Indonesia can use trade policies to accelerate its green transformation

Efforts to address climate change, whether by reducing greenhouse gas emissions or adapting to hotter temperatures, rising seas, and more extreme weather, will reshape the flow of trade in goods and services around the world. This, in turn, poses a challenge to developing countries, which must reconcile increasingly stringent environmental standards with sustained economic growth. Indonesia, aspiring to high-income status, is no exception.

While trade can contribute to greenhouse-gas emissions, it can also play a critical role in supporting climate adaptation and mitigation efforts, including through cross-border flows of environmentally friendly products and services. The review and reform of trade policies applied to such goods and services can help Indonesian firms become more competitive in green-goods markets and promote access to the latest green goods and technologies.

A recent World Bank report shows that Indonesia has untapped potential in exports of green goods and plastic substitutes. Indonesia’s imports of environmental goods (EGs) – such as electric vehicles, solar panels, and air filters – have been at par with global and regional averages, but its exports of EGs have lagged behind (Figure 1). And while Indonesia is among the top 20 exporters of plastic substitutes, trade in goods such as natural fibers and biodegradable fishing nets has remained relatively static. These findings suggest that Indonesia has so far been unable to capitalize on increasing global demand for such products.

The private sector will be key to realizing Indonesia’s potential in trade of green goods and plastic substitutes. This is especially so for firms involved in global value chains, which account for two-thirds of Indonesian exports. The degree of integration of Indonesian firms in global and regional value chains matters for competitiveness, especially for exports of EGs. Firms that both export and import have been found to export more green products, trade in higher-technology EGs, and have higher survival rates in export markets (Figure 2).

_{Source: World Bank staff estimates using BPS and World Integrated Trade Solution (WITS) data.}

_{Note: EGs in this analysis have been defined based on the environmental benefits they provide rather than their carbon content and include a list of 543 HS6 products as defined in the Green Transition Navigator.} 

To enhance its green transformation, Indonesia could adopt the following trade policies:

• Reduce remaining tariffs on imports of environmental goods and plastic substitutes, including through plurilateral trade agreements. Tariff reductions on green goods traded either regionally or under the World Trade Organization’s Environmental Goods Agreement would result in important “trade creation” effects. This could boost Indonesia’s green goods exports and facilitate firm entry into EG markets (Figure 4).
• Review, streamline, or eliminate unnecessary non-tariff trade measures (NTMs) on green goods. These include port-of-entry restrictions and mandatory certification with national standards. Estimates suggest that some NTMs, such as impose costs equivalent to a 30 percent tariff on imports of EGs and plastic substitutes. These costs are estimated to be much higher than in other ASEAN countries (Figure 3). Nine out of nearly 90 non-tariff trade measures are recommended for reform.

_{Source: World Bank staff estimates using WITS data.}

• Harmonize local product standards with international ones. This would reduce compliance costs and administrative bottlenecks for the private sector. Harmonization and the mutual recognition of climate-related regulations and technical standards would also reduce policy fragmentation and improve access to export markets.
• Review and relax local content requirements in the renewable-energy sector. Local-content requirements aimed at creating local manufacturing capacity in areas such as solar panels could also be a deterrent to the growth of these sectors. Indonesia may consider reducing minimum local content requirements to allow domestic production to develop and achieve the economies of scale required to become competitive.
• Include enforceable environmental provisions in trade agreements and participate in climate-related trade-policy initiatives. While Indonesia has committed to reducing tariffs on some EGs, it does not participate in most ongoing plurilateral initiatives on trade and climate. Furthermore, only six of Indonesia’s 14 trade agreements include environmental provisions, and only one of these is strongly enforceable.

By integrating trade policies with broader climate strategies, Indonesia can do more to position itself in the global and domestic transition to a more environmentally sustainable economy.