Indonesia ................................... 63
3.3 Exposures of Indonesia's Wood Product Exports to the Green Market ....65
3.4 Recent Developments in the World Wood Market .................................... 68
3.5 Recent Developments in the US. Intermediate Input Market
for Certified Wood ..................................................................................... 72
3.5.1 The Survey ...................................................................................... 74
3.5.2 Characteristics of the Sellers and Non Sellers of Certified Wood
Products ........................................................................................... 75
3.5.3 Company Familiarity and Buyers Interest for Certified Wood
Products“ .80
3. 5. 4 Company Motivation ........................................................................ 81
3. 5. 5 The Cost and Price Premium of Certified Wood Products .............. 83
3.5.6 Buyers’ Willingness to Pay ............................................................. 88
Chapter IV
EFFECTS OF ECOLABELING ON MARKET EQUILIBRIUM AND WELFARE ..92
Introduction ..................................................................................................... 92
4.1 Demand for Ecolabeled Wood Product .................................................... 93
4.2 Cost and Supply of Ecolabeled and Conventional Wood ........................ 97
4.3 Market Equilibrium of Ecolabeled and Conventional Wood ..................... 99
4.4 Welfare Effect of Ecolabeling in the Absence of Pigouvian Tax ............ 106
4.5 Welfare Effects of Pigouvian Tax in the Absence of Ecolabeling .......... 111
4.6 Welfare Effect of Ecolabeling under Existence of Pigouvian Tax .......... 114
Chapter V
QUANTIFYING ECOLABELED MARKET SEGMENT AND CHANGES IN
CONSUMER SURPLUS ................................................................................... 121
Introduction ................................................................................................... 121
5.1 Characteristics of the Demand Functions ............................................... 122
5.2 Descriptions of Simulation Procedures ................................................... 125
5.3 Results of Simulations ............................................................................. 128
5.3.1 Demand Functions ........................................................................ 128
5.3.2 Ecolabeled Product Segment: Quantity Demanded
and Market Share .......................................................................... 130
5.3.3 Gain in Consumer Surplus ............................................................ 133
viii

Chapter VI
VIABILITY OF TIMBER CERTIFICATION AND ECOLABELING FOR

INDONESIA'S FOREST CONCESSIONAIRES ................................................ 135
Introduction ................................................................................................... 1 35
6.1 Break-even Net Present Value Method ................................................... 136
6.2 Data Used in Break-even Net Present Value Analyses .......................... 137

6.2.1 Physical Timber Yield .................................................................... 137
6.2.2 Market and Financial Information .................................................. 140
6.3 Results of the Break-even Net Present Value Analyses ......................... 143
6.3.1 Baseline Break-even Net Present Value Results .......................... 144
6.3.2 Effects of the Changes in the Silviculture Cost on
Break-even Sales Proportion Requirement ................................... 147
6.3.3 Effects of Changes in Price Premium on Break-Even
Sales Proportion Requirement” .. 151
6. 4 Discussions of the Results of Break-even NPV AnalySIs 155

Chapter VII

CONCLUSIONS ................................................................................................ 158
7.1 Summary of Research Issues ................................................................. 158
7.2 Summary of Literature Review ................................................................ 159
7.3 Conclusions of the Study ........................................................................ 160
7.4 Policy Implications ................................................................................... 163
7.5 Limitation and Suggestion for Future Research ...................................... 165

.162

Table 2.1

Table 2.2

Table 3.1
Table 3.2

Table 3.3

Table 3.4

Table 3.5

Table 3.6

Table 3.7

Table 3.8

Table 3.9

Table 3.10

Table 3.11

Table 3.12

Table 4.1

LIST OF TABLES

ISO Environmental Labeling Program

Willingness to Pay Price Premium for Certified Timber

Products in the US

Demand and Supply of Timber for Wood Industry in 1994 .....
Share of Indonesia in the Foreign Country Import Market ......

Number of Companies and Volumes of Production in

Certified Forest Area around the World ..

Number of Companies in the Data Set by Business Type ......

Number of Companies by Sales Range and Whether They
Sell Certified Wood Products

Companies by Proportion of Certified Wood Products

in the US. Sales

Number of Companies by Request for Certified Wood
Products.

Companies Selling Certified Wood Product by Increase
in Cost of Good Sold Due to Certification .. .

Number of Companies Selling Certified Wood Products by
Premium Paid to Suppliers and Charged to Buyers

Number of Companies by Premium Charged and Primary
Buyers

Passing the Extra Cost to the Buyers

Willingness to Pay for Price Premium among the Primary
Buyers ..

Consumer Choices of Wood under Various Price Differences .

1O

39

59

68

72

76

78

79

81

84

85

87

88

89

97

Table 5.1

Table 6.1

Table 6.2

Table 6.3

Table 6.4

Table 6.5

Price Premium, Market Share and Gain in Consumer Surplus
in the Ecolabeled Market Segment 130

Volume of Stocks and Potential Harvest of Timber, National
Averages (in cubic meter per year) .... 138

Volume of Stocks and Potential Harvest of Timber From
Unlogged Area, Regional Averages (in cubic meter per year) . 139

Price and Cost Parameters Used in Break-Even Analysis ...... 140

Break-Even Proportion of Sales in Ecolabeled Market under
Various Silviculture Cost Scenarios 148

Break-Even Proportion of Sales in Ecolabeled Market under
Various Price Premium Scenarios 152

xi

Figure 3.1
Figure 3.2
Figure 3.3
Figure 3.4
Figure 3.5
Figure 3.6
Figure 3.7
Figure 4.1

Figure 4.2

Figure 4.3

Figure 4.4

Figure 4.5

Figure 4.6

Figure 4.7

Figure 4.8

LIST OF FIGURES

Indonesia’s Forest Land Use Plan

Indonesia’s Annual Deforestation Rates and Causes ..

Major Export Markets of Indonesia’s Wood Products in 1995 .
Trend of Indonesia’s Timber Export Products. 1981 -95 .........
Geographical Distribution of Companies in the Data Set... .
Reasons for Selling Certified Wood Products
Reasons for NOT Selling Certified Wood Products

Demand for Conventional and Ecolabeled Wood ..

Separation of Demand for Ecolabeled and Conventional

Wood

Equilibrium in Wood Market under Existence of Ecolabel ......

Marginal Willingness to Pay, Extra Cost and Equilibrium of

Ecolabeled Wood Market ..

Welfare Changes Due to the Introduction of Ecolabeled

Wood in the Absence of Pigouvian Tax

Welfare Effects of Pigouvian Tax in the Absence of

Ecolabeling

Welfare Changes Due to the Introduction of Ecolabeled

Wood in the Existence of Pigouvian Tax ..

Welfare Changes with Administrative Cost of Ecolabeling

in the Existence of Pigouvian Tax

xii

55

60

68

77

82

83

94

100

105

108

112

115

119

Figure 5.1

Figure 5.2
Figure 5.3
Figure 5.4
Figure 5.5

Figure 6.1

Figure 6.2

Figure 6.3

Figure 6.4

Figure 6.5

Figure 6.6

Evaluating D. and Dc at the Same Price or Quantity

Demanded
Conventional and Ecolabeled Plywood Demand Schedules...
Premium and Quantity in Ecolabeled Market Segment
Price Premium and Market Share of Ecolabeled Product

Increase in Consumer Surplus by Level of Price Premium .....

Break-even Proportion of Sales in Ecolabeled Market,

NationalAverage

Break-even Proportion of Sales in Ecolabeled Market,

Major Producing Region ..

Break-even Proportion of Sales in Ecolabeled Market at

Various Level of Annual Silviculture Cost, National Average ..

Break—even Proportion of Sales in Ecolabeled Market at

Various Level of Annual Silviculture Cost by Region .............

Break-Even Proportion of Sales in Ecolabeled Market at

Various Levels of Price Premium, National Average

Break-Even Proportion of Sales in Ecolabeled Market at

Various Levels of Price Premium by Region ..

xiii

123

129

132

132

134

145

147

149

150

153

154

AF &PA
AIA
ASEAN
ASID
ATO
BRC
CWP

EPA
FAO
FSC
GATT
GOI
IBD
IFBWW
IHPA
IHF C

INFORMAN

INTAG
ISO
ITTO
ITW
LEI
MF N
MOF
NGO

Non-CWP

0500
$08
SK:
TBT
10207
TCEl
TFF

LIST OF ABBREVIATIONS

American Forest 8. Paper Association

American Institute of Architecture

Association of South East Asian Nations

American Society of Institutional Designer

African Timber Organization

British Retail Consortium

Name given to companies that purchase certified wood products
when referring to them as a group

Environmental Protection Agency

Food and Agriculture Organization

Forest Stewardship Council

General Agreements on Tariff and Trade

Government of Indonesia

Institute of Business Designers

International Federation of Building and Wood Workers
International Hardwood Product Association

International Home Furnishing Center

Indonesian Forest Management (name of a spreadsheet model)
lnventori dan Tata Guna Hutan (Forest Inventory and Land Use)
International Standard Organization

International Tropical Timber Organization

Initiative Tropenwald

Lembaga Ekolabel Indonesia (Indonesian Ecolabeling Institute)
Most favoured nation

Ministry of Forestry

Non Governmental Organization

Name given to companies that do not purchase certified wood
products when refererring to them as a group.

Organization of Economic Cooperation and Development
Scientific Certification System

Standard of Industry Classification

Technical Barrier to Trade

Technical Committee 207 (within ISO)

Timber Certification and Ecolabeling

Tropical Forest Foundation

xiv

TPTI

TTF
UNCTAD
UNCED
UNEP
WALHI

WGZ
WTO
WTP
WWF

Tebang Pilih Tanam Indonesia (Indonesian Selective Logging
System)

Timber Trade Federation

United Nation Commission on Trade and Development
United Nation Conference on Environment and Development
United Nation Environmental Program

Wahana Lingkungan Hidup Indonesia (Indonesian Environmental
Forum)

Working Group 2 (within ISO/T0207)

World Trade Organization

Willingness To Pay

World Wildlife Fund

XV

Chapter I

ECOLABELING AS AN ECONOMIC INSTRUMENT

Introduction
This chapter explains the problem studied in this research, the coverage

of the study, and the organization of the dissertation.

1.1 Research Problem

This research examines ecolabeling initiative as an alternative economic
instrument to mitigate externality problems in renewable natural resource
extraction. Ecolabeling of tropical timber is chosen as an application area.

An ecolabel carries information on the degree of “environmental
friendliness” or “pro-sustainability" characteristics of the product to which it is
attached. From externality theory, the degree of “environmental friendliness” or
“pro-sustainability” characteristics of a product is the extent to which the
producer has internalized his production externalities toward the efficient level of
internalization. The ecolabeling initiative elaborates this concept into a set of
standards and criteria to be followed by the producers.

Ecolabeling of tropical timber offers a possible way out to maintain the
sustainability of the natural tropical forest by inducing internalization efforts
(Organization of Economic Cooperation and Development (OECD) 1991 ). In this

1

2

context, sustainability of the natural forest is defined as its capacity of the forest
to continuously supply the constant amount, of timber on perpetuity basis while
maintaining its ecological and environmental (Forest Stewardship Council (FSC)
1996) functions. The primary objective of the timber ecolabeling is to promote
sustainable forest management and to ensure access or entry into the green or
ace-sensitive markets (Haji Gazali and Simula 1994). Given this potential,
however, there is a gap in the knowledge on the working of ecolabeling as an
economic instrument. In this research, theoretical and empirical analyses were

conducted to evaluate the economic properties of ecolabeling.

1.2 Objectives and Scope of the Study

The objectives of this study are: ( 1) to investigate the effects of
ecolabeling on the demand, supply and market equilibrium of tropical timber; (2)
to evaluate the welfare effects of ecolabeling; and (3) to determine condition(s)
under which ecolabeling can be a viable business option to the forest
concessionaires.

The scope of this study is to analyze the application of ecolabeling on
dipterocarp timber (one species logging) at the concession level (logging site)
within the designated permanent production forest. This focus saves the
analysis from the potential complication of alternative land-use issues. The
analysis examines the market for ecolabeled wood products using one primary
source of tropical timber products, namely Indonesia, and one major wood

product market, namely the United States.

3

The ecolabel addressed in this research is an instrument based on an
internationally negotiated and agreed principles. It is not a self-claimed
environmental label. Specifically, the ecolabel analyzed is based on an
independent third party certification system under Forest Stewardship Council
(FSC).

F SC is an international non governmental organization with a mandate to
bring harmonization to many forest product certification programs around the
world. The F SC’s goals are to promote environmentally sound, socially
beneficial and economically viable forest management by providing an
internationally consistent framework for the certification and ecolabeling of
timber products. As prescribed by F SC’s statutes, certification of sustainable
forest management operation is based on evaluation of forest management
practices against a set of performance standards. Among the consequences of
this performance standard is the requirement to use timber production processes
that will ensure the long-term economic viability and the sustainability of the

resource, as well as the environmental functions it supports (F SC 1996).

1.3 Organization

This dissertation is organized as follows. Chapter two presents a literature
review on ecolabeling from economics perspective. This part summarizes
existing concepts and views of ecolabeling in general and timber certification
and ecolabeling in particular. This chapter also presents support for ecolabeling

as an economic instrument from an economics-of-information perspective.

4
Chapter three provides the setting of the study. The first part analyzes the

situation that may necessitate the adoption of timber certification and
ecolabeling in the supplying country if it is a viable economic instrument. The
second part includes analyses of recent developments in the US. intermediate
input market of wood products.

Chapter four conceptualizes demand and supply and how ecolabeling
effects equilibrium in the wood-product market. This chapter also presents an
analysis of the effect of ecolabeling on the welfare of consumers and society as
a whole.

Using the US. imported plywood market as a case study, Chapter five
quantifies the demand, supply, and price at the current market equilibrium. This
chapter also presents estimates on the effects of ecolabeling on consumer
surplus if a portion of the market becomes an ecolabeled segment. The
estimates of gains in consumer surplus are presented for a plausible range of
price premium for the ecolabeled product.

Chapter six provides a prospective analysis of the viability of ecolabeling
from the interest of individual private timber producers. Several break-even
analyses are presented based on a few alternative scenarios to evaluate the
feasibility of adopting timber certification and ecolabeling for forest concessions
in Indonesia.

Chapter seven summarizes the results of the analyses and provides some

conclusions and policy implications of the findings. The limitations on the

5

applicability of this research are presented along with suggestions for future

research.

Chapter II
LITERATURE REVIEW:

ECONOMICS PERSPECTIVE ON ECOLABELING

Introduction

The purpose of this chapter is to analyze ecolabeling using an economics
framework which includes existing literature on consumption theory and product
information. However, before examining ecolabeling in that framework, this
chapter presents a general review of ecolabeling. First is a summary of the
development of general ecolabeling initiatives, followed by the development of
timber certification and ecolabeling in particular. Subsequently, a description of
the existing timber certification and ecolabeling under the F SC is presented.
Next is a discussion of the responses and views of various stakeholders to the
emergence of timber certification and ecolabeling. Also included in this chapter
is a review the existing information on the costs, price premium and willingness
to pay for ecolabeled wood products in the market. The last two sections discuss
the role of timber certification and ecolabeling from the perspective of consumer
utility and asymmetry of information between producers and consumers about

the sustainability characteristic of the wood products.

7

2.1 Development of General Ecolabeling Initiatives

Since early eighties business communities have engaged in labeling
products and packaging with environmental attributes. Companies use labels
such as “package recyclable," "content 30% of post consumer products," "ozone
friendly” and so on (OECD 1991). This wave of self-labeling initiative was then
followed by government-sponsored ecolabeling program (Environmental
Protection Agency (EPA) 1993). The next stage of ecolabeling development is
the third-party independent certification program. In this program, certification of
a product to carry ecolabel is based on the assessment by an independent third-
party of the producer’s performance in environmental management. The latest
development of ecolabeling initiatives is the second-party certification program.
Second-party certification is based on criteria and standards developed by a
trade or industry association. Under the second-party system, certification is
provided after an assessment of the producer’s environmental management
performance by the industry association to which the company belongs. The
American Forest & Paper Association (AF&PA) is among the industry
associations that have developed and implemented its own environmental
certification program (AF &PA 1996).

Currently, two types of ecolabeling programs are used (Scientific
Certification System (SCS) 1996): (1) Comprehensive ecolabel which is based
on life-cycle analysis of the environmental effects of a product from the stage of

material input generation to the stage when a product becomes a waste; and (2)

8
SingIe-issue ecolabel which is based on the environment or sustainability impact
assessment at one particular stage in the life cycle of a product.

EPA (1993) reported that many developed-country governments have
started engaging in the policy that applies some environmental standards on the
products sold in their domestic markets. Many of them have gone as far as
sponsoring the development of institutions as well as standards and procedures
to implement ecolabeling programs. Currently, 14 government-sponsored
ecolabeling programs are in operation around the world.

Germany, which started the Blue Angel Program as early as 1978,
currently has more than 3,600 ecolabeled products under 64 categories. Canada
started in 1983 with its ecolabeling program called "Environmental Choice
Program" and has so far covered more than 700 products within 30 categories.
Japan, which seems to be the most progressive, has approved more than 2,300
products under 49 categories since the establishment of its EcoMark Program in
1989. In the US, at least seven ecolabeling programs are currently in operation
and run by private organizations, plus nine mandatory labeling programs
enforced by EPA or state laws (EPA 1993). '

At regional levels, some initiatives establish ecolabeling programs. The
Nordic Council granted its first “White Swan” label in 1991. The label is
recognized in Sweden, Norway, Finland and Iceland. The African Timber
Organization (ATO) expects to build an ecolabel program for all African
countries (International Tropical Timber Organization (ITTO) 1994). In 1992, The

Economic Council of the European Union adopted a regulation for community-

9
wide ecolabeling programs. The Council is now preparing applications for six
industrial products: timber, wood products, pulp, paper, textile, garments and
footwear (Jha and Zarilli 1994).

At the global level, various national ecolabeling programs are developing a
Global Ecolabeling Forum chaired by Canada (International Standard
Organization/Technical Committee 207 (ISO/1’ C207) 1994). In February 1994,
(United Nations Commission on Trade and Development (UNCTAD) and United
Nations Environmental Program (UNEP) jointly launched an initiative to create
certification program for environmentally friendly products. The certification
program is planned to be based on three elements, i.e.: (1) equivalent
environmental standard for all countries, (2) mutual recognition on principles and
guidelines, and (3) internationally agreed guidelines for certification procedures.

The ISO is preparing general principles for all types of ecolabeling
program under the T0207/Sub-Committee-3. The Sub-Committee is developing
terms, definitions, verification methods and guiding principles for the three types
of labeling described in Table 2.1. The ISO’s ecolabeling program is part of the
more comprehensive lSO14000-Environmental Management Standard that is
proposed to be adopted by international industries (Tibor and Feldman 1996).

Reactions of producers on the ecolabeling initiative vary from country to
country. Producers in developed countries seem to favor the ecolabeling
programs more than their counterparts in developing countries. For genuine
market incentives or protectionism spirit, industry associations in developed

countries continue to suggest additional products to be listed under the program.

 

 

10

In Canada and Germany, for instance, more than 70% of the proposals for new

product categories come from the industry (Jha and Zarrilli 1993).

 

 

 

 

 

Table 2.1.
ISO Environmental Labeling Program
Types of environmental labeling Description
Type I Third gag certification program
Type II Informative environmental self-declaration claims
Type III Quantitative product information label based upon
independent verification using preset indices.

 

 

Source: ISO/TC207 (1994)

The main concern of the developing countries’ producers is that
ecolabeling may become a condition for market access to developed countries.
This is certainly a valid concern for countries such as Indonesia and Thailand
that ship 40% and 22% of their exports respectively to the markets of US,
Canada and Western Europe (Wigzell 1994; Ahmad 1994). Many producers in
developing countries view the green consumerism as merely a false issue.
Consumers’ lack of willingness to pay (WTP) and higher costs of production for
environmentally friendly products tend to put developing country producers in a
disadvantaged position vis-a-vis the competition (Jha and Zarrilli 1993). In
addition, hidden protectionism agenda in the developed countries often
manifests itself in the form of biased ecolabeling criteria that discriminates
against developing countries’ exports.

Companies from developing countries may find it difficult to represent
their interests in national ecolabeling programs of OECD countries (Jha and

Zarrilli, 1993). The selection of product categories for ecolabeling in developed

 

11

countries is more easily influenced by their industries’ interests as they
participate in the process of product selection. Sometimes the rules for
ecolabeling eligibility were made in a way that it does not provide a level playing
field for similar products coming from different parts of the world. For instance,
the Austrian (original) compulsory ecolabeling program for timber excludes
temperate woods so that in practice it means discrimination in market access
against the tropical woods which are originating mainly from developing
countries. In other cases, the criteria are so specific that they may actually
mandate a particular technology. The textile labeling proposal in Germany
defines environmentally friendly chemical so narrowly that it excludes natural
dyes which in most cases are environmentally friendly (UNCTAD 1994; Wigzell
1994). In the proposal prepared by Denmark for European Community’s pulp
and paper ecolabeling program, criteria for eligibility was primarily based on the
use of recycled raw material. No account was given at all toward the use of
forest plantation as an alternative ‘sustainable’ source of pulp raw material.
Clearly this rule is disadvantageous to Brazil that produces pulp and paper of
wood from forest plantation. If Denmark’s proposal is accepted for
implementation in all EC countries, then access for Brazil’s pulp and paper
export to the region will be limited by its non-eligibility for ecolabeling. This case
shows how differences in the priority of environmental and resource policy
across nations could lead to trade discrimination (da Motta Veiga, et. al. 1994).

Many analyses show that the impact of ecolabeling on developing

countries’ exports is not significant as only a few products of export interest to

12
developing countries are affected (Varangis, Prima-Braga and Takeuchi 1994).
However, view from developing countries' side would result in a different
conclusion. Although small by the world total, export of a particular product may
contribute a great deal in a country's export earnings. A developing country
could face a significant problem if the bulk of the country’s export depends
heavily on the so called eco-sensitive products (products whose environmental
attributes are under the scrutiny of importing countries). Although ecolabeling
may provide challenges for new product niches, the threat of losing the existing
markets is the major source of resistance by developing country exporters

toward ecolabeling.

2.2 The Emergence of Timber Certification and Ecolabeling Initiative

The emergence of timber certification and ecolabeling initiatives is
induced by two situations: (1) the problems in the implementations of the first
best economic instruments to solve externality problems associated with timber
production; and (2) the rise of green consumerism that has not been
appropriately responded to by market institutions. To illustrate these situations,
this study uses Indonesia, one of the world’s largest producers of tropical timber,
and United States and Western Europe as primary international markets of the

tropical timber products.

13
2.2.1 Externalities in Timber Production

Generally in tropical logging operation two main problems are associated
with the production process. First, logging of tropical old growth forest tends to
have negative stock feedback effect. Commercial volume recovered from a
logging operation is always smaller than the total reduction of the timber stock in
the forest. Logging waste and damage to the standing residual trees make up
the balance of the calculation. Harvest of the mature mahogany trees, for
instance, may damage young mahogany trees and other tree species in the
neighborhood of the fallen trees. Skidding of the logs from the logging sites to
the trucking yard is another cause of damage to the residual trees. If a
concessionaire does not internalize this stock feedback effect by conducting
proper silviculture efforts, it is imposing an externality on the future production in
the form of lower stock growth and potential harvest. Secondly, reduction of
timber stock in the forest may lead to deforestation through insufficient
regeneration of trees. Deforestation will in turn causes losses of all
environmental and resource functions supported by the existence of the tropical
forest.

Several authors have analyzed the forest resources by incorporating the
value of the resource stocks. Vousden (1974) and Hartman (1976) both studied
the optimal depletion of the natural forest if the stock has value. Vousden
focused on the amount of optimal depletion while Hartman looked at the optimal
timing of the depletion. Berck (1981) analyzed the optimal stock size in steady

state. He found that if the forest resource stock has value, it is optimal to

14
maintain higher stock of the resource at the steady state as compared to the
situation in which stock value is not considered. Graham-Tomasi (1984)
analyzed the utilization of old growth forest in the light of stock value in its
wilderness function and the existence of back-stop technology (i.e. plantation)
that serves as an alternative source of wood. He identified the optimal size of old
growth forest to be maintained as a wilderness area, the size of land to be
converted to plantation, and optimal time to convert the natural forest into

plantations.

All the theoretical studies mentioned above shared a set of common
characteristics in their analyses. They all assumed that the optimization would
happen under the first best market conditions, i.e., property rights are clearly
defined and enforced over a significantly long period of time and no distortion
exists in the credit market to make the interest rate so high that it discourages
long term investment. Unfortunately, empirical analysis to evaluate the

consequences of the findings has yet to happen.

2.2.2 Problems in the Implementation of the First Best Economic Policy
Instrument
In the developing countries that house tropical natural forests, the
externality problem is mainly caused by two situations: ( 1) insecure property
right over the forest resources; and (2) distortion in the credit market (Lopez

1994, Panayotou 1992). Short forest concession period and high interest rate

15
are often accused as the main sources of short-sightedness of the forestry
business (Panayotou 1992).

To correct this kind of externalin problem, economic theory offers a
series of standard policy instruments to bring the economy toward the Pareto
Efficient allocation and to ensure that the social costs equal the social benefits.
The common policy prescriptions include: (1) rearrangement of property right a
la Coase to secure future income; (2) reform of credit market to lower interest
rate; and (3) the Pigouvian tax to reduce externality to its Pareto Efficient level.
However, all these instruments have problems and are unlikely to be
implemented.

Rearrangement of property right is difficult in practice. This
rearrangement may involve changing the length of concession period as well as
the system of concession allocation. In developing countries such as Indonesia,
the delicate webs of political structure affecting economic priority and the use of
resources stand behind this difficulty (Ascher 1993; Broad 1995).

Reform in credit markets serves as a precondition to induce the interest
rate to decrease. However, it can not guarantee that the interest rate will decline
because high interest rates reflect high risk of doing business. It may take
decades to remove all the institutional constraints and for all rent dissipated from
the economy before the capital market can offer a low interest rate. In Indonesia,
for instance, although financial markets (especially banking and credit markets)
have been liberalized since 1983, the interest rates and banking spread have

not shown significant declines (Woo, Glassburner and Nasution 1994).

16

Although some experts advocate the application of Pigouvian tax to
mitigate the externality problems (eg Daly and Goodland 1994), it appears as
an unfavorable choice for exporting countries. The tax reduces product
competitiveness in the market, no matter whether it is implemented by the
importing or exporting country (Baumol and Oates 1988).

Pigouvian tax is the tax imposed by government to reduce the externality of
an economic activity to the most efficient level in Pareto Optimality sense. Imagine
that a country A harvest and use some of the timber (T) from its forest stock, and
export some of it to country 8. T has negative externality effects from its production
and consumption. As the producer and consumer, people in country A receive both
the production and consumption externalities of T production. People in country B
who import T from A and other sources receive the consumption externalities effect
of T (for instance more wood waste in the community). People in country C, which is
located next to A, do not import T from A, but received the negative externality effect
of T production, for instance, because flood or damaged watershed.

As inferred from Baumol and Oates (1988) arguments, the first best way to
tackle this externality problem is to impose an excise tax on the production of T to
cover all externalities costs, and costlessly distributes the proceed to the damaged
parties. This would guarantee that damages in A, B and C receive the appropriate
compensation, and resource would be well maintained. Obviously, this is not an
option favored by A, the producer of T, as the policy will likely price it out of the
international market if other producers of T are not doing the same. Furthermore, the

costless redistribution mechanism is not a conceivable practical solution. An

17

international institution to implement this externality tax does not seem to be an

operational concept so far.

As trading partners, the followings are some tax policy alternatives that the
governments of country A and 8 could do without involving C:

(1) A unilaterally imposes production tax on T. B does not do anything.

(2) A imposes an export tax on T. B does not do anything.

(3) A does not impose any tax on T, B impose import or consumption tax.

(4) A impose export tax to counter the domestic production and consumption
externalities and B impose import tariff based on consumption externalities
generated by T.

Unfortunately, none of these options provides incentives to generate the
efficient level of internalization. Baumol and Oates (1988) showed that the first and
second choice do not necessarily reduce employment and foreign exchange earning
of country A However, this is true only if country B does not have an alternative
source of T import other than country A. These options are not favored by the T
producers and government of country A because these options will jeopardize their
competitive position in the market if other producing countries that are exporting to B
are not implementing the same policy.

In option 2 and 3, each individual country will only calculate the local damage
as the basis for imposing the externality tax on the border price. As a result, over
production of T will still be apparent in A because producers do not incorporate all
externality costs of their products. For the same reason, even if both country are

simultaneously imposing export and import tax based on their own domestic

18
damages, T would still be over-produced because the total amount does not include
necessary compensation for people in country C.

Given the problems of imposing the optimal tax to correct the externality
problems, and the impracticality of promoting the community contractual
arrangement a la Coase, it is very unlikely that the first best economic
instruments alone can be used effectively to deal with externality. However, the
first best instruments such as reform of property rights and Pigouvian tax, can
complement the incentive for the adoption of ecolabeling.

Ecolabeling offers a way to persuade producers to internalize their
production externalities. Ecolabel provides the means for sustainability-concemed
consumers to appreciate the producers’ effort through the market mechanism, and
to exercise their preference toward resource or environmental sustainability.
Ecolabel facilitates the creation and transmission of market incentives for
producers to internalize the costs of externalities associated with production
process. A property right system that guarantees the flow of future benefits to
the forest concessionaires will strongly complement the financial incentive of
ecolabeling. And as shown in Chapter IV, implementation of ecolabeling under
the existence of Pigouvian tax will results in higher welfare than under situation

in which only one of these instruments is in place.

2.2.3 The Rise of Green Consumerism
The search for alternative approaches is also progressing on the

consumer side of the market. The increasing consumers’ awareness about

19
environment and resource sustainability has resulted in some changes in the
consumer’s purchasing behavior. Green consumerism exists if consumers are
discriminating in favor of pro-sustainability products and/or showing some
willingness to pay for this characteristic as a consequences of their preference.
Bans and boycotts on the use of tropical timber in several US. cities (EPA 1993)
are examples of the change in consumers' behavior. However, since bans and
boycotts lower the value of the forests as an economic resources, they serve as
disincentives for the owners to maintain the resources.

Prior to the ecolabeling initiative, other than bans and boycotts,
consumers have almost no instruments for exercising their new preferences. The
rise of green consumerism -- which potentially generates some willingness to
pay for externalities -- has not been sufficiently recognized and responded to by
market institutions. Consumers who care for resource sustainability are left with
few or no devices for exercising their concerns through purchasing behavior, i.e.
to discriminate in favor of pro-sustainability products.

Some studies reveal that green consumerism does exist and is growing
around the world (Cairncross 1995). A survey by Winterhalter and Cassen of
Purdue University (Winterhalter and Cassen 1993; Winterhalter 1993) finds that
67% of affluent US. households in their sample had avoided certain products for
environmental reasons. When it comes to buying furniture, about 93% of
consumers would like to know that their furniture originate in a sustainably
managed forest, and 82% consumers mentioned that they trust environmental

labels when making purchases.

 

20
A survey by Gerstman and Meyer in 1991 supportd these results. More
than two-thirds (72%) of consumers said that environmental information of a
product should be readily available or included with the packaging, and 85%
said that currently too little of that information is available. This survey reported

WI’P for 1-5% premium from 75% consumers (Schwartz and Miller 1991).

Winterhalter (1994a) reported that American Institute of Architecture
(AIA), American Society of Institutional Designers (ASID), and Institute of
Business Designers (IBD) had campaigned for the use of certified timber
products among their members. These groups consist of architects, interior
designers and furniture designers as well as other wood specifiers.

A more recent study on the environmentally marketed wooden household
furniture were conducted by Ozanne and Smith (1996) to characterize the
potential market segments of the products. Using a cluster analysis they found
that about 39% of US. consumers prefer the environmentally marketed wooden
household furniture. Consumers in this segment are characterized as
environmentally concerned, moderate to high income levels, Democrats, and
quality-conscious.

To respond to the changes in consumer preferences, ecolabeling is
emerging as an alternative approach to bans and boycotts to mitigate the
externality problems. Ecolabeling creates an economic link between consumer
preference and the sustainability objectives of forest utilization. From the

perspective, the advantage of ecolabeling is that it allows consumers to make an

21
informed choice at the time of purchase, and to discriminate in favor of pro-

sustainability products.

2.3 Timber Certification and Ecolabeling under FSC System

Timber certification and ecolabeling (TC/EL) is a single issue ecolabeling
program. It is based on an independent third party evaluation of sustainability at one
particular stage in the life cycle of wood products, namely the stage of input
generation at the wood source. Certification is given at the concession level by
certifying institution accredited by the FSC.

The FSC was established by the initiative of forest-concerned non
governmental organizations (NGOs) from several countries in October 1993.
The FSC goal is to promote environmentally appropriate, socially beneficial, and
economically viable management of the world forests by providing an
internationally consistent framework for the certification and ecolabeling of
timber (FSC 1994). In defining the principles and criteria for sustainable forest
management, F SC uses the performance standard approach that tends to be
more prescriptive and strict compared to the management system standard used
by ISO. The FSC formulates and applies its Principles and Criteria for Natural
Forest Management, one for each type of forests, temperate, boreal and tropical.
The Principles and Criteria will be used by F SC-accredited certifiers to evaluate
forest management practices of producers Seeking certification. FSC
accreditation aims at providing a guarantee for the authenticity of the certifiers'

claims.

22

The Principles state that forest management shall: (1) respect local,
national and international laws and treaties and the FSC’s Principles and
Criteria; (2) legally establish and document long-term tenure and use rights to
the land and forest resources; (3) respect indigenous people’s use rights,
including compensation for applications of indigenous knowledge of forest
management or species use ; (4) maintain or enhance the long-term social and
economic well-being of forest workers and local communities; (5) encourage the
efficient use of the forest’s multiple products and services to ensure the
economic viability and a wide range of environmental and social benefits; (6)
conserve biological diversity and its associated values, water resources, soil,
and unique fragile ecosystem and landscapes, and by doing so, maintain the
ecological functions and integrity of the forests; (7) write and maintain a
management plan; (8) monitor of forest conditions, product yields, chain of
custody, management activities and their environmental impacts; (9) conserve
primary forests, well-developed secondary forests, and sites of major
environmental, social and cultural significance, not replacing them with
plantation or other uses; and (10) not replace natural forest with plantations, but
should relieve pressure on natural forest.

F SC-accredited certifiers are required to evaluate forest management
using detailed forestry standards which take account of specific national or
regional forestry issues that meet or exceed FSC Principles and Criteria. The
certifiers are also required to remain independent from outside influence, and

maintain rigorous evaluation standards and practice. The evaluation for

23
certification is based on a series of criteria that can be classified into three main
groups: (1) long-term economic viability of the timber production; (2)
environmental impact of the logging operation; and (3) the benefits of the
concessionaires’ operation to the welfare of its surrounding community. Due to
technical difficulties in defining, measuring, and setting the operational standard
for sustainability, the current certification practices aim only at providing

certification for “well-managed forest” instead of “sustainable forest”.

The FSC machinery includes a general assembly, a board of directors, an
executive director and secretariat, a technical committee, and an accreditation
appeal committee. The board of directors makes the accreditation decisions.
Memberships and officers are divided by north-south category and by social,
commercial and environmental interest groups. Votes are divided equally among
these three groups.

The FSC's effort to win leadership in TC/EL seems to gain support based
on its world-wide coverage of all types of forests and the common rules and
norms it has developed. However, the FSC has also been criticized for the lack
of participation of governments, timber-based industries and trade associations
in the process of preparation of principles and criteria (AF&PA 1997). As of
March 1997, 62 forest management companies around the world have been
certified as “well managed forest" under F SC system, covering a total area of

more than 2.9 million hectares (FSC 1997).

24
2.4 Views on Timber Certification and Ecolabeling

The TC/EL initiatives emerged from several different backgrounds which
may not be mutually exclusive. It might first have appeared as a response and
alternative to boycotts and bans of the use of tropical timber products. It could
be termed as a more civilized way for discriminating against the tropical timber
export. It could also appear as a genuine economic proposal to practice
business with environmental consideration. And finally, timber certification
proposals were also seen as an effort to create a new business opportunity, i.e.
providing the certification service1 (ITTO 1994).

With all these backgrounds, timber certification initiatives and views toward
it vary widely across stakeholder in the business. Importing country governments
as well as their timber-based business associations and Non-Governmental
Organizations (NGOs) are developing plans regarding the future imports of
timber. By the same token, the exporting country governments, NGOs and

private sectors have also taken various initiatives to deal with their concerns.

2.4.1 Initiatives and Views of International Organizations

In 1990, International Tropical Timber Organization (ITTO) initiated a
program to promote that by the year 2000 all tropical timber trade should
originate from sustainably managed forest. This "Year 2000 Target" is supported

by three guidelines I‘I'I’O had developed to be implemented by its member

 

1As noted by Canadian delegation to ITTO meeting in Cartagena, May 1994, the main supporters of
timber certification program are the certifying companies (ITTO 1994).

25
countries: (1) Guidelines and Criteria for Sustainable Forest Management of
Natural Tropical Forest, (2) Guidelines for the Establishment and Sustainable
Management of Planted Tropical Forest, and (3) Guidelines for the Conservation
of Biodiversity in Tropical Production Forests. All these guidelines have served
as a groundwork for an internationally agreed standard and criteria for
certification program for tropical forest products. Regarding certification itself,
without taking any position, ITI'O has explicitly recognized TCIEL as a possible
tool toward sustainable forest management (Haji Gazali and Simula 1994). ITTO
member countries have expressed that a TCIEL program should be voluntary,
based on a transparent system, internationally recognized and harmonized, and
compatible with General Agreements on Tariff and TradeNVorld Trade
Organization (GATT/WTO) rules. However, due to its limited mandate to tropical
timber, many I‘ITO member countries stated that timber certification and
harmonization of internationally accepted standards should be pursued outside
the organization.

Timber certification can be considered as an application of Article 7 of the
"Technical Barriers to Trade (TBT) Agreement" within the Uruguay Round of the
GATT trade negotiation. The "Code of Good Practice and the Preparation,
Adoption and Application of Standards" which is part of the TBT text, requires
autonomous body to apply the same principles and rules as are required to be
followed by central government bodies. The bottom line of TBT Agreement is
that the standard should be applied on non-discriminatory basis, and the

adoption of standard by the industry should be left on voluntary basis. TBT

26
Agreement also indirectly provide recognition to the role of International
Standard Organization (ISO) in harmonizing industry standards internationally
(Jha and Zarrilli 1993).

ISOITC207’s works on environmental management system has been
discussed as the place where all TCIEL initiatives are expected to converge.
Many national standard institutions view ISO as the appropriate place to seek
international harmonization and mutual recognition for any standardization
program. In addition to preparing the ecolabeling guidelines, ISO/T C207 has
formed a working group (i.e. W62) with the specific task to elaborate the
guidelines for implementing forest management certification as part of the ISO
14000 initiative. As of June 1997, ISO has begun offering accreditation for the
companies interested in providing certification service to forest management
operation (Registrar Accreditation Board 1997).

The Tropical Forest Foundation (TFF) is reportedly working to establish
"Tropical Forest Recognition Program", designed to allow companies to
voluntarily disclose confidential information on environmental friendliness of their
products to an Expert Review Committee. The committee will then provide
recognition for companies whose supply bases - which is the forest from which
the wood originates - are moving toward sustainability (EPA 1993; TFF 1996).

Food and Agriculture Organization of the United Nations (FAO),
whose mandate on forestry issues covers all types of forests, has expressed its
willingness to help developing an appropriate timber certification system for all

timber in cooperation with l'ITO. Another international non governmental

27
organization, the International Federation of Building and Wood Workers
(IFBWW) calls for making timber certification a binding precondition for market

access over a medium term (IT‘I’O 1994).

2.4.2 Initiatives and Views of Importing Countries

Most developed countries that import timber and timber products are now
involved in the debates about timber certification and ecolabeling. Some of the
governments of importing countries have taken unilateral initiatives and policies
to restrict the import of timber that does not 'originate from sustainably managed
forest. Fourteen importing countries plus the European Union have reported
their preparations and views on TCIEL program (Haji Gazali and Simula 1994).

The United States government, has expressed its support for private and
voluntary timber certification mechanisms within the existing legal frameworks
(le0 1994). At the federal level no specific action has been taken. However,
within the last few years, some state and municipal level governments have
passed or are considering legislation to ban the use of tropical timber in public
contracts unless it comes from certified well-managed forest (EPA 1993; United
States Department of Agriculture (U.S.DA) Forest Service 1993). New York City
and The State of Arizona have adopted the law. The cities of Minneapolis, San
Francisco, Santa Monica, Baltimore, Bellingham and Harrisburg, as well as the
states of California, New York, and New Jersey are considering similar laws.
Campaigns of NGOs and some private companies have raised the awareness

among the wood product users about the need for certification. U.S.-based

28
NGOs and companies have been leading the forest certification business since
1990. Currently, three timber certification programs are operating in the US.

More recently, a group of US. environmental NGOs have launched a new
initiative called the North American Buyers Group. Its objective is to reduce the
number of middlemen in the marketing channel and create the closest link
possible between the certified forest concessions and the end users. By
streamlining the marketing channel, the initiative aims at increasing the incentive
for the forest concessionaires to adopt certification and ecolabeling. At the same
time, it will not incur a significant increase in the cost of purchasing wood
materials to the secondary manufacturers, and hence, the end users of the wood
products. The group believes that by cutting the number of middlemen, TCIEL
can work even without any willingness to pay for some price premium among the
consumers (Crossley and Lent 1996)

Canada, as a major exporter of temperate and boreal timber and importer
of tropical timber, takes the view that if certification takes place, it should cover
all timber from all forests. Although the Canadian government has not taken any
specific position, the Canadian Forest Service has supported the Certification
Committee of the Canadian Forest Industry. The Canadian forest industry
proposed that a credible certification system should be done only under ISO
which can be disciplined under General Agreements on Tariff and Trade/World
Trade Organization (GATTNVTO) provisions. The Silva Forest Foundation in
British Columbia appeared to be the first forest certifying agency in Canada

(Canadian Standard Association (CSA) 1994).

29

In Germany the Initiative Tropenwald (ITW) was founded by timber
industry, timber importers and a trade union in 1992 to search for an alternative
to boycotts and bans. The initiative has gained support from the NGOs and the
government who are against the boycott and bans of tropical timber. While ITW
is still developing a voluntary timber certification, major big cities like Cologne,
Hamburg, Bremen, Frankfurt and, Munich, as well as a growing numbers of
small cities, have effectively dropped the use of tropical timber and timber
products in response to the pressures from environmental groups (Haji Gazali
and Simula 1994).

In United Kingdom, World Wildlife Fund of UK (WWF-UK) developed a
partnership with major timber distributors to set up The 1995 Group. This group
wants to phase out the sale and use of all timber that does not come from well-
managed forests by the end of 1995. After some evaluation on the supply
availability and to allow more flexibility in the program, the group changed its
name into The 1995 Plus Group. The British Retail Consortium (BRC) that
represents 90% of retail industry in UK has publicly declared its support for WF F
initiative. The whole group claims to be working in the market that has a
combined value of $2.2 billion (WWF-UK 1996).

The UK Timber Trade Federation (TTF) has endorsed timber certification
and launched its Forest Forever Campaign which adheres to IT'I'O Year 2000
target. The TTF has also endorsed its Environmental Purchasing Policy which
gives preferential treatment for timber from sustainable sources. The TTF also

supports country certification which is backed by a national forest management

30
plan. The UK government, while recognizing TCIEL as a potential means to
promote sustainable forest management, mandates that it should not become
any impediment to trade. In the UK two timber certifying companies are now in
operation.

In France, the government sees that TCIEL can be a desirable or even
inevitable instrument if it is implemented in line with the principles of UNCTAD,
ITTO and GATTNVTO. The French government had issued a Green Label for
Okoume (Eurokoume) which is timber mainly imported from Gabon. At the
moment, the French government is providing support for the development of
green label for African timber.

Austria was the first country that took an unilateral action to limit import of
tropical timber. In 1992, Austrian parliament enacted the Federal Law/BGB1.309
which imposed mandatory ecolabeling for tropical timber import into the country.
After Indonesia and Malaysia contested it as non compatible with GATT
provision on Technical Barriers to Trade Agreement, the law was amended to
become Federal Law/8681.228 as to apply on voluntary basis for all timber from
all sources. The Austrian government has expressed its support for
internationally accepted labels for all timber and timber products (Haji Gazali
and Simula 1994).

In June 1993, the government of Netherlands, private sectors, and NGOs
signed a covenant called The Netherlands Framework Agreement on Tropical
Timber. The covenant called for the complete cessation of the use of non

certified tropical timber products by the end of 1995. The private sector

31
signatories of the covenant cover 90% of the tropical timber market, thus posting
a significant threat for tropical timber exporting countries. Although the Dutch
government had expressed its support for certification under internationally
accepted umbrella, no statement was made about the non tropical timber. In
practice, this pattern of unequal treatment could place tropical timber products in
disadvantageous position in the Netherlands’ timber market (the Netherlands
Ministry of Environment 1994).

In Belgium, the Federation of Timber Importers and WWF-Belgium have
agreed to establish certification program for all timber in the forms of roundwood
and sawnwood. The voluntary system expects traders to stock sustainably
produced timber from January 1997 onwards.

The Switzerland government supports voluntary labeling on private basis
for sustainably produced timber. Domestically, timber production has been
subject to scrutiny from the Committee of Swiss Wood since 1988.

In conjunction with Council Regulation No. 880/1992 on ecolabel award
program, The European Union has stated that certification is inevitable to
respond to the green demand in order to avoid bans and boycotts. The EC
commission sees that TC/EL as a first step toward a more comprehensive
ecolabeling program based on life cycle analysis. For this reason the
commission has said to support the harmonization of TCIEL within the EU
ecolabeling system. The commission agreed that the TCIEL should be applied
for all timber, based on the principles of non-discriminatory, transparency and

acceptability for all concerned parties (Haji Gazali and Simula 1994).

32

In Australia, the National Association of Forest Industry is urging the
government to evaluate timber certification as a means to comply with ITTO
Year 2000 objective. At this points, timber importers accept ecolabeling
programs of producer countries provided it is based on international standard.
Currently, in Australian market there are some timber from Malaysia that carries
ecolabel certificate issued in the country of origin.

Japan, the world third largest timber importer after the United States and
Germany, has not taken any position nor given support specific to the TCIEL
initiatives. Although Japan has engaged in EcoMark program since 1989, the
Japanese government views TCIEL as part of the general question of how to
harmonize trade and environment policies. In the case of TCIEL, the Japanese
government awaits for “convincing evidence” that certification and labeling will

indeed promote sustainable forest management (ITTO 1994).

2.4.3 Initiatives and Views of Exporting Countries

Reactions from the exporting countries regarding timber certification vary
even wider than that of importing countries. The reactions range from suspicion
on eco-imperialism (e.g. Liberia) to pro-active efforts trying to preempt the
actions of importing countries (e.g. Indonesia). It is conceivable that these views
vary a great deal due to: ( 1) differences in the pressure or threat of loosing the
existing export markets; (2) differences in product competitiveness in the market
if ecolabeling becomes a condition of entry; and (3) differences in expectation in

the future development of the green market. .

33

The Brazilian government has expressed strong reservation against
timber certification program. Brazil views that TCIEL should not be required
before developed countries have fulfilled their commitment to provide sufficient
financial resources and necessary technology to enable developing countries to
attain sustainable development. Brazil is not convinced that TCIEL will provide
incentive for producers due to its high cost of conducting sustainable forest
management (ITTO 1994). Although the government support the SBSIBrazilian
Silviculture Society to develop the CERF LOR certification system, it is oriented
primarily to counter ecolabeling program proposed by European Union on pulp
and paper products. The Andean Group (Peru, Ecuador, Bolivia) views that
TCIEL could play a role for sustainable forest management if it can provide
incentives and be arranged to be consistent with lTTO, GATT and UNCTAD’s
most favored nation (MF N) clause.

The Malaysian government voiced its suspicion at the beginning. It
suspected that the initiatives that have been developed in the name of
sustainability were governed actually by political and business expediency. This
view was driven by the fact that most proposals for TCIEL initiatives come from
major consuming countries. Malaysia now sees that if there is a credible and
workable TCIEL system, it would not be realistic to implement it sooner than the
IT'I'O Year 2000 target (ITTO 1994). In the mean time, with World Wildlife Fund
~Malayisa (WWF-Malaysia) support, some Malaysian private producers are
involved in experimentation with TCIEL. Malaysian Timber Producer Board

Certificates, a purely local certification system, are being granted to some

34
producers and currently finding acceptance in Australian markets. A more
recent publication reported that SGS/Forestry has certified a forest management
company in Malaysia (FSC 1997).

Indonesia, a major producer in Asia region, seems to be leading the
trend toward timber certification. Indonesia is now in the process of establishing
the Indonesian Ecolabeling Institute whose first duty is to prepare a TCIEL
program. Indonesia is seeking recognition and accreditation from FSC and other
international organizations for its proposed domestic certification system. The
program is being prepared to primarily aim at independent domestic inspection
and enforcement of sustainable forest management standard and criteria. One
major teak producing company has been certified in Indonesia and a few others
are being evaluated for certification (SmartWood 1996; Lembaga Ekolabel
Indonesia (LEI) 1997).

Philippines and Papua New Guinea, other major producers in the
region, are both supportive of the TCIEL initiative. In addition to their significant
reservations toward the cost and competitiveness impacts of TCIEL, producers
in both countries are facing less pressure to implement the initiatives because
they are exporting mainly to the non-ecosensitive markets of East Asia. As of
March 1997, one forest concessionaire in Papua New Guinea had been certified
by SGS Forestry.

The African Timber Organization (ATO) announced its preference to
have a TCIEL system unique for African countries. Supported by the French

government, ATO is now preparing a Green Label for African Timber. Haji Gazali

35
and Simula (1994) reported that compared to other existing principles and
criteria for sustainable forest management, the ATO proposed criteria may be
considered as representing the minimum level of sustainability requirements.

Ghana, Cameron, and Ivory Coast have participated in ATO's program.

In New Zealand, timber certification aims more at the issue of
sustainability of domestic forest. In June 1990 the Forestry Ministry imposed an
interim ban for the export of timber and timber products except those that
originate from the area managed under certified sustainable management plan.
The Forest Industry Council of New Zealand has adopted the New Zealand
Brand as TCIEL-like certificate on sustainable criteria for forest management.

Finland, Sweden and Poland, whose timber industries are export
oriented, view TCIEL as inevitable for maintaining the export market. The
Finnish and Swedish governments prefer to have an internationally harmonized
system of timber certification. As of mid 1997, these three countries have

certified forest management operations (SGS/Forestry 1997; F SC 1997).

2.5 Costs, Price Premium and Willingness to Pay for Ecolabeled Wood

In practice, a TCIEL program entails two types of costs at the company
level: (1) the cost for the company to operate in the sustainable manner
according to a set of performance standard. It consists of the costs to implement
better logging techniques and control as well as conducting proper silviculture

and tending for the residual trees in the logged-over area; and (2) the cost of

36
becoming a certified source that consists of pre—certification assessment and
periodical auditing cost.

The cost of sustainable forest management, which is also referred to as
compliance cost to TCIEL program, varies widely across types of forests
(heterogeneous vs. homogenous, tropical vs. temperate and boreal, and so on).
As pointed out by Haji Gazali and Simula (1994), the lack of reliable estimates
on the cost of sustainable forest management is mainly caused by the lack of
commonly agreed operational definitions of sustainability. Jaakko Poyry
Consultants/CINTRAFOR (1993) estimated that the cost of compliance to
sustainable forest management standard in the tropic ranges between zero and
$13 per cubic meter of logs produced. For a typical forest concession in
Indonesia, the cost of conducting proper logging and silviculture is estimated
about $5 per hectare per yearz.

For certification costs which consist of assessment and auditing costs, the
estimated range is $0.05 - $2.00 per cubic meter log produced. This cost
depends mainly on the size of the concession area, availability of information on
the forest inventory and adequacy of forest maps. In developed countries where
expertise and forest information system have been developed, the cost is

estimated to range between US. $0.30 - $0.60 per hectare of forest. As for

 

2 This estimate is based on the information supplied by an assessor of forestry practices. Due to the
proprietary nature of this information and by agreement, the provider’s name can not be disclosed. Typical
concession in Indonesia has 100,000 hectare area. Proper logging and silviculture refers to the use of
methods and care that would result in: (1) higher wood recovery from logging; (2) less damage to the
residual trees; (3) replanting in the logged over area to maintain growth potential; and (4) good tending of
the logged-over area (World Bank 1994)

37
Indonesia, the cost is estimated at $0.35 - $0.45 per year per hectare of

concession area’.

The cost of timber tracking, which is also known as chain-of-custody, is
another cost that needs be borne by the ecolabeled sellers in the market.
Septiani and Eliot (1994) reported that SGS/Indonesia estimated a US. $1.30
cost for tracking per cubic meter log. In contrast, SGS/New Zealand came up
with $7 per cubic meter estimate.

In order for timber certification and ecolabeling to work, all costs borne by
the forest concessionaires and wood product industry would have to be
compensated in the market. Currently, demand for ecolabeled or certified wood
products is believed to come from the eco-sensitive markets. These are markets
in which green consumerism has been manifested into willingness to pay (WTP)
for a green premium and/or where the consumers has practiced discrimination in
favor of environmentally friendly products (Van Orsdol and Keikens 1993; Ekins
1992). For certified timber products, demand is expected to come from: (1)
importers of developed countries who are facing strong local environmental
pressures; (2) traders who see the opening of a new market niche and see
certified timber as a competitive advantage relative to other similar products in
the market; and (3) traders who see the opportunity to exploit consumer surplus
by means of differentiating products according to different levels of consumers'
environmental awareness (Van Orsdol and Keikens 1992; Ahmad, Hernandez

and Nilagupta 1993); (4) public sector projects in accordance with regulations;

38
and (5) architects, designers and other specifiers. And as pointed out by
Crossley, Prima-Braga and Varangis (1994), high value-added products which
are also highly visible timber products such as furniture, doors and windows and
their frames, would be among the first certified wood product markets to develop.
These products is expected to be able to absorb the certification costs.

The preference toward environmentally friendly wood products has been
reportedly growing in a number of developed countries. Winterhalter of Purdue
University reported that with respect to timber and its products, 60% of the
consumers and 93% of direct wood users, i.e., architects and wood product
designers, said that they are willing to pay up to additional 10% above the
original price for the wood that is certified as coming from sustainably managed
forest (Winterhalter 1994a; 1994b). These results come from a survey among
the institutional wood specifiers.

Another Purdue University survey that focus on household consumers,
found that when buying wood products, in addition to price consideration
consumers rank the following features by the order of importance: (1) the
finishing: textures, gloss, stain; (2) appropriateness of design; (3) solid wood
construction; and (4) sustainable forest origin. Winterhalter and Cassens (1993)
reported that 34% of consumers are willing to pay a 6%-10% price premium.
Both Purdue University’s surveys found that most consumers and wood users

share the view that ecolabeling of wood products is important.

 

3 These costs were estimated using information from some forest management companies and their
certifiers during the 1996-97 MSU survey of certified wood products.

39

Together with the result of the previous survey, Table 2.2 illustrates the

sense of WTP for certified wood products from US. consumers and wood

specifiers.

Table 2.2.

Willingness to Pay for Certified Timber Products in the US

 

Price premium

% of consumers
(1993 consumer survey)

% of wood users and specifiers
(1994 AIA, ASID and IDB survey)

 

 

 

 

 

 

 

 

0% 22% 3%
> 1 - 5% 26% 57%
> 6 40% 34% 36%
> 11 - 15% 8% 2%
> 16 - 20% 0% 2%

 

Source: Winterhalter (1994a), Consumer Perception and WT P: Results of Two National
Surveys, Lafayette, IN, Purdue University.

Results of two surveys in the United Kingdom have also been reported by

Haji Gazali and Simula (1994) and WWF-UK (1991). The first survey, conducted

by WWF-UK and MORI in 1991 claimed that, on average, the researcher found

MP for 13% green premium for tropical timber products. Half of consumers in

the survey find ecolabeling of wood product as important. In contrast, The

Timber Merchant survey in 1993 reported that UK consumers have little

environmental awareness and low WTP. Almost 90% of the traders interviewed

reported that very few consumers ask about the timber source. The survey found

that price, and then quality, are the main factors in consumers’ decision. The

sustainability of resources ranked fourth.

Comparison with the results of a survey on organic food may help put the

WTP issue in perspective. Van Ravensway and Hoehn (1991) reported that

based on a national survey, the increased price that US. consumers are willing

 

40
to pay for health and environmental attributes is between 5%-7% on average. A
more general survey by Roper Organization in 1990 (Schwartz and Miller 1991)
reported that 53% Americans are not willing to pay more for a healthier
environment. It also found that about one quarter (26%) of consumers have
environmental concerns but do not believe individual actions make a difference.
This is precisely the issue faced by all environmentally friendly products: how to
convince consumers that their individual atomistic action such as paying for a
small price premium could indirectly contribute to the sustainability of world

resources and environment.

2.6 Consumer Utility and Product lnforrnation

As theorized by Lancaster (1971 ), consumers derive utility from product
characteristics. In this perspective, how much each particular product is
purchased within a consumer’s consumption bundle is determined by the amount
of each characteristic that consumers are willing to consume, their incomes, and
the price of the product.

Consumers' preferences for a product are determined by its visible
features such as color and package, as well as the information that consumers
receive about the intrinsic characteristics of the product. Such information can
be the maximum life of a product, the technology used in production, the country
where the product is made (which is relevant in the case of boycott), or its
environmental impacts and sustainability characteristics. The consumer’s

preference over particular goods will be determined by the degree of relevance

41
of such information to the consumer given his or her income, education level,
cultural background, tastes and aspirations. Demand for a product may change
as consumers receive more information about its characteristics. Schlesinger
and von-der Schulenburg (1991) found that consumers whose preferences for
certain product characteristics are strong do switch their purchase and are
willing to pay higher prices.

Ecolabel conveys to consumers information about the level of
environmental friendliness or pro-sustainability characteristics of a product.
Ecolabels help remind potential buyers of the characteristics that they are
looking for at the time of purchase. Therefore, ecolabeling programs target pro-
sustainability consumers who actively discriminate in favor of environmentally or
resource friendly products (Van-Orsdol and Kiekens, 1993). While the cradle-to-
grave principle would be an idealistic objective of the ecolabeling program,
labeling at different stages of production and marketing is viewed as the most
realistic practice. It can be viewed as a Ieaming process if labeling is conducted
cumulatively starting from the extraction of the natural resource content of a
product up to its final packaging stage. OECD (1991) claims that environmental
labeling can improve the sales or image of the product, raise consumers'
awareness on sustainability issues, provide accurate information, direct
manufacturers to account for the environmental impacts of their products, and
therefore, help protect the environment.

To consumers, the ecolabel serves as a limited guarantee that the product

is environmentally friendly or pro-sustainability at the stage indicated by the

42
label. The label “package recyclable” does not guarantee that the content of the
package is produced in environmentally friendly manner. In similar way, a label
on wooden furniture that claims “using wood coming from sustainably managed
forest“ only guarantees the sustainability of the wood sources. It does not
provide any information on the wood-working stage of production, nor on the
stage when the used-up furniture becomes a waste.

Firms may view ecolabeling as an advertising instrument which can
enhance the marketing appeals of a product. However, without any means of
verifying the credibility of the label, the confusion could lead to consumers’
mistrust or distrust of the product labels. To be an effective market warranty, a
product label needs be credible. With respect to this credibility issue, an
independent accreditation system is a way to provide the credibility for the
market warranty‘.

To be effective and credible, an ecolabeling system needs to have the
following elements: (1) A meaningful label that gives practical information to be
used by consumers at the time of purchase (Akerlof 1970); (2) A verifiable
certification system that guarantees claims made by producers. A certification
system must have an independent third party assessment and objective audit
mechanism; (3) Voluntary participation of producers to ensure that the system
works based on market incentives; (4) Internationally and nationally agreed

principles, standards and criteria for the sustainability performance to be

 

4 Spence (1974) and Kreps (1990) argued that in the case of labor market signaling, accreditation of
university system serves as a source of credibility of quality signals carried by graduates of certain
universities.

43
achieved; (5) Accreditation system for certifiers to ensure that the certifiers
adhere to the principles, standards and criteria set by the accrediting institutions.
The accrediting institution should consist of representatives of all stakeholders
(government, consumers, producers, environmentalist) in the business, and (6)
GATT/WTO compatibility to ensure that the ecolabel is not being used as a
barrier to trade.

In the case of tropical timber, the ultimate objective of the certification
program is to maintain the sustainability of the tropical forest, hence the
sustainability of the ecological and wilderness functions it supports. The
existence and sustainability of the tropical forest and its functions contain a
significant notion of public goods. Cornes and Sandler (1986) and Sandler
(1992, 1993) argues that if consumers derive utility from a public good, they are
willing to provide it to some extent. In this context of private provisions of public
goods, by buying the ecolabeled products with some price premium, the
consumers are paying a proportion of the costs of internalizing the externalities
as a way to provide some level of resource or environmental sustainability - the
public good that they care about. The total amount of the privately provided
public goods may not be Pareto Efficient, but some provisions as opposed to
none can be considered as a move toward the Pareto Optimum level.

From an information economics point of view, ecolabel carries warranty
and information from the informed party (in this case the sellers or producers) to
the uninformed party (buyers or consumers) that the product is made using

sustainable production process. Conceivably the producers and sellers know

44
more about the environmental or pro-sustainability characteristics of the
products they sell than the buyers do. In this situation, information is asymmetric
between the producers/sellers and the buyers/consumers. Such asymmetry of
information about the product characteristics provides the opportunity to use the
certified ecolabel as a warranty instrument. The ecolabel carries information that
would prevent adverse selection of products in the market. The latter means that
in the absence of complete and symmetric information on product quality to
sellers and buyers, only low quality products get selected in the market while the
high quality ones are driven out (Akerlof 1970).

In the absence of certification mechanism, Spence (1974), Kreps and
Wilson (1982), Kreps (1990) and Milgrom and Robert (1986, 1987) showed that
under such asymmetry of information, high quality producers will have the
incentives to signal to distinguish themselves in the market. The purpose of the
signal is to attract potential buyers who are willing to pay for higher quality
products. This signaling effort of high quality producers could lead to a
separating equilibrium in the market in which each market segment represents a
particular level of product quality and a particular level of consumers’ awareness
and willingness to pay for that level of quality.

Under the existence of a certification mechanism, the same results can be
achieved with a greater certainty. Certification and the use of labeling to
communicate the characteristics that has been certified would solve most of the
asymmetric information problem explained above, provided that the cost for

doing so can be justified by the expected return. By engaging in timber

45
certification and ecolabeling, the wood producers who use sustainable
production process could credibly inform consumers about the performance of
their product in terms of the pro-sustainability characteristic.

Following Krieger and Hoehn (1991), one could also argue that the
information contained in the ecolabel has value because it provides an
opportunity to change behavior. In the case of timber ecolabeling, the receipt of
new information about the pro-sustainability characteristic of the wood product
permits the sustainability-concerned consumers to recognize their past
‘mistakes’ and engage in sustainability-promoting behavior. The value of he
information lies in the increased utility it makes possible over less favorable

consumption habit it helps avoid.

2.7 Asymmetry of lnforrnation and the Role of Certification and Ecolabeling
The arguments developed in this section were based mainly on the
literature on asymmetric information, adverse selection and certification as a
warranty institution to avoid the adverse selection (Akerlof 1970; Spence 1974,
Kreps 1982, 1990; Campbell 1996; Albano and Lizerri 1997). Akerlof showed
that the asymmetry of information could lead to the collapse of the high quality
market, or worse, the complete collapse of the market for the commodity as a
whole. Spence ( 1974), Kreps 1990) and Milgrom and Roberts (1986) maintain
that quality signaling is a way to prevent the collapse of the market. Campbell
(1996) and Albano and Lizerri (1997) suggest that certification is a potential

alternative to signaling in the situation of information asymmetry. Signaling the

46
content of information, issuing warranties, or investing in establishing reputation,
all aim at solving the problem of asymmetry of information (Albano and Lizerri
1997)

In the tropical timber market, there is asymmetry of information about the
stock feedback effects of timber production between the producers/sellers and
the buyers. Under this circumstance, ecolabeling can prevent the collapse of
the market of the environmentally friendly or pro-sustainability tr0pical timber. If
an ecolabel is a credible and verifiable market warranty, it will lead to a situation
of separating equilibrium in which several equilibrium points are being reached
simultaneously at different market segments. Each segment corresponds to one
particular level of consumers’ willingness to pay that is based on a particular
level of consumers' awareness on environmental or resource sustainability.
Cooper (1992) and Kennedy, Laplante and Maxwell (1994) shows that in the
situation of asymmetric information between sellers and buyers, the government
may want to facilitate the provision of information from producers to consumers.
The provisions of information can be welfare enhancing if it moves economic
allocation toward Pareto Efficient point.

Asymmetry of information means that both parties are not using the same
set of information. In our example buyers are the uninformed agents because
they do not know the quality (in this case, the degree of pro-sustainability) of the
tropical wood offered in the market. Buyers have to rely on some average market
statistics or general information to judge the sustainability characteristics of the

product. The buyers cannot evaluate the wood as to whether it is a pro-

47
sustainability product or not. On the other hand, producers/sellers are the
informed agent because they know the quality or pro-sustainability
characteristics of the wood they produce or sell. Under this circumstance, the
sellers can take advantage of this lack of information on the buyers side and sell

wood of below average quality at a price justified by the average quality.

This self-selection toward low quality product is what Akerlof (1970) called
the “lemon principle” - low quality goods drive high quality ones out of the
market. The market serves as a self-selection device toward adverse selection:
only the worst gets selected in the absence of complete information for both
sellers and buyers. In other words, only the market for less-than-average pro-
sustainability wood exists. Buyers are content by assuming that they are buying
wood of average pro-sustainability quality and paying the price accordingly.
Markets of high quality goods break down because the buyers cannot accurately
judge the quality of the goods offered.

Here is an example: A cubic meter of highly pro-sustainability tropical
wood (referred to as “good wood”) is worth $600 to a buyer and $500 to a seller.
A cubic meter of environmentally unfriendly tropical wood (referred to as “bad
wood”) is worth $400 to a buyer and $ 200 to a seller. For this example we
assume that: ( 1) the supply of tropical wood is fixed and the market demand is
perfectly elastic; (2) that buyers and sellers know that there are twice as many
bad woods as the good ones; and (3) the woods are being offered at any price

above $200.

48

Consequently, all bad woods will be offered for sale. Notice that
environmentally friendly wood will only be offered if the price is $500 or higher.
Hence, at any price below $500 and above $200, the rational buyer will judge
that the woods must be the bad ones. Given this, the buyer concludes that the
wood is worth only $400. If the price is above $500, the wood has a two-thirds
chance of being a bad wood. Therefore, to the buyer, the expected value of the
wood is (1I3)(600)+(2l3)(400)=$467. However, there is no demand for the price
above $400 because: (1) above $467 there is no demand at all since no buyer is
willing to pay that much, (2) below $500 the demand only starts at $ 400 and
down since buyers believe they must be getting the bad wood. Equilibrium
occurs when only bad woods are offered in the market at a price of $400 per
cubic meter.

Under certain conditions" the process of degeneration of the quality could
lead to the complete collapse of the market - nobody is willing to buy the
tropical wood at the market price because the buyers are sure they are going to
get the bad ones. In the above example, when the price is within the $400 - $500
range, absolutely no transaction takes place despite the fact that the produced
wood should be sold at some price; there would be someone willing to pay a
price for that wood and somebody willing to sell it. However, making the

connections for those transactions is prevented by the asymmetry of the

 

s Akerlof, in his 1970 "lemon paper“, showed a mathematical proof. Since this totally collapsed market is
of little relevance to us, the reader is referred to the original article. We shall content ourselves by referring
to the tropical wood case.

49
information. This is a situation in which the market collapses due to asymmetry
of information: adverse selection by the informed agents who hold off high
quality products from the market.

In spite of the potential breakdown, markets for some products whose
buyers and sellers do not face a symmetric information set do exist. This is made
possible because the party that has superior information will do something to
indicate the quality of the goods being sold. In general, one can deal with them
in either of the following ways: (1) shifting the cost of asymmetric information
onto the informed agent; or (2) providing credible information to the uninformed
parties.

Guarantee is an example of the first measure. The informed agents/
sellers guarantee the quality of the products they sell and are willing to replace
or refund If the product does not meet consumers expectation about its quality.
This puts the cost of asymmetric information onto the informed party. Brand
name and company’s good reputation is a way of providing such guarantee
(Shapiro 1983).

One can also argue that product certification is one way to provide the
warranty on certain quality of the product that consumers care about (e.g.,
Campbell 1996; Albano and Lizerri 1997). Hence, it can be used to prevent the
collapse of the market for high quality products. Certification that is based on
independent third party assessment contributes positively to the credibility of
warranty stated in the product label. The role of the independent third-party

assessment is especially important when a company’s direct warranty cannot be

50
sensibly implemented in the market. For instance, distance between the primary
wood producers (i.e., the forest concessionaires) and the final consumers of the
tropical wood products makes it impossible to use the company’s direct
warranty. The certified ecolabel provides valuable warranty on pro-sustainability
characteristics of the product. This warranty could potentially increase the
market efficiency by conveying information to the uninformed agents (Campbell
1996).

In the example of the market for tropical hardwood, the characteristic is
only known by the producers/sellers. They are the informed parties. Unless the
buyers can become informed of the pro-sustainability level of the timber sooner
or later, the price that the sellers offer will have to be the price which reflects the
average quality of the product. So, in the market, bad wood sellers have a high
incentive to hide the fact because if the buyers pay a uniform price, they are
going to be paid above their quality level. On the other hand, sellers of good
woods have the incentive to reveal themselves to show that they are selling the
pro-sustainability products. They have this incentive because the uniform price
they receive is less than the real price for their quality level. Hence, it is in the
interest of the good wood producers to provide a warranty that they are selling
good wood. The key to such warranty is that the sellers of high quality products
are willing to take actions that the sellers of lower quality product do not find
worthwhile. To be eligible for certification and ecolabeling, the bad wood
producers would have to invest significantly higher than the good wood

producers.

51

Reliability of the certified ecolabel as a warranty means its degree of
credibility or whether a warranty is a honest warranty or a false one. This
credibility will depend on the existence of mechanisms within the certification
system to verify the information conveyed by the label as well as to punish the
false label. The potential market power of consumers to boycott or to
discriminate against the false ecolabel should be considered as part of the
enforcement mechanism to ensure credibility (Klein and Leffler 1981).

Look at the tropical timber market example once again to study the
equilibrium of ecolabeled wood. Assume a lot of woods of different levels of
qualities or pro-sustainability characteristics are in the market. The market is
very remote from the forest where the woods originate so the buyer can not
easily keep track of the stock feedback effects of the timber production. The
degree of the pro-sustainability of the woods is the information that the
producers send to the potential buyers through the ecolabel. The
producers/sellers would then choose whether to get certified and ecolabeled to
maximize the difference between what they can get from sending the warranty
and the cost of generating that warranty. The buyers are going to make their
price-bidding decision taking the warranty provided by the sellers as given.
Sellers take the anticipated price as given and they make a decision of how
much to warranty in order to maximize their profits. If the verifying and
punishment and/or retaliation mechanisms exist, at the equilibrium, producers of
good wood will spend resources to get certified and ecolabeled to inform

consumers credibly that they are pro-sustainability and thus will receive a higher

52

price. Producers of bad woods will optimally decide not to certify their operation
because it does not pay to do so.

In the credible ecolabeling situation, buyers will get perfect information on
the pro-sustainability characteristics of the products. Consumers will adjust their
bid price so that it will cover the extra marginal costs of using sustainable
production process. When the consumers see no ecolabel in the product, they
will bid for the price of the bad wood. This example shows a two-level separating
equilibrium in the market. Upper level equilibrium prevails for the pro-
sustainability product at a higher price; a lower level equilibrium exists for buyers

and sellers who are not concerned about resource sustainability.

Chapter III
SITUATION IN INDONESIA AS A MAJOR TIMBER SUPPLIER

AND IN THE UNITED STATES INTERMEDIATE WOOD INPUT MARKET

Introduction

Haji Gazali and Simula (1994) and Dauvergne (1997) reported a growing
worldwide consensus that timber certification and ecolabeling are now a
common interest among many parties. Sustainability concern about timber and
timber products are shared by consumers (as they become more aware of
environmental impact of their consumption patterns), traders of timber and
timber products (to secure their market access as response to consumers'
changing behavior), the governments of forest-rich countries as well as the
timber-based industry (to ensure continuity or long-term availability of timber
input).

This chapter discusses the concern over long-term sustainability of timber
production in Indonesia and recent developments in the international and US.
wood product markets. Sections 3.1 through 3.3 focus on the situation,
problems, and issues faced by Indonesia that may necessitate the adoption of
timber certification and ecolabeling. Section 3.4 discusses recent developments

in the world wood market that is relevant to Indonesia as a major tropical timber

53

54

producer. This section serves as a bridge to section 3.5 that analyzes the

current situation in the US. intermediate wood input market.

3.1 Indonesia’s Forest, Timber Production and Deforestation Issue
3.1.1 Forest Land Use Plan and Timber Extraction Policy
The Forest Resources

Indonesia owns 144 million hectares or about ten percent of the world’s
tropical natural forest and is one of the biggest tropical timber producers. The
government designates 64 million hectares of its total natural rainforest as
permanent production forest (GOI-MOF/Dirjen INTAG 1996). The permanent
production forest is forest area which is expected to be utilized as timber source
on sustainable basis in perpetuity. In this context, the government defines
sustainability as constant flow of timber production per year. The rest of the
forest area is divided into conversion forest, protected forest, and national
parks'. Figure 3.1 illustrates the Indonesian forest land use plan. Production
forest generates 85-90% of total log production in Indonesia. Timber from
conversion forest makes up the rest of the balance. This study focuses on the
certification of timber originating from the permanent production forest.

About three quarters of the tree species found in Indonesia’s forest are

categorized as commercial species. On average, forty percent of the standing

 

‘ Conversion forests are area designated for conversion for other uses such as agriculture; Protected
forests are areas designated for water and soil protection; and conservation forests and national parks are
area designated for nature preservation and genetic conservation (GOI-MOF 1993). No timber exploitation
is permitted in the protected as well as in conservation forests and national parks area.

55

Figure 3.1.
Indonesia’s Forest Land Use Plan

 

Protection forest
21 96

      
  

 

Convertible forest
24%

Conservation forest
1 2%

Limited production
forest Production forest

22% 21%

 

 

 

Source: GOI-MOF/Dirjen INTAG (1996)

timber stock is considered as having commercial size by the existing timber
extraction policy. The major commercial species from the Indonesia’s natural
forest is meranti (one of dipterocarp species). It makes up to 70% of the volume
of commercial species. Meranti has a 35-year rotation period and it grows
together with all other tree species in the forest (GOI-MOF/FAO/WB 1991; The

World Bank 1994).

The Timber Extraction Policy
Logging of meranti is restricted within the boundary of each forest
concessionaire. To maintain the continuous supply of meranti from the

permanent production forest, the logging process needs to ensure that the

56

residual trees remain intact for sustainable growth. For this purpose, the
government imposes a selective cutting policy known as Tebang Pilih Tanam
Indonesia (TPTI/Indonesian selective logging system). This logging system
requires the loggers and forest concession companies to cut meranti trees
whose diameter is at least 50 centimeters (20 inches), and to do some
silviculture and post harvest tending of the logged-over area. Replanting is
required if the remaining number of young meranti trees is less than 25 per
hectare. These trees have at least an 8-inch diameter at breast height. The
young trees are expected to grow to commercial size for harvest in 35 years.
Clear cutting is not allowed in the permanent production forest.

Forest concession is allocated by government discretion under a close
system of the patronage circle instead of through an open bidding system (Broad
1995; Ascher 1993). About 61 million hectares of the natural forest is currently
allocated into 575 forest concessionaires. The concession costs $1.25 per
hectare for 20 years exploitation right. This concession period is shorter than the
perceived average tree rotation period which is 35 years (The World Bank
1994). The low concession license fee has induced large ownership of forest
area among Indonesia’s forest concessionaires? The short concession area
relative to the tree rotation, although by law it is renewable subject to the forest

management performance, does not provide sufficient warranty for the

 

2 Forest concession area ranges from less than 10,000 hectares to about 920,000 hectares (Wahana
Lingkungan Hidup indonesia (WALHI) 1991).

57

concessionaire to be able to harvest for the second time (GOI-MOF/FAO/WB
1991)

After cutting the trees, the concessionaires pay an average amount of $22
per cubic meter log harvested. The amount consists of about $6 timber royalty
(which is based on 6% of government’s reference price), and an average of $14
reforestation fund. The remaining $2 consists of a few cents from each of the
following revenues: property tax, scaling and grading fees, and the concession

license fee.

3.1.2 Current Situation and Problems in Timber Production

In 1995, the country exported about $6 billion in value of timber products
(excluding pulp and paper) which constituted about one-sixth of the total export
value. Plywood and sawnwood make up about three quarters of the total value of
timber product exports. More than a quarter of the timber product exports were
destined to the eco-sensitive markets of US, Canada and Western Europe.

Indonesia's timber processing industry (sawmills and plymills) commands
an effective demand of 53 million cubic meter of logs (raw timber) per year. In
sharp contrast, the country’s production forest can only sustain the supply of 22
million cubic meter of logs on recurrent annual basis without inhibiting the

growth of timber stock in the logged-over area3 (The World Bank 1994).

 

3 The 53 million cubic meter effective demand estimate differs significantly from the official government log
production figures. The officially reported production in 1994 is 24.7 million cubic meter from production
forest plus 3.5 million cubic meter from the conversion forest. Government holds that the sustainable
production rate is 22.5 million cubic meter per year which is based on 39.9 million hectares area of
undamaged production forest in 1990 and about 1 cubic meter stock growth per hectare per year.

58

Currently, no meranti production comes out of plantation forest. And it is
very unlikely that any production of meranti will come out of plantation forest at
all within the next 35 years. The reason is that the processing industry does not
have enough incentive to develop alternative source of input under the currently
depressed domestic log price. The huge effective demand relative to the forest
supplying capacity has made the over cutting inevitable (Ramli and Ahmad
1993). Table 3.1 illustrates the extent of over cutting in 1994 due to excessively
high investment in the wood processing industry. The estimated logs consumed
by the industry in 1994 is 19 million cubic meter above the concessionaires’
supplying capacity, and it is almost double the official sustainable cutting rate.

In addition to the problem of over harvesting, few concessionaires have
complied with the regulation that requires concessions to conduct post harvest
silviculture and to tend the logged-over area. As announced by the Ministry of
Forestry, less than 20% of the concessionaires can be considered as having
good forest management practice. Although sanctioned with fines and threat to
revoke the concession license, enforcement of the required custodianship of the
concession area has not been effective. Lack of professional and institutional
capacity in the part of Ministry of Forestry is one reason. The delicate
patrimonial relationship between the owner of forest concessions and the ruling
elite is a more significant reason that blocks the effort to enforce the required

forest management practices (Sunderlin and Resosudarmo 1996).

59
Table 3.1.

Demand and Supply of Timber for Wood Industry in 1994

 

A. Demand from wood processigg industry

 

 

 

 

 

 

 

 

 

A1. Number of establishment 2,438 units
- sawmills 2,321
- plymills 117

A2. Output production capacity 29.6 million cubic meter
- sawnwood 17.8
- plywood 11.8

A3. Log intake capacity 1 59.1 million cubic meter
- sawmills 35.6
jalymills 23.5

 

A4. Effective demand for logi

53.2 million cubic meter

 

 

8. Supply capacity

 

B1. Number of forest concessionaires

575 establishments

 

B2. Total concession area

61.1 million hectares

 

B3. Log supplying capacity3

34.2 million cubic meter

 

 

C. Official log production figure

28.2 million cubic meter

 

 

D. Official sustainable cutting rate

22.5 million cubic meter

 

 

E. Excess demand

 

19.0 million cubic meter

 

E1. Above forest supplying capacity (A4-B3)
E2. Above official sustainable cutting rate (A4-D)

30.7 million cubic meter

 

 

E3. Under reporting / Illegal logging estimate (A4-C)

 

25.0 million cubic meter

 

2Conversion1 factor used: 2 cubic meter logs for 1 cubic meter output (MOF 1993)
:9096 capacity utilization is assumed in this table. Actual utilization ranges between 85-110%.
3Estimated based on annual cutting area and average yield per hectare.

Source: Calculated based on Ministry of Forestry data (The World Bank 1994).

As a consequence of the over cutting and the lack of silviculture efforts,

the stock externality effects and the associated loss in forest environmental

functions have become threatening externality problems. Estimates of

Indonesia’s deforestation rate ranges from 623,000 hectares (Dick 1991) to

2,400,000 hectares (Hasanuddin 1996) per year during the eighties and early

nineties (Sunderlin and Resosudarmo 1996). However, not all of these losses

are attributed to the timber harvest. Using Dick (1991) analysis that provides the

 

60

most conservative estimate of the annual deforestation rate, at least one-fifth of
the 623,000 hectare loss in forest cover per year can be attributable directly to
the logging operation. The indirect effects of logging to deforestation
materializes through the entry of shifting cultivators and spontaneous
transmigrants to the logged-over area which is left unmaintained after harvest.
Figure 3.2 depicts the agents responsible for the deforestation according to
Dick’s analysis.

Figure 3.2.
Indonesia's Annual Deforestation Rate and Causes

 

Total deforestation = 623,000 hectare per year

Fires __ Forest harvest

  
 
 

Govttransmigration (10991"9)
program 19%
13%
Estate crops -
2% j R 'I. .\
Swamp development l"""lllllll"WHHHH I
5* ”mum“ ”“llnllll- Traditional
lllllllllllllllll lllllllllllll
2296

Spontaneous
transmigration
28%

 

 

 

Source: Dick (1991)

Maintaining logged-over area to remain intact for harvest potential in 35
years time poses its own problems to the forest concessionaires. First,
uncertainty of concession renewals. Although rules have been specified for

concession renewal, rent seeking behavior in the bureaucracy tends to

61

undermine any written procedure (WALHI 1991). Secondly, maintenance of the
logged-over area requires some investment. Although the amount necessary is
relatively small in nominal term and in proportion of log price, the myopic
business practices prevent the concessionaires from investing for the future
benefits of the forest. This situation is caused by high interest rates in the capital
market.

Despite the continuous financial sector deregulation since 1983, the
domestic credit markets offer a persistently high nominal interest rate in the
neighborhood of 24% per annum. Deducting it with 9% average annual inflation
in Indonesia during the last 10 years, the real interest rate is 15%. Taking into
account depreciation of domestic currency (i.e., Rupiah) the entrepreneurs are
used to discounting future benefits at 20% real effective interest rate as a
measure of opportunity cost of their Rupiah-denominated investment (The World
Bank 1994). With 6% average annual depreciation rate of Rupiah, the 20%
interest rate is equivalent to a real rate of 14% if the investment values are
denominated in US. Dollar.

Given the extent of deforestation problem in Indonesia, many have
suggested a series of policy reforms to improve the situation. These include:

(1) Improve the pricing ’of the forest resource resources through substantial
increase in rent captured by the government (WALHI 1991; The World Bank

1992, 1995; Thiele 1994). Inclusive in this category are suggestions:

62

a. to increase timber concession fee and annual property tax (which are
area-based charges) to discourage large ownership of concession
right.

b. increase the timber royalty and reforestation fund which are volume-
based charges.

(2) Improve the tenure security by extending the length of concession period to
cover at least one harvest cycle (The World Bank 1994; Thiele 1994)

(3) Change the concession allocation system from closed and patrimonial toward
an open bidding system (WALHI 1991; Thiele 1994)

(4) Rationalize the wood industry by stopping the expansion of the processing

facility and revoking the log export ban (WALHI 1991).

One can argue that these policies will encourage improved management
of the production forest as well as increase government revenue substantially
(Sunderlin and Resosudarmo 1996). However, there is not enough interest
within the government circle to realize the reforms. No significant changes have
been made except rationalizing the wood industry as suggested in point (4)
above (Hasanuddin1996).

Many commentators argue that the reason for this resistance to change
lies in the political system. Ascher (1993) suggests that the government,
including the Ministry of Forestry, sees forest as an asset to be liquidated to
diversify the economy; rent capture is kept low to facilitate that process. Forest

concessions are allocated as a form of political patronage to influential people

63

around the ruling elite (Ross 1996). King (1996) sees that efforts toward
improvement in the forest sector are blocked by the patrimonial characteristics of
the government elite. He concludes that significant reform will require “a regime
change, a critical shortage of timber supply, or external threats to Indonesia’s
exports of forest products.” The rise of green consumerism and ecolabeling
initiative as a way to face the threat of dwindling forest resources come forward
in line with this conclusion. The threats of loosing a significant portion of export

market will create some pressures to improve forest management in Indonesia.

3.2 The Emergence of Ecolabeling Issue In Indonesia

Ecolabeling and timber certification issue emerged in Indonesia in 1992 as
the Austrian parliament enacted the law to impose mandatory ecolabeling for
tropical timber imported into the country. Lack of information and understanding
on the effects of ecolabeling had generated a wide range of reaction from
various parts of the society. The timber-related businesses have succeeded in
voicing their concerns that eco-labeling of timber and timber products will limit
market access of Indonesia products into developed countries and reduce their
international competitiveness. Indonesia, supported by other Association of
South East Asian Nations (ASEAN) countries questioned the legality of Austrian
ecolabeling law in GATT forum since it discriminates against the tropical timber.
In response to the latter criticism, the law was finally amended in 1993 to cover

all timber and to be implemented on voluntary basis.

64

The experience with Austria and the growing number of boycotts from
several German and US. cities and state governments have induced Indonesian
government to realize the potential threat to the succession of Indonesia’s forest
product exports in the future. The incidence with the Austrian law was also used
by the Indonesia's pressure groups to persuade the government to look into the
possibility of using ecolabeling to improve forest management practices.

In response to the potential market pressures and the growing concerns
over poor forest management practices, plus the official commitment to achieve
the ITI'O Year 2000 objective, the Indonesian government initiated the
preparation for establishing the Indonesian Ecolabeling Institute (LEI/Lembaga
Ekolabel Indonesia) in late 1993. As of June 1997, the preparatory works are
still in progress to establish the institute.

Haji Gazali and Simula (1994) maintain that the primary objectives of
timber certification and ecolabeling (TC/EL) are to improve forest management
and to ensure access into eco-sensitive markets. Additional objectives of TCIEL
which seem to fit to Indonesia situations are: (1) to internalize the externalities
costs caused by timber production; (2) to improve control over illegal logging; (3)
to rationalize the existing over-investment in timber-based industry; and (4) to
improve efficiency of the timber-based industry if the TCIEL is to include product
certification. All these additional objectives are particularly relevant to Indonesia
because of the existing excess capacity in Indonesia's timber processing

industry and the related problem of illegal logging.

65

3.3 Exposures of Indonesia's Wood Product Exports to the Green Market

The threats to Indonesia’s exports come primarily from developed
countries to which Indonesia depends a great deal for marketing its forest
products. Many developed countries have slowly turned into eco-sensitive or
green market as the awareness of their society toward resource and
environmental sustainability increases. Eco-sensitive markets are countries in
which the pressure for the green products seem to be high. In terms of world,
Septiani and Eliot (1994) reported that North American and Western European
countries appeared as origin of green consumerism. The US, Canada,
Germany, Netherlands and the UK can be ranked on the top of the layers on
consumers environmental awareness by looking at various NGOs' campaigns
and boycott toward the tropical timber products.

In Japan, which is the primary market of Indonesia’s wood products, the
Association of Building and Construction Industry announced the target of 35%
reduction in the use of panel made wholly of tropical hardwood. Furthermore,
they also announced l'l'l'O’s Year 2000 target as the compliance target for its
membership. The primary reason behind this action is the uncertainty about the
sustainability status of tropical forest management (The World Bank 1994,
Harago 1994).

As Figure 3.3 shows, more than half of Indonesia’s wood product exports
are currently exposed to these markets. About US. $1.3 billion or 23% of
Indonesia's total wood product export value in 1995 (exluding fuelwood, charcoal

pulp and paper products) was destined to eco-sensitive North America and

66

Figure 3.3.
Major Export Markets of Indonesia’s Wood Products in 1995

 

Total export value = 85.8 million
( 4 = ..Z, ..--d: ‘ ' ' , products+furniture)

 

Others
1 3%

   

 

Japan

East Asia
28%

North America
10%

 

European Union
1 3%

 

 

 

Source: Biro Pusat Statistik (1996)

European markets. Another 36% of the export value was shipped to Japan
where tropical forest sustainability is becoming a sensitive issue. In terms of
commodity, North America and Japan each absorbs about one-quarter of
plywood and sawnwood exports from Indonesia. For the growing exports of
woodworking products and furniture, the shares are even more significant. About
one-third of the US. $833 million worked-wood (e.g. joinery, moulding,
window/door’s frame, grill and panels) exported in 1995 was directed to US,
Canada and European market. The same proportion of the US. $864 million
wooden furniture exports went to the same market. Japan, which is on the brink
of eco-sensitivity, absorbs about one quarter of Indonesia’s exports of

woodworking products, as well as furniture.

67

Volume wise, about one-fifth of plywood exports and close to 30% of
sawnwood exports depend upon the eco-sensitive market of North America and
Europe. Japan absorbed 30% of Indonesia’s 8.3 million cubic meter plywood
export and 20% of 640,000 cubic meter sawnwood exports.

The pressures for environmentally friendly products primarily comes from
the increasingly eco-sensitive markets of North America, Western Europe and
Japan. These pressures also need be taken seriously by Indonesia as the share
of high value-added products is increasing in Indonesia’s exports. These
products are expected to pave the way for the developments of ecolabeled wood
product markets. Figure 3.4 shows that since 1992, the wood-working products
and furniture have contributed more than 20% of the revenues from the wood
products export. The majority of furniture and woodworking products are
exported to the eco-sensitive market of North America and Western Europe, as
well as to Japan whose awareness for environmental sustainability is rising.

From Indonesia’s wood industry perspective, another interest is to maintain
the existing market shares within the primary export markets. The size of the
stakes that Indonesia’s industry needs to maintain is summarized in Table 3.2.
Indonesia supplies 52% of the US. tropical plywood import market, and 78% of
the Japan’s.

With all these pressures and interests, it seems inevitable for Indonesia’s
producers to start engaging in timber certification and ecu-labeling. The head

start will also put Indonesia in an advantaged position as other importing

68
countries join the green consumerism trend, and as other timber producing
countries start positioning themselves in the green market later.

Figure 3.4.
Trend of Indonesia’s Timber Product Exports, 1981-95

 

 

7000<

§

3

E

8. furniture

 

in “mutant! US 3
§

'§’

7%

  

 

 

 

 

.-. , > . -
N V (D N V
a a 3 § § 8: 8:
a F a a a a F

 

 

 

Source: Biro Pusat Statistik, Statistik Ekspor Indonesia, various issues.

Table 3.2.
Share of Indonesia in The Foreign Country Import Markets

 

3.4 Recent Developments in the World Wood Market
In relation to the growing adoption of timber certification and ecolabeling
World wide, certain characteristics of world timber market are relevant to

lhdonesia’s situation. These include the issues of competition, market share,

69

and potential benefits and losses from embracing the timber certification and
ecolabeling.

First, in the world tropical timber market, Indonesia is competing with
other countries that also have high proportions of export relative to their timber
production volumes. Indonesia exports two-third of its timber (in round-wood
equivalent) which made it the largest exporter in 1992 followed by Malaysia who
exports about 75% of its production. Other countries that have high export
shares in their production are Congo (62%), Ivory Coast (57%), Gabon (57%),
Ghana (49%), Liberia (64%), and PNG (64%) (Crossley, Primo Braga and
Varangis 1994). All of these countries with highly export-oriented or export-
dependent timber production can be potential competitors for Indonesia to win
the currently small niche ecolabeled timber market. Or, they can also be an
alternative sources of importing countries if ecolabeling program diverts trade
away from Indonesia. Malaysia appears to be the main competitor of Indonesia
in almost all markets of tropical timber products, especially plywood and
sawnwood. Brazil, the largest tropical timber producer in Latin America, only
compete in the US. sawnwood market.

Second, competition of tropical and non tropical woods is expected to limit
increases in the international prices of tropical timber products (Vincent 1992).
This is believed to limit the chance to seize the green premium from certified
timber products. Increases in the production of temperate and boreal timber
have contributed to this situation. Technological advancement in making

reconstituted wood products had also helped slacken the scarcity of timber

70

supply. Although the prices of timber are still increasing in nominal and real
terms, the increase has been steadily diminished. However, recent evidence
from the U.S. certified intermediate wood market suggests possibly a different
trend. A Survey of the MSU Forestry Department reveals that the existing sellers
of certified wood products have been able to pay some price premium for their
inputs and pass this extra costs down to the next buyer in the processing stages
(please see section 3.5 for more elaboration on this survey).

Third, most tropical timber currently has commodity end use for which
many substitutes are available. Tropical timber is believed to have high price
elasticity of demand. Tropical plywood, which is mainly used for concrete
formation and other structural purposes, faces strong competition from
temperate softwood plywood. Sawnwood, which is the main input for furniture,
woodworking products and building decorative, is competing with both temperate
softwood and hardwood. But, the US. market data used in various study reveal
a different story about the elasticity of demand in the market. GOI-MOFIFAO/WB
(1991), Smith, Haas and Luppold (1982, 1996), Ahmad (1995) and Suprapto
(1995) all found that the demand for tropical wood in general, and for
Indonesia’s export to the US. in particular, tend to be inelastic in terms of price.
Luppold (1982) found that the price elasticity of demand is about 0.9 for tropical
wood in general, while studies by GOI-MOF/FAONVB (1991) and Suprapto
(1995) found the elasticity in the neighborhood of 0.6. These studies suggest
that there exist little possibility of substitution between tropical hardwood and

temperate softwood in the US. market.

71

Fourth, opportunities exist to increase the revenue from the small premium
of ecolabeled wood products. The opportunities exist because: (1) the price
elasticity of demand for Indonesian plywood and sawnwood in US. market is low
(GOI-MOFIFAO/WB 1991; Suprapto 1995); and (2) the elasticity of substitution
between tropical and temperate wood in most northern countries is also low
(Barbier 1996; Smith, Haas and Luppold 1996). The introduction of ecolabeled
wood products into a market with such characteristics will likely increase the
market share of the exporting country. In addition, as discussed in chapter II, the
existence of market segments that will buy environmentally marketed wood
products in the US. market (Ozanne and Smith 1996), and Western Europe
(The WWF-UK 1995 Group 1996) provides new opportunities for Indonesia’s
wood product industry.

Finally, recent developments in timber certification movement suggest
that competition in certified wood markets may be increasing in the future.
Currently, 62 forest concessions around the world have certified their operations
under FSC system. Table 3.3 presents the global estimates of total certified area
and total log productions. As of March 1997, close to 6 million hectares of forest
lands with total estimated production about 7.4 million cubic meter. Table 3.3
includes only 51 operations and productions of timber for solid wood purposes
(instead of for charcoal or pulpwood). Seven of these companies are located in
the US. This trend may reflect the strategy of US. companies to deal with their
tropical competitors either to protect their own traditional domestic markets or to

seize new marketing opportunities in the high-valued ecolabeled wood markets.

72

Table 3.3.
Number of Companies and Volumes of Production
in Certified Forest Area Around The World

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Country Number of Total area Total estimated Wood species
establishment (hectares) production (m3)
I
[Belgium 1 66,915 285,600 Oak, Beech
[Bolivia 1 52,000! 1,720 Hardwood
[Brazil 2 60,734 30,000 Hardwood
[Costa Rica 1 3,900 2,000 Hardwood
@nduras 1 25,000 2,800 Hardwood
[lidonesia 1 3,028,000 866,600 90% hardwood,
10% softwood
[Malaysia 1 251 7,000 Rubber wood
[Mexico 2 110,316 35,800 Hardwood
[Papua New Guinea 1 12,500 2,000 Hardwood
[Poland 3 1,551,563 4,588,800 Pine, Spruce, Beech.
Oak
Solomon Island 13 4,296 2,230 Hardwood
South Africa 1 51,922 500,000 Pine, Eucalyptus
Sri Lanka 3 12,726 33,700 Rubber wood
Sweden 1 309,000 80,000 Softwood (7)
[United Kingdom 6 664 700 Hardwood
[United States 12 620,906 920000 25% hard, 75%
softwood
LZimbabwe 1 24,850 4,200 Teak (hardwood)
L Total 51 5,935,543 7,363,150

 

Source: Good Wood Alliance (1996); FSC (1997); SGS/Forestry (1997)

3.5 Recent Developments in the U.S. Intermediate Input Market for Certified

Wood

Many parties questioned whether the commercial benefits can support

timber certification. The views range from the non existence of opportunity to

gain a price premium (Vincent 1992), to the smallness of the world market for

certified wood (Crossley, Primo Braga and Varangis 1994), and t0 the

 

73

impracticality and costliness of the implementation of timber certification and
ecolabeling (IHPA 1996). This section explores these issues.

As more companies have adopted timber certification within the last few
years, more can be learned from the certified wood products markets. Many
people in the wood product business have not been convinced about the
commercial benefits of engaging in certification. However, entrepreneurs who
are selling certified wood products have been enjoying some benefits. Although
many adopted certification programs with a view to increase market access,
most of them have also been able to appropriate some price premium. Most
sellers of certified wood products are able to pass the extra costs to their buyers.

This section reports the main findings of the “Wood Product Certification”
survey that was conducted by MSU Department of Forestry in two stages:
August-December 1996, and March - June 1997 (Stevens, Ahmad and Ruddell
1997). The objectives of the survey were: (1) to determine the extent of and
motivation for wood product companies for adopting timber certification and
labeling; (2) to estimate the increase in the costs incurred by the companies to
implement this new instrument; and (3) to estimate the existing willingness to
pay for the price premium for ecolabeled wood among the wood industry at
various stages of processing and marketing.

In the following subsections, analyses of the U.S. intermediate wood input
market will be presented in two forms. The first is the general comparisons

between the groups of companies that are currently selling certified wood

74

products and those that are not. Otherwise, discussions will be focused on the

segment of certified wood product sellers.

3.5.1 The Survey

In the survey, a certified wood product company is defined as a company
that has been certified by an F SC-accredited independent third party as selling
wood products that originate from well managed forests.

The analyses classify the wood product sellers into 10 business types
based on the way the companies identified themselves. The sample base,
however, is taken from the following sources. The wood product importers
information were taken from “1996 Directory of United States Importers” (The
Journal of Commerce 1996). Only companies that import more than $1 million in
the values of wood products are included. These companies import one or more
of the following: lumber, panel, furniture, furniture parts and moulding products.
The sellers of certified wood products were taken from the directories issued by
the two U.S. certifying companies, namely the Scientific Certification System and
the SmartWood Program of The Rainforest Alliance (SCS 1996; SmartWood
1996). The rest of the samples were taken from “1996 Ward’s Directory of U. 8.
Private and Public Companies” based on SIC (Standard of Industry
Classification) codes that cover hardwood industry at various stages (Gale

Research 1996). The 1996 Resource Guide of International Home Furnishing

75

Center supplements the sample base for the household wooden furniture
manufacturer group (IHFC 1996).

In total, researchers mailed 1290 questionnaires to wood product
companies in the U.S.. Twenty-nine of them went to companies that have been
certified by FSC—accredited organizations as sellers of wood products originating
from well-managed forests. This covers 100% of the certified wood companies
that are located in the U.S., seven of which are forest management firms. In
addition to the questionnaires, 26 company visits were made during the first
stage of the survey to discuss a broader issue of timber certification and

ecolabeling with the wood product companies.

3.5.2 Characteristics of the Sellers and Non Sellers of Certified Wood

Products

In return, we received 154 usable questionnaires; 22 of them came from
the certified companies. This constitutes 76% of total certified-wood-product
companies in the U.S.. In addition to these 22 companies, we found six
companies that are selling certified or ecolabeled wood products although they
have not been certified by F SC-accredited certifiers. As a whole, the 28
companies that sell certified wood products account for 52% of the total 54
sellers of certified wood products in the U.S. (Good Wood Alliance 1996). It is
acknowledged that the 126 companies that do not sell certified wood products

comprise a small proportion of its population in the U.S.. Hence, the answers

76

and numbers generated from this group can only be taken for indicative
comparison. In the following paragraphs, the companies that sell certified wood
products are called CWP groups; those that do not sell are called Non CWP
groups. Table 3.4 summarizes the distribution of the wood product companies in
the sample. In terms of business type, the wood products importers/brokers]

wholesalers constitute 25% of the total 154 company in the data set.

 

 

 

 

 

 

 

 

 

 

 

 

 

Table 3.4.

Number of Companies in the Data Set by Business Type
L Business type 00 not sell CWP Sell CWP Total %
[Ember mill 7 0 7 4.5%
[Wholesaler/broker/importer 30 8 38 24.7%
Mnension 8. Flooring 8 1 9 5.8%
[Veneer 8. Plywood manufacturer 9 3 12 7.8%
Willwork manufacturer 15 1 16 10.4%
[Household Furniture 16 1 17 11.0%
[(itchen Cabinets 11 0 11 7.1%
[Furniture Retailer 15 3 18 11.7%
Eorest Management 0 7 7 4.5%
[Others 15 4 19 12.3%
| Total 126 28 154 100.0%
L 81.8% 18.2% 100%

 

 

 

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ruddell 1997)

Figure 3.5 illustrates the geographical distribution of the companies in the
data set. More than 40% of non CWP are located in East Coast states. About
the same proportion of CWP group, however, are located in the West Coast.
Companies in the Mountain States constitutes only 4% of the non CWP group

and none in the CWP group.

77

Figure 3.5.
Geographical Distribution of Companies in the Data Set

 

Non Sellers of Certified

Wood Products (126 Sellers of Certified Wood

Products (28 companies)

companies)
West
Coast “1.. West
24% x K,“ g Coast

43%

   

      
    

  

 
   
  
    
     

 
  
 

     

\\ \

822/ ,
Mountain M'd'

Wfl

     
  
  
 

 

 

 

x2; States fie: 36%
31% 4%

 

Source: MSU Forestry Department Survey (Stevens, Ruddell, Ahmed 1997)

Table 3.5 presents companies distribution by sales range and whether
they sell certified wood products. A majority of the companies have sales that
range from $1 million to $10 million per year. The medium-sized companies, ‘
namely those in the $10 million to $50 million, account for about one-third of the
total sample. Distribution of companies within each group, non CWP and CWP,
closely follows the pattern of general distribution. Among the 11 companies
whose sales are higher than $100 million, four are in the wood product
wholesaler/ importer category. Four others are from household furniture and

cabinet manufacturers.

78

Table 3.5.
Number of Companies by Sales Range
and Whether They Sell Certified Wood Products

 

 

 

 

 

 

 

 

 

 

 

Sales range # of companies # of companies selling Total # of %
not selling CWP CWP companies

< $1 M 5 1 6 3.9%
$1-9.9M 55 10 65 42.2%
$10-199M 20 4 24 15.6%
$2049.9M 19 6 25 16.2%

$50-99.9M 1 1 2 13 8.4%

$100-4999M 5 3 8 5.2%

$500M-1 B 1 0 1 0.6%

>$1 B 1 1 2 1.3%

No Answer 9 1 10 6.5%
Total 126 28 154 100.0%

 

 

 

 

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ruddell 1997)

Of the existing proportion of certified wood products in the total sales
value of the CWP companies, only seven fully specialize in certified wood
product markets. These include five forest management companies that have
100% of their inputs originate from certified forest area. The other two
companies are furniture retailers that specialized in teak wood furniture. Table
3.6 summarizes the distribution of companies by business type and the
proportion of certified wood products in their sales in the U.S.. The majority of
companies have 5% to 15% of certified wood products in the total values of their
domestic sales.

All of the non forest management companies in CWP group said that they
will be able to increase their sales of certified wood products if there is more

supply. All of them believe that currently there is a supply constraint in promoting

79

the markets for certified wood products. Some certified mills have not been able
to acquire more certified logs in spite of the fact that they are willing to
compensate for the increased costs due to certification. At the same time, some
certified land owners are hesitating to switch completely to the new certified log
market despite the existence of a price premium. They choose to maintain their
traditional market (where certification is not recognized and no price premium is
involved) as an insurance against uncertainty in the new market. One company’s

view is that the current premium is not sufficient to cover that risk.

 

 

 

 

 

 

 

 

 

 

 

Table 3.6.

Companies by Proportion of Certified Wood Products in U.S. Sales
[ Business type < 5% 5-9.9% 10-14.9% 15-20% >20% Total
[Wholesaler/broker/importer 2 4 0 0 2 8
[Dimension 8. Flooring 0 1 0 0 0 1
[Veneer & Plywood manufacturer 2 0 1 0 0 3
[Millwork manufacturer 0 1 0 0 0 1
[Household Furniture 1 0 0 0 0 1
[furniture Retailer 0 1 0 0 2 3
[Others 1 0 0 1 2 4
[Forest Management company 0 0 2 O 5 7
| Grand Total 6 7 3 1 11 28
| 21.4% 25.0% 10.7% 3.6% 39.3% 100.0%

 

 

 

 

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ruddell 1997)

Interviews with certified companies revealed that the certified products
currently in demand are: (1) flooring materials for domestic and Western
European markets. Most certified lumber in the U.S. market ends up as flooring;
(2) furniture, especially garden and patio furniture; (3) doors and windows’ grills
and components; (4) architectural moulding such as joinery, and panels with

decorative veneers.

 

80

3. 5.3 Company Familiarity and Buyers Interest for Certified Wood

Products

The survey asked the companies specifically if they are familiar with wood
product certification under the F SC system. Among 126 non CWP companies in
the data set, 44 (35%) are familiar with it. When asked about the meaning of the
certified label on the wood products in the interviews, about two-thirds of the
companies interviewed mentioned that the certification assessment at the forest
level is based on selective periodical cutting and sustained yield principles.
Regionally, 55% of the companies that are familiar with timber certification and
labeling are located in the East Coast, 30% in the Mid West, and the rest in the
West Coast.

Forty-five companies, or 23%, of the total 154 companies have actually
received inquiries and interests from their customer bases to purchase certified
wood products if they are available. Nineteen of the companies that have
received requests for certified wood products are from the non CWP group.
Regarding the level of interest among the potential buyers, on average, this
group said that they have received inquiries for certified wood from about 4% of
their customer base. Within the CWP group, the companies said that on
average, they have received inquiries from about one-fifth of their customer
bases. Among this group, about two-thirds see that the trend of the requests has
been increasing within the last two years while about 20% said that the requests

have stayed the same. Three groups report significantly high requests in terms

81

of the proportion of customer bases. Millwork manufacturers receive request

from 65% of their customer bases, while wholesalers and furniture retailers

receive request from about one-fifth of their potential customers.

Regionally, the West Coast is the primary area where potential customers

ask for certified wood products. CWP companies on the West Coast receive

requests from about 28% of their customer bases. Table 3.7 summarizes the

distribution of companies that have and have not received request for certified

wood products by region. Consistently, more companies on the West Coast

than in other region reported that their customers are interested in purchasing

certified wood products.

Table 3.7.

Number of Companies by Request for Certified Wood Products

 

 

 

 

 

 

 

 

 

 

 

 

CWP Group Non-CWP-Group
Region # of companies # of companies # of companies # of companies
receiving not receiving receiving not receiving
requests requests requests requests
,Qst Coast 9 1 13 39
Mid West 6 0 0 5
Mountain States 0 0 1 38
West Ccoast 11 1 5 ~ 25
__I_p_taL 2w3%) 2 (7%) 19 (15%) 107 (85%)

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ruddell 1997)

3.5.4 Company Motivation

When asked about their reasons to sell or not to sell certified wood

products, most companies checked more than one answer. From the 28

companies that are currently selling certified wood products we have 52

 

82

answers. The five top answers from this group are summarized in Figure 3.6
along with the “other reasons" category. The primary motive for the companies to
embrace timber certification and ecolabeling is to gain market access (23% of
total answer). The second most important reason is related to the companies’
philosophy. They see it is an environmentally responsible thing to do. Fifteen
percent referred to customer demand. Improving public image does not seem to
be a very compelling reason for these CWP companies.

Figure 3.6.
Reasons for Selling Certified Wood Products

 

(52 answers from 28 companies)

other reasons market access
23%

   
 
   

niche market
1 0%

customer demand

public image

responsible thing to
<10 10%

21%

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ahmad 1997)

Among the 126 companies that are NOT currently selling certified wood
products, the number one reason for not selling them is that the companies are
confident that they are buying wood products that originate from well-managed

forests (29% of 257 answers). Figure 3.7 illustrates the answers from this group.

83

Another important answer is that these companies do not need to sell certified
wood products to maintain market share. About 11% said the cost of adopting
timber certification and labeling is so high that it prohibits them from doing it.
One-tenth of the answers refer to the lack of supply of certified wood products at
competitive prices.

Figure 3.7.
Reasons for NOT Selling Certified Wood Products

 

(257 asnwers from 128 companies)

we buy from
managed forests
29%

other reasons
27%

 
 
  
  
 
 

cost is prohibitive

donl‘t need cwp to

lack of cwp supply maintain market
at competitive price share
10% 23%

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ahmad 1997)

3.5.5 The Cost and Price Premium of Certified Wood Products

We asked companies two questions regarding the increase in the cost of
certified wood products. First, what was their estimate of the increase in their
cost of goods sold due to certification. Second, if they purchased certified wood
products, what percentage of the price premium did they actually pay to their

suppliers. Table 3.8 presents answers to the first question. Three quarters of

84

companies that provided estimates of the increase in their cost of goods sold

due to certification said that the increase is less than 10%. About half of them

said that the increase is less than 3%. Eight companies responded that their

costs of goods sold increased between 3 and 4.9% due to becoming the sellers

of certified wood products. Only four of 28 companies said that the increase in

costs is more than 10%. The average increase in the cost of goods sold is

estimated roughly about 4%‘.

Among the 28 companies that sell certified wood products, 21 companies

purchase their materials from other sources. On average, based on answers

from 20 companies, the premium actually paid by the CWP group is 6.6% above

the price of comparable non-certified products.

Table 3.8.
Companies Selling Certified Wood Products
by Increase in Cost of Good Sold Due to Certification

 

 

 

 

 

 

 

 

 

 

 

I Business type < 3% 34.9% 59.9% 10-14.9% 15-20% >20% No Total
answer
Mholesalerlbrokerflmporter 2 3 2 0 0 1 0 8
[Dimension 8. Flooring 0 0 0 0 0 0 1 1
Veneer 8 Plywood 0 2 0 1 0 0 0 3
manufacturer
[Millwork manufacturer 1 0 0 0 0 0 0 1
[Household Furniture 1 0 0 0 0 0 0 1
[Furniture Retailer 1 0 0 0 0 0 2 3
[Others 2 1 0 0 1 0 0 4
Forest Management 3 2 1 1 0 0 0 7
company
| Grand Total 10 8 3 2 1 1 3 28
L 35.7% 28.6% 10.7% 7.1% 3.6% 3.6% 10.7% 100%

 

 

 

 

 

 

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ruddell 1997)

 

' This is a weighted average figure estimated using the mid point of the range and number of companies

within each range as weights.

 

85

Table 3.9 provides a comparison between the premium paid and charged

by the companies that are currently selling certified wood products. It shows that

more than 30% of the companies paid less than 3% premium for the certified

wood products they purchased. One-fifth of these companies paid their

suppliers a premium between 3% and 4.9%.

Table 3.9.
Number of Companies Selling Certified Wood Products
by Premium Paid to Suppliers and Charged to Buyers

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premium Range Dist. of companies by Dist. of companies by
range mid-point premium paid premium charged
# 0f comany % # of company %
Zero 0% 1 5.0 2 7.7
0 - 2.9% 1.5% 6 30.0 9 34.6
3 - 4.9% 4.0% 4 20.0 7 26.9
5 - 9.9% 7.5% 3 15.0 5 19.2
10 - 14.9% 12.5% 4 20.0 2 7.7
15 - 20% 17.5% 2 10.0 1 3.8
Total 20 100 26 100
Weighted average premium avg. premium paid avg. premium charged

[weight = number of companies)

 

= 6.6%

 

 

= 4.7%

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ruddell 1997)

On the selling side, based on answers from 26 companies, about 35% of

the sellers charged price premiums between zero and three percent. More than

one—quarter, or a total of five companies charge between 3% and 5%. Another

fifth of the companies charge between 5% to 10%. None of the companies in the

CWP group paid or charged more than 20% price premium. The average

premium charged to the buyers is 4.7%. This sales premium average looks

significantly (i.e. 29%) lower than the average of the premium that these

companies actually paid, which is 6.6%. The situation raises the question of

86

whether the companies that sell certified wood products are suffering some
financial losses. The answer is: most probably not I From a cost accounting
point of view, based on the averages of the cost and sales premiums, the sellers
of the certified wood product only lose if their cost of the purchased wood is more
than 71% of their sales prices. This figure was obtained from the following
calculations:

Po+Vo=So and P1+V1=81

P = purchase price of wood material

S = selling price

V = company’s value added

Subscripts “0” denote uncertified wood

Subscripts “1” denote certified wood of the same characteristics.
With the purchase and sale price premium

P1 = 1.066 Po and 81 = 1.047 80
To find the indifference condition for the firm whether or not to sell certified wood
products, V0 = V1. By substitution we get:

So - P0 = $1 - P,

So - Po =1.047 So-1.066 Po

0.66 P0 = 0.47 So

(Pol So) = (0.47)I(0.66) = 0.712 = 71%

In reality, it is unlikely that the cost of the purchased wood materials will

exceed that threshold at any stage along the processing and marketing channel.

87

The survey found that, on average, the proportion of wood materials in the

selling price of the CWP companies in the U.S. is about 60%.

In Table 3.10 we look at the type of buyers to which the sellers of certified

wood products are charging some premiums. The table suggests that the

premium of more than 3% has been charged primarily to secondary

manufacturer groups, then to end users, and finally to architectural/construction

companies. Eight of the eleven secondary manufacturers in the data set are

being charged more than 3% by their wood suppliers. Two other companies in

this group of primary buyers are charged between 0% and 3%.

Table 3.10.
Number of Companies Selling Certified Wood Products
by Premium Charged and Primary Buyers

 

 

 

 

 

 

 

 

 

 

L Primary buyers < 3% 3.49% 59.9% 104.9% 15-20% >20% No Total
answer
Mholesalerlbroker/importer 4 1 1 0 0 0 0 6
Erimaly manufacturers 1 0 0 0 O 0 0 1
[Secondary manufacturers 3 3 2 2 1 0 0 11
rchitecturaI/Building 0 1 1 0 0 0 0 2
Construct.
[Retailer 1 0 0 0 0 0 0 1
[grid users 2 2 0 0 0 0 1 5
[Others 0 0 1 0 0 0 1 2
L Grand Total 11 7 5 2 1 0 2 28
L 39.3% 25.0% 17.9% 7.1% 3.6% 0.0% 7.1% 100.0%

 

 

 

 

 

 

 

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmad and Ruddell 1997)

Table 3.11

illustrates the extent to which the sellers of certified wood

products have been able to pass the cost increase to their buyers. The eight

companies in the diagonal (shaded) cells in the table charge their buyers the

same premium as they pay their suppliers. Four of the 20 sellers that answer this

88

question are above the diagonal cells. It indicates that they charge a higher
premium rate than the rate they pay. Seven timberland companies in the sample
are not included in this table. Five companies below the diagonal cells can only
charge between 0% and 3% premium despite a higher rate they pay to their
suppliers. Three other companies, including one that pays between 15% and
20% premium, can only charge between 3% and 4.9% premium to their buyers.
On a product basis, secondary manufacturers and wholesalers have been able
to charge their buyers a higher premium than the percentage they pay to their
suppliers.

Table 3.11.
Passing the Extra Costs to the Buyers

<

answer

 

3.5.6 Buyers' Willingness to Pay

Table 3.12 summarizes answers to the question on the estimate of
willingness to pay (WTP) among the primary buyers of the CWP companies. It
shows that the secondary manufacturers are the group of primary buyers that

are willing to pay higher prices for the certified wood products. This table

89

reflects a strong consistency with table 3.10 which shows that this group is also

the one that are being charged higher premiums. Four of the seven secondary

manufacturers in this group are willing to pay more than 3% premium. The

consistency is also reflected by the architectural/construction company group.

This group is estimated to be willing to pay between 10-15% premium.

 

 

 

 

 

 

 

 

 

 

Table 3.12.
Willingness to Pay for Price Premium Among the Primary Buyers
I Primary buyers < 3% 34.9% 5-9.9% 10- 15-20% >20% NO Total
14.9% answer

[Wholesaler/broker/importer 3 0 1 0 0 0 2 6
[Primary manufacturers 0 0 0 0 0 0 1 1
[Secondary manufacturers 3 2 1 0 1 0 4 11

rchitecturaI/Building 0 0 0 2 0 0 0 2
Construction
[Retailer 1 0 0 0 0 0 0 1
[End users 4 1 0 0 0 O 0 5
[Others 1 0 1 0 0 0 0 2
| Grand Total 12 3 3 2 1 0 7 28
L 42.9% 10.7% 10.7% 7.1% 3.6% 0.0% 25.0% 100.0%

 

 

 

 

 

 

 

 

 

Source: MSU Forestry Department Survey (Stevens, Ahmed and Ruddell 1997)

Using the same simple method as applied to calculating the average

premium, overall, the estimated average of the existing willingness to pay of the

companies in the intermediate wood product market is 4.2%. Forty-two percent

(12 out of 22 companies) believe that the WTP for a price premium is only in the

range of 0% to 3%. Eleven percent of the companies estimated the WTP for

premium in the range 3%-5%. The same proportion said that the WTP premium

is between 5% and 10%. Four companies stated that there is no WTP at all

among the end users. 'On the other hand, three companies estimate the WTP to

be higher than 10%. Regarding the trend of the WTP, 38% of the CWP

 

90

companies think that the WTP will increase. However, 57% others responded
that WTP will stay the same as it is now.

In conclusion, judging from the information collected from the survey,
some new developments are occurring in the U.S. intermediate wood input
market. These new developments may provide support for the commercial case
of timber certification and labeling. Companies that have adopted the
certification initiative (ones that have become the certified sellers of wood
products, or simply sell certified wood products without getting themselves
certified) do it primarily to increase market access. Some have succeeded in
getting access to additional markets.

Strong evidence Of the existence of price premiums was also found. Most
of the sellers Of certified wood products in the sample are currently paying a
certain premium above the price Of uncertified comparable products. At the same
time, they have been able to pass the extra costs of certified wood products to
their buyers. Although the average price premium charged by all companies in
the sample (4.7%) is lower than the average premium they pay to their suppliers,
(6.6%) there is no reason to believe that the sellers are experiencing financial
losses. Based on these averages, the company will lose only if their costs of
purchased wood materials is more than 71 % of their selling price. In reality, the
average proportion of purchased material costs is about 60%.

The survey found that a WTP the price premium among wood product

industries in the intermediate input market is in the order of 4.2%. This figure

91

was based primarily on the responses of the companies that actually sell
certified wood products. While a few companies maintained that the demand for
certified wood products is a temporary market fashion, some others are more

optimistic and believe that WTP will still increase.

Chapter IV

EFFECTS OF ECOLABELING ON MARKET EQUILIBRIUM AND WELFARE

Introduction

The first objective of this chapter is to conceptualize the demand, supply
and equilibrium in the market of ecolabeled timber products. The analysis
presented here is a simplification of the aggregate demand and the aggregate
supply discussed in chapter III. In the analysis we examine how the market
becomes segmented as a result Of introduction of ecolabeling.

The second purpose is to present diagrammatic analysis of the welfare
effects of timber ecolabeling. It uses the concepts of consumer surplus, producer
surplus, and damage cost induced by the externality of timber production. First,
we discuss the welfare situation under conventional market without ecolabeling.
This analysis serves as point of comparison in the subsequent sections.
Secondly, we introduce the ecolabeling and see how the welfare changes. Next,
we look at the welfare effect of Pigouvian Tax as the first best alternative
instrument to deal with externality instead of ecolabeling. Then, we consider the
welfare effect of ecolabeling under the existence of Pigouvian Tax. Finally, we
make comparisons among the three situations.

Throughout this chapter, we assume that the ecolabeled wood has

identical characteristics with the conventional wood, except in one aspect,

92

93
namely the pro-sustainability characteristics of the woods. Pro-sustainability
characteristic reflects whether the wood was produced using sustainable
production process. The certified ecolabel confirms that the producer of the

wood has been verified for doing so.

4.1 Demand for Ecolabeled Wood Product

Consumers (as a group of buyers in the market) are assumed to have two
demand functions, one for conventional wood, one for ecolabeled wood. Total
demand in the market is fixed. It consists of demand for conventional wood and
demand for ecolabeled wood. When purchasing the wood products, consumers
choose the one that provides the largest extra surplus. The extra surplus for
consumers is defined as the positive difference between the total willingness to
pay for a product and the actual price of the product.

With these assumptions, the conditional demand schedules for
conventional and ecolabeled wood products can be illustrated as in Figure 4.1.
The demand schedules in Figure 4.1 are conditional in the sense that they are

conditional upon certain range of price levels to be effective.

If p90 - pc0 is the minimum increase in the marginal cost to produce the
ecolabeled wood, for any price levels at and above p90, the effective demand
schedule would be the solid segment of line De. Only demand for ecolabeled

wood exists at the price p.,0 or higher. Within this price range, the consumers’

marginal WTP for the wood’s sustainability characteristics equals or is greater

94
than the amount needed to compensate the extra cost of the producer for using
sustainable production process.

Figure 4.1.
Demand for Conventional and Ecolabeled Wood

 

price

D. = demand for ecolabeled product

    

D6 = demand for conventional product

 

 

0 q.1 q.° qc° quantity demanded

 

 

For the price levels below poo, the effective demand schedule would be
the solid segment of line Dc, and only demand for conventional wood prevails
within this price range. If quantity demanded is higher than qao, for instance qc°,

the amount between q,,0 and qcowill be supplied by conventional producer

because the consumers’ marginal WTP to pay for the sustainability
characteristics is not sufficient to compensate producer for the extra cost of

using sustainable production process.

 

95

The vertical distance between the schedules of demand for conventional
and ecolabeled wood represents the extra (or marginal) WTP Of consumers for
sustainability characteristics at each point of quantity demanded. All segments of
D. is effective if there is no supply of ecolabeled wood in the market (or if the
extra cost of using sustainable production process is so high that makes it
prohibitive to do so). And all segments of D. will be effective if all markets
become the ecolabel market at all levels of quantity demanded.

The determination Of the effective part of the demand schedules can be
illustrated by the following example and Figure 4.2. Suppose q.° is the amount
of wood that a consumer wants to buy. At this amount of quantity demanded, if
the price Of the conventional wood equals p.° = $1.00 and the price of the
ecolabeled wood equals p.° = $1.50, the consumer is in indifferent position
between buying the conventional and ecolabeled wood in terms Of price. The
reason is that the consumer can not enjoy extra surplus or saving from either
type Of the wood. The actual prices of both choices are the same with their total
willingness to pay for each type. Notice, however, that the total consumer
surplus will be higher if they choose the ecolabeled wood. Graphically speaking,
this is because the distance between D. and D. is increasing as price increases.
In reality, demand functions that represent (dqc /dp) > (dq.9 /dp) are sufficient
for this outcome. The consumer’s extra marginal willingness to pay for the

certified wood (if they do buy the certified one) is enough to buy the extra utility

they derives from the sustainability characteristics of the wood.

96

Figure 4.2.
Separation of Demand for Ecolabeled and Conventional Wood

 

 

   
 

 

 

price
D. = demand for ecolabeled product
Dc = demand for conventional product
poo =$150 ’I'xnt". °°°°°°°°°°°°°°°
p.‘=$ 1.40 """""""""" .,
p.°=$1.00 -----------------------
p.‘ = $0.80 -------------------------- g
E " D.
5 0.
q.0 quantity

 

 

If the price of the conventional wood is $0.80 and the price of the
ecolabeled one is $1.50, then the consumer would choose to buy the
conventional wood because of a $0.20 saving or extra surplus per unit
purchased. The same type Of argument applies if the price of the conventional
wood is $1.00 and the price of the ecolabeled one is $1.40. The consumer would
choose the ecolabeled one to gain a $0.10 extra surplus per unit wood they
consumes. Table 4.1 provides some possible cases in which the consumer
decides which type of wood to buy based on the extra surplus that they could

enjoy. The quantity demanded is the same across all cases.

97

 

 

 

 

 

 

Table 4.1.
Consumer Choices of Wood under Various Price Differences
Case-1 Case-2 Case-3 Case-4 Case-5

p. ($/unit) 1.50 1.50 1.40 1.40 1.55

c (slunit) 1.00 0.80 1.00 0.80 1.10
Extra consumer surplus from E 0 0 +0.10 +0.10 -0.05
(ecolabeled)
Extra consumer surplus from C 0 +0.20 0 +0.20 -0.10
(conventional)
Buy 'E' or ‘C" indifferent C E C E

 

 

 

 

 

 

 

 

From Table 4.1 we can infer that consumers make decision using the
following rule: they would choose E (ecolabeled wood) over C (conventional
wood) if

Total WTP for E - Actual price of E >= Total WTP for C - Actual price of C

Total WTP for E - Total WTP for C >= p. - pc

marginal WTP for E >= price premium for E

In the market, a consumer would exercise their marginal willingness to
pay in maximizing utility from consumption. Thus, at the optimum consumption
point, they would purchase ecolabeled wood up to the point where their marginal

willingness to pay for sustainability characteristic of the wood equals the price

premium.

4.2 Cost and Supply of Ecolabeled and Conventional Wood
This part discusses the costs of wood production and supply at the forest
concession level, where the wood logs are produced. It is assumed that all firms

have the same level of constant marginal cost if producing conventionally, that

98

is, without using the sustainable production process. However, when switching
toward sustainable production process, the extra cost per unit product varies
widely across firms. This is due to differences in the historical logging practices
and management of the logged-over area of the concessions. Product
differentiation through partial ecolabeling of total wood production is not allowed
at the forest concession level1 .

From a representative firm’s point of view, if the unit cost of producing
conventional product is Co. the unit cost of producing ecolabeled wood would be

Ca = Cc + S
where Sis the extra cost of using sustainable production process. Profit per unit
product can be expressed in the following equations

conventional product I'Ic = pc — cc

ecolabeled product He = pe — Ce
The firm would switch into using sustainable production process and get certified
ecolabel if H. > He. This implies p. - C,9 > pc - Cc and p,9 - pc > C. - Cc. It
means that the firm would use sustainable production process if the price

premium is greater than the extra cost that the firm needs to absorb to get its

product certified as sustainably produced wood.

 

' This is in line with the most commonly adapted principles and criteria for timber certification
under the FSC (Forest Stewardship Council). FSC provides accreditation for certifying
institutions who are offering certification services to the primary wood industry (forest
management or concessionaires).

99

Assuming that producers are facing competitive market where price
equals marginal cost equals average cost, then our representative producer
maximizes profit per unit product until their marginal benefits from ecolabeling
equals marginal cost of doing so. Since their marginal benefit equals the price
premium they can receive from the market, at the optimum they will produce at

the quantity where the price premium equals the extra cost of using sustainable

production process, or where p. - pa = c. - cc .

4.3 Market Equilibrium of Ecolabeled and Conventional Wood

From consumers’ optimization problem we have that the consumer would
purchase ecolabeled wood to the point where marginal WTP equals the price
premium. At this point the consumers have already used up all extra surplus that
they can get from the market.

From the representative producer’s optimization problem, we have that
the producer would produce ecolabeled wood up to the point where the price
premium they can get from the market equals the extra cost they needs to bear.
At this point the producer has extracted all consumers’ marginal willingness to
pay for the sustainability characteristic of the wood.

Thus, at the equilibrium point, the consumer’s marginal WTP for
sustainability characteristic equals the price premium of ecolabeled product. This
also equals the marginal cost of using the sustainable production process.
Figure 4.3 illustrates the equilibrium in the wood market under the existence of

ecolabeled wood and marginal WTP among some consumers in the market.

100

Figure 4.3.
Equilibrium in Wood Market under Existence of Ecolabel

 

 

 

 

 

 

 

 

 

 

 

101
Suppose we have a competitive equilibrium represented by point T before
ecolabeled wood is introduced in the market. The total wood quantity demanded

is qr and the price per unit is pc. This price level equals the constant marginal

cost of producing wood in conventional way which is depicted as coo.

Assuming the total quantity of wood demanded as fixed, now we introduce
the ecolabeled wood. We will see how the market splits into ecolabeled and
conventional segments.

Some extra cost would be inevitably incurred in using sustainable
production process to produce the ecolabeled wood. Assume that this extra cost

is a fixed amount above the marginal cost of producing in conventional way. In

Figure 4.3, if the extra cost equals 80, the marginal cost to produce the

ecolabeled wood is 0.0, and its price will be p.0 = 0.0. If this is the case, the
market equilibrium will be point E. The whole market will become ecolabeled
wood market at qr level of total quantity demanded. The consumers choose to

buy the ecolabeled wood because the total consumer surplus will be bigger. This
will be the case even though, price wise, consumers cannot enjoy any extra
surplus from the difference between their total willingness to pay and the actual
unit price of the ecolabeled wood. The bigger consumer surplus is a reflection of
the increased utility enjoyed by the consumers from knowing that the wood they
purchase has been produced using sustainable production process or in

environmentally friendly way.

102
If the extra cost is greater than S0 , for instance, if it equals S1 = 0.1- Coo,
then producers could only sell q.’ amount of the ecolabeled wood at the price

per unit equals p91 . Although the line p.1 = 691 crosses the ecolabeled demand
schedule at point K, the producers can not sell OK1 amount of the ecolabeled
wood. The reason is, at this level of quantity demanded, if the price of

ecolabeled wood is p.,,1 , the consumers would rather buy the conventional wood

that is available at the price poo. By purchasing the conventional wood, the

consumers enjoy an extra surplus of K2K3 per unit wood. At OK1 amount of
quantity demanded, the ecolabeled wood does not offer any extra surplus or
saving to consumers.

To find the equilibrium in the ecolabeled market segment we need to look
for a level of quantity demanded that corresponds to the condition where the
marginal willingness to pay of consumers equals the price premium equals the

extra cost of using sustainable production process. We found that the extra cost
of 5’ matches the height of the line MM1 which represents the vertical distance
between the D. and D. (which equals the marginal WTP) at the level of quantity
demanded equals Qe1. Hence, equilibrium in the ecolabeled wood market
segment is represented by point [q.1, p91]. At this point, the price premium p.1 -

0 matches the extra marginal cost 0.1 - Cc0 and also matches the consumers’

Po
marginal WTP of MM‘. If at q.’ amount of quantity demanded the price of the

ecolabeled wood is higher than p91, the consumers will switch to buying

103

conventional wood. This happens because the consumers will receive negative
surplus if they buy the ecolabeled wood. In this case, the price of the ecolabeled

wood is higher than consumers’ total WTP for it.

Considering that the total quantity demanded for wood equals QT. and
that only q.1 amount is being served in the ecolabeled segment, then the portion
qr - q.’ will be served in the conventional market. The price in the conventional

market remains pea.
By the same argument it can be shown that if the extra cost of producing

ecolabeled wood equals 52 = 0.2 - Coo, then the equilibrium in the ecolabeled
wood market segments will occur at point E2. The quantity demanded will be q.2
at the price per unit equals p92. Compared to point E‘, at this higher level of

extra cost, the portion of total demand served in the ecolabeled market is

smaller. A larger portion of the market, i.e. CIT - q.2 is served in the conventional

segment.

Connecting points E, E‘, E2 and E3 (by the dashed line) we get the
equilibrium path of the ecolabeled wood market. This path reflects the common
intuition that the higher the extra cost of producing the ecolabeled wood, the
smaller the portion of the market that will be able to purchase it. Along this path
we see that the equilibrium for the ecolabeled wood is determined by the extra
cost of using sustainable production process and the existence of marginal

willingness to pay above the conventional wood price for that level of required

104

premium. This path also reflects how the market splits into two segments as
voluntary certification and ecolabeling of wood is introduced in the market.

Given the existence of marginal WTP for any level of the price premium
wi = p.‘- poo, the equilibrium points for each market segments can be stated
as follow:

Equilibrium for ecolabeled wood = [q.i , psi = Cei ], and

. . . . _ i 0 _ 0

Equ1llbrlum for conventlonal wood - [qT- q. , pc — CC ]

Equilibrium quantity demanded for ecolabeled wood, q.’, and its
corresponding price level, psi = C.i , become a demarcation point that separates

the markets for the ecolabeled wood and the conventional one. On and above

this price level, only demand for ecolabeled wood exists. The rest of the demand
in the market, i.e., the one to the right of point qei , is the demand for the
conventional wood. However, the demand for the conventional wood exists only
at the price below poo. If GT is the total quantity demanded for wood in the
market, q.0 is the portion served in the ecolabeled segment and qr - q.’ is the
portion served in the conventional market segment. Point q.’ on the x-axis is the

quantity demanded for ecolabeled wood that corresponds to p..." - pa = Cei- Cc .

To the right of q.’ , the size of the premium that producer can capture is
smaller than the extra cost they has to bear when switching toward using
sustainable production process. To the left of q.’ the premium is greater than

this extra cost.

105
Using the consumers’ marginal WTP and the producer’s extra cost of
using sustainable production process, market equilibrium of ecolabeled wood
segment can also be illustrated as in Figure 4.4. Y-axis measures the price
premium or the extra cost of producing of ecolabeled wood above the

convenfionalone.

 

 

 

 

 

Figure 4.4.
Marginal Willingness to Pay, Extra Cost and Equilibrium
of Ecolabeled Wood Market
w, s
54
w. ...................................... $3
52
s1 w = p. - p.
. 9e
Clo

 

 

 

The curve for consumers’ marginal WTP, W = p. - p. will be downward

sloping. The step function pictured in Figure 4.4 represents several possibilities

of extra cost of using sustainable production process and get certified to carry

ecolabel. If W. represents the prevailing WTP for ecolabeled wood above the

106
conventional one in the market, each segment of the step function (i.e. S1, 82,

83, and S4 ) represent relative competitiveness of different wood producers in the

ecolabeled wood market. If the level of willingness to pay for the price premium
equals w*, companies that need to spend less than s3 as extra cost to produce
ecolabeled wood (such as companies whose extra cost is represented by s1 and
s’) will have a lot of incentive to switch into using sustainable production

process. These companies will be rewarded more than the extra expense they
have to bear for producing the ecolabeled wood. Certainly, concession with 3‘

cost level will not be able to compete in the ecolabeled wood market. Company
that needs to bear 33 extra cost to produce sustainably represents a typical firm
at the market equilibrium where the extra cost of producing ecolabeled wood

equals the marginal willingness to pay for that product above the conventional

one. As depicted, with W.Ieve| of WTP for the price premium, the corresponding

quantity demanded for ecolabeled wood will equal qe.at the equilibrium.

4.4 Welfare Effect of Ecolabeling in the Absence of Pigouvian Tax
Toward the end of this chapter, the producer surplus is always zero due
to the competitive market assumption. Therefore, leaving out the producer
surplus from the analysis will not affect the conclusion on the direction Of the
welfare changes. As discussed in Chapter II, the conventional production
process in logging activities imposes some negative stock feedback effects for

future production as well as non-timber externalities. Hence, the use of this

107
technology is always associated with some damage cost that is borne by the
society as a whole. In this section, it is assumed that if producers are using the
sustainable production process, the marginal damage costs associated with
logging operation are zero.
Before ecolabeling is introduced in the market, suppose we have an
equilibrium that is represented by point [qT, pc ] in Figure 4.5 Total quantity of

wood demanded equals £77 at the price pc . This price equals 0. , the constant

marginal cost of producing the wood conventionally. The damage cost caused
by the externality of the timber production is represented by curve MDC. Hence,
the marginal social cost (MSC) is represented by the vertical summation of MC°
and MDC. The total damage cost is reflected by the area between the MSC and
MC° curves.

At the equilibrium, consumer surplus equals the size of the area of
the triangle SZTC , and the total damage cost is the area DC'I‘I'3 . The net
welfare under this purely conventional market is represented by the difference

between these two areas. In other words,
Netwelfare = Wc = SZT‘D - TT’T‘ (1)
The later triangle represents the part of social cost that does not get

compensated in anybody’s income. This is the dead weight loss borne by the

society due to the externality of producing and consuming wood in the amount of

(IT.

108

Figure 4.5.

Welfare Changes Due to the Introduction of Ecolabeled Wood

in the Absence of Pigouvian Tax

 

 

R2

123......

 

R4.

R1

MSC=MC° + MDC

MSC’

MDC

 

 

 

 

 

 

109
When we introduce the ecolabeled wood, the market will split into two

segments. Equilibrium in the ecolabeled segment is [q., p. = Ce]. Equilibrium

in the conventional market segment is [qr - q. , p6 = Cc ].
To see changes in consumers’ welfare, we compare the consumer surplus

at q. amount of quantity demanded under both demand curves, given the
existing price premium and cost differences at that level of demand. At q. level

of quantity demanded, if a consumer buys the conventional wood, his consumer
surplus will be the triangle area S18283 . If he buys the ecolabeled wood, his
consumer surplus is the triangle R'Rl’R3 . Since the distance between Dc and D.
increases as price rises, we can see that the area R'R2R3 is larger than that of
S'S’S3 . By taking a parallel line with Do at point R1 , we can find the difference

in the size of the triangle areas. The triangle R‘RZR‘ is the gain in consumer
surplus from switching into consuming ecolabeled wood.

To see changes in the social cost, we shift the MSC curve horizontally to
point E‘. The new total social cost with the introduction of ecolabeled wood is
TTZE'EZ. Please note that the new social cost that is not compensated by any
income is the triangle area TT2T5. This loss is significantly smaller than the
triangle area 1T3'l" that occurs under purely conventional market. The
difference, i.e. the area of trapezoid TzT’T‘Ts represents the welfare gain of

introducing the ecolabeled wood into the market.

1 10
Under simultaneous equilibria in conventional and ecolabeled market as
depicted by [q., p. = c.] and [qT - q. , pc = c. ] , the welfare calculation can be
presented as follows:
Consumer surplus = p.ER'R2 + S‘TE2
= p.132TT2 + R‘RZR‘ + s‘TE2

= $sz. + R‘RZR‘

Damage cost = E1E2TT2 = DchGT‘

Net welfare = W. = SZTpc + R‘RZR‘ - E‘EZTTZ
= ssz. + R'RZR‘ - 0p.T“T‘
= $2110 + R'RZR‘ (2)
Comparing the net welfare before and after ecolabeling is introduced in
the market, i.e. comparing W. from equation (1) with W. from equation (2), we
find that the benefit from introducing the ecolabeling in the wood market is
Welfare gain = Wc - We
= TT’T‘ + R‘RZR‘ (3)
The first term in equation (3) is the unrealized damage cost because
some producers switch to using sustainable production process to produce the
ecolabeled wood, hence reducing the total damage. The second term is the
additional consumer surplus due to the positive value of information carried by

the certified ecolabel.

111

4.5 Welfare Effects of Pigouvian Tax in the Absence of Ecolabeling

In this section we use all set up explained previously. Here we assume
the technology or process to produce wood in sustainable way is always
available for every producer at some extra cost. This is the same technology that
is used to get certified and acquire the right to use ecolabel.

‘ Suppose now the government imposes a Pigouvian tax on producers who
are inducing some externality and damage cost. The tax is imposed in order to
force the producers to bear the total social cost of their activities, not just the
direct marginal cost when producing the wood. The tax rate equals the marginal
damage cost per unit output at the corresponding level of production. In Figure
4.6, if the technology of sustainable production process were not available, the
new equilibrium will occur at point [qp , p, ]. Triangle TT2P represents the welfare
gain under Pigouvian tax compared to the original conventional market
equilibrium. This is the value of unrealized damage because of the reduction in
production.

Since the technology of sustainable production process is always
available to every producer, the equilibrium will be reached at a different point
other than P. Notice that in Figure 4.6, the cost curve of using sustainable

production process, c., crosses the marginal social cost curve (MSC), at point
R. Under this situation, as long as C. is above MSC, it is cheaper for the
producer to produce conventionally and pay the Pigouvian tax accordingly.

However, when the quantity produced reaches qR, it is no longer the cheapest

112

Figure 4.6.
Welfare Effect of Pigouvian Tax in the Absence of Ecolabeling

 

 

MSC = mc° + MDC

T2

 

MDC

 

T MC°

 

 

 

QR Q? (Is QT

 

 

113
strategy to follow. Switching to sustainable production process becomes
cheaper than producing in conventional way and paying the Pigouvian tax. In
this scenario, producers switch to using sustainable production process merely
to avoid paying tax, not to let people know that they are producing in sustainably
or environmentally friendly way. The new equilibrium will occur at point [q. , p.] .

The quantity produced and demanded equals qs which is bigger than qp (the

efficient level of production implied by the Pigouvian tax), but smaller than qr,

the original equilibrium.
At equilibrium point [qs , p. ] , qR portion of the total quantity is produced

by conventional production process while producer paying the tax at the rate of
RR5 per unit output. Under the assumption of Pigouvian tax system, the

government would use the proceed to neutralize the damage cost of the size

p..R"‘RP4 . The q. - qR portion of the total supply is produced using sustainable

production process. No damage is done under this range of production. With this
Pigouvian tax, we can calculate the welfare as follows:

Consumer surplus = p.SP5

Government tax revenue = pcRst.

Damage cost = pcRsRP4

Government surplus = p.RP4

Net welfare = Wp = consumer surplus + government surplus

= 13,5135 + p.RP‘

= PP‘P5 + PRS (4)

114
In Figure 4.6 we also see that the original equilibrium (i.e. before
Pigouvian tax or Ecolabeling is introduced) is represented by point [qT, p. ] and
net welfare equals W. = PP4P5 - TT2P. Compared to the net welfare in the

original equilibrium, the Pigouvian tax clearly brings the benefits in the amount of
WI) - W. = TTZP + PRS (5)
The first term reflects the unrealized damages cost due to the decrease in

production from qr to qs . The second term is the increased consumer welfare

due to the reduction of the damage cost compared to the situation under original

equilibrium.

4.6 Welfare Effect of Ecolabeling under Existence of Pigouvian Tax

If timber certification and ecolabeling are introduced under the existence
of Pigouvian tax and cost structures depicted in Figure 4.6, equilibrium and
welfare level will be different. Figure 4.7, which is essentially a combination of
Figures 4.5 and 4.6, shows this different equilibrium point. The cost of producing
ecolabeled wood is the same as the cost of using sustainable production
process. The only difference is that under ecolabeling the producers adopt
sustainable production process to get certification as a sustainable wood source
and acquire the right to use the certified ecolabel to let the consumers know that,
indeed, they are producing in a sustainable manner. Based on the labels that

function as a discriminating instrument in the market, consumers may purchase

Welfare Changes Due to the Introduction of Ecolabeled Wood
in the Existence of Pigouvian Tax

115

Figure 4.7.

 

 

 

 

M2
M3 r.
P5 M1
E1
T2 MSC
82
[3
pp ........................................................
MDC
MC°
D.
Dc

 

 

 

0 0. on 011‘ q.» qs

QT

 

 

116
the ecolabeled wood and derive utility from knowing about the pro-sustainability
characteristic of the wood.

If s = c. - c. is the extra cost of using the sustainable production process
over the conventional one, the equilibrium in the ecolabeled market segment will
occur at point [q. , p. ]. At the quantity demanded = q. and price = p. consumer
would choose ecolabeled product. Price wise, both choices give zero extra
surplus of total WTP above their actual prices. However, the consumer would
choose the ecolabeled wood because they will gain an increase in consumer
surplus represented by area M‘M2M3 . This welfare gain in the ecolabeled
segment in the wood market can be attributed to the value of information
conveyed by the ecolabel. Consumers value the information carried by the label
positively because it provides them with the opportunity to exercise their
preference toward pro-sustainability products.

To look at what happens in the conventional market segment where the
Pigouvian tax is in effect, we shift the social marginal cost curve MSC = MCo +
MDC horizontally to the point R‘ . Equilibrium in the conventional market will
happen at point [qs - q. , p.] . In the range qR‘ - q. , the producers who have not
certified and ecolabeled their products continue using the conventional
production process and pay the Pigouvian tax to compensate for the damage
induced by their productions. But, after qR‘, it will be more profitable for them to
switch into using sustainable production process. The quantity q. - q,1 is the
portion of the wood produced through sustainable production process but does

not get ecolabeled.

117

Under the existence of both Pigouvian tax as well as ecolabeling, the
welfare calculation will comprise of the followings:
Welfare in the conventional market segment:
Consumer surplus = ESE1
Government tax revenue = R3R2R3E = p.R5Rp.
Damage cost = R3R2R‘R‘ = p.R5RP‘
Net welfare = ESE1 + P‘Rp.
Welfare in the ecolabeled market segment :
Consumer surplus = p.EE‘P5 + M‘MZM3
Total net welfare = w .5 = ESE' + P‘Rp. + p.EE‘P5 + M‘lvFM3
= p.SP5 + P‘Rp. + M‘M2M3
= PP4P5 + PRS + M‘M2M3 (6)
If we compare the situation of having both Pigouvian tax and ecolabeling
simultaneously in place with the original equilibrium, the advantage we have is
Net welfare gain = TI'2P + PRS + M‘M’M3 (7)
It indicates that the combination of policies reduces the damage cost by the size
of 'ITZP and increases the consumer surplus in two ways. One is through
reductiOn in damage from using the sustainable production process (i.e., PRS),
the other is through the increased utility attributed to the value of information
conveyed by the ecolabel (i.e., M‘M2M3).
Please note, however, that the analysis that combines the existence of
Pigouvian tax and ecolabeling blurs the idea of price premium which was

originally defined as the difference between the prices of conventional and

1 18
ecolabeled products. Under the existence of Pigouvian tax, with a competitive
market assumption, the producers would always have to sell at the price
p. = p. + optimal tax rate = price of ecolabeled products.
In this situation, we could imagine that the administrative cost of timber

certification and ecolabeling is ‘another’ extra cost above C. . Under this

scenario, we should question whether the ‘pure’ benefit of ecolabeling

represented by the triangle M'M2M3 could justify any additional expense beyond

0., the cost of using sustainable production process.
Alternatively, we could illustrate the situation by having p. = C. higher

than p8 = C. to capture the administrative cost of ecolabeling on top of the cost

of using sustainable production process. This is depicted in Figure 4.8. Here we

define a new or “effective” price premium as the vertical difference between p.
and p. . This is because, with Pigouvian tax in place, the new base price or point

of price comparison would be p. . When measuring the consumer surplus in the
ecolabeled market segment, we also need to use this “new” price premium as
the effective distance of demand schedules.

In Figure 4.8, a smaller portion of the market is served in the ecolabeled
segment due to the higher price or higher required premium necessary to cover
the cost. Although the increase in consumer surplus attributable to the
information value of ecolabeling will be smaller, the same concept still applies in

measuring the total welfare under both Pigouvian tax and ecolabeling.

119

Figure 4.8.
Welfare Changes with Administrative Cost of Ecolabeling
in the Existence of Pigouvian Tax

 

 

 

1.
E:

T2 MSC

 

 

 

 

 

 

 

120
In the conventional market segment, the equilibrium would be
[q. - q. _ p. ], and the welfare calculations are as follow:

Consumer surplus = EZSE1

Government tax revenue = RaRzR‘E = p.R5Rps

Damage cost = R3R2R‘R‘ = p.R5RP‘

Net welfare = EZSE‘ + p.RP"

And in the ecolabeled market segment:

Consumer surplus = p.ENN2 = p.E2E1P5 + N‘N2N3
So, we have

Net total welfare = p.SP5 + p.RP‘ + N‘N2N3 (8)

Again, equation (8) shows that the combination of Pigouvian tax and
ecolabeling brings about the three benefits compared to the original equilibrium.
They are: (1) unrealized damage due to lower total production; (2) increase in
consumer surplus due to lower damage attributable to the technology of
sustainable production process; and (3) increase in consumer surplus
attributable to the value of information conveyed by the ecolabel.

In Chapter V, the demand for ecolabeled and conventional products, as
well as the Changes in consumer surplus due to ecolabeling is quantified. The
gain in consumer surplus is calculated as the difference between consumer
surpluses under ecolabeling and original equilibrium in the absence of other
policies. Estimations of changes in consumer surplus under the existence of
Pigouvian tax and changes in society welfare in producing country will be left out

due to unavailability of information on these matters.

Chapter V
QUANTIFYING ECOLABELED MARKET SEGMENT

AND CHANGES IN CONSUMER SURPLUS

Introduction

The empirical analysis employs a simple spreadsheet simulation to
examine the effects of the introduction of timber ecolabeling on market
equilibrium and consumer surplus in the consuming country. In this chapter we
quantify demand in the conventional and ecolabeled wood product markets, as
well as the changes in the consumer surplus if consumers purchase the
ecolabeled instead of conventional product at any particular level of quantity
demanded. The imported plywood in the U.S. intermediate input is chosen as a
case study. Section 5.1 covers the demand function for imported plywood based
on previous studies on the U.S. hardwood markets. Section 5.2 discusses the
procedures for estimating demand function, ecolabeled market segment and the
changes in consumer surplus. Section 5.3 describes the results of the

quantification of demand and changes in consumer surplus.

121

122

5. 1 Characteristics of the Demand Functions
With reference to the empirical studies by GOI-MOF/FAO (1991), Luppold
(1982) and Suprapto (1995), demand function for the plywood takes the form of
constant elasticity demand which is
q = Ap‘“ ............................................................................................ (1)
where q = quantity of wood demanded, A = constant, a = price elasticity of
demand. Assume that the market is competitive and price elasticities of demand
are the same for both conventional and ecolabeled woods.
Based on this set up, the demand functions for ecolabeled and
conventional products can be characterized further as follows:
( 1) Demand schedule for ecolabeled wood will always be above demand
schedule for conventional wood.
This can be shown by rearranging the demand function to become
A = q / (0"). Then, for each product category we have
A. = q./(p.)"' for ecolabeled wood (2)
and A. = q./(p.)"' for conventional wood... (3)
Using Figure 5.1 we could evaluate A. and A. either at the same level of
quantity demanded (i.e., q.°) or the same price level (i.e., p.°). Evaluated at q.°,
we get q.°/(p.°)'“ = A. < A. = q.°/(p.°)'“ .................................................... (4)

because p. > p. and a > 0. If evaluated at p.°, we get

q.°/(p.°)"’ = A. < A. = q.°/(p.°)"' ........................................................ (5)

123

Figure 5.1.
Evaluating D. and D. at the Same Price or Quantity Demanded

 

price

D. = demand for conventional wood

D. = demand for ecolabeled wood

 

 

 

 

 

 

q. q. quantity

 

These relations consistently show that A. is always greater than A. . This

further implies that D. schedule is always situated above and to the right of D.

schedule.

(2) The distance between the two demand schedules increases with price level,
but decreases with quantity demanded.

From the ‘intercepts’ of the demand functions,
:—:=[q./(p.) a[/[q./(p°) Ya]

evaluated at q.” = q.°, this expression gives us

 

124

A

f =7

0

Ae=7Ac ......................................................................... (7)

Since 9 > 1 for all a > 0, this tells us that distance between D. and D. is
increasing with higher price, and decreasing with higher quantity demanded. The
relation reflects the intuition that the bigger the market for the ecolabeled
products, the smaller the price premium that can be seized by the producers. If
w = p.- p. , its curve will have a negative slope in the price-quantity diagram.

From the basic form of demand function stated in equation (1 ), we can
state the form of inverse demand function for each product group as follows:

Inverse demand for conventional product

pc=[qc/Ac]—(%) (8)

Inverse demand for ecolabeled product

p. =[qe Mere) (9)

Using (7) we can substitute 7A. for A., and get the expression

pe = [qe “74.143 (1o)

125
Evaluating this expression at q. = q. and substituting further we get

I l

qc {3) 1'3; q. '(3) i-fi—
“[72] H ( )[Z] [71 ( jlei

P.=[y]'”“'[p.] (11)

Since g > 1 and a > 0, we have p. > p., That is, the price of ecolabeled wood
is consistently higher than the conventional one.
Using these notations, the equilibrium points in the wood market for

ecolabeled wood can be expressed as:

pe =[q2 /7Ac[—é = Ce (12)

where C. is the marginal cost of producing in ecolabeled wood. Equilibrium in

conventional wood market is represented by:

qT(pc)—q2 =qc(pc) (13)

5.2 Descriptions of Simulation Procedures

The quantification of demand and Changes in consumer surplus are
conducted with a reference to Figure 4.3 of chapter IV that describe the effects
of the introduction of the ecolabeled products on the market equilibrium. This
exercise uses the U.S. imported plywood market as a case. First, we estimate
the demand function conventional product. Current equilibrium price and 99% of

total quantity in the imported plywood market in the U.S. are the bases of this

126

estimation. Next, the demand function for ecolabeled is estimated based on the
4.7% average premium currently charged (Stevens, Ahmad and Ruddell 1997),
and 1% estimated size of the current segment in the U.S. intermediate certified
wood market‘. Then, calculations of the quantity demanded of ecolabeled
products, its market share, as well as the changes in consumer surplus are
based on these estimated demand functions.

As discusses previously, the demand functions to be estimated

have the form q = Ap'“ where q is quantity demanded, A is a constant, p is the

price and (1 represents the price elasticity of demand which takes the value Of

0.6 throughout this exercise. The statistics used for demand function estimations
is the average price and quantity of U.S. imported plywood during 1992-96
period. These averages are calculated based on the ITTO market data (ITTO
1997). Ninety-nine percent of current quantity of 1,547,000 cubic meter plywood
annually imported into the U.S. and sold at $689.34 per cubic meter in the
wholesale market are taken as starting equilibrium point in the conventional
market. This equilibrium point corresponds to point T in Figure 4.3. Based on
this information we calculate the value of constant A. for the conventional
plywood demand function. Hence, we get the demand function for conventional

market.

 

' 1% is the estimated size of the existing ecolabeled segment in the U.S. market for intermediate wood
products. This estimate is based on interviews with major wood product importers on the West Coast
during the 1996-97 MSU Department of Forestry Survey of Wood Product Sertification (Stevens, Ahmad
and Ruddell 1997).

127

Next, we calculate the dollar value Of premium for ecolabeled plywood
using the 4.7% average premium currently charged in the U.S. intermediate
certified wood input market. Based on this premium value and quantity
demanded that represents 1% of the total demand in the imported plywood
market, we calculate the value A. for the ecolabeled demand function. Now, we
have all components of demand function for ecolabeled wood. To illustrate the
demand functions in graphical form, several hypothetical points in the
neighborhood of existing equilibrium quantity are applied to the demand
functions.

To calculate quantity demanded in the ecolabeled market segment,
several values of price premiums in the 3% - 20% range above the price of
conventional products are applied. Then, based on the quantity demanded at
each level of price premium, the share of the ecolabeled segment in the total
market is calculated. The researcher focuses on price premium in the range of
3% -20% to reflect the current situation in the U.S. intermediate input market for
certified wood2 (Stevens, Ahmad and Ruddell 1997).

To calculate the Changes in consumer surplus we take the difference
between the area under the two demand curves, each defined by the following

integral value:

ConsumerSurpIus = [fig/A] "(l/a) dq (14)

 

2 The MSU Forestry Department Survey found the majority of premium charged and paid in the
intermediate wood input market for certified products are within 3%-20% range. No companies in the
sample charges or pays more than 20%.

128

However, since the value of consumer surplus can not be defined at q=0, we use
a lower bound in the quantity from which we can measure the value of the
integral. The size of consumer surplus between q=0 and q(= X (L for lower
bound, X for the quantity) is proxied as X times the value of integral between X
and X+1. The lower bound of quantity chosen for this exercise is the quantity
demanded where price in the ecolabeled segment is twice as the price as in the

conventional segmenta. Point E2 in figure 4.3 resembles this situation. At that

point p.2 = 2 p.°.

5.3.3 Results of Simulations

5.3.4 Demand Functions

Based on the approach explained in subsection 5.2 we can specify the
demand for plywood in the conventional market as:

q. = 77,301 (p.)'0'6 (15)
and in the ecolabeled market segment as

q. = 77,302 (p.)'0'6 (16)

Figure 5.2 illustrates some points on the demand curves based on these
two demand functions. The figure provides exposure only to a small range of
quantity in the whole demand curves. The quantities depicted are points in the

neighborhood of current equilibrium quantity in the conventional imported

plywood market. Due to exposure within this small range, the demand curves

129
look like they are linear rather than like the ones that represent constant
elasticity demand functions. The range depicted falls within the range of total
quantity imported into the U.S. in the nineties which is between 1,300 to 1,650
thousand cubic meter per year.

Figure 5.2.
Conventional and Ecolabeled Plywood Demand Schedules

 

 

93333
2538.83

V.
,_
B
,_

quantity demanded (in thousand cubic meter)

15312
1531.25
15313
53135

 

 

 

5.3.2 Ecolabeled Product Segment: Quantity Demanded and Market Share

To find several points of quantity demanded in the ecolabeled segment
and its share, we apply some price premiums in the range of 3% — 20% above
the conventional product price to the estimated demand functions. The

percentage premium is converted into dollar value. Then we find a quantity that

 

3 Please note that premium is always defined with reference to the price in the conventional market
segment at original equilibrium. Hence, p. = 2p.° does NOT refer to the point where the price in
ecolabeled demand curve is twice as high as the price in conventional demand curve.

130
corresponds to points, one on conventional demand curve, one on ecolabeled
demand curve, where the vertical distance between the two points equals the
dollar amount of the premium. Table 5.1 presents the results of this calculation.
The table also contains the estimates of the Changes in consumer surplus for
each level of price premium that will be discussed in the next subsection.
Table 5.1.

Price Premium, Market Share and Gain in Consumer Surplus
in the Ecolabeled Market Segment

 

 

 

 

 

 

 

 

 

 

Price in Quantity Proportion of Gain in
ecolabeled demanded in ecolabeled Consumer
% Premium Premium segment (3) ecolabeled segment in Surplus
($) segment total market (x $1,000)
(x 1000 cu.m) (%)
3.0% 20.68 710.02 20.1 1.3 2.864
4.7% 32.40 721.74 15.4 1.0 2.660
7.5% 51.70 741.04 11.6 0.8 2.406
10.0% 68.93 758.27 9.7 0.6 2.224
12.5% 86.17 775.51 8.5 0.6 2,067
15.0% 103.40 792.74 7.6 0.5 1.929
17.5% 120.63 809.97 7.0 0.5 1.803
20.0% 137.87 827.21 6.4 0.4 1,688

 

 

 

 

 

 

 

The 4.7% price premium in the table represents the average premium
currently charged by sellers Of ecolabeled wood products in the U.S.
intermediate wood input market, which is one of the results found in the MSU
Forestry Department Survey. This existing level of premium, if applied in the
imported plywood market, corresponds to 15.4 thousand cubic meter demand for
ecolabeled product. This quantity accounts for 1% of total demand for plywood

in the market.

131

Figure 5.3 illustrates the relationship between the price premium and the
demand for the ecolabeled product. The higher the premium above the
conventional product price, the lower is the demand for the ecolabeled product.
In line with this observation, the size of the ecolabeled segment in the total
market will also decline as the premium above the conventional product price
increases (Figure 5.4).

Figure 5.3.
Premium and Quantity in Ecolabeled Market Segment

 

 

“4°00 Te

 

5120-00 iii-’TTiI ITTII? I” ” *

 

 

 

 

prlcepremltln

......

 

moo

 

.2...

 

 

 

 

 

 

 

 

0.0 5.0 10.0 15.0 20.0 25.0
quantity demanded in ecolabeled market (in thousand cubic meter)

 

 

 

5.3.3 Gain in Consumer Surplus

As explained in Section 5.2, the quantity that corresponds to the point
where p. = 2p.° on the demand curves is chosen as a lower bound from which
part of the value of consumer surplus can be measured as the area under the

demand curve between that point and the market equilibrium quantity. Based on

132

Figure 5.4.
Price Premium and Market Share of Ecolabeled Product

 

 

 

 

price premium above conventional product price

 

 

 

the estimated demand functions, the quantity that corresponds to the point
where p. = 2p.° is found at 2 (in thousand cubic meter). The value of consumer
surplus between zero quantity and 2 is estimated as 2 times the value of the
integral in equation (14) between q=2 and q=3.

Using this approach, the value of consumer surplus is calculated for each
quantity point that corresponds to each level of hypothetical price premium listed
in table 5.1. These quantities are used to calculate the consumer surpluses for
each demand function. The difference between the value of consumer surplus
under ecolabeled and conventional demand function is the increase in the
consumer surplus if at each particular level of quantity, consumers are buying

ecolabeled instead of conventional wood product. The results of these

133
calculations are presented in Figure 5.5 and the last column of Table 5.1. The
figure intuitively illustrates that the gain in consumer surplus decreases as the
price premium increases in the ecolabeled market.

Figure 5.5.
Increase in Consumer Surplus by Level of Price Premium

 

 

1%

 

2? g."

gain In consuner surplus (x 31.000)
9

 

 

 

 

 

 

1.000 ‘
500 , ~
D 0 3 . : .A :1 « VT“: .5";
$ 8 * $ 3! 39 i
0. is In. 0. In. 0. 3
m t c e e ."2 .-

price premium above conventional product price

 

 

 

The gains in consumer surplus when the market share is small (i.e., when
the premium is high) are higher than when market share is high (i.e., when the
premium is small). For instance, the difference between consumer surplus gain
when market share is 1.3% (= when premium is 3%) and when market
share is 1% (=when premium is 4.7%), is about $ 204 thousand. This is smaller
compared to consumer gains between when the market share is 0.45% (at
17.5% price premium) and when it is 0.42% (=when premium is 20%), which is

about $ 535 thousand. This differences in the gains in consumer surplus

134

suggests that consumers who purchase ecolabeled wood at high price premium
(when the share of ecolabeled segment is small) are willing to do that because
they enjoy a significant increase in their consumer surplus that can be attributed
to the increased utility from knowing that they are consuming the

environmentally friendly product.

Chapter VI
VIABILITY OF TIMBER CERTIFICATION AND ECOLABELING

FOR INDONESIA’S FOREST CONCESSIONAIRES

Introduction

The objective of this chapter is to evaluate the prospective profitability for
Indonesia’s forest concessionaire to adopt timber certification and ecolabeling
given the existence of ecolabeled market segment in the importing countries
such as the United States.

In this Chapter, the prospects for adopting timber certification is analyzed
using an approach that combines investment analysis and comparative break-
even methods. Break—even net present value analyses is conducted for national
and regional data of Indonesia’s forest concessions to answer the following
question: given the concessionaires’ cost structure and timber yield as well as
the level of premium in the plywood market, what is the minimum proportion of
the timber logs from the concessions that must receive price premium in order to
be break-even if the concessionaires adopt timber certification and ecolabeling?
The wood origins considered in this exercise represent Indonesia’s permanent
production forests in the low land area (i.e., area with altitude 1000 meter or

lower above the sea level), excluding the swamp and mangrove forests.

135

136

Section 6.1 provides a summary of the break-even NPV method. In
section 6.2, after the baseline break-even analyses, some sensitivity analyses
with respect to changes in the silviculture cost, as well as with respect to
Changes in price premium, are presented. At the end of this chapter we discuss

the results of this company-level prospective analyses.

6.1 Break-Even Net Present Value Method

Evaluation of the concessionaires’ prospects to adopt timber certification
and ecolabeling is conducted using the combined approach of investment
analysis and break-even analysis. The approach involves investment analysis
because the benefits of switching from conventional to sustainable logging
practice materializes over many years after the decision is made. Standard
investment analysis is done by projecting future cash flow of costs and revenues
due to undertaking the new investment. Net present value (NPV) is the most
common measure used in investment analysis.1

Break-even net present value method is a special case of NPV analysis.
The evaluation of the concessionaires’ prospects involves comparative break-

even method (which is commonly used for one period cost-benefit

 

' The equation below illustrates how to compute the NPV of an investment by summing up net cash flows
that vary from the time of the investment (year 0) until the end of the investor’s planning horizon (in year
T).

NPVr = (R. - c.) + (1+r)"(R, - c.) + ........................ + (1 +r)'T(Rr - c.)

R. represents revenue cash flows while Q represents cost flows that vary due to the investment. The term
(1+r)“ represents discount rate which is based on interest rate r.

137

analysis, which is also known as partial budget analyses), because we are
comparing the returns (in our case: the NPV of benefits) of two mutually
exclusive alternative business decisions (Hilker, Black and Hesterman 1987).
Break-even situation is achieved when the NPV under the new sustainable
regime is the same as the NPV under the conventional practice.

In the break-even NPV analyses we are comparing the basic benefits of
the two alternative logging and forest management regimes. The basic benefits
of sustainable practice over the conventional one are: (1) the sustainable yield,
which is simply defined as the amount of timber recovered in the second harvest
cycle is the same as in the first one; and (2) the price premium that can be
enjoyed in the ecolabeled market.

Any other benefits of regime switching, such as possible higher timber
recovery, would be an extra advantage that will improve the profitability of the
sustainable regime. However, these extra benefits will be left out from the NPV
calculations because the purpose of the comparative break-even analysis is to
provide the bottom line comparison, i.e., to find the minimum requirements of the

new regime that will make its NPV the same as that of the old one.

6.2 Data Used in Break-Even Net Present Value Analyses
6.2.1 Physical Timber Yield
Two sets of information were used for timber yield data. The first set of

information was adopted from the data set in the model of Indonesian Forest

138
Management (INF ORMAN) originally developed by a World Bank team (The

World Bank 1994). This model provides a way to simulate the quantitative
benefits of Changes in the forest management regime in Indonesia. The second
set of information comes from the report titled “National Forest Inventory of
Indonesia: Final Forest Statistics Report” (GOI-MOF/ Dirjen INTAG 1996)’. This
report will be referred to as INTAG report in this chapter. The INF ORMAN data
differs from INTAG data set in the estimates Of the timber stock in the forest. The
two data sets represent a more optimistic view and a more pessimistic view of
the timber yield and could be interpreted as a plausible range of yield scenarios.
Table 6.1 summarizes the information about the average stock of timber per
hectare in the forest and the potential amount that can be harvested for logs
within the two data sets.

Table 6.1.

Volume of Stocks and Potential Harvests of Timber, National Average
(in cubic meter per hectare)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INfORMAN DATA INTAG. DATA
DESCRIPTION Unlogged Logged-over Unlogged Logged-over
Area Area Area ALQL

Stock of timber, all species, >=20 286 201 1 52 107
__cm diameter at breast height _

Stock of commercial species 212 149 62 57

Stock of commercial size 85 60 41 36

Potential volume recovered:

- at the first harvest 55 39 26 23

- at the second harvest 39 27 23 21

Source: The World Bank (1994); GOI-MOF/Dirjen INTAG (1996)

 

 

2 Both these data sets, the one used in INFORMAN model and the one produced by the GOI-MOF/Dirjen.
INTAG, do not have any relationship with the emergence of ecolabeling issue in Indonesia. The
INFORMAN model, which is hardly known by Indonesian forestry circle, is simply a tool of analysis in the
World Bank's 1994 report (which is not yet made public as of August 1997). The INTAG data set was
produced as an output of the first ever national forest inventory project that was administered by Dirjen
INT AG. The latter stands for Direktorat Jenderal lnventori dan Tata Guna Hutan that translates into
Directorate General of Forest Inventory and Land Use Planning', a unit within the Indonesia’s Ministry of

Forestry.

 

139

Taking the INFORMAN and INTAG data sets as two different basic
scenarios, comparison can be made across the empirical results generated from
them. Within the INTAG data set, comparisons can also be made among major
timber producing regions by island group. Breakdown of stock and yield data by
island group is available only for the unlogged area. Hence, no comparison with
the logged-over area can be done on an island by island basis. Table 6.2
summarizes the stock and yield data in five major timber producing islands in
Indonesia. Kalimantan (Borneo) appears to be the most productive forest area in
Indonesia. The logged-over area refers to the area that has been harvested
within a concession area. The area is still under the concessionaire’s control and
should be ready for the second harvest 35 years after the first one provided that
the concession license is renewed at the end of the first 20 year licensing
penod.

Table 6.2.

Volume of Stocks and Potential Harvests of Timber from Unlogged Area,
Regional Average (in cubic meter per hectare)

 

 

 

 

 

 

 

 

 

DESCRIPTION Sumatera Kalimantan Sulawesi Maluku Irian Jaya

Stock of timber, all species, >=20 151 164 178 229 135
cm diameter at breast height

Stock of commercial species 74 95 39 71 21
Stock of commercial size 49 64 22 42 13
Potential volume recovered:

- at the first harvest 32 41 14 27 9

- at the second harvest 23 25 12 24 7

 

 

 

 

 

Source: GOI-MOF/Dirjen INTAG (1996)

 

140

6.2.2 Market and Financial Information

Table 6.3 presents a summary of prices and costs that are used as
parameters in the break-even analysis. In the baseline analysis, these values
are taken as given when calculating the minimum percentage of sales of
ecolabeled logs that must receive a price premium to generate the break-even
NPV from the sustainable production process. Subsequently, in the sensitivity
analysis, the researcher use several alternative values of the silviculture cost to
evaluate its effects on the required minimum percentage of sales that must

receive price premium in the ecolabeled market segment.

 

 

 

 

 

 

 

 

 

 

 

 

Table 6.3.
Price and Cost Parameters Used in Break-Even Analysis

PARAMETERS VALUE

Domestic price of logs per cubic meter 5 100.00
_nggi_ng cost per cubic meter logs $ 45.00

Timber royalty per cubic meter logs $ 22.00
Silviculture cost per hectare per year (for 10 years after loggiflg) $ 5.00
Certification and audit cost per year $ 0.40
Price of plywood in the US intermediate wood input market (per cubic meter) 3 689.34
Premium received by ecolabeled plywood per cubic meter in US market1 3 32.40
Premium transmitted back to the log price at concession (per cubic meter)T $ 4.67

 

 

TEstimated using 4.7% average premium found in MSU Forestry Department Survey
of the US intermediate wood market.
2 Estimated using 14.4% proportion of 1 cubic meter logs in the U.S. wholesale plywood price.
Source: The World Bank (1994); Djalin (1996); Stevens, Ahmad and Ruddell (1997);
ITTO (1997)

Prices of timber logs in Indonesia and plywood in the US intermediate
wood market are crucial price information in the NPV calculations. The price of
plywood in the US intermediate input market is linked to the price of logs in

Indonesia by the proportion of cost of purchased logs in the cost of good sold of

141

the product at every stage of production and distribution. In Indonesia’s case,
the channel from the wood origin to the market is relatively short due to vertical
integration in the wood industry. Companies that own the forest concession also
own the plymills. The plymills export their products directly to importers in foreign
countries.

The information on the cost structure of Indonesia’s plywood industry
comes from the study done by Djalin (1996). This study found that the cost of
logs accounts for 44% of plywood export price from Indonesia. In the US, due to
the wholesale nature of purchasing in the intermediate input markets, assume
that the plywood only goes through one more wholesaler before it reaches the
users. Based on the MSU Forestry Department Survey of intermediate wood
product market, the proportion of Indonesia’s export price in the US wholesale
price is about 65%. Based on these two ratios, and the conversion factor that 2
cubic meter logs is needed to make 1 cubic meter of plywood, the proportion of
log cost in the US wholesale price is estimated to be 14.4%. This is the
percentage used for calculating the amount of dollar premium per cubic meter
logs that can be transferred back from the U.S. plywood market to Indonesia’s
forest Concessionaires.

Throughout the simulations, the cost of logging per cubic meter log is
$45 per cubic meter log produced. Another volume-based cost that the
concessionaires need to pay is the $22 timber royalty.

In the baseline break-even NPV analysis, the costs of adopting

sustainable production process are taken as the same across all concessions.

 

142

Later, we will do sensitivity analyses with respect to these cost differences in
order to account for the current status of sustainability (the extent to which
logging had caused damages to the standing tree) which is the result of logging
and the management practices in the past. The cost of adopting the timber
certification/ecolabeling program comes from:

(1) The cost incurred as consequences of adopting the sustainable production
process. This process includes:

a. the use of better logging techniques and control

b. increased silviculture (doing replanting as necessary)

0. tending to the standing trees in post-logging period.

Silviculture and tending for sustainable forest management practice is
required during the 10-year period after logging (The World Bank 1994). An
estimate which is based on evaluation of a typical forest concession in
Indonesia, suggests that the extra cost for using sustainable production
process is about $5 per hectare per year".

(2) The costs of certification, re-certification every 5 years and annual auditing.
Based on the data provided by an evaluator on a typical concession in
Indonesia, the total certification and auditing costs will be $0.40 per hectare
per year throughout the 35-year period covered in the analysis‘.

In the NPV calculations, a 14% interest rate is applied to represent the

rate at which Indonesian entrepreneurs are accustomed to in discounting future

 

3 Due to proprietary nature of this information, and by agreement with the provider, the data source can not
be disclosed.
‘ Data is provided by the same source as in footnote 3.

143

benefits. This rate is used because the costs and benefits are denominated in
US dollar. With 6% average annual depreciation rate for the Rupiah (Indonesian
currency), the 14% interest rate for US dollar is equivalent to 20% interest rate
for Rupiah, which is the rate commonly used to evaluate private investment

denominated in local currency.

6.3 Results of the Break-Even Net Present Value Analyses

In Subsection 6.3.1 we first analyze the baseline break-even
requirements applied to both data sets for the national average. Then the results
generated from lNTAG’s data set for unlogged area of five island groups is
presented.

Subsections 6.3.2 presents sensitivity of break-even requirements to the
changes in the costs of conducting better logging and silviculture efforts as

required under timber certification and ecolabeling.

6.3.1 Baseline Break-Even Net Present Value Results

This section is aiming at answering the following question: given the cost
and price parameters values stated in Table 6.3 and the timber yield provided in
Tables 6.1 and 6.2, what is the proportion of logs produced under sustainable
practice that must be sold in ecolabeled market segment in order to generate the
same NPV as generated by the conventional practice ? The break-even
proportion of sales in ecolabeled market segment are computed on per hectare

basis. This break-even proportion is also referred to as the required minimum

144

proportion of sales in ecolabeled market’ or the minimum proportion of sales that
must receive price premium.

The premium that may be received on top of the regular plywood price in
the intermediate input market is assumed to be transmitted back to the
concessionaire in prorated fashion based on 14.4% proportion of log cost in the
U.S. plywood wholesale price. Using 4.7% average premium charged for
certified wood products in the US intermediate wood input market, the premium
of ecolabeled plywood is estimated at $32.40 per cubic meter. Based on
discussion in Section 6.2.2, the amount of premium that can be received by
forest concessionaires is $4.67 per cubic mete logs, or 14.4% of the $32.40
premium in per cubic meter plywood in the U.S. market.

Figure 6.1 illustrates the comparison of the required minimum
percentages of sales in ecolabeled market in order to break-even if the
concessionaire adopts the timber certification and ecolabeling. Comparisons are
provided between the results from unlogged and logged over forest area within
as well as across each of the INF ORMAN and INTAG data sets. These
comparisons are based on national average yields from each data set.

The comparison suggests that, given the yield suggested by INF ORMAN
data set, the concessionaire has a strong incentive to use sustainable practice
rather than the current practice. This is true whether the concessionaire is
operating on previously unlogged or on logged-over areas because the
proportion of sales that must receive the price premium is relatively small. It the

timber is harvested from the unlogged area, the certified concessionaire only

145

needs to sell 14.7% of its logs in the ecolabeled wood market. If the timber is
harvested from the logged-over area which has lower yield, the required
minimum percentage of sales that must be sold in ecolabeled market is 21.5%.
The INTAG data show that there is still incentive to switch into sustainable
practice under baseline values of the experimental variables. However, the
advantage is much less significant compared to INFORMAN-based estimate.
Under INTAG yield scenarios, for the unlogged forest area, the proportion of
timber that needs to be sold in ecolabeled market is 34.7% while for the logged-
over area, the proportion is close to 40%.

Figure 6.1.
Break-Even Proportion of Sales in Ecolabeled Market, National Average

 

 

   

   

 

  
   
     
    
     
 
 

 

 

  
 
 

 

 

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g 35% A\\\\\\\\\‘\\\\\\\\
i; 2:.
Eg 20%

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E. 5% §§§

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146

In these baseline results, over all, INF ORMAN data set produces a more
optimistic picture than INTAG data set does on the prospects Of using
sustainable management as an alternative for the current (unsustainable)
practice. The difference is caused by higher estimate of timber stocks and yield
potentials in the INFORMAN data set than that in lNTAG’s.

Figure 6.2 displays the required minimum percentage of sales in the
ecolabeled market by island groups for unlogged area which are based on yield
estimates from the INTAG data set. Sumatera and Kalimantan show profitable
prospects for switching from conventional to sustainable logging and forest
management practice. Kalimantan, which currently produces about 60% of
timber in the country, appears to be the most prospective region to adopt timber
certification and ecolabeling. This region requires only 19.8% of its timber from
unlogged forest area to be sold in ecolabeled market in order to break-even
when switching into using sustainable production process. For Sumatera, the
break-even proportion of sales would be 26.9%. Maluku requires more than one-
third of its timber production be sold in ecolabeled market in order to be able to
adopt sustainable logging and forest management practice.

At the lower end, concessionaires in Sulawesi have little incentive to
switch because this region requires 65% break-even proportion of sales in
ecolabeled market segment. Concessionaires operating in lrian Jaya do not
have any incentive to switch into using the sustainable production process. At its
level of productivity and a $5 annual silviculture cost per hectare, the NPV

generated under sustainable practice is smaller than that under conventional

147

even if all timber produced in this region is sold in ecolabeled market and getting

the price premium.

Figure 6.2.
Break-Even Proportion of Sales in Ecolabeled Market,
Major Producing Regions

 

 

Analyses in this section clearly suggests that productivity of forest area
determines the viability of the adoption of timber certification and ecolabeling
among Indonesia's forest concessionaires. The higher the yield of the forest
land, the smaller the required proportion of sales in the ecolabeled market
segment in order to break even when switching from conventional logging and

forest management practice to using sustainable process.

148

6.3.2 Effects of the Changes in the Silviculture Cost on Break-Even Sales

Proportion Requirement

This section includes an analysis of sensitivity of the break-even
proportion of sales in ecolabeled market toward the Changes in silviculture costs.
This exercise was conducted to evaluate possibilities for concessionaires that
may have different cost of conducting silviculture than the level of cost borne by
the typical concession that was used as the baseline value of this variable. As
mentioned previously, the cost of conducting sustainable logging and forest
management may vary at the concession level due to differences in historical
logging practice within each concession. The baseline value of the silviculture
cost per hectare per year is $5. One of experimental values for this variable,
which is $10 per hectare per year, is adopted from an estimate that was used in
the original INF ORMAN model (The World Bank 1994). Two other values for the
silviculture cost in the exercise are $2.50 and $7.50 per hectare per year. All
the silviculture costs apply only for the first ten years after logging is conducted.
The effects of the changes in silviculture cost are presented in Table 6.4 and

Figures 6.3 and 6.4.

 

Break-Even Proportion of Sales in Ecolabeled Market

149

Table 6.4.

under Various Silviculture Cost Scenarios

 

ANNUAL SILVICULTURE COST PER HECTARE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

YIELD SCENARIOS S 2.50 $ 5.00 $ 7.50 $ 10.00
(bgsefine)

INFORMAN - unlogged area 6.9% 14.7% 22.5% 30.28%
INFORMAN - logged-over area 10.5% 21.5% 32.5% 43.4%
‘TrTrAG - unlogged area 18.3% 34.7% 51.2% 67.6%
INTAG - logged-over area 20.9% 39.6% 58.1% 76.7%

UNLOGCfl) AQE‘A OF:

Sumatera 13.5% 26.9% 40.2% 53.6%
Kalimantan 9.3% 19.8% 30.2% 40.6%

Sulawesi 34.4% 65.0% 95.5% negative
rel—um
Maluku 17.6% 33.4% 49.3% 65.1%

Irian Jaya 53.5% negative negative negative
return return return

 

Figure 6.3 and the upper portion of Table 6.4, show comparisons of the

break-even proportion of sales in an ecolabeled market based national average

yield scenarios for each value of experimental silviculture cost. If the annual

silviculture cost is $2.50 per hectare, then all forest areas that produce within the

range of yields represented by INF ORMAN and INTAG data sets become

prospective areas to adopt timber certification and ecolabeling. The break-even

proportions of sales in ecolabeled market segment range from 6.9% to 20.9%.

The upper limit of this range is the proportion required by the most pessimistic

yield scenario represented by INTAG Logged-over area.

As the annual silviculture cost rises above $5.00 per hectare, the

prospects of adopting timber certification and ecolabeling decline for concession

areas whose yield is represented by INTAG data set. Even the more productive

 

 

150

Figure 6.3.
Break-Even Proportion of Sales in Ecolabeled Market at Various Level of
Annual Silviculture Cost, National Average

 

§

§§

9%

Required "infirm percentage ofealee In
ecolabeled marketeegnent
8
i

6
92

 

2

$2.50 $5.00 $7.50 $10.00
Sllvlvulture costs per hectare

 

 

 

unlogged forest area in INTAG yield scenario requires 51.2% break-even
proportion of sales in ecolabeled market. Using the yield in INTAG data set, at
$10.00 annual silviculture cost, the concessionaires would have to sell more
than two-thirds of their logs in the ecolabeled market in order to break-even.
Figure 6.4 and lower portion of Table 6.4 provide comparisons of required
minimum percentage sales in ecolabeled market across major island group. The

breakdown by island group only covers unlogged area from INTAG data base.

 

151

Figure 6.4.
Break-Even Proportion of Sales in Ecolabeled Market
at Various Level of Annual Silviculture Cost by Region

 

 

 

 

 

 

 

 

 

 

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c 50% DSULAWESI
E IMALUKU
E; 40% IIRIAN JAYA
c
"E '3
g 8
a
3'
K

. 2
_.....l .

silviculture cost per hectare per year

c
a?

 

 

 

 

At $ 2.50 annual silviculture cost per hectare, sustainable logging and
forest management can be a viable option for most of the regions.
Concessionaires in lrian Jaya, who cannot participate in timber certification and
ecolabeling if the silviculture cost is $ 5.00 or higher, will be able to participate at
$ 2.50 silviculture cost if they can sell 53.5% of their logs in ecolabeled segment.
For concessionaires in Sulawesi, the break-even proportion of sales at $2.50
silviculture cost is 34.4%. At $7.50 silviculture cost, these concessionaires would
have to sell more than 95% of their products in ecolabeled market in order to be
profitably able to adopt timber certification and ecolabeling.

As the most productive region, Kalimantan seem able to absorb the

annual silviculture cost up to $10.00 per hectare. At this level of cost, the

 

152

required break-even proportion for concessionaires on this island is about two-
fifths. Concessionaires in Sumatera and Maluku can probably absorb up to
$7.50 annual silviculture cost. The required break-even proportions of sales in

ecolabeled market at this level of cost for these islands are about 40% and 50%

respectively.

6.3.3 Effects of Changes in Price Premium on Break-Even Sales

Proportion Requirement

 

This section discuss a sensitivity analysis of the break-even proportion of
sales in ecolabeled market with respect to the changes in price premium in the
U.S. intermediate wood market. The baseline value of the price premium in this
analysis is 4.7%, which is the average premium found through the MSU Forestry
Department Survey of the U.S. intermediate wood input market (Stevens, Ahmad
and Ruddell 1997). When calculating the break-even sales proportion in
ecolabeled market segment, the value of annual silviculture cost is kept constant
at $5 per hectare. Results of the simulations are presented in Table 6.5 and
Figures 6.5 and 6.6.

Figure 6.5 and the upper portion of Table 6.5, show comparisons of the
break-even proportion of sales in an ecolabeled market based national average
yield scenarios for each value of price premium in the US intermediate wood
input market. At 3% price premium in the plywood market, the concessionaires

would have sell high proportion of their timber production in the ecolabeled

153

Table 6.5.
Break-Even Proportion of Sales in Ecolabeled Market
under Various Price Premium Scenarios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PRICE PREMIUM SCENARIOS
Premium in plywood market 3% 4.7% (baseline) 10% 15%
Plywood premium in 5 $20.68 $32.40 $68.93 $103.40
Premium received by concessionaire $2.98 $4.67 $9.93 $14.89
YIELD SCENARIOS
Wm 23.1% 14.7% 6.9% 4.7%
INFORMAN - logged-over area 33.7% 21.5% 10.1% 6.8%
INTAG - unlogged area 54.5% 34.7% 16.4% 10.9%
INTAG - logged-over area 62.0% 39.6% 18.6% 12.4%
UNLOGGED AREA OF:
Sumatera 42.2% 26.9% 12.7% 8.5%
Kalimantan 31.0% 19.8% 9.3% 6.2%
Sulawesi negative 65.0% 30.6% 20.5%
return
Maluku 52.5% 33.4% 15.8% 10.5%
Irian Jaya negative negative return 47.6% 31.7%
return

 

segment in order to be break-even when adopting timber certification and

ecolabeling. The most optimistic yield estimate in the INFORMAN data set

 

requires about 23% of the concession output to be sold at that price premium in
order to break-even. Simulation based on INTAG’s logged-over area data
requires more than 60% of the timber that need to be sold in ecolabeled
segment. The break-even proportions of sales decrease significantly rapidly as
the price premium rise above 5%. At 10% price premium, for instance, the most
pessimistic yield estimate requires that only less than one-fifth of the logs
produced that need to receive that level of premium.

Figure 6.6 and lower portion of table 6.5 present comparisons of required
minimum percentage sales in ecolabeled markets across major island group.

This regional comparison includes only unlogged-area of the production forest.

154

Figure 6.5
Break-Even Proportion of Sales in Ecolabeled Market
at Various Levels of Price Premium, National Average

 

§

 

 

6
a:

 

w ilfilfiMA’n’W i
D lNFORMAN-Logged-over Area
I INTAG-Unlogged Area
[3 INTAG-Logged-over Area

were
l

61
3‘

Required mlnlrnum percerltege of sales In
ecolabeled market segment

 

 

 

 

 

 

 

10%

 

Sllvlvulture costs per hectare

 

 

 

The exhibits show that at 3% premium rate, Sulawesi and lrian Jaya will not be
able to participate in ecolabeled timber market. Maluku, Sumatera and
Kalimantan are able to participate if they can sell 30%-53% of their products in
the ecolabeled markets segment. Concessionaires in Sulawesi may be able to
adopt timber certification and ecolabeling at 4.7% premium if about two-thirds of
their products can receive the corresponding price premium in the market. If the
premium is 10% or higher, the option of adopting timber certification and
ecolabeling becomes a viable option for all concessionaires despite some
regions may have high break-even proportion of sales. At 15% premium,

producers in Sumatera and Kalimantan need to sell only less than 10% of their

155
products in the ecolabeled market in order to break-even in adopting timber
certification and ecolabeling.
Figure 6.6.

Break-Even Proportion of Sales in Ecolabeled Market
at Various Levels of Price Premium by Region

 

 

' ' [’7 " =' :. 1. ’ ISUWW
1' ' NUKALIMANTAN
. 5:]SULAWESI
. IMALUKU
35 IIRIAN JAYA .

 

    
 

 

 

8
:2

 

 

B
at

 

ecolabeled market segment
8
8

Required mlnlmum percentage of sales In

 

 

    

10.0% 15.0%

price premlum In the U.S. Intermediate wood Input market

 

 

 

6.4 Discussions of the Results of Break-Even NPV Analysis

Two basic variables on the producers’ side appear to have very strong
effects on the required break-even proportion of sales in ecolabeled market
segment in order for the concessionaire to be able to participate in timber
certification and ecolabeling. The first variable is the estimate of timber yield
potentials of the commercial species in the forest. Differences in the basic
estimates of INFORMAN and INTAG data set illustrate the importance of these

yields in determining the minimum proportion of sales that must receive price

156

premium in the ecolabeled market to induce concessionaires to implement
sustainable logging and forest management practice.

Second, silviculture cost also turns out to be an important factor affecting
the breakcven proportion of sales in ecolabeled market. The higher the
silviculture cost, the higher the break-even proportion of sales in the ecolabeled
segment. Concessionaires have to be able to sell more of their products in the
ecolabeled market to make timber certification and ecolabeling a viable
business Option. Simulations of break-even proportion of sales based on the
changes in the silviculture cost also allow us to roughly identify the maximum
level of the cost that can be absorbed by concessionaires in each region in order
to become a certified/ecolabeled source, given their expectation about the
maximum proportion of their sales in the ecolabeled market.

On the market side, section 6.3.3 shows the importance of the role of
price premium in inducing the adoption of timber certification and ecolabeling.
The required proportion of sales in ecolabeled segment decreases rapidly as the
price premium goes up.

The issue of break—even proportion of sales in the ecolabeled market
segment and getting premium is relevant in'evaluating entrance into the
ecolabeled wood product markets in the consuming countries. The situation in
the US intermediate wood input market gives a mixed signal on this issue
(Stevens, Ahmad and Ruddell 1997). A few forest management companies have
been able to get 100% of their products recognized and receive price premium

in the market. A few others say that only up to 40% of their products are

 

157

currently receiving recognition from the market. In place or in addition to the
price premium, receiving recognition from the market could sometimes mean
getting access to the market they were not used to be part of. This is certainly
an option for the companies whose intention is to establish a share in the
existing market. Another small number of certified forest land companies in the
US choose not to sell all their products in the ecolabeled market - despite a
strong demand and willingness to pay for certified logs - because they are not

sure that the risks of completely shifting the customers from traditional to

 

ecolabeled market can be justified by the benefits they received from the
ecolabeled market segment.

Based on the analysis in this chapter, two general policy implications can
be identified. First, there emerges a possibility of selectively promoting timber
certification and ecolabeling based on regional basis and forest condition.
Second, if timber certification and ecolabeling is to be used to promote
sustainable forest management in all area, the potentially large social and
environmental benefits of sustainable forest management may justify some
public initiative with a view to reducing the burden faced by the private forest
concessionaires when practicing the sustainable logging and forest
management. Both these implication will be discussed further in the concluding

chapter.

Chapter VII

CONCLUSIONS

7.1 Summary of Research Issues

This research examined the potential use of ecolabeling as an alternative
economic instrument to mitigate externality problems in renewable natural
resource extraction. With timber certification and ecolabeling, the mitigation of
externalities is achieved through the adoption of sustainable logging and forest
management practice. The practice will result in sustainable yield and less
damage in the forest, hence it helps maintain other economic and non-economic
functions of the forest. The timber certification and ecolabeling analyzed in this
study are based on the internationally negotiated Principles and Criteria of
Sustainable Forest Management under the Forest Stewardship Council.

The Objectives of this study were: (1) to investigate the effects of timber
ecolabeling on the demand, supply and market equilibrium of tropical timber; (2)
to evaluate the welfare effects of ecolabeling ; and (3) to determine condition(s)
under which the ecolabeling can induce the producers to adopt ecolabeling;

hence, internalize the stock externalities of the timber production.

158

 

159
7.2 Summary of Literature Review
The review of the literature documented that the rise of ecolabeling
initiatives in general, and timber certification in particular, were induced by two
situations: (1) The existence of externality problems associated with production.
In the case of timber, these include both stock and non stock externalities.
Reduction in timber stock in the forest is always larger than the amount of timber .44

recovered for commercial use. This problem is unlikely to be solved with the first

T‘!‘

best economic policy instruments alone, especially in the developing countries
such as Indonesia; and (2) The rise of green consumerism that has not been
appropriately responded to by market institutions. With this perspective,
ecolabeling initiatives emerged as an alternative to bans and boycotts which
create disincentives for resource conservation and for promoting sustainability.
Further, ecolabeling: (1) allows consumers to make an informed Choice at the
time of purchase, and to discriminate in favor of environmentally friendly
products; and (2) facilitates the creation and transmission of market incentives
for producers to internalize the costs of externalities associated with production
process.

Support from economics literature on the workings of ecolabeling can be
built on the application of the economics of information. With an asymmetry of
information between producers and consumers on product characteristic,
product certification and labeling offer a way to provide warranty to prevent
adverse selection in the market. As it is true in market signaling situations, the

key to the working of ecolabeling is that high quality (in this case,

160
environmentally friendly) producers find it worthwhile to convey the information
on the product characteristics. At the same time, less environmentally friendly
producers do not find it worthwhile to do so due to higher costs needed for
meeting the labeling requirements. With the existence of mechanisms to verify
the environmental claim stated on the label, and the threat of punishment from
the market, certification and ecolabeling can potentially be an economical way to

overcome the problem of information asymmetry about product characteristics.

7.3 ConCIusions of the Study

Theoretical and empirical analyses were conducted to evaluate whether
ecolabeling is a viable economic instrument. Using simple diagrammatic
analysis of market equilibrium, this study showed that:

(1) Markets for wood products split into two segments as the result of the
introduction of the ecolabeled products in the market. Taking total demand in
the market as constant, a portion of it will become an ecolabeled segment.
Buyers in the ecolabeled segment are willing to pay a higher price than the
ones purchasing the conventional product. The size of the proportion of this
segment is determined by the price premium of the ecolabeled product above
the conventional one.

(2) Total welfare is increasing as the results of ecolabeling introduction. In he
case of timber ecolabeling, three sources of increase in the welfare are:

a. a larger consumer surplus results due to a smaller need to compensate

losses induced by the externality of the production.

 

1 61

b. a larger consumer surplus results due to higher utility from knowing the
characteristics of the product. This part of consumer surplus gain can be
attributed to the value of information provided by the ecolabel. The
information conveyed by the ecolabel has value because it helps
consumers make the pro-sustainable choice and avoid the mistakes they
used to make when the information is not available.

c. a lower total social cost in timber production occurs because less damage

is realized under the sustainable production process compared to the

 

situation under conventional logging and forest management practice.

Adopting the constant elasticity demand function and parameters
developed in other studies, the empirical analysis quantifies the theoretical
findings. The empirical finding reflects the intuition that the size of the increase
in consumer surplus will become smaller if the price premium for the ecolabeled
wood increases. It also shows that the size of the ecolabeled segment in the
total market becomes smaller with the rise in premium. Consumer surplus is
larger if consumers purchase ecolabeled wood product instead Of the
conventional one. The surplus decreases as the price premium rises.

Unfortunately, from the business perspective, adoption of timber
certification and ecolabeling does not always appear as a viable option. The
Break-even NPV analyses showed the required minimum percentage of sales in
the ecolabeled market in order that the log producer can adopt timber

certification and ecolabeling. At the national, at the average annual silviculture

162
cost of $ 5.00 per hectare, an Optimistic yield scenario suggests that the break-
even proportion of sales in ecolabeled market is in the range of 14.7% - 21.5%.
The more pessimistic yield scenario suggests that the minimum required
proportion of sales in ecolabeled market is between 34.4% and 33.9%.

Regionally, for the unlogged forest area, the break-even proportion of
sales in ecolabeled market falls within 19.8% - 65.0% range. Kalimantan
appears to be the best prospective region for adopting timber certification and
ecolabeling while lrian Jaya will not be able to participate at this level of
silviculture cost. A sensitivity analyses with respect to changes in silviculture
effort shows that the viability of adoption declines as the cost of silviculture
increases. The concessionaires will have to sell higher proportion of their timber
in ecolabeled market in order to break-even when they adopt timber certification
and ecolabeling.

These Break-even NPV analyses show that the viability of the adoption of
timber certification and ecolabeling depends largely on: (1) productivity of the
forest concession area; and (2) the cost of conducting proper silviculture effort to
comply with certification and ecolabeling requirements. The higher the yield of
the forest land, the lower is the break-even proportion of sales in the ecolabeled
market, and the more viable is the adoption of timber certification and
ecolabeling. The higher the silviculture cost, the less viable is the option
because concessionaires have to sell a higher proportion of the logs in

ecolabeled market in order to reach the break-even point.

163
7.4 Policy Implications

Based on the analysis in this Chapter, two general policy implications can
be identified. First, there emerges a possibility of selectively promoting timber
certification and ecolabeling based on regional basis and forest condition. It may
also be appropriate to prioritize the promotion toward the existing unlogged
forest area to prevent potential damage. Of 64 million hectares permanent
production forests in Indonesia, about 60% are still unlogged. And about 56% of
this unlogged area is located in the more productive forests of Sumatera and
Kalimantan (INTAG 1996). As the Break—even NPV analyses show (figures 6.2
and 6.3), adoption of timber certification and ecolabeling by concessionaires in
these regions has a strong appeal. At a $ 5.00 annual silviculture cost per
hectare, concessionaires in Sumatera and Kalimantan only need to receive $
4.67 price premium in less than 30% Of their logs in order to break-even if they
adopt timber certification and ecolabeling. Given a significant share of
Indonesia’s plywood in the U.S. as well as in the world hardwood plywood
market, reaching the 30% break-even proportion of sales in ecolabeled market
seem feasible to the Indonesia’s forest concessionaires.

In the logged-over area, timber certification and ecolabeling will be viable
only for high growth forest regions and where silviculture can be done at low
cost. Among the 30 million hectare forests that has been logged over since
1967, about 10 million had become deforested. Promotion of timber certification

and ecolabeling within the logged-over area can then be viewed to slow down

164
further deforestation that begins when the logged-over area is left unmaintained
by the concessionaire.

Second, large potential social and environmental benefits of sustainable
logging and forest management may justify some public initiative with a view to
cover part of the costs faced by the private forest concessionaires when
practicing sustainable logging and forest management. This policy implication is
particularly relevant for Indonesia’s setting given the availability of the stock of
unused reforestation fund (which is part of timber royalty) currently maintained
by the Ministry of Forestry outside the official budget system.

However, some larger problems of commercial forest may need be
addressed before timber certification and ecolabeling can be an effective
economic instrument to promote sustainable forest utilization in Indonesia.
While Break-even NPV analysis may show it is feasible for a concessionaire to
certify its operation, a short concession license period (i.e., 20 years) does not
guarantee that the concessionaire will be able to harvest the results of his
investments in 35 years time after the first logging. The government should
reconsider this property right issue while trying to promote the timber
certification and ecolabeling. If the warranty for long-term benefits for
sustainable forestry can be provided, this will act as a counter balance against
the pressures and short term incentive to over harvest which is induced by over

investment in wood processing industry.

165
7.5 Limitation and Suggestion for Future Research

Validity of the results presented in this dissertation and applicability of the
approach for empirical analysis depends largely on the parameters borrowed
from other studies. The ratios and relationships used to calculate the empirical
results are all averages that represent, if at all, the aggregate situation. While
the theoretical equilibrium analyses may be applied to significantly wider cases
of ecolabeling initiatives, the applicability of empirical results depends mainly on
the demand function specification adopted for this study. Nevertheless, the
approach used for concessionaire prospective analysis for adopting timber
certification and ecolabeling, can potentially be applied to help forest
management companies evaluate their position. However, for the model to be
realistic at the firm level, some ratios and parameters would need be adjusted to
represent the reality in which the concessionaires operate.

With respect to future research potentials, currently, ecolabeling is
perhaps the least mined research topics in the field of resource and
environmental economics. In my limited view, this study opens up the
Opportunity to develop a research program on this topic. Many aspects of
ecolabeling need be studied to provide more support (or to negate) that
ecolabeling is an economical way to promote sustainability to complement the
first best economic instrument. Some possible topics that seem productive along
this line include: (1) consumer response toward ecolabeling; (2) potential trade
generation and diversion effects of ecolabeling; and (3) the set up of

ecolabeling-related institutions to support an efficient ecolabeling program.

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