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A Final Report to inform a Regulation Impact Statement for the proposed new policy on illegally logged timber

Prepared for

Department of Agriculture, Fisheries and Forestry

F I N A L R E P O R T

Centre for International Economics Canberra & Sydney

29 January 2010

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FINAL REPORT TO INFORM A REGULATION IMPACT STATEMENT: PROPOSED NEW POLICY ON ILLEGALLY LOGGED TIMBER 3

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Contents

Glossary 7

Executive summary 9 Size of the problem: the global cost of illegal logging 9 Existing measures to address the problem 10 Australia’s contribution to the problem 10 Options available to Australia 11 Compliance and enforcement costs 12 Benefits and costs of Australian measures 13 Effectiveness of Australian measures: the international context 14 Consultation 15 Recommendation 17

1 Background 18 Methodology 20

2 The problem 22 The size of the problem 22 Costs of illegal logging 26 Costs of removing illegal logging to consumers 30 Total costs of illegal logging 30

3 Regulatory and non-regulatory policy options 32 Context for the policy 32 Regulatory options for the restriction and disclosure elements 34 Factors to consider in designing the regulatory options 36 Illegal logging regulatory options examined in this RIS 42

4 Approach to modelling policy options 44 Impacts of compliance costs on willingness to supply 45 Factors affecting compliance costs 45 Modelling compliance costs of legal verification 46 Costs of disclosure measures and chain of custody costs 48 Government enforcement cost 49 Uncertainties about estimates of compliance cost 49 Summary of assumptions and implications of compliance costs 49

5 Economic costs of legality verification 51

4 FINAL REPORT TO INFORM A REGULATION IMPACT STATEMENT: PROPOSED NEW POLICY ON ILLEGALLY LOGGED TIMBER

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Costs of the regulatory options 57

6 Cost–benefit analysis 60 Cost–benefit analysis of a unilateral response by Australia 61

7 Sensitivity analysis and impacts of regulatory options 64 Sensitivity to key assumptions 65 Summary of sensitivity analysis 67 Other sensitivities 67 Summary of regulatory options 68

8 Consultation statement 74 Affected and consulted parties 74 The consultation process 74 Stakeholders response to the draft report 78 Policy options 93 Legal verification 95 Policy objectives 95

9 Conclusion 97 Restricting imports 97 Effectiveness of Australian initiatives — international context 98 Product disclosure 99 Recommendation 100

References 102

APPENDICES 105

A GTAP model 107

B Methodology 110

C Various estimates of the non-market (social and environmental) costs of illegal logging 120

D Opportunity cost of complying with certification 128

E Cost of legality compliance 130

F Stakeholders consulted 141

G Stakeholders that sent public submissions on the Draft RIS 144

Boxes, charts and tables 1 Key elements of the regulatory options analysed in this RIS 12 1.1 Our analytical approach 19 1.2 Methodology 21 2.1 Estimate of illegal logging in selected countries 23


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2.2 Estimated share of suspicious wood products in exports of wood products 24

2.3 Impacts of illegal logging 26 2.4 Estimates of costs of illegal logging 31 3.1 Proposed product categories for regulation 37 3.2 Key elements of the regulatory options analysed in this draft RIS 43 4.1 Compliance requirements for SDL, VLO, VLC and FC schemes 44 5.1 Simulations: Australian imports of wood products from risk countries 52 5.2 Simulations: Australian imports of paper products, printing and

publishing from risk countries 52 5.3 Simulations: global reductions in logging in risk countries from

unilateral action 53 5.4 Simulations: changes in illegal logging in risk countries 53 5.5 Change in production in Australia from unilateral action: all wood

products 54 5.6 Change in employment in Australia forestry and wood products sector 55 5.7 Simulations: costs to the Australian economy if Australia acts

unilaterally 56 5.8 Simulations: costs to the world economy 56 5.9 Welfare changes in Australia, risk countries and other countries: legality

verified by full certification if Australia acts unilaterally 57 5.10 Simulations: cost to Australia per cubic metre reduction in logged wood

in risk countries if Australia acts unilaterally 57 6.1 Simulations: benefits 61 6.2 Simulations: ratio of total global benefits to Australian cost 61 6.3 Simulations: ratio of total global benefits to total global cost 62 7.1 Sensitivity results for full certification and high product coverage:

unilateral action 66 7.2 Sensitivity of costs and benefits for Australia under unilateral action 68 7.3 Potential impacts of legality verification, regulatory and non-regulatory

options 72 8.1 Summary of submission responses 79 8.2 Views of some stakeholders on policy options 93 A.1 Region classification 108 A.2 Sector classification 109 B.1 Logging supply and demand 111 B.2 Impact of eliminating illegal logging 112 B.3 Welfare change of eliminating illegal logging: sensitivity analysis 114 B.4 Social and environmental costs of illegal logging 115 B.5 Average shares of product categories in GTAP sectors 116 C.1 Social costs of logging 123 C.2 Estimating the benefits of eliminating greenhouse gas emissions

associated illegal logging 125


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C.3 Ecosystem services included in the estimate of biodiversity loss in forestry 126

D.1 Supply and demand responses to lower resources availability 128 D.2 Changes of 1 per cent reduction in forestry resources 129 E.1 Estimated annual costs of certification for a 5-year period certificate.

Medium size operation. Native forest 132 E.2 Composition of certification cost 132 E.3 Estimated annual costs of certification for a plantation with well

developed systems for a 5-year period 133 E.4 Cost of compliance for various types and sizes of operation, diverse

standards 134 E.5 Estimated unit cost of compliance under various standards 134 E.6 Cost of compliance for various types and sizes of operation, full

certification 135 E.7 Estimated unit cost of certification 135 E.8 Legality Assurance System (LAS) costs under various scenarios 137 E.9 CoC certification components 139 E.10 Example of a supply chain with 2 steps (nodes) and 2 suppliers per step 140


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Glossary

APFSCB Asia-Pacific Forestry Skills and Capacity Building Program

CBD Convention on Biological Diversity

CERFLOR Certificação Florestal (Brazilian Forest Certification System)

CERTFOR Certificacion Forestal (Chilean system for Sustainable Forest Management)

CITES Convention of International Trade in Endangered Species

CoC Chain of Custody

CPRS Carbon Pollution Reduction Scheme

DAFF Department of Agriculture Forestry and Fisheries

EU European Union

FAO Food and Agriculture Organization of the United Nations

FLEG Forest Law Enforcement and Governance

FLEGT Forest Law Enforcement governance and Trade

FMU Forest Management Unit

FSC Forest Stewardship Council

GTAP Global Trade Analysis Project

IPPC Intergovernmental Panel on Climate Change

ITTO International Tropical Timber Organization

LEI Lembaga Ekolabel Indonesia

MDF Medium-density fibreboard

MTCC Malaysian Timber Certification Council

NGO Non-government Organisation

OBPR Office of Best Practice Regulation


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OSB Oriented Strandboard

PEFC Programme for Endorsement of Forest Certification

RIS Regulation Impact Statement

SDL Self-declared legal

TheCIE The Centre for International Economics

TLAS Timber Legality Assurance System

TLTV Timber Legality and Traceability Verification

UNCCPCJ United Nations Commission on Crime Prevention and Criminal Justice

UNFCCC United Nations Framework Convention on Climate Change

UNFF United Nations Forum on Forests

UN REDD United Nations collaborative programme on Reduced Emissions from Deforestation and Degradation in Developing Countries

US United States of America

VLC Verified Legal Compliance

VLO Verified Legal Origin

VPA Voluntary Partnership Agreements

WTO World Trade Organization


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Executive summary

The Australian Government is considering introducing a policy to combat illegal logging and associated trade by establishing systems that will promote trade in legally logged timber and, in the long term, trade in timber and wood products from sustainably managed forests. The proposed policy includes restricting importation of illegally logged timber and thereby assisting in reducing the environmental, social and financial damage caused by it to Australia and other countries in the region. It also includes action to require disclosure of species, country of harvest and any certification at point of sale.

The Office of Best Practice Regulation (OBPR) has informed the Department of Agriculture Forestry and Fisheries (DAFF) that a Regulation Impact Statement (RIS) is required in relation to those elements of the proposed policy dealing with restricting imports and product disclosure. A RIS is required to assess the potential economic, social and environmental impacts of a range of regulatory and non-regulatory options available to Government.

This report is the final report to DAFF on the RIS process. It is designed to assist DAFF to inform Government consideration of the options for combating illegal logging and associated trade in the most cost effective and efficient manner. It has drawn on initial consultations based on an issues paper circulated earlier in the process, a Consultation (Draft) RIS and stakeholder submissions responding to that and on interactions with government agencies with portfolio interests in combating illegal logging and associated trade.

Size of the problem: the global cost of illegal logging

The most thorough estimates of the extent of illegal logging by Seneca Creek Associates (2004) suggest that between 5 and 10 per cent of global industrial production may be associated with illegal activity and that similar percentages of global trade in wood products can be traced to origins suspected to be illegal.

It is difficult to value many of the social and environmental costs resulting from illegal logging. However, estimates compiled for this report suggest the following:

Non-market (environmental and social) costs associated with illegal logging are of the order of US$60.5 billion a year.


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The financial costs to legal producers around the world are estimated at US$46.0 billion a year.

But consumers (through lower prices) and producers of illegal timber (through higher incomes) and products receive gains worth around US$92 billion a year.

The net result of these costs and gains is a net cost of $15 billion a year, with a potential benefit to cost ratio of 1.16.

There is thus a potential benefit to the world from eliminating illegal logging. The key questions for this RIS concerns what additional costs would be incurred as a result of measures to reduce illegal logging, how much of the benefits might be achieved through actions that Australia can take, and how the measures being assessed might interact with other Australian and international initiatives.

Existing measures to address the problem

At the present time the Australian Government is using bilateral agreements on forestry with countries in the Asia-Pacific region — such as existing bilateral forestry agreements with countries such as Indonesia and Papua New Guinea — and multilateral processes, including the United Nations Forum on Forests (UNFF) non-binding arrangements on the management of all types of forests and the United Nations Commission on Crime Prevention and Criminal Justice (UNCCPCJ) resolution on illicit international timber trafficking, combined with capacity building to support efforts for combating illegal logging and associated trade.

Other countries concerned with importation of illegally logged timber are also implementing or considering new initiatives to combat illegal logging and encourage enforcement of forestry laws in producer countries. These include the amendments to the Lacey Act recently introduced in the United States, and the ‘due diligence’ regulation being considered by the European Union. There may also be initiatives to improve enforcement of existing laws but they have not solved the problem. Should they be successful in the future they will reduce the size of the problem and Australia’s imports of illegally logged timber.

Australia’s contribution to the problem

How much of the costs of illegal logging is likely to result from Australia’s importation of timber products?

Currently, only around 15 per cent of world production of timber products is internationally traded. Of this trade, Australia’s imports account for around 2.5 per cent. This study has estimated that around 10 per cent of these imports may include illegally logged timber. Thus Australia’s imports account for about 0.034 per cent of global timber production, and 0.34 per cent of products incorporating illegally


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logged timber. So if Australia were able to stop its importation of such products, and this led to a commensurate reduction in illegal logging (rather than a diversion of products to other markets), it could reduce the global costs of illegal logging by 0.34 per cent, or around US$51 million a year. But any available measures would impose compliance and other costs on Australia, and may not be fully effective in eliminating illegal logging. Assessing these costs and the potential effectiveness of measures is a key part of this RIS.

Options available to Australia

This RIS has considered a number of options for implementing the import restriction element of the Government’s policy. They include self-regulation, quasi-regulation, co-regulation and explicit regulation1. Each of these options would employ some kind of legality verification scheme, and decisions would be needed as to what range of timber products would be covered. This RIS has considered the use of four types of certification schemes (self-declaration of legality (SDL), verified legal origin (VLO), verified compliance with all forestry and trade laws in the country of harvest (VLC) and certification of sustainability (full certification, FC). These schemes cover an increasing range of elements of legal compliance (details are provided in table 4.1 of this report).

Restrictions have been considered for different levels of coverage of imports defining three categories.

Category I — solid timber and wood products (covers about 12 per cent of imports);

Category II — category I plus partially processed/processed timber and wood products (covers about 39 per cent of imports); and

Category III — category II plus selected complex products, including paper manufactures and most furniture (covers 70 per cent of imports).

Options that the Australian Government might adopt could include phased introduction of more comprehensive verification requirements and phasing over a wider range of products, as well as introduction of any one of the potential combinations of schemes and product coverage. This RIS has considered the effects of introducing each of the options on a stand alone basis. 1 Quasi-regulation refers to rules or arrangements where governments influence businesses to

comply, but which do not involve government regulation. Co-regulation is defined by the situation where industry develops and administers its own arrangements but government provides legislative backing to enable the arrangements to be enforced. Explicit government regulation is the most commonly used form of regulation to achieve the objectives of government and includes initiatives like the EU due diligence and US Amendment of the Lacey Act. How effective any of these might be will depend on codes of enforcement by government or the institutional arrangements.


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Table 1 summarises the main elements of the regulatory options that have been analysed.

1 Key elements of the regulatory options analysed in this RIS

Regulatory option Phasing product coverage

Legality, verification compliance

Phasing compliance

options

Enforcement regime

Self - Current systems - Industry

Quasi-regulation + Code of conduct - Industry

Co-regulation + Legislate + Government

Explicit regulation + Legislate + Government

Note: The regulatory options could utilise the SDL, VLO, VLC or FC schemes. The pluses and minuses indicate whether it is likely that the regulatory approaches would involve phasing-in of the product coverage or the development of timeframes for requiring importers to shift from less to more onerous legality compliance schemes.

Compliance and enforcement costs

A key element of measures that Australia might adopt to restrict imports of illegal logging is that in order to demonstrate that imports do not contain illegally logged timber, traders will have to ensure that products are covered by the selected legality verification scheme. This will impose costs on producers in source countries, and on importers and other players up the value chain in Australia. In order to meet its international trade obligations, Australia would also have to impose the same requirements on products sourced in Australia.

These compliance costs will have economic effects: they will lead to higher prices of timber product imports and higher costs to Australian producers. Consumers will face higher prices, and may reduce consumption of timber products and/or substitute products made from other raw materials such as aluminium or cement. Some Australian producers may expand their sales on the domestic market, but so might producers in other countries, such as New Zealand or the United States.

For the purposes of this study, compliance costs have been modelled using information from a range of sources (including stakeholders consulted in the early stages of this RIS process). They have been estimated for producers in developing countries where the risk of illegal logging is considered to be high, and for producers in developed countries where risks are thought to be low, and for each of the legality verification schemes. The estimates in appendix E also take account of how costs escalate the more complex and lengthy is the value chain. As with other key parameters, the sensitivity of results to alternative values for these costs has been carried out.

The measures will also impose costs of enforcement. Because information has not been available on the extent of costs associated with the policy options, they have not been included in the benefit cost analyses carried out for this report.


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Benefits and costs of Australian measures

The benefit cost analyses carried out for this RIS indicate that, for Australia, there is an overall net cost from unilaterally implementing import restriction and product disclosure elements.

The results also make it clear that any unilateral action taken by Australia is likely to be ineffective in reducing illegal logging because of the potential for timber products incorporating illegally logged timber to be diverted to less discerning markets and because Australia is such a small part of the global market.

The analysis indicates that applying unilateral import restrictions would only stop production of about a tenth of the products incorporating illegally logged timber currently coming to Australia. The rest would be diverted to other markets and other products (export and domestic). Because so much timber is used domestically in the country of harvest, and because much of the trade in timber flows through countries with weak or no controls on the legality of imported timber, the scope for diversion is high. Further, although it is difficult to restrict all products, if the product coverage of measures is small, illegally logged timber will flow into the non-restricted trade.

The bottom line is that because Australia’s imports account for such a small share of illegally logged timber, and restricting imports has limited effect in reducing illegal logging, Australia incurs all the costs of restricting imports without achieving commensurate benefits of reducing the damaging effect of illegal logging. This reflects the inherent difficulty of constructing measures within Australia to affect behaviour in other countries. If the United States and the European Union were also successful in restricting illegal timber imports, Australia’s effectiveness improves but not by enough to materially change the results.

The analysis shows that the measures are likely to cause welfare losses in Australia and in those developing countries from which Australia may currently be importing products incorporating illegally logged timber. However, national welfare would be increased slightly in countries such as New Zealand and the United States, whose producers would expand export sales to Australia.

The analysis also shows that options using the more comprehensive legality verification schemes, such as full certification, typically impose higher costs on Australia compared to the less extensive schemes such as verified legal origin or verified legal compliance, but also achieve high relative levels of effectiveness.

The analysis of the disclosure measure shows if it is introduced in parallel with the import restriction scheme, and only required at the point of entry into Australia, the additional compliance costs are very small. However, it is clear that the compliance costs increase (escalate) the further along the supply chain that the disclosure of information is required. Enforcement of the measure will also be more expensive if disclosure is required at the wholesale or retail trade. Depending on how the


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disclosure measure is legislated, enforcement costs may fall on state governments. Require disclosure measures at point of sale will increase the cost of compliance but will not reduce further the imports of illegally logged timber.

The sensitivity of the benefit and cost estimates to alternative values for key parameters, including the level of compliance costs, the extent of illegal logging, the responsiveness of producers to changing market opportunities has been tested and reported in this document.

Effectiveness of Australian measures: the international context

An important issue shaping the results of the cost-benefit analysis is that while Australian measures to restrict imports of products incorporating illegally logged timber can be reasonably — although not completely — effective in limiting such imports, they are much less effective in reducing the amount of illegal logging occurring in the world.

A new Australian initiative would, however, be implemented in a context where some significant importers of timber products are also putting in place measure targeting importation of illegally logged timber. This could reduce the scope for diversion of illegally logged timber. This analysis has tested whether the actions being taken or considered in the United States and members of the European Union would increase the effectiveness of an Australian restriction measure in reducing the extent of illegal logging. The results show that the effectiveness of Australia’s actions would be increased, but not enough for the benefits to exceed the costs. This is because opportunities for leakage would remain. This is not entirely unexpected because trade in timber products is only about 15 per cent of global production so a significant share of illegally logged timber (85 per cent) is consumed within the country where it is harvested. So any action aimed at trade is only likely to directly target about 15 per cent of illegal logging. It may have other flow-on effects to domestically consumed products, however, that said; even action targeted at the 15 per cent of timber products that is traded is unlikely to be 100 per cent effective in its enforcement. (It is possible, of course, that actions taken by governments in countries which are major markets for timber products may encourage a more rapid adoption of a culture of legal compliance within countries where illegal logging occurs or extensive use is made of illegally logged timber. This study has not modelled this possibility.)

Despite there being numerous forestry-related multilateral processes, there is currently no universal mechanism or plan of action in place to meet a common objective of combating illegal logging or to address the multiple drivers (corruption and capacity to enforce forestry laws) which underpin illegal logging (page 32). However, to the extent that initiatives in risk countries may eventually lead to enforcement of existing forestry laws, it will reduce the size of the problem and the


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quantity of illegal imports to Australia and therefore the need for Australia to restrict imports.

If a full — and effective — multilateral agreement were in place that included the main sources and users of illegally logged timber the scope for diversion of illegally logged timber in response to an Australian measure to restrict imports would be substantially reduced. To be effective such an approach would need to target domestic consumption as well as trade. Similarly, agreements and cooperative arrangements with developing producer countries, such as Indonesia, Malaysia and Papua New Guinea, and consumer countries, such as China, that are designed to improve forest governance, achieve sustainable forest management, forest certification and verifying the legal origins of timber products would also complement a restriction measure and increase the probability that it would be effective. This might also be true for initiatives for regional capacity building through overseas development aid. This analysis has not assessed the likely impacts of such complementary measures.

Consultation

Initial consultations for this RIS were conducted in April with about 60 stakeholders in Australia directly involved in production and trade of wood products, or in efforts to reduce illegal logging and improve the sustainability of forestry activities. An Issues Paper was prepared to introduce key issues/questions likely to influence the outcome of the RIS. One common view emerging from the initial consultation was that taking action to address illegal logging is a complex task, and that there were considerable uncertainties on what the timeframe, instruments and outcomes of the Australian policy approach would be.

Another round of consultation was based on the Draft RIS. Twenty one submissions were received commenting on the findings and methodology of the Draft RIS.

Most submissions sympathized with the initiative of the Australian government to take action on illegal logging or at least with the perception that illegal logging is an issue to be dealt with. More than half of the submissions support an Australian policy that contains elements of capacity building on forest management practices in high-risk countries, bilateral and/or plurilateral agreements to tackle illegal logging, self-regulation, quasi regulation and approaches other than regulatory ones.

There is a strong expectation in industry submissions that whatever policy the Australian government eventually decides to pursue, it should be such that it must have little or no effect on the domestic forest and wood products industry. This is because the industry is already complying with strict standards on forest management and should not be further penalized. Some industry stakeholders insisted that should it penalize them they should be compensated by the Government.


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Generally, stakeholders appeared to understand the economic analysis the RIS provided and recognize the complexity of the issues dealt with in the exercise.

Some stakeholders questioned the estimates of illegally logged timber imports and of compliance costs but none contested these with alternative data. There is concern about information not included in the analysis such as enforcement costs, value of intangible benefits and details on the government’s policy proposal.

Compliance costs

Based on the evidence and concerns raised by stakeholders, TheCIE sees no reason to change any of the compliance costs used in the Draft Report. Although considerable uncertainty is acknowledged in the Draft Report and by stakeholders over the marginal compliance costs, the wide sensitivity band used in the Draft Report is adequate to cover this uncertainty. Moreover, the available evidence on price premiums from stakeholders points directly toward compliance costs at least as high as those used in the Draft Report.

Representatives of small and medium businesses in the wood products sector indicated concern that it may be challenging for them having to comply with even softer policies than regulatory options; such as a Code of Conduct. The estimates of compliance costs presented in the Draft Report are consistent with this claim. Small firms unable to afford the costs of compliance may decrease production or be forced out of business. However, higher domestic prices that cover the low costs of compliance of large firms will induce them to expand. Large firms in Australia will be made more competitive at the cost of small firms.

Intangible costs and benefits

Although some stakeholder hold concerns about intangible costs and benefits, TheCIE sees no reason to believe that a closer examination of intangibles will change the conclusion that the benefit to cost ratio is very low and well below 1.02. TheCIE can identify a number of reasons why:

intangible benefits are likely to be small;

estimates of tangible benefits are already generous; and

several intangible and tangible costs have been omitted.

2 A benefit cost ratio below 1.0 indicates that the policy will cost the community more than it

will provide in terms of environmental, social and financial gains. The policy will therefore reduce Australia’s welfare. Economic benefit cost analysis is used to discriminate between policies/regulations/laws that will impose a net cost on Australia’s welfare (B:C < 1.0) and which should not be pursued, and policies/regulations/laws that will generate net benefits and so increase Australia’s welfare and which should be pursued (B:C > 1.0).


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On closer consideration of all tangible and omitted benefits and costs, TheCIE believes that, in all probability, it has underestimated costs and overstated benefits. This strengthens the conclusion that the benefit cost ratio is well below 1.0.

Recommendation

The analysis presented in this RIS shows that Australia faces many constraints in trying to reducing illegal logging in foreign countries by restricting imports of illegally logged timber into Australia. The main reason any Australian initiative focussed on imports will be so ineffective is due to two main facts: world trade in timber products is only around 15 per cent of world timber product production and Australia’s share of that is tiny, so Australia’s influence is equally tiny.

Any action Australia takes to restrict imports will impose costs on all products consumed in Australia. However, benefits will only relate to the tiny influence Australia has in foreign markets. In assessing the effectiveness and efficiency of any regulatory policy aimed only at restricting imports, the mathematics of the market is stacked convincingly against success. Moreover, there is no evidence that the balance of intangible costs and benefits could change this. Indeed, because the effectiveness of the policy is so small, intangible benefits will be commensurately low.

For this reason, TheCIE recommends that Australia consider only non-regulatory policy options to combat illegal logging. Capacity building is one possibility. This has not been assessed here as this was not of concern to the OBPR. Nonetheless, an advantage of capacity building options is that they are designed to tackle the problem of illegal logging at its source. That is, they are designed to change ambiguous laws and/or to see enforcement of laws closer to the source of the problem. They also act directly on domestic production, not just part of trade. At this level, Australia is likely to provide more direct leadership and to establish influence without creating reasons for retaliation or non-cooperation. It can also limit and contain costs by targeting action toward initiatives where it has a reasonable chance of success.

Bilateral and/or plurilateral agreements designed to tackle illegal logging by directly influencing the reform and enforcement of forestry laws in the country of origin of the problem may also hold promise. They too are targeting all levels of production in risk countries, not just a small amount of exports.


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1 Background

The Australian Government is considering ways to meet an election commitment concerned with combating illegal logging and associated trade by establishing systems that will promote trade in legally logged timber and, in the long term, trade in timber and wood products from sustainably managed forests.

It is intended that the policy will have five main elements, in which the Australian Government would work with regional (international) governments to:

build capacity within regional governments to prevent illegal timber harvesting;

develop and support legal and sustainable certification schemes for timber products sold in Australia;

identify illegally logged timber and restrict its import into Australia (the restriction element);

require disclosure of species, country of origin3 and any certification (the disclosure element); and

argue that market-based incentives aimed at reducing emissions from deforestation and forest degradation should be included in a future international climate change agreement.

This policy would complement other national government and industry initiatives aimed at combating illegal logging and associated trade, as well as initiatives being taken by other countries that play a significant role in trade and production of timber and timber products.

Actions to regulate the importation into Australia of timber and associated products would have a range of impacts for Australia, including increased business compliance costs to meet legality and disclosure requirements, increased costs to consumers of imported and domestically-supplied timber products and a potential decrease in the supply of imported timber products. The Office of Best Practice Regulation (OBPR) accordingly informed the Department of Agriculture, Fisheries and Forestry (DAFF) that a Regulation Impact Statement (RIS) was required to assess the impacts and efficacy of potential measures to deliver the import restriction and product disclosure elements of the policy.

3 To avoid confusion, throughout this report, ‘country of origin’ is referred to as ‘country of

harvest’.


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1.1 Our analytical approach

6 Define options and scope

5 Identify variables affecting

effectiveness of policy

Identify 4 variables affecting effectiveness of policy

7 Write issues paper, conduct initial stakeholder consultation

Assess and quantify economic and market impacts of options and conduct sensitivity tests

Assessand

quantifyrange of

likelypotentialbenefits

fromoptions to

reduce illegal logging 12 Assess, quantify enforcement and compliance costs

13 Build and use financial model to determine benefits–costs of options

and conduct sensitivity tests

14 Write draft RIS highlighting

benefit–cost analysis

15 Consult stakeholders/OBPR

17 Write final RIS with recommendation

16 Write consultation statement

1

Assess problem, size, risk, objective, rationale, existing regulation and/or experiences

2 Specify world and domestic model to trace economic and/or market impacts

3 Assess literature on environmental, social, economic costs of illegal logging

9 Quantify range of

effectiveness

Quantify 8 range of effectiveness

10 11

Source: TheCIE.

The Centre for International Economics (TheCIE) has been engaged by DAFF to prepare a RIS. As part of the RIS process, a Draft Statement was prepared for consultation with affected and interested parties. The paper was sent to 88 stakeholders. Only twenty-one submissions were received in response to the Draft. Sixty-seven stakeholders did not respond. This document is TheCIE’s final report to DAFF. It builds on the Draft by including a Consultation Report which summarises stakeholder views and offers a response to these. This report presents an assessment of the costs and benefits of a range of regulatory options for delivering the import regulation and disclosure elements of the proposed policy. It also considers the potential for achieving the underlying objectives using non-regulatory means. The RIS is designed to help DAFF determine the most effective and efficient options for meeting these objectives.


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Chart 1.1 summarises the 17 step approach adopted by TheCIE for preparing the RIS. The approach involves four stages:

clearly defining the rationale behind the policy and policy options;

economic modelling of the forestry sector;

assessing the costs (economic, environmental and social) of illegal logging and benefits of reducing it; and

bringing the first three streams together to assess the benefits and costs on a consistent basis and logically argue through the findings via a transparent reporting process to stakeholders, the OBPR and DAFF.

Methodology

The methodology for undertaking the cost–benefit analysis and the main elements considered in this process are set out in chart 1.2.

The analysis relies on existing global estimates of illegal logging. These have been used together with current trade data to estimate the volume and value of illegal timber imports to Australia.

As there is considerable uncertainty surrounding these estimates, sensitivity testing has been conducted on parameters derived from these estimates.

The analysis also uses existing literature to identify the non-market costs of illegal logging and a variety of secondary sources to estimate these costs globally.

Various regulatory and non-regulatory options for delivering the restriction and disclosure elements of the proposed policy are assessed. To assess benefits to Australia we use a global general equilibrium model of trade to estimate the global financial costs of eliminating illegal logging and compare these costs to the global non-market benefits of eliminating illegal logging. From this we can determine Australia’s potential share of these global benefits. To estimate costs to Australia we use a model of compliance costs and the global general equilibrium model to estimate the global and Australian impacts of Australia’s options to restrict imports of illegal logging. This also enables us to closely infer the reduction in illegal logging caused by Australia’s actions and the net cost to Australia and to other countries.

We use the estimates of reductions in illegal logging from Australia’s options to estimate what proportion of the global benefits of reducing illegal logging might be attributed to Australia’s policy approach. We are then able to assess costs to Australia against benefits achieved to determine the net benefits or costs from the policy.


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1.2 Methodology

Literature review on illegal logging Estimates of global non-market

benefits of eliminating illegal logging*

Global general equilibrium model (GTAP) • Most countries • Most products

including: – Forest products – Wood products – Paper/pulp

• Production/ consumption/ trade/prices

• Baseline includes current levels of illegal logging

Estimates of illegal logging globally*

Estimates of Australian illegal imports*

Options for Australia to combat illegal logging*

Model of costs of complying with options*

Estimates of global financial costs of eliminating illegal logging

Estimate of decline in global illegal logging due to Aust. options

Net financial cost to Aust/world from Australian options

Estimate of net global benefit of elimination

Benefits from Australian options

Net global & Aust benefit from options

*indicates key uncertain variables for sensitivity testing

Source: TheCIE.


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2 The problem

The motivation and rationale for the proposed policy stems from the proposition that illegal logging, and resulting trade, is a significant global problem causing environmental, social and financial harm.

Forest laws (in theory) are designed to overcome economic problems relating to the public good characteristics of forests. They aim to limit access to forest resources in order to ensure that users take account of the full social costs of exploitation. In the absence of laws and well defined and enforced property rights, logging can lead to sub-optimal environmental, social and economic outcomes. 4 And so logging that occurs in breach of these laws can also have negative impacts, not only for the localities and countries where the logging occurs, but also, in the case of losses of some environmental functions of forests, such as carbon sequestration and maintenance of bio-diversity, for the whole world.

Unclear forest tenure, weak political institutions, poverty, corruption, poor enforcement, and large financial incentives involved in avoiding the full costs of obtaining timber legally lie at the heart of most illegal logging (Seneca Creek Associates (2004)).

Preventing illegal logging is an important part of realising the full benefits to society provided by forests (along with ensuring that forestry laws are well-designed to achieve these broader benefits.) Restricting imports of products derived from illegal logging is seen as one way of reducing illegal logging and associated trade, and in effect to help enforcement of forest laws. However assessing the impact of such restrictions on reducing environmental, social and financial damage caused by illegal logging involves dealing with some complex issues.

The size of the problem

Estimates of the extent of the global level of illegal logging vary substantially, depending on the definition of illegal logging used and the methodology and

4 See the issues paper (http://www.thecie.com.au/content/news/Issues%20paper%20-

%20RIS%20illegal%20logging.pdf) prepared for this RIS for a discussion of the public good characteristics of forests, and how forest laws attempt to reduce the social, economic and environmental harm that absence of laws and the property rights they create or support can lead to. See also Bennett 2001)


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assumptions employed. At the lower end, the American Forest and Paper Association (2009), estimates that illegal logging accounts for around 10 per cent of the total global harvest, whereas Greenpeace (2009) estimates that the proportion may be up to 80 per cent in some countries.

The wide range in the estimates of the extent and associated cost of illegal logging raises the issue of the reliability and accuracy of underlying data and methodologies used to generate them. For example, the most widely cited study, Seneca Creek Associates (2004), uses data which is 6 years old and therefore may be out-of-date. It is important to take into account the relative uncertainty of such estimates when considering the impacts of illegal logging in a particular country.

Many of the estimates of illegal logging are also constructed using anecdotal evidence or limited research (due to the difficulty with obtaining up-to-date empirical data). A common approach has been to assess the overall governance of a country based on a corruption index to infer some level of illegality: the resulting proportion (percentage estimate) is then applied to all of the country’s timber harvest (Curtin 2007). A briefing prepared for Chatham House asserts that half of the logging occurring in countries judged to be at ‘high risk’ of illegal logging is illegal (Brack, 2007). The brief further estimates that illegal logging accounts for about 10 per cent of the total global timber trade, or around US$15 billion per year.

A snapshot of illegal logging in some countries

Table 2.1 presents some published data for key countries such as their share in world production of roundwood, estimated size of illegal logging, and perceived corruption.

2.1 Estimate of illegal logging in selected countries

Country

Share in world production of

roundwood (per cent)(a)

Proportion of illegal production of timber

(per cent) (b)Corruption index

(of 180 countries (c)Brazil 6.8 20-47 80China 8.2 30 72Indonesia 2.9 70-80 126Papua New Guinea 0.2 70 151Russian Federation 5.8 10-15 (northwest)

50 (far west)147

Solomon Islands 0.03 109United States 12.4 < 1 18

Sources: (a) FAO (2009, data for 2007). (b) World Bank (2006) and Seneca Creek Associates (2004). (c) Transparency International (2008).

Estimation of illegal logging exports

The most comprehensive and widely cited estimates of illegal logging production and trade are those in Seneca Creek Associates (2004) and Turner et al (2007).


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Turner et al (2007) estimated the illegal share of roundwood harvested in 2005 with three estimates for each exporting country or country group — high, low and most likely (table 2.2). Seneca Creek Associates (2004) estimated the shares of products from suspicious sources for softwood roundwood, lumber and plywood, and hardwood roundwood, lumber and plywood in 2002, which are between the high and most likely estimates by Turner et al (2007).

The data from these sources have been used to generate the starting estimates of the proportion of illegally logged timber and products from the countries and regions used in the modeling undertaken for this study.5 These estimates are presented in table 2.2.

2.2 Estimated share of suspicious wood products in exports of wood products

2005 share from Turner et al (2007) b

2002 share from Seneca Creek (2004)a Low Most likely High

Australia 0 0 0 0 New Zealand 0 0 0 0 Other Oceania 75 50 75 80 China 31 20 30 40 Japan 16 0 0 0 Korea 17 12 17 23 Hong Kong and Singapore 17 12 17 23 Indonesia 67 50 60 80 Malaysia 11 3 5 35 Thailand 17 12 17 23 Vietnam 17 12 17 23 Rest of Asia 17 12 17 23 Russia 23 10 18 40 EU15 0 0 0 0 Acceding EU10 4 7 10 13 Rest of Europe 3 0 0 0 North America 0 0 0 0 Brazil 5 13 19 25 Other Latin America 8 6 8 11 West and Central Africa 25 20 30 40 Rest of Africa 3 0 0 0 Rest of the world 3 0 0 0

a Applying Australia’s import share of hardwood and softwood roundwood, lumber and plywood. b Turner et al (2007) estimates the suspicious roundwood harvest.

5 The estimates assume that the share of softwood and hardwood roundwood, lumber and plywood in the exports of wood products of these countries is the same as the share of these products in Australia’s imports. For the purposes of the trade flow modelling, importers and exporters were separated into the 22 ‘regions’ shown in table A.1.


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Australia’s imports of wood products

In 2007 Australia imported A$8.4 billion of timber and wood products (including wooden furniture).Furniture (imports classified to chapter 94 of the Harmonized System (HS) of trade nomenclature — HS94, which also includes non-wood products) is the biggest component, valued at almost A$3 billion (35.5 per cent), followed by paper and paperboard (HS48) at A$2.8 billion (33 per cent), wood (HS44) at A$1.2 billion (14.8 per cent), and cork (HS45), straw (HS46), pulp (HS48) and publication (HS49) at A$1.4 billion (17 per cent).

Sources of imports

In 2007, 26.7 per cent of Australian imports of timber and timber products were from China, with 22.3 per cent coming from EU-15 group of countries, 10.3 per cent from New Zealand, and 7.9 per cent from the United States. China’s share has grown from just 4.7 per cent in 1994 to 26.7 per cent in 2007. The ten countries/regions with the largest shares of Australian imports accounted for 86.3 per cent of total imports in 2007.

The commodity structure of Australia’s imports varies considerably across the source ‘regions’. For example, in 2007 over two thirds of timber imports from China were furniture, while over 90 per cent of imports from South Korea were paper and paperboard.

Proportion of Australia’s timber product imports might incorporate illegally logged timber

Turner et al’s low and most likely estimates suggest that around 8-12 per cent of Australia’s imports of timber products could contain illegally logged timber. These are consistent with direct estimates for Australia of approximately 9 per cent or A$400 of imported forest products and wooden furniture (Jaakko Poyry, 2005).

Australia’s influence in world trade

World trade in timber and wood products appears to be around 15 per cent of world output by value. Australia’s imports of timber products account for a very small share of world exports, and an even smaller share of world output. Consequently, its importation of products incorporating illegally logged timber is also small, as the following summary shows:

World production of timber products (excluding furniture) is estimated to be around US$1 trillion a year.

World exports of timber products (excluding furniture) is around 15 per cent of this:

– this is valued at around US$150 billion


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– (approximately 10 per cent of this, worth US$ 15 billion, incorporates illegally logged timber).

Australia’s imports of these products is estimated at:

– A$4.4 billion;

– equivalent to around US$ 3.75 billion or 0.375 per cent of global output and 2.5 per cent of global trade.

Australia’s imports of product incorporating illegally logged timber is estimated at A$400 million which is equivalent to around US$340 million, or 0.034 per cent of global production and 0.34 per cent of estimated global production of timber products incorporating illegally logged timber.

When furniture is also considered, Australia’s share of total global production is 0.3 per cent.

Costs of illegal logging

There is a range of economic, social and environmental costs associated with illegal logging. Illegal logging involves waste and reduction in aggregate national welfare in the source countries, and imposes global costs.

Table 2.3 summarises the main financial, social and environmental effects associated with illegal logging. Financial effects are generally market related while social and environmental effects can be considered as non-market effects. The OBPR guidelines require that both market and non-market effects and impacts be taken into account when a RIS is being prepared.

2.3 Impacts of illegal logging

Financial Social Environmental

Loss of revenue for governments and legal producers of timber

Distortion of global prices of timber

Losses of non-wood forest products

Illegal logging also results in a number of economic transfers associated with: lower prices of timber and timber

products income from logging and

transport operations non-payment of taxes by illegal

loggers.

Displacement of forest-dependent communities from their livelihoods, cultural identity and spiritual values

Challenges to law and order and encouraging arbitrary (corrupt) exercise of power from government officers

In some countries illegal harvesting practices have been linked to funding of armed conflicts.

Waste of resources in pursuing gains from illegal logging.

Illegal logging that leads to a net loss of forest resources causes a number of environmental problems: Loss of biodiversity Removal of important carbon

sinks which also compounds global warming

Soil and water degradation which could lead to erosion, reduced water quality, landslides and avalanches

Loss of future resource

Source: TheCIE.


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Financial costs of illegal logging

The literature offers estimates of the extent of the main financial effects attributed to illegal logging.

Seneca Creek Associates (2004) estimate that illegal logging depresses global prices of timber. Turner et al (2007) estimate that world wood product6 prices would increase if illegal product were eliminated. Their estimates show that production in Asia, South America and Russia would decline but it would increase for countries and regions such as the USA, the EU, Australia, New Zealand and Finland, where the occurrence of illegal logging is considered to be small. That is, there would be a switching from illegal to legal logging (switching would also occur in countries where illegal logging is prevalent). Overall, Turner et al (2007) estimate that global production of wood and wood products would decline in the short term if illegal logging were eliminated.

The World Bank (2006) estimates that illegal logging in developing countries causes losses in assets, and industry and community revenue streams, in excess of US$10 billion per year. The World Bank also estimates that some US$5 billion of logging tax and royalties is evaded each year.7

However these estimates do not capture all of the financial consequences of illegal logging, as they ignore the wider economic impacts on downstream users and consumers and some other trade-offs.8 Modelling undertaken for this study, of the financial consequences of illegal logging at current levels using a comprehensive general equilibrium global trade model (details of the modelling are presented in appendices B and C) gives the following results:

Producers of legal forest products in non-risk (high cost) countries like the United States, Europe and New Zealand are around US$15 billion a year worse off due to reduced production, lower prices and lost trade opportunities caused by illegal logging;

High cost legal producers in risk countries9 such as China, Indonesia, Russia and Malaysia receive profits and income that are around US$31 billion lower than they would be without illegal logging.

6 Refers to industrial roundwood, sawn wood, wood panels and wood pulp. 7 Strictly speaking these are transfers of wealth rather than losses of wealth. 8 Only partial equilibrium models were used. 9 The risk countries and regions include Oceania (excluding Australia and New Zealand),

China*, Korea, Hong Kong, Singapore* (Not a big forested country — may be a ‘source’ versus ’origin’ issue), Indonesia, Malaysia, Thailand, Vietnam, the rest of Asia, Russia, the 10 acceding members of the European Union, Brazil, Other Latin America, West and Central Africa. (* Indicates countries with significant transhipment.)


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On average, total production of wood products is about 3 per cent higher than it would be without illegal logging (illegal logging accounts for 10 per cent but legal logging is 7 per cent less than it would otherwise be), and consumption of timber substitutes is lower than it would otherwise be (without illegal logging, consumers would switch to substitute such as steel, concrete and aluminium).

The implication of this analysis is that illegal logging imposes financial costs on those involved in legal logging of around US$46 billion a year. Prices to consumers and down-stream users of wood products are about 3 per cent lower than they would otherwise be, and average prices in developing countries are more than 8 per cent lower than they would otherwise be.

Social and environmental (non-market) costs of illegal logging

Various international organisations have estimated some of the social and environmental costs of illegal logging (see, for example, World Bank 2006 and FAO 2005). The European Commission has commissioned studies that have tried to quantify the costs of biodiversity loss. Other estimates in the literature provide a basis for homing in on the possible magnitude of social and environmental costs borne by the world as a result of illegal logging. Drawing on these sources, it has been possible to construct estimates of the costs of six types of non-market social and environmental impact of illegal logging (see appendix C for the methodology and assumptions employed):

Loss of non-wood forest products Illegal logging can result in the loss of non-wood forest products such as animals, food, fruit, and plants. It is estimated that the loss of non-wood forest products due to illegal logging could be around US$0.86 billion annually.

Resources wasted in pursuit of gains from illegal logging Although much of the impact of illegal logging may be the illegal transfer of assets and income from the legal owners to loggers, real economic costs may be imposed from the waste of resources used to effect the illegal transfer. This includes the resources used in corrupt behaviour and in suppressing efforts by communities and law enforcement agencies to stop predation. For illegal logging, this transfer includes the value derived from the timber that is illegally logged, and the taxes and other payments that should have been made to the government. We estimate the value of resources wasted in bringing about and securing this transfer — the direct economic costs of illegality — to be around US$7.5 billion annually. (Inasmuch as illegal logging contributes to broader problems with governance, there may be additional costs, but there are complex issues of causality that make quantification very problematic: for example is illegal logging a cause or effect of poor national governance?)

Displacement of forest communities Deforestation can potentially displace subsistence communities from their


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livelihoods, cultural identity and spiritual values. About 60 million indigenous people are fully dependent on forests for their livelihoods (FAO 2007c). Quantifying the costs of displacement of forest-dependent communities caused by illegal logging requires that some consideration be given to the extent to which these groups’ forests would have been at risk from legal logging or land clearing activities anyway, which might be occurring due to the land pressures associated with broader demographic pressures and economic development. (The fact that logging complies with the law does not mean that indigenous communities will not face costs because of losing access to the amenities that affected forests provide.) One way of placing a value on these costs is to estimate how many people may be displaced each year by illegal logging, and use estimates of expenditure on relocation outlays made in donor supported relocation programs designed to compensate communities for the loss of amenities associated with their move. Using a relocation cost estimate drawing on actual experience in donor-funded projects, we have estimated the loss associated with community displacement caused by illegal logging to be of the order US$6.6 million a year.

Costs of greenhouse gas emissions Increased greenhouse gas emissions and reduced carbon absorption are considered to have global impacts on the climate that imposes real costs on the world. There are many uncertainties surrounding the cost of greenhouse gas emissions caused by illegal logging operations. However we have estimated that US$43 billion annually is a plausible representation of the cost of greenhouse gas emissions caused by illegal forestry activities.

Costs associated with loss of ecosystem services and biodiversity Illegal logging can impose costs on society because of the loss of ecosystem services provided by forests, in particular through loss of biodiversity. Annual loss of ecosystem services species and flora and fauna in forested biomass due to land use change has been estimated at €28 billion (say US$45 billion a year) (Braat and Brinks 2008). Using a similar process to estimating green house gas costs we estimate that illegal logging might be imposing costs due to loss of forest ecosystem services of around US$4.5 billion a year.

Soil and water degradation Forests influence the chemical composition of underground water and affect rain patterns. The effects of forests filtering and regulating water flows can be lost with deforestation and landslides and avalanches can occur. Reduction of forests affects the productivity, temperature and humidity of the soil. According to the FAO (2007b) mismanagement of woodlands in humid and subhumid tropical countries significantly contributes to soil losses equivalent to a 10 per cent loss of agricultural gross domestic product (GDP) per year. We estimate the costs of soil and water degradation caused by illegal logging to be around US$5 billion annually.


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The derivation of these estimates is discussed in appendix C. It should be noted that in some cases, it is hard to be certain what the underlying cost estimate actually covers, although all such estimates have been taken from internationally or domestically reputable sources. In some cases, the estimate of underlying cost is rather indirect, using a measure of what society might be prepared to pay to achieve a reduction in the costs, or upper bounds based on assumptions about the behaviour of firms and individuals engaging in illegal logging.

Costs of removing illegal logging to consumers

The modelling that generated the estimates of the financial costs of illegal logging imposed on legal producers’ losses also indicates that in the absence of illegal logging:

It would cost consumers and down-stream users of wood and wood products in low risk countries and regions (such as the United States and the European Union) an extra US$12 billion a year to buy their wood products due to having to pay higher prices— in response they would reduce consumption of these products and switch in part to other products made of substitutes.

Producers, consumers and downstream users of illegal forest, wood and paper products in risk countries such as China, Indonesia, Russia and Malaysia would have profits and income about $80 billion lower than would otherwise be the case10. Exactly how this $80 billion is distributed between producers, consumers and downstream users will depend on many variables including whether illegal products sell at discounts to legal products. To the extent they might, consumers and downstream users may be bigger beneficiaries than producers.

Total costs of illegal logging

Table 2.4 summarises the estimates of the various costs associated with illegal logging. The non-market costs associated with illegal logging are estimated to be of the order of US$60.5 billion a year. The financial costs to legal producers around the world are estimated at US$46.0 billion a year, but these are more than offset by the fact that without illegal logging, consumers in the developed world would be worse off by around US$12 billion a year, and that in source countries consumers and producers of illegal timber and products using it would be worse off by US$80 billion a year. So the net cost to the world associated with those impacts included in the estimates is US$14.5 billion a year. Australia’s consumption of imported products incorporating illegal timber accounts for around 0.34 per cent of this cost.

10 It is important to note that the illegal logging confers a net financial benefit to high risk

countries and regions of around US$49 billion a year.


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2.4 Estimates of costs of illegal logging Source Estimate

$ billion a year

Financial costs/benefits

Losses to legal producers 46.0

(less financial gains to consumers and those involved in illegal logging) -92.0

Total financial costs -46.0

Non-market costs

Social costs

Loss of non-wood forest products <1

Wasted resources 7.5

Displacement of forest communities <1

Environmental costs

Greenhouse gas emissions a 43.0

Loss of ecosystem services (biodiversity) 4.5

Soil and water degradation 5.0

Total non-market costs 60.5

Total costs 14.5a Midpoint based on a range of estimates using different values placed on emissions of greenhouse gases and on the share of emissions caused by deforestation (see appendix C). * May not add exactly due to rounding errors.

Source: TheCIE calculations.


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3 Regulatory and non-regulatory policy options

The OBPR has indicated that a RIS is required to assess the impacts and efficiency of potential measures to deliver the import restriction and product disclosure elements of the proposed policy for combating illegal logging and associated trade. In doing so, the RIS should consider whether the underlying problem might be best addressed by alternative approaches to regulation, ranging from self-regulation by Australian operators, through to quasi-regulation and co-regulation to black-letter law approaches.

The RIS has to address the complexity of the factors potentially impacting on the effectiveness of import restrictions and product disclosure requirements in contributing to the overall objective of the policy. At the same time, consideration of the findings of the RIS has to recognise that measures aimed at these elements will be implemented in the context of complementary actions taken by the Government with respect to the other three elements of the policy as outlined in chapter 1. As such, the RIS is looking at a range of regulatory import restriction and product disclosure options to be used in conjunction with Australia’s non-regulatory efforts to combat illegal logging by encouraging the enforcement of forestry laws in other countries.

Further, the effectiveness of the measures may be enhanced because other governments are introducing measures to restrict their country’s imports of products incorporating illegally logged timber, and to help with the construction and enforcement of laws in source countries. Most wood producing countries are improving their systems of forestry governance and timber suppliers are introducing timber legality assurance and chain of custody schemes.

This chapter discusses the potential mechanisms that suppliers could use to verify the legal origins of timber products based on their compliance with forestry laws, the range of products to be targeted, and the potential regulatory options available for government enforcement of the import restriction and product disclosure elements of the new policy.

Context for the policy

At the present time the Australian Government is using bilateral agreements on forestry with countries in the Asia-Pacific region and multilateral processes


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combined with capacity building to support efforts for combating illegal logging and associated trade. It may be possible to enhance each or all of these activities as part of the Government’s overall policy response, in association with the import restriction and product disclosure elements. Further, initiatives being taken or contemplated by the United States and the European Union which provide examples of alternative approaches to the problem will also affect the way in which Australian measures might impact on illegal logging and associated trade.

Multilateral processes

Multilateral processes seek common agreement through a convention or other internationally agreed instrument on the mechanisms for achieving a common objective such as combating illegal logging or improving forest management. In the case of illegal logging and sustainable forest management, Australia participates in multiple forums. The United Nations Forum on Forests (UNFF) has an agreed objective to combat illegal logging and the United Nations Commission on Criminal Prevention and Criminal Justice (UNCCPCJ) has focussed on reducing illicit trafficking of timber products.

A process aimed at combating illegal logging in the East Asia Pacific region (East Asia-Pacific Forest Law Enforcement and Governance, EAPFLEG) was established in 2001 but has been inactive for over 18 months. The United Nations Framework Convention on Climate Change (UNFCCC) is seeking to reduce greenhouse gas emissions and has noted the importance of enforcing forestry laws (which may be interpreted to include the combating of illegal logging).

However, despite there being numerous forestry-related multilateral processes, there is currently no universal mechanism or plan of action in place to meet a common objective of combating illegal logging or to address the multiple drivers (corruption and capacity to enforce forestry laws) which underpin illegal logging.

Bilateral processes

Bilateral forestry agreements between countries can be employed to support cooperation in sustainable forest management and improve the systems of governance that could be used to verify the legal origins of timber products. These elements are captured in Australia’s existing bilateral forestry agreements with countries such as Indonesia and Papua New Guinea. Governments use these bilateral agreements to accelerate the reform processes underpinning the changes in governance and law enforcement required to effectively combat illegal logging and associated trade.


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Capacity building program

One of the options for achieving specific outcomes and targeted reforms is for governments to invest in capacity building activities in the developing timber producer countries. Examples include official aid from developed countries to fight corruption and improve the institutional and governance frameworks associated with forestry.

Phase I of the Australian Government’s Asia-Pacific Forestry Skills and Capacity Building Program contributed to these efforts by supporting the training of forest managers in forestry certification, and promoting the application and use of legality verification and certification schemes to demonstrate compliance with forestry laws. That is, assisting forestry managers to establish the systems for verifying the legal origins of timber products.

International initiatives

If Australia were to adopt import restriction and product disclosure measures on its own, this would represent a unilateral approach to achieve its policy objective. There is a risk, assessed in later chapters, that a unilateral approach may impose costs on Australia with limited effectiveness in reducing illegal logging and associated trade because trade in illegal product may be diverted to other markets. However the options proposed for the restriction (and disclosure) element(s) may interact positively with the initiatives of other importing countries. The combined effect of these efforts, by bolstering requirements for governments in producer and consumer countries to verify the legal origins of timber products, will reduce the potential for trade to be redirected to markets with less onerous requirements.

The US Lacey Act amendments and the ‘due diligence’ regulation being considered by the EU represent two such processes for combating illegal logging and encouraging enforcement of forestry laws in producer countries. Indonesia is implementing a Timber Legality Assurance Scheme (TLAS) scheme as part of its Voluntary Partnership Agreement (VPA) with the EU, and Association of South East Asian Nations (ASEAN) is currently developing a TLAS for its member countries. As national and international initiatives proliferate, it is anticipated the additional costs for timber producing countries to comply with Australia’s requirements will be reduced, as long as those processes continue to develop in a consistent way. A multilateral agreement for verifying the legal origins of timber products would further enhance the capacity of these initiatives to achieve their objectives.

Regulatory options for the restriction and disclosure elements

Regulatory options that could be employed to achieve the import restriction and disclosure outcomes sought by the Australian Government might include using


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quasi-regulation, co-regulation or explicit regulation policy in conjunction with one or more of the non-regulatory processes.

Self-regulation — existing industry arrangements

In recent years, as the impacts of illegal logging and associated trade have become of wider public concern, Australian importers have increased their efforts to source legal timber and wood products, with some enterprises able to provide credible assurances of the legality of their products. However, a substantial number of importing firms still do not seek any legal verification of their products under voluntary arrangements. Industry-wide willingness to comply with a voluntary arrangement is an important factor to consider when assessing the potential effectiveness of regulatory policy options to combat illegal logging and associated trade.

The current legality verification approaches adopted by Australia’s timber and wood products importers (and domestic producers) include a mix of voluntary industry guidelines, legality verification schemes, codes of ethics and procurement policies. These instruments are employed by industry on an ad hoc basis to guide their purchase decisions and to assess potential risks that products might be derived from illegally harvested sources. There is no reported assessment of performance of any of these instruments and therefore no way of assessing their effectiveness. However, the restriction and disclosure elements adopted by the Government could build on these existing systems and processes.

Quasi-regulation

Quasi-regulation includes a wide range of rules or arrangements where governments influence businesses to comply, but which do not involve government regulation. Some examples of quasi-regulation include industry codes of practice developed with government involvement and guidance notes or industry–government partnership agreements and accreditation schemes.

An example of government/industry co-operation under quasi-regulation could be the development of a draft code of conduct for timber product importers. Such a draft generic code is currently being developed for Australian importers by the Timber Development Association of NSW. Such a code should assist companies along the supply chain to demonstrate the legality of their products. Legality verification guidelines for importers purchasing timber from PNG and Indonesia (currently being prepared with funding from phase 1 of the Asia-Pacific Forestry Skills and Capacity Building Program) could assist importers to understand the risks of sourcing illegally-harvested products and the verification schemes available to demonstrate legality.


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Co-regulation

Co-regulation typically refers to the situation where industry develops and administers its own arrangements to demonstrate the legality of its product, but government provides legislative backing to enable the arrangements to be enforced. This is known as the ‘underpinning’ (through legislation) of codes, standards and other forms of legality verification schemes.

Explicit government regulation

Explicit government regulation, prescribing a standard to be met, is the most commonly used form of regulation to achieve the objectives of government policy. In this case, regulation would prescribe the requirements for verifying that timber products have been legally sourced.

Factors to consider in designing the regulatory options

Design of any of the regulatory options outlined above requires a consideration of:

the definition of legality to be employed;

the range of products to be covered;

mechanisms for demonstrating compliance with forestry laws;

enforcement of regulatory options for the restriction and disclosure elements;

penalty regimes for non-compliance with the restriction and disclosure elements; and

international trade agreement implications.

Definition of legality

In its 2007 election commitment, the Government defined illegal logging as occurring when timber is: stolen; harvested without the required approvals; bought, sold, traded or processed in breach of law; or authorised for harvest or trade through corrupt practices. However, to restrict the importation of illegally-logged timber it will be necessary to differentiate between legally and illegally harvested timbers. Legality of product may be demonstrated through the use of credible timber legality verification and chain of custody schemes that provide proof of compliance with the applicable laws of the country of harvest.

Product coverage

The US Lacey Act Amendments provide an indication of how product coverage may be phased in over time to enable importers and their suppliers to comply with new regulatory requirements. For the purpose of this analysis, three product categories are proposed for Australia’s policy response, based on the complexity of their


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components (for example, sawn timber versus furniture) and of their supply chain (single versus multiple input sources) (table 3.1).

The Australian Government could choose any or all of these categories as the range of products to be targeted by the restriction and disclosure elements, or could seek to target category I products in the first instance and provide a time frame for phasing in the coverage to include category II and/or category III products.

Category I covers about 12 per cent of Australia’s current timber imports.

Category II covers about 39 per cent of Australia’s current timber imports.

Category III covers 70 per cent of Australia’s current timber imports.

The remaining timber product categories not included in this analysis are those products in which the timber and wood component is difficult to identify and therefore regulate (for example, wooden tool handles, composite products containing wood and other materials).

3.1 Proposed product categories for regulation

Category I Category II Category III

Solid timber and wood products and some paper products

Partially processed/processed timber and wood products

Complex products – e.g. highly processed/composite timber and wood products/from multiple sources

Wood in rough (4403) Sawn wood (4407) Plywood (4412) Newsprint (4801) Printing & writing (4802-03; 4808-11; 4823)

Category I plus

Particleboard (4410) Fibreboard (4411) Mechanical (4701) Semi-chemical (4705) Chemical pulp (4702-07)

Categories II plus

Household and sanitary (4803, 4818) Packaging & industrial (4804-08, 4810-11, 4823) Paper manufactures (4811-23) Most furniture (9403*) Veneer (4408) Casks and barrels (4416) Other articles of wood (4421) Continuously shaped wood (4409)

*Relates to 940330 Wooden furniture of a kind used in offices, 940340 Wooden furniture of a kind used in the kitchen, 940350 wooden furniture of a kind used in the bedroom and 940360 Other wooden furniture. Note: Number in parentheses is harmonised system tariff codes. Source: TheCIE.

Mechanisms for demonstrating compliance with forestry laws

The Australian Government could recognise different off-the-shelf legality verification and chain of custody schemes to demonstrate compliance with forestry laws. These schemes range from self-declaration of legal origin, through to verification of legal origin, verification of legal compliance, and full certification.


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Self-declaration

Self-declaration of legal origin requires suppliers to provide evidence that all timber products are legally sourced. They could be required to provide, for example, credible documentation to demonstrate that a forest manager holds a right to harvest, has paid all royalties, taxes and fees and has complied with all legal trade and export procedures. This level of legal compliance is termed SDL (self-declared legal).

A higher level of compliance using the verification of legal origin, legal compliance, or full certification schemes would require the use of existing schemes and an acceptable standard of auditing of compliance against their particular requirements to provide a credible level of assurance that timber was obtained from legal sources.

Verified legal origin

Verification of legal origin would cover compliance with forestry laws including right to harvest, forestry practices and payment of taxes and royalties using a formal standard or scheme. This form of legal verification is termed VLO (verified legal origin).

Verified legal compliance

Verified legal compliance covers all forestry and trade laws in the source country, which include requirements for compliance with harvesting rules, codes of practice and observing indigenous rights and meeting social obligations. This form of legal verification is termed VLC (verified legal compliance) and represents a greater level of legality assurance than exists for SDL or VLO.

Full certification

Full certification relates to compliance with all forestry and trade laws including environmental, social and economic regulations. This level of legality verification represents the highest tier achievable and may be considered equivalent to legal and sustainable forest management. It is termed FC (fully certified).

Self-declaration and schemes for VLO, VLC, and FC only verify the legal origins of harvested timber up to the forest gate. Chain of custody schemes are required to provide a verification of legality for timber products as they move along the processing and product supply chain to the end user.

In each case, auditing of compliance with the legality verification schemes could be undertaken by first (self), second (government or industry organisations), or third party (independent) auditing (with levels of rigour and independence associated with the auditor’s auditing processes which might vary according to whether


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industry accredited auditors or auditors accredited by an international body were involved).

The Government could consider implementing the above legality verification requirements under the restriction element using a phased approach, depending on the capacity of both domestic producers and exporters in producer countries to comply with the proposed requirements. A timeframe could be identified for implementing these requirements across the range of SDL to VLO, VLC, and possibly FC.

A phased approach for the enforcement of legality verification requirements could also sit over the top of a possible phasing-in of timber product categories covered by the restriction element, as described earlier, to minimise the economic impacts or unnecessary trade impacts and any possible unintended consequences of compliance.

Regulation in the form of quasi, co- or explicit regulation could then rely on these processes and product coverage as previously described.

Enforcement of regulatory options for the restriction element

Quasi-regulation

Under quasi-regulation industry could establish its own code of conduct (designed in accordance with the government’s policy objective) and manage its enforcement. The government could establish a suitable timeframe for implementing this option and expectations of how it should provide an effective regulatory measure in terms of the proportion of industry that becomes a signatory to the code, the strength of the compliance auditing regime, and the performance of industry in complying with the code.

It might be suggested that this option would be relatively ineffective. However, the incentive for industry sign-on and effective compliance auditing would be the potential for the government, in the event that this approach was ineffective, to mandate that all importers and domestic producers have to be signatories to the code to be able to market their products within Australia. In effect, this would shift this quasi-regulation option to a co- regulation or explicit regulation instrument.

Co-regulation

Under a co-regulation option, the government would legislate which standard of legality verification from the four compliance levels (SDL, VLO, VLC, or FC) would be acceptable for providing an adequate assurance of legal origin.


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Explicit regulation

Under an explicit-regulation approach the government would legislate, as for co-regulation, but prescribe the legality verification compliance schemes industry should use to demonstrate an acceptable level of assurance. These would impose additional costs on industry and government including the need for having a regular review of schemes to be accredited as adequately verifying the legal origins of timber products or meeting the increased legality verification requirements.

Due diligence

Another option for government regulation may be to establish legislation for due-diligence requirements. This could take the form of a positive measure whereby importers (and domestic producers) are required to undertake a due diligence assessment of risk over the legal origins of their timber products. On the basis of that assessment, importers and producers would determine which of the available SDL, VLO, VLC, or FC schemes should provide adequate evidence of product legality. The Government’s role under this option would only be to legislate the requirements for the due diligence assessment.

An important distinction between this regulatory option and the co-regulation and explicit regulation options is that a due diligence regulation would require the government to assess:

the adequacy of the due diligence process used by importers and domestic producers to determine the level of risk of sourcing illegal timber products;

the actual level of risk of timber products being illegally sourced; and

whether the legality verification schemes selected by suppliers adequately addresses the risks to avoid acquiring illegally sourced product.

Enforcement of options for the disclosure element

The regulatory options for the disclosure element might include voluntary labelling or a government specified requirement that includes disclosure of species, country of harvest and any certification at a particular point along the supply chain. Its enforcement could be partially addressed through collection, assessment and verification of relevant information at the border and linked to existing procedures employed by the Australian Customs Service, Australian Quarantine and Inspection Service (AQIS) and the Convention on International Trade in Endangered Species (CITES) procedures under the EPBC Act. This information could be provided to importers and suppliers using their legality verification and chain of custody schemes. However, the election commitment is to enforce this requirement ‘at point of sale’.


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Substantial costs might be associated with the provision and collection of this information for both government and industry. Some products such as sawn timber are likely to involve a simple supply chain, while furniture and particle board may incorporate several species and places of origin for the timber products utilised in their manufacture. Importers such as IKEA (2008) have indicated, in a submission on the disclosure requirements for the US Lacey Act amendments, that they will be challenged by the significant amount of record keeping in that regard.

It might be possible to have the enforcement regimes for both the restriction and disclosure elements managed as part of a single process. Using a single enforcement regime for the two elements, might mean that the data collected for the disclosure element assists with enforcement of the restriction element.

Penalty regimes for the restriction and disclosure elements

Consideration will need to be given to the penalty regime for non-compliance with each regulatory option. Industry could develop its own sanctions for non-compliance under a code of conduct in the case of quasi-regulation. For the government’s regulatory options, decisions would have to be made on the level of penalty applied.

Proposed penalty regimes would need to take into account the management and associated costs of seizing products that arrive without appropriate documentation versus those that have been identified as sourced from illegally harvested forests, including:

whether they would be held at importers cost until the required documentation is provided;

how they would be disposed of either through destruction or re-export, if the required documentation cannot be provided;

the level of sanction to be imposed such as a warning for a first offence, a fine for a second offence, and more substantive penalties for continued non-compliance; and

the possible imposition of felony charges if timber is determined to be knowingly obtained from illegal sources.

Post-border compliance and enforcement checks could include random audits by the government once cleared shipments have been released by Customs. This might require establishing a government/industry partnership for post border inspections, similar to existing processes, which build on the post-border enforcement regimes for timber product imports currently implemented by the Australian Government agencies noted above. These government enforcement procedures might be complementary to industry’s own enforcement regime applied under a code of conduct (as described by the quasi-regulation option).


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International trade agreement implications

Australia’s longstanding position has been to ensure that trade and environment policies are developed and implemented in a mutually supportive way. That is, policies will be developed to address legitimate environment concerns in an effective manner while at the same time preserving our interest in maintaining an open international trading system.

Efforts made by Australia to address illegal logging could be greatly enhanced through effective cooperation with both timber-producing and timber importing countries. In relation to illegal logging policy, the Government will need to ensure that whichever regulatory measures are adopted not only achieve the stated objective, but are also consistent with Australia’s international trade obligations.

Illegal logging regulatory options examined in this RIS

The ultimate objective of the policy is to promote trade in timber products from sustainably managed forests, but the emphasis of the framework under consideration is on restricting the importation of illegally logged timber. Accordingly, a strategy for progressively shifting towards the more demanding levels of legality verification (that is, VLO to VLC to certification) might be a way of targeting the ultimate objective in the medium term. Using a phased approach, it might be possible to move in a systematic way from an emphasis on relatively simple aspects of legality through to eventual certification of timber products from sustainably managed forests. This way, legality verification could provide a logical stepping stone towards measures targeting sustainable forest management practices. A phased approach to legality verification could be assisted by phasing-in the range of products covered by the restriction measure, and be assisted by the disclosure measure requirements.

A number of regulatory and non-regulatory options, and possibly a combination of these, are available to the government to achieve its policy objective. The cost–benefit analysis will indicate the relative efficiency of alternative regulatory approaches to meeting the Government’s objective.

Examining the costs, and subsequently the cost–benefit outcomes of these options requires a multi-dimensional examination in the draft RIS of the:

products to be covered;

legality verification compliance regimes available to industry and government; and

potential phasing from less to more onerous legal verification schemes, taking into account domestic and producer countries’ capacity to comply with the requirements of such schemes.


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The regulatory options for the restriction element are summarised in table 3.2. This summary indicates whether there could be a phasing-in of the product categories covered by each measure, whether legislation is required to support implementation of the regulatory options, if there might be a phasing from less to more onerous legality compliance regimes over time, and whether industry or government would be responsible for enforcing the regulatory options.

3.2 Key elements of the regulatory options analysed in this draft RIS

Regulatory option Phasing product coverage

Legality, verification compliance

Phasing compliance

options

Enforcement regime

Self - Current systems - Industry

Quasi-regulation + Code of conduct - Industry

Co-regulation + Legislate + Government

Explicit regulation + Legislate + Government

Due diligence + Legislate - Government

Note: The regulatory options could utilise the SDL, VLO, VLC or FC schemes. The pluses and minuses indicate whether it is likely that the regulatory approaches would involve phasing-in of the product coverage or the development of timeframes for requiring importers to shift from less to more onerous legality compliance schemes. Source: TheCIE.

The modelling approach and costs of compliance with the legality verification options are outlined in chapters 4 and 5. A cost–benefit analysis is presented in chapter 6 and an assessment of the possible effectiveness of the regulatory options for achieving the government’s objective in chapter 7.

Additional matters to be considered around the regulatory and legality verification compliance options available to industry and government are the costs to government for administering the policy response and the potential use of non-regulatory measures.

Australia’s participation in bilateral and multilateral processes, maintaining consistency with plurilateral processes during the design of regulatory options and the possible use of capacity building to assist other countries with their enforcement of forestry laws would all be expected to influence the costs and benefits of the government’s final regulatory response.

Because the regulatory options do not deal directly with the causes of illegal logging, their effectiveness in reducing the phenomenon is inevitably constrained. Complementary initiatives measures targeting the underlying causes and fostering greater legal compliance in countries where illegal logging and use of illegally logged timber is prevalent could increase the effectiveness of Australian import restriction and other domestic regulatory measures. But if complementary initiatives were successful, there would be less of a problem for the Australian measures to influence, and less of a case to impose the burdens of additional regulation.


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4 Approach to modelling policy options

In chapter 2, we used the Global Trade Analysis Project (GTAP) model (see appendix A) to assess who would be better off and who would be worse off if there were no illegal logging, and how large these effects might be. The analysis did not consider how illegal logging might be eliminated, nor what the costs of compliance and enforcement of policies to achieve this outcome might be.

Chapter 3 considered ways in which the Australian Government’s policy approach could be implemented through a phasing of product coverage (from category I to III) and adopting a range of increasingly stringent systems of legality verification (from SDL to FC) over time. It was also pointed out that levels of disclosure could be made more or less demanding.

In this chapter we summarise how we have modelled the costs of compliance on businesses and the global and domestic economies from verifying the legal origins of timber products. The modelling of verification of legally-sourced timber products uses a combination of the three product categories and four legality verification options described in chapter four. The potential compliance costs of extending disclosure are also discussed. Estimates for the cost of quasi regulation, co-regulation and explicit regulation options will be interpolated from the legality verification modelling outcomes.

Table 4.1 summarises the elements of legality compliance covered by each of the VLO, VLC, and FC compliance schemes, and illustrates how the coverage increases across the spectrum of these schemes.

4.1 Compliance requirements for SDL, VLO, VLC and FC schemes

Compliance standards

Compliance elements SDL VLO VLC FC

Tenure/use rights/responsibilities (Minimum*) Compliance with national laws Indigenous people’s rights Community relations/worker rights Environmental impact Forest management plan Monitoring and assessment systems

* This would be a minimum requirement. Source: TheCIE.


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Impacts of compliance costs on willingness to supply

Having to comply with the requirements to achieve legal verification will impose direct costs on business. Importers will need to demonstrate that the products they are bringing in are legally produced and meet the government’s prescribed standards. In order for Australia to comply with its international trade obligations, comparable efforts to address illegal logging would be required for domestic suppliers. This may increase the compliance costs for smaller Australian producers depending on the measures employed.

The increases in costs imposed will affect the willingness of producers and importers to supply to the Australian market. This willingness to supply will determine the economic impact of the policy. In general, willingness to supply will vary across three groups of producers.

Producers who are already compliant with the standard or are progressing toward it will face very small additional costs other than potentially small increases in paper work to provide proof to Australian importers or wholesalers that they are compliant. This group will be largely unaffected and are likely to continue to supply to the Australian market.

Producers who are highly reliant on illegal sources of timber or who are engaged in other illegal activities will face very high costs of compliance. Essentially, to become compliant, this group will need to abandon their cheap sources of timber supply or other illegal activities. This will cost them dearly. That is, it will impose a high opportunity cost on them to meet the required standard and to provide proof of legality. In effect, they face a prohibitively high cost of compliance. In the main this group will not be prepared to pay the high costs required to comply and they will cease supplying the Australian market.

Producers who are either mostly already compliant but as yet have no proof of compliance will potentially be able to meet the required standard but may resist doing so owing to a moderate cost impost of achieving and proving it.

– Some may respond by no longer supplying the Australian market to avoid the compliance costs.

– Others could be responsive to the import restrictions if higher prices are received for legally verified products in Australia. They may decide to invest in meeting the standard and trying to recoup some of the additional costs from Australian consumers.

Factors affecting compliance costs

Systems for verifying legality of timber products vary according to the definition of legal applied and the extent of other elements included. The number of items to be ‘ticked’ during the legality verification process using existing legality verification


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schemes will influence the costs of compliance to domestic and overseas forestry businesses.

Stakeholders consulted reported a wide range of costs associated with certification, and verifying the legal origins of timber products. Estimates of these potential costs are provided in appendix E with the costs of compliance dependent on many variables such as the size of the enterprise, the complexity of the value chain and the level of economic development of the country of operation.

Modelling compliance costs of legal verification

To model the impacts of the different levels of legal verification, it is necessary to identify the average legality verification compliance costs of the most responsive of the three groups of producers in each country.

In practice, high cost producers in any country will not be willing to incur additional costs in order to supply exports to Australia, so for the modelling, it is only low and medium cost producers that are of interest. In general, costs of compliance to export to Australia will be low in developed countries where producers are large with already well developed systems to prove compliance. Costs will be higher in high-risk developing countries, due to lower scales of operation, less well developed and more ambiguous forest laws and under-developed systems for proving compliance.

Developing, high-risk countries

The analysis in appendix E and stakeholder consultation leads TheCIE to believe the responsive group in high risk (developing) countries will face the following compliance costs (presented as a share of the fob value of exports).

Full certification (FC) — 10 per cent.

Verified legal compliance (VLC) — 5 per cent.

Verified of legal origin (VLO) — 3 per cent.

Self-declared legal (SDL) — 1 per cent.

Developed countries

Producers in developed countries face relatively low legality verification compliance costs due to their established systems of forest management and governance. TheCIE has assumed the patterns of compliance for New Zealand, the United States and the European Community apply only to their exporters to Australia, and generally these exporters are large with low potential costs of compliance.

Analysis in appendix E and stakeholder consultation leads us to believe developed country exporters to Australia in the responsive group will face the following (very low) compliance costs (presented as a share of costs of production).


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Full certification (FC) — 0.1per cent.

Verified legal compliance (VLC) — 0.1 per cent.

Verified of legal origin (VLO) — 0.05 per cent.

Self-declared legal (SDL) — 0.025 per cent.

Because developed countries typically already have strong and strongly enforced forest laws, changes in forest practices to achieve full certification are likely to be relatively small, so the major costs will be administrative and relate to chain of custody costs. For this reason it is unlikely that there will be a large difference in legality verification in compliance cost between full certification and verified legally compliant.

Australia

In Australia, costs of compliance are likely to be higher than for developed country exporters to Australia. This is because in Australia, not only large exporters will be affected. There are small forest enterprises in Australia, small furniture makers, small cabinet makers, small to medium sized importers and producers of products such as veneer suppliers who may struggle economically to obtain full certification and verification of legal compliance. However, TheCIE assumes most operators are likely to be able to achieve the requirements of VLO and SDL.

Analysis in appendix E and stakeholder consultation leads us to believe Australian producers, on average will face the following compliance costs (as a percentage of production costs).

Full certification (FC) — 0.6 per cent.

Verified legal compliance (VLC) — 0.6 per cent.

Verified of legal origin (VLO) — 0.3 per cent.

Self-declared legal (SDL) — 0.15 per cent.

Inclusion of the costs in the GTAP model

The legality verification compliance costs are included in the GTAP model in two different forms. For exporting countries they are modeled as a special form of export tax on each country’s exports of timber products to Australia, since they will operate as an increase in domestic costs of supplying the Australian market. For Australia, they are modeled as a special form of a ‘production tax’. These notional export and production taxes are treated as an increase in costs, and are not counted as contributing to government revenues.

The compliance costs are expressed as percentage of the production cost/ export price and are applied only to the share of products covered in each product category for each region of the model.


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The GTAP model simulations show how much producers’ willingness to supply will alter in response to the assumed compliance costs. This is indicated by changes in output of forestry products in risk and non risk countries and changes in levels of exports to Australia. However, not all of the changes in forestry production and exports arising from meeting Australia’s legality verification requirements from Australia will be due to changes in illegal logging. Several outcomes are possible.

Illegal loggers decrease their output and legal loggers increase theirs.

Illegal loggers transform their activities to be legally compliant.

Some legal loggers may decrease their production if compliance costs are too high to profitably supply the Australian market.

Illegal loggers increase their production by substituting away from the restricted markets to non-restricted less onerous markets.

The economy-wide costs of the different legality verification options are presented as the foregone welfare resulting from restricting Australian imports of illegally sourced timber products. The GTAP model simulations give estimates of the welfare changes (indicators of income and levels of consumption) for each country identified in the model. We are therefore able to calculate the costs to Australia, risk countries, and the world. The benefits of these policy options are calculated by applying the reductions in illegal logging, as discussed above, to the total global reduction in the costs of illegal logging.

Costs of disclosure measures and chain of custody costs

Suppliers may need to extend documentary proof (of species, country of harvest and any certification) up to the point of wholesale or retail sale to meet the disclosure element requirements. Additional costs will be incurred to establish and operate chain of custody schemes to demonstrate the legal origins of timber products throughout the supply chain.

In the case of reconstituted panels (particle board, OSB, MDF and other fibreboard) as well as pulp and paper, the investment needs may be substantial in mills which use both certified and uncertified raw materials and have to keep these separate in storage areas and during processing. In addition, operational costs may increase due to less efficient use of equipment and increased handling requirements (Vogt et al 2000). These problems can also occur in further processing of tropical timber into furniture and joinery if the end products contain only a specified percentage of certified material.

The chain of custody compliance costs can become high in situations where wood supply is very fragmented and comes from a very large number of small and medium-scale landowners (see appendix E). As regards tropical timber, such situations occur among for example, small-scale rubber wood producers in Asia and in the case of various tree farm and out grower schemes (ITTO 2004, p. 14).


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Chain of custody costs may increase the further along the supply chain the disclosure of information is required. For instance disclosure of information at retail level will be more expensive than at the point of wholesale and the more information required, the more expensive it will become. For the compliance cost estimates presented above, it is assumed that:

the verification for traceability of legal products using a chain of custody scheme and verification of legal origin represent the same proportional costs along the supply chain only to the point of free-on-board (fob) in the case of exports to Australia and at-factory-gate in the case of Australian production; and

beyond these two points the compliance costs are simply passed along the supply chain and are no longer proportional to production costs.

This restricted treatment of disclosure and chain of custody costs may represent a conservative representation of costs in some instances, particularly for complex value chains and if disclosure is required at higher levels along the supply chain.

Government enforcement cost

At this stage the costs to government of enforcement have not been estimated and have therefore not yet been included in this exercise. TheCIE has been informed that the costs to government will be determined once a decision on the preferred policy option has been made. There may be additional costs of border management and control, as well as costs of vetting certification systems and dealing with breaches of regulations. The non-inclusion of these costs in the analysis will lead to an underestimation of the total costs of policy options.

Uncertainties about estimates of compliance cost

Although it is possible to narrow down the range of compliance costs, what remains uncertain is the true extent of illegal logging, how close some producers in some countries may be to achieving verification of legality using acceptable schemes, the flow through effects of compliance costs along the supply chain and enforcement costs. For this reason, compliance costs should be considered indicative. Sensitivity tests are conducted around these estimates in the economic modelling exercise to address some of these uncertainties.

Summary of assumptions and implications of compliance costs Compliance costs vary widely within and between countries due to a wide range

of factors.

In general, compliance costs will be substantially higher in developing countries than developed countries because:


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– legal loggers in non-risk developed countries who currently export to Australia will, in general, already be compliant, so extra costs will be minimal or negligible;

– legal loggers in high-risk developing countries will have to set up systems to prove and maintain their legality;

– the integrity and enforcement of forest laws is not as well established as in developed countries, even though the laws are often similar to those in developed countries;

– ambiguity surrounds elements of forest laws and ownership in developing countries;

– significant levels of illegal logging currently occur in developing countries; and

– systems for verifying legality are not as well developed.

Illegal loggers who cause environmental, social and financial damage will face very high or prohibitive costs of compliance because, to comply, would require them to give up the substantial financial advantage they gain by currently engaging in illegal activities (the opportunity cost of compliance is high). Illegal loggers who gain substantial financial benefits from illegal logging will be forced to cease supplying the Australian market due to these costs.

Legal loggers in high-risk countries are not likely to face the high opportunity costs of compliance that illegal loggers face, but nonetheless may face some opportunity cost due to changes in forestry and other practices required to become compliant. However, it is assumed in this exercise that these producers face no opportunity cost, only costs of proving and maintaining legality.

Legal loggers in non-risk developed countries with low compliance cost are likely to face financial incentives to expand supply to Australia if Australian prices rise by more than compliance costs due to restriction on illegal imports. In developing countries this is less likely to occur because costs of compliance are likely to be substantially higher to prove and maintain legality for most producers. Were this not the case, they would in all likelihood, already be compliant.

Chain of custody/disclosure costs are assumed only to apply up to fob or factory gate stage in the supply chain which is a conservative assumption and may indicate compliance costs are underestimated.

Enforcement costs have not been included biasing down estimates of total costs.

Forestry enterprises in developing countries are assumed to be of a moderate size with an average forest area of 90 000 hectares and production of 60 000 cubic metres per year. If average areas and production are larger, compliance costs could be lower than estimated.

Various unknown factors may bias estimates of compliance costs either up or down, making a wide range of sensitivity testing around compliance costs important.


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5 Economic costs of legality verification

We use the Global Trade Analysis Project (GTAP) model discussed in appendix A and C to explore the potential range of economic impacts of legality verification costs of compliance. In this chapter we examine what would happen if Australia were to act unilaterally. Later, in chapter 7, we assess how this would change given that some other countries may be restricting imports of illegally logged products in parallel with Australia’s proposed action. To address some of the uncertainties regarding the many assumptions that underpin the legality verification cost modelling, we have conducted a sensitivity test that has the compliance costs for import restriction measures varying by plus or minus 50 per cent.

Reductions in imports

An important consequence of any measure requiring legality verification is that it will impose costs on trade in legal timber as well as (hopefully prohibitively) costs on trade in products incorporating illegally logged timber. It could thus reduce imports of products that do not incorporate illegally logged timber.

Tables 5.1 and 5.2 show the percentage reductions in wood product and paper product imports to Australia from risk countries 11associated with each tier of legality verification. Table 5.1 shows that using full certification schemes could reduce imports of wood products from risk countries by up to 33 per cent. Table 5.2 shows that such a requirement could reduce imports of paper and related products from these countries by up to 47 per cent. The least demanding requirement — for self declaration over Category I products — would decrease imports of timber products and paper products by around 1 per cent. (The numbers given in parentheses in the tables are the results of sensitivity tests, showing how the estimated reduction in imports varies if compliance costs are assumed to be 50 per cent lower or 50 per cent higher than the estimates used.

Product category III include products that account for about 70 per cent of Australia’s wood and paper product imports, so options with that coverage are likely to target imports at risk of incorporating illegally logged timber that account for 7 per 11 The risk countries and regions include Oceania (excluding Australia and New Zealand),

China, Korea, Hong Kong, Singapore, Indonesia, Malaysia, Thailand, Vietnam, the rest of Asia, Russia, the 10 acceding members of the European Union, Brazil, Other Latin America, West and Central Africa


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cent of total imports (since risk imports account for an estimated 10 per cent of total world trade) or 14 per cent of imports from risk countries (since risk imports account for an estimated 20 per cent of imports from those countries). Reductions in imports of wood and paper products from risk countries of between 33 and 47 per cent under a full certification requirement reflect the fact that the measure would also reduce imports that do not include illegally logged timber — the additional costs make some ‘legal’ products uncompetitive. This problem arises also with other options — cells in tables 5.1 and 5.2 shown in bold are for options where a substantial reduction in imports may occur.

Reduction in illegal logging if Australia acts unilaterally

Although the reductions in imports can be considerable, the percentage reduction caused in logging in risk countries might be very small if Australia acts unilaterally. Many excluded imports would then find markets elsewhere in the world. Further, if legality verification only extends to category I product coverage, some countries could decrease category I product exports to Australia, but increase exports of category II and III product that incorporate illegally logged timber. This might be an unintended consequence of implementing a system that requires legality verification for a limited range of products only. This scope for leakage and substitution explains

5.1 Simulations: Australian imports of wood products from risk countries (percentage change from unilateral action)

Standard for access Product coverage

Category I Category II Category III Self-declared -0.75

(-0.38~-1.11)-0.76

(-0.39~-1.12)-5.38

(-2.72~-8.00) Verified legal origin -1.46

(-0.75~-2.14)-1.48

(-0.76~-2.16)-10.55

(-5.38~-15.51) Verified legal compliance -2.13

(-1.12~-3.05)-2.13

(-1.12~-3.05)-16.89

(-8.73~-24.46) Full certification -5.18

(-2.79~-7.25)-5.30

(-2.85~-7.43)-32.65

(-17.57~-45.35) Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations.

5.2 Simulations: Australian imports of paper products, printing and publishing from risk countries (percentage change from unilateral action)



(-0.85~-2.46)-6.82

(-3.47~-10.05)-8.89


(-1.67~-4.69)-13.16

(-6.82~-19.06)-17.00


(-2.71~-7.36)-20.87

(-11.07~-29.57)-26.61


(-5.19~-13.06)-37.56

(-21.05~-50.52)-46.56

(-26.90~-60.85) Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations.


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why for some options shows in the tables the reduction in imports of products is smaller than the estimated share of trade incorporating illegally logged timber.

Table 5.3 shows the estimated reduction in logging in risk countries that results from imposition of the various options. It shows that even for the most demanding option (full certification and category III product coverage) the reduction in logging is very small at 0.0134 per cent, a small fraction of 1 per cent.

Not all logging is illegal, but it is the percentage reduction in illegal logging that is of interest to assess effectiveness. The percentage reduction in illegal logging will be greater than the percentage reduction in logging. Table 5.4 shows the estimated reduction in illegal logging that results from imposition of the various options. Under all options the impact is still small — 0.0035 to 0.0331 per cent12.

5.3 Simulations: global reductions in logging in risk countries from unilateral action (%)


Category I Category II Category IIISelf-declared -0.0003

(-0.0002~-0.0005)-0.0002

(-0.0001~-0.0003)-0.0021

(-0.0011~-0.0031)Verified legal origin -0.0006

(-0.0003~-0.0009)-0.0004

(-0.0002~-0.0006)-0.0041

(-0.0021~-0.0060)Verified legal compliance -0.0005

(-0.0003~-0.0007)-0.0002

(-0.0001~-0.0002)-0.0062

(-0.0033~-0.0088)Full certification -0.0030

(-0.0017~-0.0040)-0.0026

(-0.0015~-0.0034)-0.0134

(-0.0074~-0.0181)Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations.

5.4 Simulations: changes in illegal logging in risk countries (%) Standard for access Product coverage

Category I Category II Category IIISelf-declared -0.0035

(-0.0017~-0.0051)-0.0028

(-0.0013~-0.0042)-0.0147

(-0.0096~-0.0193)Verified legal origin -0.0068

(-0.0035~-0.0075)-0.0054

(-0.0028~-0.0061)-0.0237

(-0.0147~-0.0274)Verified legal compliance -0.0068

(-0.0051~-0.0084)-0.0046

(-0.0036~-0.0048)-0.0284

(-0.0198~-0.0285)Full certification -0.0087

(-0.0049~-0.0117)-0.0081

(-0.0046~-0.0108)-0.0331

(-0.0319~-0.0356)Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations.

It was indicated in chapter 2 that Australia imports of illegally logged products account for about 0.34 per cent of global production incorporating illegally logged timber. The 0.0331 per cent reduction in illegal logging (for FC and category III) in 12 The methodology for estimating the change of illegal logging using the estimated change in

total logging is described in appendix B.


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table 5.4 indicates that Australian import restrictions at best would stop the production of about a tenth of the illegally logged timber that presently comes into Australia. The rest would be diverted to other export markets and the domestic market of origin.

Trade diversion and leakage outcomes

The small reduction in log production for legality verification in Australia, despite quite large reductions in imports, is due to trade diversion and because Australia’s imports as a share of world round wood production is so small. Wood and paper products denied access to the Australian market could be diverted to other markets, so the overall reduction in logging resulting from import restriction measures is small

Costs of unilateral action for legality verification

With reduced imports, prices in Australia will rise. In some cases price increases induce increased Australian production and provide benefits to Australian producers, particularly large producers. Smaller producers whose legality verification compliance costs increase by more than the price rises would lose. However, not all options create increases in production (table 5.5). For the less demanding legality verification (for example SDL) small domestic production decreases occur. This is a result of the fact that small compliance cost increases in Australia are not matched by large enough increases in timber product prices. The effects vary significantly between sectors of the wood and paper products industry.

5.5 Change in production in Australia from unilateral action: all wood products (per cent)



(-0.0156~-0.0480)0.0266

(0.0141~0.0376)0.1562

(0.0801~0.2285) Verified legal origin -0.0648

(-0.0316~-0.0994)0.0471

(0.0266~0.0623)0.2969

(0.1562~0.4232) Verified legal compliance -0.1580

(-0.0771~-0.2419)0.0143

(0.0148~0.0003)0.4063

(0.2234~0.5528) Full certification -0.0506

(-0.0176~-0.0950)0.2819

(0.1701~0.3478)0.9951

(0.5744~1.2930)

Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations.

With more demanding legality verification options, domestic prices increase sufficiently to offset the higher compliance costs, so domestic production on average increases. The largest increase in domestic production is associated with the most demanding verification option, which generates an average 1 per cent increase (table 5.5).


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Where legality verification leads to increased production, it may also lead to changes in employment in the wood products and paper industries. For the most demanding legality verification option, full certification with category III product coverage, an estimated 1108 extra forestry jobs might be created (table 5.6). However, the net increase in jobs for the economy would be lower as forestry bids for labour from some other sectors. Some options, however, lead to increased production and an estimated reduction in jobs in the industry (of up to 383 with category II product coverage VLC). This occurs because the effects of restriction measures induce changes in the types of timber products manufactured in Australia, with a shift to less labour intensive products.

5.6 Change in employment in Australia forestry and wood products sector (number of FTE jobs)


Category I Category II Category IIISelf-declared -84

(-42~-127)-82

(-41~-125)148

(76~217)Verified legal origin -170

(-84~-257)-167

(-82~-254)281

(148~401)Verified legal compliance -378

(-187~-572)-383

(-189~-582)340

(189~454)Full certification -225

(-103~360)-194

(-84~-325)1108

(633~1445)Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations.

The price increases cause losses in welfare for Australian consumers who are forced to pay more for wood products. In fact, consumers’ losses outweigh gains to producers. The net effect is a reduction in aggregate incomes and welfare for Australians, as shown in table 5.7. The losses range from US$13 million for the least demanding policy option (SDL, category I product coverage) to US$168 million a year for the most demanding option (FC, category III product coverage). Losses arise because the costs of all wood products sold on the domestic market — imported and domestically produced — are inflated by the legality verification requirements on imports. Further, some of the gains that arise from higher prices are captured by exporters from non-risk countries such as New Zealand and North America. They receive higher prices for the products they export to Australia (at the expense of Australian consumers) and they export more products to Australia.

An observation from table 5.7 is that the wider the coverage of the products, the higher the impact on Australia. For example, the net loss for the FC option would rise from only US$59 million per year with category I product coverage, to US$96 million with category II coverage, and US$168 million with category III product coverage.

Risk countries as a whole lose because they have higher costs to meet the legality verification requirements of any impact restriction measure introduced by Australia.


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Table 5.8 shows the net global financial costs of the various options. Compared with table 5.7, it can be seen that Australia bears most of the cost.

Non-risk countries (excluding Australia) would gain if Australia adopted requirements of using full certification schemes, because their compliance cost is relatively small and their exports to Australia would rise to make up the fall in exports from risk countries. However, this is true even if Australia’s compliance cost is the same as other non-risk developed countries.

Chart 5.9 shows the relative cost of the three full certification options for Australia, risk countries and non-risk countries.

Effectiveness

Although lower levels of product coverage reduce the costs to Australia, it tends to proportionally reduce the potential effectiveness of using legality verification schemes to restrict imports of illegally sourced products. One measure of relative effectiveness is the cost imposed on the Australian economy per cubic metre of illegal round wood harvest reduction caused in source countries. This is shown in table 5.10.

5.7 Simulations: costs to the Australian economy (US$m/year) if Australia acts unilaterally

Standard for access Product coverage Category I Category II Category III Self-declared -13.38

(-6.70~-20.03)-20.90

(-10.50~-31.18)-35.10


(-13.38~-39.85)-41.36

(-20.90~-61.43)-68.96


(-25.78~-76.61)-76.92

(-39.02~-113.82)-123.62


(-30.08~-87.49)-96.36

(-50.27~-139.15)-167.68

(-89.83~-236.17) Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations

5.8 Simulations: costs to the world economy (US$m/year) Standard for access Product coverage


Self-declared -11.87 (-5.94~-17.79)

-20.57 (-10.31~-30.79)

-36.32 (-18.21~-54.32)

Verified legal origin -23.70 (-11.87~-35.49)

-40.97 (-20.57~-61.18)

-72.21 (-36.32~-107.62)

Verified legal compliance -44.87 (-22.49~-67.10)

-74.84 (-37.67~-111.43)

-128.25 (-64.76~-190.28)

Full certification -56.35 (-28.48~-83.62)

-105.44 (-53.92~-154.41)

-196.93 (-101.44~-285.00)

Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations


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5.9 Welfare changes in Australia, risk countries and other countries: legality verified by full certification if Australia acts unilaterally

-200

-150

-100

-50

0

50

100

Australia Risk countries Other countries

US

$ m

illio

n

Cat. I Cat. II Cat. III

Data source: GTAP simulations.

5.10 Simulations: cost to Australia per cubic metre reduction in logged wood in risk countries (US$/m3) if Australia acts unilaterally



Self-declared 1972.9(1914.7~2032.0)

4438.4(4404.3~4616.2)

788.2(782.6~792.3)

Verified legal origin 2090.2(1972.9~2230.2)

4806.0(4438.4~5192.2)

798.3(788.2~808.5)

Verified legal compliance 4552.8(3838.4~5471.8)

20 100.7(13360.1~34253.6)

954.1(928.1~983.7)

Full certification 932.8(839.7~1031.9)

1792.1(1646.3~1947.0)

595.7(577.0~621.0)

Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: GTAP simulations

Based on the assumptions used in this exercise, results indicate that costs are very high relative to the free on board (fob) price of round wood logs which can vary from around US$200 per cubic metre to over US$500 per cubic metre depending on the variety and quality of log. Moreover, the results show that the more demanding legality verification options tend to be the most effective in terms of cost per cubic metre reduction in logging and possibly illegal logging.

Costs of the regulatory options

The government may use the different product categories and range of legality verification schemes assessed in the modelling framework to establish a quasi, co-, or explicit regulation to restrict the importation of illegally sourced timber products into Australia. It is important to note that with both product coverage and/or strength of legality verification scheme requirements, the possible government regulation could be phased in over time from less to more onerous options.


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Business compliance costs

Under quasi-regulation, with industry-based enforcement of a code of conduct, it is highly likely the costs of legality verification would be in the lower range of the cost estimates for each of the 12 options presented in the chapter. The reason being, that this would be a voluntary system where not all suppliers would be signatories to the code.

Under a co-regulatory option, the government might choose to allow the use of existing legality verification schemes as modelled in the analysis. As such the costs of compliance with the regulation would be represented by the ranges indicated in the modelling. These costs would depend on the starting position for the policy being determined by government, in terms of product coverage and legality verification requirements, in addition to how a broader range of products and more rigorous verification of legality could be phased in over the longer term.

With explicit regulation, the government could specify minimum requirements for the range of products to be covered and the acceptable legality verification schemes. Given that this approach is likely to restrict the range of legality verification options available to industry, it is reasonable to expect that the costs of compliance would be at the higher end of the ranges presented in this chapter.

Government enforcement costs

Effective enforcement of the co-regulatory and explicit regulatory options would require the government to establish systems for administering and monitoring performance of industry and to introduce a penalty regime for non-compliance with the chosen regulation. Systems for monitoring performance could include at-the-border measures consistent with existing Customs and AQIS procedures. Alternatively a government/industry partnership could be developed to assist the implementation of the regulatory regime with the possibility of utilising a stronger focus on post-border assessment of regulatory compliance. These costs to government (and possibly industry) need to be added to the compliance costs described in this chapter.

Sanctions for non-compliance would also need to be elaborated and considered in light of the existing penalty regimes for legal activities. Further costs to government (particularly state governments) will arise with the establishment of an enforcement regime for a product disclosure measure.

Costs to industry, the economy and the government of compliance with the product disclosure element

In assessing the costs of disclosure of species, country of harvest and any certification at point of sale, it is reasonable to assume that the costs of industry complying with this requirement would only be marginally higher than the legality verification


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compliance costs presented in this chapter if product disclosure is required at the point of entry into Australia. Essentially, the disclosure requirements will be verified from the forest through to the point of export and subsequently the point of import into Australia. To support this approach some form of data collection investment by the government would be required at the point of entry together with the expansion of the above-mentioned penalty regime to cover non-compliance with this requirement.

Requiring disclosure at the point of wholesale or retail sale would be expected to raise the cost to business relative to the legality verification compliance costs described in this chapter. A decision for government will therefore be the point along the supply chain for enforcing the disclosure measure. It is reasonable to assume that further along the supply chain that this measure is applied, the higher the cost to industry. For government, collecting the information required to support enforcement of the disclosure measure might be greater than the costs of collecting that information at the border, where it could be incorporated into the existing data collection systems of Customs and AQIS. It may also be that enforcement becomes a responsibility of state governments if it becomes an issue covered by their fair trading legislation.


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6 Cost–benefit analysis

The OBPR guidelines indicate that the impact analysis of a RIS should be comprehensive and include all economic, social and environmental costs and benefits, not just those of a financial nature. To quantify overall impacts, here we bring together the costs of using legality verification schemes to reduce imports of products incorporating illegally logged timber with earlier estimates from chapter 2 on the global benefits of eliminating illegal logging.

In chapter 2, the annual non-market global costs of illegal logging were assessed to be approximately US$60 billion and financial costs to legal loggers were estimated to be around $46 billion a year. So the total benefit of avoiding these costs if illegal logging could be eliminated would be $106.5 billion a year. However, it was also estimated in chapter 2 that consumers and those involved in illegal logging would be worse off to the tune of US$92 billion per annum (table 2.4) due to the higher global prices for timber and substitution away from some timber products. This suggests that if illegal logging could be eliminated with no further costs, a global net benefit of around US$15 billion a year could be achieved, with a global benefit-cost ratio of 1.16.

World trade in wood products accounts for about 15 per cent of global production. Australia’s share of that trade is about 2.5 per cent (US $3.75 billion compared to US$150 billion) and about 0.375 of one per cent of global production. Australia’s potential contribution to the net global benefit might therefore be $56 million a year ($15 billion times 0.00375). However, this might be thought of as a maximum net benefit. Although it includes market (or opportunity) costs, it assumes that the benefit can be achieved without compliance or enforcement costs. In reality, achieving this benefit will require policies, involving compliance costs and enforcement cost.

The question for Australia is what proportion of the gross non-market benefit of $60 billion can Australia achieve with its policies and what will it cost to implement those policies? This can be considered with Australia acting alone (unilaterally) or in parallel with other countries’ initiatives to restrict the trade in illegal logs. Bearing in mind that trade measures act directly on only 15 per cent of world production and on approximately 15 per cent of illegal logging, such measures, even if implemented by many importing countries, will be intrinsically limited.


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Cost–benefit analysis of a unilateral response by Australia

Estimates of reductions in global illegal logging for the 12 legal verification options assessed in chapter 5 can be used to assess what proportion of the $60 billion non-market benefit Australia might expect to generate from restricting illegal imports.

Essentially table 6.1 represents a multiplication of the percentage reductions in illegal logging in risk countries (from table 5.4) against the US$60 billion estimate of global benefit from stopping illegal logging.

The benefits range from around US$2 million a year for the least demanding option to US$20 million for the most demanding requirements. The largest absolute estimate within the sensitivity range extends to US$34 million for the most demanding option (that is, full certification and category III coverage of forest products).

Although sizeable, benefits are less than the costs estimated for each option in table 5.7. Global benefits relative to Australian costs are set out in tables 6.2. In all cases benefit to cost ratios are well below 1.00. A benefit cost rate of 1.00 represents a break even situation. The ranges of benefits to costs vary little because upper bound benefits are being compared with upper bound costs. (Table 6.2 was derived by dividing the results in table 6.1 by the estimates of costs to the Australian economy from table 5.7.)

6.1 Simulations: benefits (US$ million) Standard for access Product coverage

Category I Category II Category IIISelf-declared 2.08

(0.43~4.89)1.68

(0.34~3.99)8.82

(2.40~18.34)Verified legal origin 4.11

(0.86~7.14)3.22

(0.70~5.83)14.21

(3.68~25.99)Verified legal compliance 4.07

(1.29~8.00)2.74

(0.90~4.59)17.02

(4.94~27.10)Full certification 5.24

(1.23~11.09)4.85

(1.15~10.21)19.88

(7.99~33.77)Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: TheCIE based on GTAP simulations.

6.2 Simulations: ratio of total global benefits to Australian cost Standard for access Product coverage

Category I Category II Category IIISelf-declared 0.155

(0.064~0.244)0.080

(0.032~0.128)0.251

(0.136~0.351)Verified legal origin 0.154

(0.065~0.179)0.078

(0.033~0.095)0.206

(0.105~0.256)Verified legal compliance 0.079

(0.050~0.104)0.036

(0.023~0.040)0.138

(0.078~0.150)Full certification 0.089

(0.041~0.127)0.050

(0.023~0.073)0.119

(0.089~0.143)Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: TheCIE based on GTAP simulations.


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Comparing global non-market benefits to Australian costs is not exactly correct. The true benefit to cost ratio is given by comparing like with like, that is, global benefits relative to global costs. Global benefit to global cost ratios are set out in table 6.3. These results are obtained by dividing the benefit estimates in table 6.1 by the cost estimates in table 5.8. However, because Australian costs when considering a unilateral approach make up most of the global costs, the global benefit to cost ratios are similar to those presented for Australia only.

6.3 Simulations: ratio of total global benefits to total global cost Standard for access Product coverage


Self-declared 0.175 (0.072~0.275)

0.082 (0.033~0.129)

0.243 (0.132~0.338)

Verified legal origin 0.173 (0.073~0.201)

0.079 (0.034~0.095)

0.197 (0.101~0.242)

Verified legal compliance 0.091 (0.057~0.119)

0.037 (0.024~0.041)

0.133 (0.076~0.142)

Full certification 0.093 (0.043~0.133)

0.046 (0.021~0.066)

0.101 (0.079~0.119)

Note: Numbers in parentheses are ranges of results assuming 50 per cent lower and 50 per cent higher compliance costs. Source: TheCIE based on GTAP simulations.

Costs of unilateral action are high

The costs are driven mainly by the price increases to Australian consumers and down-stream industry users of wood products, as well as the increased compliance burden placed on some small wood industry operators in Australia. The very low level of effectiveness from unilateral action is driven mainly by Australia’s very small share of trade and world production, and partly by a number of other factors:

the ability of producers in countries with illegal logging to divert trade to other markets;

the ability of consumers to substitute between products and sources; and

the fact that Australia’s imports are mainly of value added timber products, not forestry products, so unilaterally restricting the imports of timber products has only an indirect impact back at the forestry level. This allows the forestry products to be diverted to the production of many other wood products.

Benefits of unilateral action are small

With such small reductions in logging being achieved under unilateral action, the objective of reducing the financial, social or environmental damage assumed to be associated with illegal logging is unlikely to be fulfilled to any significant extent. Under all unilateral action options considered in table 6.3 costs exceed benefit by a considerable margin. This is a very different result to the global benefits costs ratio of 1.16 estimated earlier in this chapter, but it reflects the high costs of action and the


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relative ineffectiveness of unilateral action. There is a possibility that costs of compliance might be lowered through capacity building initiatives and the effectiveness of reducing illegal logging might be improved if the parallel action of other nations to restrict imports of illegally logged products is taken in to account. However, even if other countries restrict imports of products incorporating illegally logged timber, it should be remembered that trade accounts for only 15 per cent of global production, so the potential to substitute to the domestic market in most risk countries remains a major problem. Moreover, cost would need to decline considerably and benefits rise substantially to achieve a benefit to cost ratio greater than 1. Different benefit and cost scenarios are considered in the next chapter.


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7 Sensitivity analysis and impacts of regulatory options

Chapter 3 discussed several regulatory approaches to restricting the importation of products incorporating illegally logged timber — self-regulation, quasi-regulation, co-regulation and explicit regulation. The costs and benefits of implementing the import restriction element of the Government’s policy will be sensitive to the choice of approach. Chapters 5 and 6 assessed the costs and benefits of alternative legality verification schemes that could be used under each of the regulatory approaches. We can use those results as a direct estimate of the costs and benefits of a co-regulatory approach, because such an approach would involve government enforcing the use of available verification systems. However, the costs and benefits for other regulatory approaches can be inferred from the results in chapter 5 and 6, because they will involve similar verification systems and product coverage options. However, what will differ will be the form of enforcement.

Further, it should be noted that the estimates of the costs and benefits presented in chapters 5 and 6 depend on several crucial assumptions. These assumptions cover:

the level of illegal logging in each country;

the compliance costs that would be incurred, which themselves are affected by the extent of illegal logging and the level of company investment in implementing compliance systems for legality verification;

enforcement costs — it is assumed that none are incurred under any policy options;

the global benefits of eliminating illegal logging;

the degree to which producers using legally logged timber can increase production in response to higher prices and the degree to which producers using illegally logged timber will decrease production when facing higher potential compliance costs (which is captured in a parameter called the elasticity of supply);

the point at which disclosure of information is required — it is assumed that it is only required up to wholesale level; and

the independence of Australian actions — it is assumed that Australia acts independently rather than in a plurilateral or multilateral context.

Uncertainty surrounds these assumptions. In this chapter we assess how sensitive the results are to changes in these assumptions.


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Sensitivity to key assumptions

Implementation in a plurilateral or multilateral context

The United States and the European Union are implementing policies to restrict the importation of illegal wood products. Were they successful, this might limit opportunities for risk countries to divert trade to other countries with less onerous or no restrictions on imports. Other initiatives of interest in a plurilateral context relate to national requirements for compliance with code of practice in high-risk countries, combined with the introduction of timber legality assurance schemes for all domestic producers in countries such as Indonesia. These could have a bearing on the effectiveness of Australian, US and EU approaches.

Results indicate that with the most demanding legality verification option (full certification and category III product coverage) under a unilateral setting the decline in logging in risk countries was 0.013 per cent (table 6.3). This is relative to Australia’s import share of global logging of 0.375 per cent. With the same conditions, but under a plurilateral setting, the reduction attributable to Australian action is 0.017 per cent. This is a 34 per cent increase in effectiveness. For the VLO option the increase in effectiveness is smaller at about 14 per cent. Given that the European Union and the United States are concentrating more on aspects of legal verification than certification, the results for SDL, VLO, and VLC are probably more relevant than those for certification.

It appears that although plurilateral action would increase the effectiveness of Australian regulatory approach, the increase would be small. Opportunities for leakage would remain. This is not entirely unexpected because trade in timber products is only about 15 per cent of global production. So any action aimed at trade is only likely to directly target about 15 per cent of illegal logging. It may have other flow-on effects, but, that said, even action targeted at the 15 per cent traded is unlikely to be 100 per cent effective as assumed.

Were a full multilateral approach possible that included China, India, Russia, Japan, ASEAN, Brazil, Argentina and Chile, among others, it is conceivable that Australia’s level of effectiveness in restricting imports would improve substantially.

Achieving a multilateral agreement on combating illegal logging would appear extremely challenging in the short to medium term. Multilateral arrangements are difficult to achieve. The Doha Round of trade negotiations bears testimony to this. However, CITES, CBD, UNFF non-legally binding proposals for action and UNCCPCJ are examples representative of multilateral arrangements dealing with forest issues that have been reached.


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Sensitivity to key model parameters

Table 7.1 present results from an analysis of the sensitivity of the results presented in chapters 5 and 6 to variations in the parameters concerning the extent of illegal logging, the capacity of producers to expand or contract production and the level of compliance costs. The table shows variations in results due to changes in key parameters compared with a central estimate for full certification, category III product coverage option.

The table shows that if estimates of illegal logging were half the level assumed in the modelling analysis in chapters 5 and 6, the benefit to cost ratio would decline from around 0.11 for the central estimate to 0.07. The reason for this is that although compliance costs decline to some extent, the reduction in illegal logging is simular because it is lower to start with (50 per cent lower).

7.1 Sensitivity results for full certification and high product coverage: unilateral action

50 per cent compliance

costsHalf illegal

logging CentralDouble

elasticity

150 per cent compliance

costs Australian imports (%) Wood products -17.57 -16.89 -32.65 -32.69 -45.35

– Risk countries 0.98 1.03 26.61 1.90 2.76 – Total -9.54 -9.13 -6.99 -17.71 -24.51

Pulp and paper products – Risk countries -26.90 -26.61 -46.56 -46.56 -60.85 – Non-risk countries 0.37 0.37 10.38 0.65 0.87 – Total -6.97 -6.89 -4.94 -12.05 -15.73

Australian production (%) Forestry 0.01 -0.04 0.02 0.03 0.01 Wood products 1.21 0.61 2.12 2.13 2.77 PPP 0.40 0.37 0.69 0.69 0.89

Welfare loss (US$ million) Australia -89.8 -123.6 -167.7 -167.7 -236.2 World* -101.4 -128.3 -196.9 -197.0 -285.0

Benefit Changes in illegal logging -0.032 -0.014 -0.033 -0.056 -0.036 Benefit (US$ million) 19.2 8.5 19.9 33.7 21.3 Benefit–cost ratio 0.21 0.07 0.11 0.20 0.09

*Note: Australian costs are a large proportion of global costs because Australia is undertaking this action unilaterally. Source: TheCIE. .

The table also shows how results vary if the responsiveness (supply elasticity) of producers to higher prices or higher compliance costs is double that used in the central analysis.13

It shows that costs are similar to the central estimate, but benefits are larger because decreases in illegal logging are greater. This is because producers in non-risk

13 Responsiveness might be higher, for example, if there is greater reliance on plantations

than nature forests.


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countries are able to increase output. Nonetheless, despite increases in benefits, the benefit to cost ratio remains well below 1.0.

All estimates presented in chapters 5 and 6 included results from sensitivity analyses of results to changes in estimated compliance costs. Lower compliance costs may arise if risk countries are more advanced in being able to achieve legal verification than has been assumed. Higher compliance costs would occur if:

we included enforcement costs and assumed these were passed on to industry in the form of levies;

compliance were to impose opportunity costs, in the form of reduced harvestable areas, on loggers other than illegal loggers whose opportunity cost has been accounted for in this exercise.

Table 7.1 summarises the results of varying the estimated compliance costs up or down by 50 per cent. If compliance costs were 50 per cent lower than the central estimate, the costs would be lower, but still considerably higher than the benefits. If compliance costs were 50 per cent higher, costs would be higher, and so (to lesser degrees) would be the benefits.

Summary of sensitivity analysis

Chart 7.2 summarises the sensitivity tests set out in table 7.1. It sets out the costs and benefits with three key parameters or assumptions (compliance cost, share of illegal logging, and supply elasticity) varied significantly. It also shows the relative effect of operating in a plurilateral context rather than unilaterally. It shows that among the uncertain variables and assumptions, the results are most sensitive to compliance cost estimates (and therefore assumptions that underpin the compliance costs estimates in appendix E).

Other sensitivities

The results assume that Australian citizens (who will pay the price of the restrictions) fully value the tangible environmental benefits and other intangible benefits that might arise from a reduction in illegal logging in foreign countries. The reality is that if Australia pursues a unilateral response, Australians will pay the costs of a small reduction in illegal logging whilst benefits will accrue to both overseas and Australian citizens.

A number of intangible benefits associated with the policy are not taken into account in the analysis above. These intangibles include:

Australia provides a role model to other trading partners;

Australia could ‘send a message’ to trading partners that they should also invest in measures to curb illegal logging;


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a sense of morality for those Australians concerned about the issue; and

a stronger position for Australia to negotiate international actions if the country is not seen to be benefiting from illegal or unsustainable behaviour in other countries.

Could adoption of a policy by Australia affect the problem indirectly by encouraging other countries to take action even though the effects of the Australian initiative by itself are very small compared to the costs? Recent evidence from how the international community has addressed other issues with global spillovers and market failure dimensions, such as climate change, suggest this can be very difficult for a small country like Australia. Whether it is in Australia’s interest to incur the costs of such action hinges on the probability that it will affect other countries’ behaviour in a positive or negative way. This is not easy to evaluate although as a small country it is more difficult to be effective in providing leadership than for a large country.

Given the very low benefit to cost ratios presented in chapter 6, the sum of intangible benefits would need to be between 4 and 8 times the tangible benefits derived directly from reducing illegal logging under a unilateral approach.

Summary of regulatory options

The OBPR guidelines require that a table summarising the key impacts and net benefits of alternative options be provided. This is set out in OBPR format in table 7.3 for some of the options.

7.2 Sensitivity of costs and benefits for Australia under unilateral action (full certification, high product coverage)

250 200 150 100 50 0 50

Low compliance cost

Half illegal logging

Central

Plurilateral

Double supply elasticity

High compliance cost

US$ million

Australian cost Benefit

Note: ’Plurilateral’ depicts Australian contribution to the plurilateral action on restricting illegal logging imports. Source: TheCIE.


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Chapters 5 and 6 analysed the effects of adopting alternative standards/approaches to verification of legality of timber and timber products, and of varying their coverage across different classes of timber product. Any of the resulting combinations could be used in a quasi-regulatory, co-regulatory or explicit regulatory approach to deliver import restriction measures and traders might choose to use elements of these in a self-regulatory approach. Further, a product disclosure measure could also build on the documentation prepared under the various verification schemes.

Self-regulation

Consultations for this study revealed that many traders and producers in the Australian value chain are implementing a range of measures to limit the risk that they may import, use or sell product incorporating illegally logged timber. Thus the current situation could be characterised as one where self-regulation is in operation. The available estimates imply that these measures are 90 per cent effective: that is that around 10 per cent of wood and paper product imports (as noted in chapter 3) are thought to incorporate illegally logged timber. Model results indicate that this approach might currently be costing Australia around US$90 million a year and providing benefits in terms of reduced illegal logging of an estimated US$28 million a year14 (see table 7.3).

Quasi-regulation

The Government could support traders and producers of timber products to further reduce the importation of illegally logged timber through ‘quasi-regulation’. For instance the Government is working with all relevant domestic industry sectors to develop a generic code of conduct for the purchase and sale of illegally sourced timber products in Australia. Compliance with such a code could be encouraged by industry audits, but there would be no government enforcement. For those who did comply with the code, they would incur compliance costs similar to those estimated in chapter 5. The benefits are not easy to determine, as this will depend on how many importers, wholesalers and producers adopt the code. The main disadvantage is that those importing most of the products incorporating illegally logged timber are unlikely to be signatories to a voluntary code. These will also tend to be those facing the highest potential compliance costs and they will face incentives to opt out. In that case, a ‘quasi-regulatory’ approach is likely to be less effective than a co-regulatory approach but also the costs will be lower. From the results presented in chapters 5 and 6, the costs and benefits are likely to be those represented by the lowest 14 We used the model to simulate what would happen if Australian imports of illegally

logged products fell from 20 per cent to the current level of 10 per cent. This reflects an assumption that without the current self-regulation, such imports would account for 20 per cent of total imports.


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compliance costs in the range of results presented. On this basis, we estimate that the cost of a quasi-regulation option could be between US$7 to 90 million a year, while benefits would be between US$0.43 to 8 million a year (see table 7.3).

Co-regulation

Under a co-regulatory approach government would establish regulations requiring that imports of wood and paper product falling into the chosen product category be accompanied by a certificate attesting to legal conformance of supplies with a SDL, VLO, VLC or FC standard. Co-regulation would require operators along the supply chain to obtain certification under any of the above-mentioned schemes as proof of legality. The Government might initially require accreditation consistent with the SDL standard, and progressively shift the requirement to one of the more onerous standards presented to increase the level of certainty of legality verification and expand the types of legal compliance to be covered.

A co-regulatory approach using one of the 12 options would have costs and benefits as presented in tables 6.1 and 6.2. Then a co-regulatory approach would impose costs to Australia of between US$13 to 168 million a year and generate benefits of between US$2 to 20 million a year: under all options the net benefit is negative (see table 7.3).

Explicit regulation

Under an explicit-regulation approach government would legislate, as for co-regulation, but prescribe the legality verification compliance schemes industry should use to demonstrate an acceptable level of assurance. These would impose additional costs on industry and government including the need for having a regular review of schemes to be accredited as adequately verifying the legal origins of timber products or meeting the increased legality verification requirements. Were Australia to adopt such an approach it could end up being more expensive than the most demanding option assessed in chapters 5 and 6. It could require higher product coverage because it would include all products and although it specifies no particular standard, it would require importers to seek the highest standards (for purposes of due diligence) to avoid the risk of prosecution. Results that extend product coverage beyond category III in chapters 5 and 6 to full product coverage increase costs to Australia from between US$13 to 168 million a year to between US$20 to 236 million a year. They raise benefits from US$2 to 20 million a year to US$5 to 34 million (see table 7.3).

Due diligence

Another option for government under explicit regulation may be to establish legislation for due-diligence requirements. This could take the form of a positive measure whereby importers (and domestic producers) are required to undertake a


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due diligence assessment of risk over the legal origins of their timber products. On the basis of that assessment, importers and producers would determine which of the available SDL, VLO, VLC, or FC schemes should provide adequate evidence of product legality. The Government’s role under this option would be to legislate the requirements for the due diligence assessment, and put in place systems to assess due diligence systems.

Disclosure at point of sale

Disclosure of information about country of harvest, species and any certification, through to retail level rather than just to the point of import or wholesale could impose additional chain of custody costs. Evidence presented in appendix E suggests that chain of custody costs can rise with the complexity of the supply chain and the amount of information that needs to be verified. To model this for FC and category III product coverage, we assumed that the legality verification compliance costs increased by 0.5 per cent (for example, to 10.5 per cent for responsive suppliers from high-risk countries and from 0.1 to 0.6 per cent from low-risk countries –a large increase). In this situation the total compliance costs would increase from US$168 million a year to US$241 million. Reductions in imports of illegally logged product would not change by much, but imports from non-risk countries, instead of increasing by 26 per cent (without the disclosure requirement) would increase by only 2.0 per cent. It would become more profitable for non-risk countries to export to other countries and not Australia (table 7.3).


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7.3 Potential impacts of legality verification, regulatory and non-regulatory options

Options Impacts, costs and benefits Overall impacts using a unilateral approach

Business Government Other stakeholder groups

Net impacts

Self-regulatory (status quo)

Voluntary arrangements

Compliance determined by individual businesses

Small cost attempted to be recovered from consumers, but not fully. Loss of profit.

Some government monitoring through stakeholder/govern-ment interaction

Consumers pay lower prices for imported and domestic timber products.

Australia’s share of global problem is $28m/yr but benefits of cheaper imports are $90m/yr

Legality verification compliance options

Least demanding legality verification compliance regime (self-declaration)

Small compliance costs

Not applicable Small cost from higher product prices. Tiny reduction in illegally logged timber

Cost to Australia $13m/year

Benefit $2 m/year

Net benefit is negative

Most demanding legality verification compliance regime and Category III product coverage (full certification)

Significant compliance costs

Increased costs to domestic producers and importers

Not applicable

Significant price increases. Tiny reduction in illegally logged timber

Cost to Australia $168m/year

Benefit $20 m/year


Regulatory options

Quasi-regulation option

Industry code of practice

Incentives disincentives developed and administered by industry

Overall compliance costs will depend on level of industry adoption

Increased costs for code signatories

Government/industry monitor effectiveness

Increased product prices. Tiny reduction in illegally logged timber.

Cost to Australia US$7-90 m/year

Benefit US$ 0.43-8 m/year


Co-regulation option

Government recognised legality verification schemes enforced by legislation


Increased costs for domestic producers importers

Administration and enforcement costs may be significant

Increased product prices. Tiny reduction in illegally logged timber

Cost to Australia US$13-168m/year

Benefit US$2-20 m/year


Explicit regulation option

(a) Government prescribed legality verification schemes enforced by legislation


Increased costs for domestic producers importers

Administration and enforcement costs may be significant


Cost to Australia US$20-236m/year depending on scheme applied



(Continued next page)


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7.3 Potential impacts of legality verification, regulatory and non-regulatory options (Continued)

Options Impacts, costs and benefits Overall impacts using a unilateral approach

Business Government Other stakeholder groups

Net impacts

Regulatory options (continued)

Explicit regulation option (continued)

(b) importer or producer due diligence enforced by legislation

Importers and domestic producers undertake risk assessments of illegal source and apply a legality verification scheme commensurate with the assessed risk

Lower compliance costs

Administration and enforcement costs dependant on how stringently laws are enforced


Cost to Australia US$20-236m/year depending on schemes applied



Disclosure measures (point of wholesale or retail sale, or at Australian border)

Voluntary

Lower compliance costs

Not applicable Slightly increased product prices

Limited impact

Mandatory Higher compliance Administration and enforcement costs may be significant

Higher product prices

Impact dependent on relationship with restriction measure

Non-regulatory considerations

Plurilateral Nil Cost of plurilateral engagement; benefit from consistency of policy with regional and international initiatives leading to more effective policy outcomes

Higher product prices

Potential to increase benefit: cost ratio of policy outcomes but net benefit likely to be negative

Multilateral Nil Cost of multilateral engagement; benefit from consistency of policy with multilateral initiatives leading to more effective policy outcomes

Not applicable Potential to increase benefit: cost ratio of policy outcomes with potential for positive net benefit, but this assumes no global costs of compliance or enforcement which may be large

Bilateral Nil Cost of bilateral engagement; benefit from consistency of policy with partner governments initiatives leading to more effective policy outcomes

Not applicable Potential to increase benefit: cost ratio of policy outcomes but net benefit likely to be negative

Capacity building Reduced costs with support from Government programs to enhance compliance

Increased overseas development aid to support policy

Not applicable Potential to increase benefit: cost ratio of policy outcomes but net benefit likely to be negative

Source: OBPR and TheCIE.


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8 Consultation statement

A variety of stakeholders in Australia would be affected by a policy that restricts the importation of illegally logged timber and requires disclosure of species, country of origin and any certification.

Affected and consulted parties

Virtually all parties consulted in conducting this RIS were deeply sympathetic to the objective of preventing illegal logging, and the economic, social and financial costs associated with it. Many were also conscious of the complexities surrounding trying to address the problem and the many and varied impacts any policy addressing the issue might have.

Were it to be implemented, the proposed policy would potentially restrict imports of illegally logged timber and timber products into Australia. This is likely to impose direct costs on Australian consumers, compliance and other costs on business and enforcement costs on governments. The benefits are potentially those that might arise in log exporting nations from a reduction in illegal activity and those that arise from reductions in environmental damage that will accrue globally. The policy potentially has trade diverting and restricting outcomes, domestic price, consumption and production impacts and economic, social and environmental outcomes. Moreover, trade restrictions hold World Trade Organization (WTO) and ‘reciprocity’ implications.

TheCIE consultation included stakeholders of the forest, wood products15, paper and construction industries, retailers, non-government organizations, people in the academia, certifiers, consultants, federal and state government agencies.

The consultation process

TheCIE conducted three rounds of consultation. DAFF provided TheCIE with a list of 88 people (or organizations) identified by the Department as key stakeholders for consultation. An initial round of consultation was conducted in April and May using this list. All 88 stakeholders were invited to participate. Stakeholders were contacted

15 This includes wood panels, veneer, cabinet making, furniture and timber frames.


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initially by email and then by phone to arrange interviews. Sixty five were effectively consulted (see appendix F for a list of the consulted stakeholders).

Stakeholders not consulted relate to people that:

preferred to be represented by peak bodies organizations;

considered they had nothing to add to the discussion;

did not want to participate in the consultation at the initial stage; or

simply did not want to be part of the consultation process at all.

The aim of this preliminary process was to seek input on the relative importance of the multiple issues associated with developing measures to combat illegal logging.

An Issues Paper was prepared and made available on TheCIE’s website to provide structure for individual meetings with stakeholders. The paper introduced key issues and questions likely to influence the outcome of the RIS. Background information presented in the paper related to:

the motivation for policy action;

what the RIS process involves;

the illegal logging problem and its size;

the rationale for action and alternatives; and

the dimension of costs and benefits to be considered in the analysis:

– benefits were discussed in terms of financial, social and environmental dimensions;

– costs were discussed in terms of economic, compliance and enforcement costs.

In the main, stakeholders welcomed the issues paper and the opportunity to discuss these issues with TheCIE. Most of the consultation was undertaken via face to face meetings with stakeholders16. Comments from stakeholders on each of the issues varied. However, there was consensus on the complexity of the problem and the difficulty of trying to address it. There were also concerns in regards to the uncertainty of the timeframe, the instruments and the outcomes of an Australian policy. Stakeholders provided considerable insights about the complexity of the costs and benefits surrounding the proposed policy measures, but also recognised the costs associated with unsustainable logging.

Some of the main points emerging from the initial consultation were:

acknowledgement and concern about the problem with key concerns being:

16 Fifty two stakeholders were consulted in a face to face manner and thirteen were consulted

in a phone interview manner.


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– imports of illegally logged timber lowers Australian prices and hurts some Australian producers;

– not enough consumers are willing to pay premiums for timber products certified as legal;

– verifying legality can be more expensive than consumers are willing to pay and can impose considerable costs on some importers and small producers;

– restricting the importation of illegally logged timber should be good for large Australian producers, but may be costly to smaller ones;

– in some cases legally produced timber products may cause more environmental/forestry problems than illegally produced products and ‘legality’ may not be a good indicator of environmental soundness;

– poorly defined property rights mean that many ambiguities surround what is legal or illegal and defining legality can be very difficult;

– many estimates of ‘illegal’ logging are dubious; and

– Australia will struggle to make its policy effective and would be wise to spend its money in other ways;

growing appreciation of the complexity of addressing the problem:

– stakeholders suggested Australia should pursue alternative policies such as capacity building and the Reduction of Emissions from Deforestation and Degradation (REDD);

– some suggested enough is being done on a voluntary basis by Australian importers to control the problem;

– some expressed concern about retaliation if Australia restricts imports and some expressed concern that adverse responses from trading partners may prove counterproductive to Australia having influence in capacity building in risk countries;

– others suggested that directly restricting imports would not be effective and that indirect mechanisms such as a code of conduct were needed, but few could suggest how such a mechanism might be effective;

– others said, irrespectively of the difficulties, the Government had no choice but to implement the policy because it was an election promise; and

– some insisted Australia had an ethical obligation to do something irrespective of the cost.

A second round of consultation was undertaken with a select group of stakeholders17 and certifiers were consulted via telephone to test the initial 17 This group of stakeholders included importers / wholesalers of wood products such as

furniture, lumber and veneer; forest and paper production large-sized companies. All these stakeholders have dealt with forest certification processes directly or indirectly (as


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estimations of the cost of forest certification. Stakeholders were sent a document with the general assumptions and costing per certification component. Input from this stage contributed to TheCIE’s understanding of the cost of compliance for the most demanding requirement on forest management; certification.

Information from stakeholders varied. Many confirmed the broad cost estimates and preliminary assumptions of 5-20 per cent price premium paid for certified input material. Some others provided insights on the certification criteria and the resources required to achieve them. Others offered broad feedback on the cost of certification per unit of production for large plantations in Australia. Others provided insights on the variables affecting the cost of chain of custody certification and how the costs may get passed through the value chain.

The third round of consultation was based on the Draft RIS. The document covered background information, the problem and its size, policy options, modelling, the costs of regulatory options, the benefit-cost analysis and conclusions. A set of questions at the end of the document were intended to stimulate feedback from stakeholders.

These questions were as follows.

Are the estimates of costs and benefits reasonable? If not, which ones are of concern and what evidence is there that they may be under or over-estimated?

Could the intangible benefits be high enough to alter the benefit to cost ratio estimates given such low levels of reductions in illegal logging?

Apart from the costs and benefits referenced in this document relating to the work of Seneca Creek (2004), Turner (2007), World Bank (2006) and OECD (2006), are there any larger estimates of the costs of illegal logging?

On average, 10 per cent of Australia’s imports appear to come from suspicious sources. Some people suggest they could be smaller. The implication is that the size of the problem at issue may be commensurately smaller, so the gain from restricting illegal logging would be less than estimated. Are the estimates we use of illegal logging reasonable?

Are the estimates of compliance costs reasonable and does the full range of sensitivity tests conducted cover the plausible range of cost?

What percentage price premiums are being experienced in the market place to buy certified product? Do these premiums adequately reflect the extra costs of compliance? Are you paying any price premiums for wood products of legally verifiable origin?

part of chain of custody certification by buying certified input material). About 10 people were contacted for this round and feedback was provided by 7 of them.


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Given Australia’s very small share of world trade and small influence over illegal logging through trade restrictions suggest there are alternative policy options that might provide Australia with a more effective way to influence or combat illegal logging in foreign countries?

TheCIE sent the document via email to the list of 88 stakeholders. The Draft was also made available in TheCIE’s website for the public in general and the Minister announced the release of the document in a media release.

A period of seven weeks was given to stakeholders for commenting on the Draft18. Submissions were received via email until 8 December (some stakeholders asked for additional days to send their comments).

The average submission was 3-5 pages long. TheCIE read all submissions, summarized them and addressed the concerns that relate to the economic analysis undertaken.

Twelve thousand, two hundred and fifty one letters were received over the 7-week period. The content of these letters was not related to the methodology or findings of the RIS but to demand that the Government fulfils its election promise of banning illegally logged timber imports irrespectively of the analysis conducted19.

Twenty one submissions were received commenting on the findings and methodology of the RIS; of the 88 stakeholders contacted only about 25 per cent made submissions. That is, 75 per cent did not make submissions . Submissions were made available on TheCIE’s website where an author’s permission was given to do so. See appendix G for a list of submitter organisations. The views expressed in those later submissions are addressed in the section below.

Stakeholders response to the draft report

We have sought to categorize the comments by major topic areas and concerns. We have tabulated the responses to obtain objective measures of the relative importance of various concerns. See table 8.1.

The tabulation shows there is a wide range of views relating to the topics. If there is one single topic that stands out of interest to stakeholders it is they are sympathetic to the objective of the policy. Only one industry stakeholder, of those who made submissions, agreed with the entirety of the report.

18 The Draft RIS was made available on the 13th of October and the deadline for submissions

was 30 November. 19 The letters were addressed to the Minister and copied to TheCIE.


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It should be noted that the responses cannot be added across topic as some stakeholders commented on several topics.

8.1 Summary of submission responses

Topic Total

responses % in total (20) Yes No

Costs and benefits

Overall estimates

Estimates are unreasonable 1 5 1 0

Estimates are reasonable (including sensitivity) 6 30 6 0

Estimates are uncertain / cannot comment 4 20 4 0

Enforcement costs

Concerned because costs are missing 3 15 3 0

Compliance costs

Concerned for SME costs not fully analysed 3 15 3 0

Costs inconsistent with other studies / reality 1 5 1 0

Costs are wide-ranging per size / industry 4 20 4 0

Price premiums for certified product by consumers 7 35 0 7

Intangibles

Concerned because intangibles are missing 8 40 8 0

Provide / suggest value for intangibles 8 40 0 8

Intangible benefits could exceed the costs 4 20 0 4

Australia has a moral obligation to act 6 30 6 0

B:C not okay, amoral 3 15 3 0

Agrees with use of shares* 6 30 2 4

Size of the problem

Data available is inaccurate 6 30 6 0

Illegal logging could be smaller than estimates 3 15 2 1

Policy options

Self declared legal 1 5 0 1

Self-regulation 2 10 2 0

Code of Conduct / due diligence (mandatory) 4 20 4 0



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8.1 Summary of submission responses (Continued)

Topic Total

responses % in total (20) Yes No

Capacity building 9 45 9 0

Agreements 6 30 6 0

Promotion of certification 2 10 2 0

Public procurement policies 3 15 3 0

Ban illegal logging imports 5 25 4 1

Phased approach from low to high requirements 4 20 4 0

RIS to recommend option (should have) 4 20 4 0

RIS options not appropriate or incomplete 5 25 3 2

Objectives

Policy's objective are appropriate 2 10 0 2

Objective should be protectionist 2 10 2 0

Methodology

Compliance cost to be applied all along the value chain 2 10 0 2

Unilateral action should be in the analysis 4 20 0 4

Benefits from illegal logging should be in the analysis 5 25 0 5

Note: This numbers cannot be added as the same stakeholder can be represented under several topics.

Source: TheCIECosts and benefits estimates

More than half of the submissions support an Australian policy that contains elements of capacity building on forest management practices in high-risk countries, bilateral and/or plurilateral agreements to tackle illegal logging, self-regulation, quasi regulation and approaches other than regulatory ones.

Many of these submissions argued that whatever policy the Australian government eventually decides to pursue, it should be such that it must have little or no effect on the domestic forest and wood products industry. This is because the industry is already complying with strict standards on forest management and should not be further penalized. Some industry stakeholders insisted that should it penalize them they should be compensated by the Government.

Generally, stakeholders appear to understand the economic analysis the RIS provided and recognize the complexity of the issues dealt with in the exercise.

The proposed estimates of the cost of compliance and the sensitivity analysis conducted in the RIS are broadly accepted as reasonable and wide-ranging. However, some stakeholders questioned the estimates of illegally logged timber imports and of compliance costs but none contested these with alternative data.


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Stakeholders have recognized that there is a lot of uncertainty about the global magnitude of illegal logging to start with. Data available on the size of illegal logging is often out of date and do not appropriately reflect the complexities of the issue. On compliance costs, stakeholders recognized that the costs can vary significantly depending on the type of the value chain and the size of the company.

There is concern about information not included in the analysis such as enforcement costs, value of intangible benefits and the costs details on the government’s policy proposal. Stakeholders expected to be provided with these elements for their assessment of the policy options.

Some comments point to a need to estimate the intangible benefits (to Australia) of an illegal logging policy but there are no suggestions on how to get a value that is impartial, or a potential range of magnitude for these benefits. There is no factual indication on how intangible benefits could turn around the cost-benefit ratio. However, some stakeholders commented that many policies do not have a positive benefit-cost ratio and are still put forward as they reflect Australian commitments in the international sphere. Implicitly, this means that political judgement decides what the value of the intangible benefits from fulfilling commitments is.

Various stakeholders were expecting the Draft RIS to provide recommendation of a preferred policy option. However, the RIS at its Draft stage was not intended to guide stakeholders towards a particular position but to provide a benefit-cost analysis of various options. The draft aimed to highlight the results of the benefit–cost analysis of options, but stopped short of providing a recommendation as it was still a ‘work-in-progress’ and should be intended to elicit feedback and reaction. The final report incorporates a recommended policy option.

About two thirds of stakeholders made specific comments about the overall estimates provided in the RIS, some did it in response to the first question of page 76 of the report and others as a part of a general reaction to it.

Three stakeholders, 15 per cent of the total, appear to be concerned with the overall results presented; only one of them contested the fundamental nature of the numbers, the other two have disqualified the analysis altogether considering it ‘amoral’.

About a third of stakeholders responded favourably on the broad estimates of the benefit-cost analysis. A fifth of stakeholders considered the estimates uncertain relating to the complexity of the problem, the limitations of the data available and the multiple elements combined in the benefit-cost analysis among other reasons.

Appropriateness of unilateral approach

Twenty per cent of stakeholders considered that the analysis undertaken on unilateral action in the draft RIS is not precise, given that the European Union (EU)


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and The United States of America (US) have recently initiated actions to tackle illegal logging.

The draft RIS addressed this issue in advance by conducting sensitivity analysis that covers plurilateral and multilateral actions. A sensitivity exercise specifically included action by the EU, the US and Australia and assumed the first two parties were 100 per cent effective in their quests.

The results presented indicate that the effectiveness of Australian actions increases in this context as the scope for trade diversion of illegally logged timber and timber products is reduced. However, the increased effectiveness of Australia’s actions is is only small and does not alter the conclusion reached. The main parameter affecting Australia’s effectiveness in a unilateral or plurilateral context is the low share of timber production traded. Only 15 per cent of global production of timber is traded. This provides an opportunity for producer countries to internally consume the illegal product and trade the legal product in the international market.

If a full — and effective — multilateral agreement were in place that included the main sources and users of illegally logged timber (including all domestic trade in major producing countries) it is true that the scope for diversion of illegally logged timber in response to an Australian measure to restrict imports would be substantially reduced. However, to be effective such an approach would need to target domestic consumption as well as trade. TheCIE concludes in the draft RIS that: despite there being numerous forestry-related multilateral processes, there is currently no universal mechanism or plan of action in place to meet a common objective of combating illegal logging or to address the multiple drivers (corruption and capacity to enforce forestry laws) which underpin illegal logging (page 32).Moreover, to the extent that initiatives in risk countries may eventually lead to enforcement of existing forestry laws, it will reduce the size of the problem and the quantity of illegal imports to Australia and therefore the need for Australia to restrict imports.

Compliance costs

From comments on the overall estimates of costs and benefits, it appears that about one third of stakeholders agree with the costs of compliance modelled in the RIS. However, only a quarter of stakeholders commented specifically on the costs of compliance.

A fifth of stakeholders considered the estimates uncertain as the cost of compliance can vary significantly between businesses depending on the complexity of the supply chain and sources of wood products. The mixing of timber and wood-based products in the various products categories adds to this uncertainty. However, some stakeholders considered that the sensitivity analysis conducted may cover a reasonable range of costs variation.


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Three stakeholders were concerned that the costs of compliance for small and medium enterprises may be underestimated or not fully covered in the draft RIS. The costs of compliance under regulatory options would be in the high end of the range for these businesses. Representatives of small and medium businesses in the wood products sector have indicated how it may be challenging for them having to comply with even softer policies than regulatory options; such as a Code of Conduct.

The estimates of compliance costs presented in the Draft Report are consistent with this claim. Appendix table E.7 of the Draft Report clearly shows that costs to small enterprises are likely to be much higher than for large enterprises. It is also stated in chapter 4 of the Draft Report that ‘There are small forest enterprises in Australia, small furniture makers, small cabinet makers, small to medium sized importers and producers of products such as veneer suppliers who may struggle economically to obtain full certification and verification of legal compliance’.(page 46).

Although the results presented in the Draft Report show the potential for average Australian production to increase slightly under most scenarios (see table 5.5), the average effect is masking compositional effects within industry. This can be seen in some scenarios where production increases but employment decreases. This occurs because of a switch in the types of timber products produced. There is a shift to less labour intensive products. Similar shifts are likely to occur between firms. Small firms unable to afford the costs of compliance may decrease production or be forced out of business. However, higher domestic prices that cover the low costs of compliance of large firms will induce them to expand. Large firms in Australia will be made more competitive at the cost of small firms.

There was also mention in some of the submissions that there is no great scope for substitution between imported and domestic input material for small and medium businesses. Were a restriction to imported timber applied in Australia, prices of certain wood products are likely to increase with a subsequent impact on consumers and domestic businesses facing increased input costs.

Only one stakeholder raised fundamental issues about estimates of compliance costs, opposing the underlying assumptions on the magnitude of the cost of certification per unit of production, the size of the forest operation used for modelling the cost and the way the cost of compliance is incorporated in the trade model.

Were all wood products required to be verified legal, price premiums for certified material should be an indicator of the costs of compliance involved. The price premiums would then reflect the marginal cost of compliance. Question 6 in page 76 of the RIS sought to elicit such information. About a third of stakeholders (7) pointed out that consumers in Australia don’t often pay price premiums for certified products and if paid, premiums are very low. However, one stakeholder mentioned that certified wood input material is 10 to 50 per cent more expensive than non-certified material. The implication of this is that the cost of certification is passed


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through processing stages of the supply chain but not to the consumer. The consumer is more responsive to price than appreciative of the product being sustainably produced (certified). The rationale for producers absorbing the cost of certification currently seems to be driven by the need to preserve access to more discerning markets and to protect corporate reputation rather than being driven by receiving price premiums.

Cost of certification per unit of production

Having to comply with the requirements to achieve legal verification will impose direct costs on business. Stakeholders consulted before the Draft Report was written reported a wide range of costs associated with certification, and verifying the legal origins of timber products. Estimates depend on many variables such as the size of the enterprise, the complexity of the value chain and the level of economic development of the country of operation.

The increases in costs imposed will affect the willingness of producers and importers to supply to the Australian market. This willingness to supply will determine the economic impact of the policy. In general, willingness to supply will vary across three groups of producers.

Illegal loggers will find it too expensive to abandon their cheap sources of timber to comply, so this group will cease supplying the Australian market.

Producers who are already compliant and legal will incur few costs and will be largely unaffected. They are likely to continue to supply to the Australian market and may expand supplies. These are likely to be producers in developed countries and some large operations in developing countries.

Producers who are currently largely legal but not compliant will need to set up compliance systems to meet the required standard to continue exporting to Australia. These are likely to be smaller to medium sized producers in developing countries who may face significant cost imposts to set up compliance systems.

In a practical modelling sense, it is necessary to model the producers in each country who will make marginal decisions to supply the Australian market20. In developed countries these will mostly be the large scale low cost compliant producers who will face very low compliance costs. In developing countries these will be the medium sized/non-compliant producers who may face substantial costs to set up and run compliance systems.

20 It is the marginal decisions that will determine price changes and it is price changes that

will play a big part in determining the benefits and costs of the policy.


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TheCIE calculations of cost of certification for developing (high risk) countries were based on a preliminary ITTO report21. This report estimated the costs of forest certification under various national and international schemes for five forest operations of diverse size and context22. TheCIE used the preliminary report data to build a stylised model of certification costs. The preliminary report data was used because it included comprehensive data on costs for medium to large scale operations in developing (high-risk) countries that required full development of the management systems for resource inventory, operational planning, monitoring systems, internal auditing and, documentation associated with certification.

The ITTO produced a later final report23with different costs. The preliminary ITTO report presented total cost of certification as high as US$77.43/m3 for a medium-to-large size natural forest operation. The final version of the ITTO reports estimates only as high as US$10.06/m3. TheCIE modelled a medium cost scenario for a forest operation and found a cost per unit of US$15.32/m3 which represents around 10 per cent of the log price (US$140.00/m3).

One stakeholder questions why the cost found by TheCIE is higher than the one reported in the final version of the ITTO document24.

The ITTO final report excluded most of the management systems costs important to TheCIE estimates, arguing that the costs reflected those of forest operations that had sound performance before certification with management systems well above the prevailing average in their respective countries (p x) and ... it is likely that the opportunity costs are also underestimated due to lack of understanding by FMU managers (p xi and 22).

On page xii, the final ITTO report states that: The case study FMUs tend to paint an excessively rosy picture of the economics certification because they represent above average level of management systems and environmental and social performance.

For this reason, the cost estimates in the final ITTO report are inadequate for the more comprehensive sort of costing needed to represent marginal suppliers in developing countries. It is important to concentrate on the costs of the marginal

21 ITTO 2004, Preliminary report on financial cost–benefit analysis of forest certification and

implementation of phased approaches, Thirty-sixth session, Interlaken, Switzerland, July. 22 Certification schemes refer to national systems in Brazil, CERFLOR, Indonesia, LEI, and

Malaysia, MTCC; and international FSC scheme. Operation sizes vary from 9000 to 140 000 hectares. Context characteristics refer to the level of development of forest management standards in the country and in the operation.

23 ITTO 2004, Report on financial cost–benefit analysis of forest certification and implementation of phased approaches, Thirty-seventh session, Interlaken, Switzerland, December.

24 ITTO 2004, Report on financial cost–benefit analysis of forest certification and implementation of phased approaches, Thirty-seventh session, Interlaken, Switzerland, December.


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suppliers as their costs will determine the price premiums that can be charged for certified product. The cost estimates quoted in the final ITTO report do not reflect evidence about the sorts of price premiums that might be obtained for certified tropical timber products given in the same report. These are quoted as being between 5 and 65 per cent in the final ITTO report (pages 7, 16 and 83). Moreover, it should be noted that these price premiums quoted are not at the log price level but at much higher levels of processing such as for sawnwood and plywood. At the log price level it implies they would be much higher if chain-of-custody costs are low (as reported in the final ITTO report — page 6).

The size of the forest operation

The same stakeholder concerned about compliance costs also argues that the estimates of certification cost in the draft RIS are high because TheCIE has based its base model in an operation smaller than average. However, the ITTO final report states that all operations analysed in the case studies correspond to medium-to-large size (page x). The forest operation used by TheCIE in the draft RIS to model the cost of certification falls into the same category of the medium to large-scale operation analysed by ITTO (see page 18 of the final ITTO report).

TheCIE mentions in the draft RIS that plantations may exceed the sizes and production yields of the medium-size natural forest operation used for the cost calculation. However, this is not the average situation in tropical countries were illegal logging occurs.

Cost of compliance in GTAP model

The same stakeholder also expressed concerns about the use of out-of-date costs and price data and multiplicative effects of the compliance cost.

TheCIE modelled the costs of certification for a medium-size native forest operation with undeveloped management systems. This model included detail of direct and indirect costs, and cost per certification criteria, based on FSC principles and data available in the preliminary ITTO report (2002 prices). Then assumptions about the size and the type of the operation and the level of development of its management systems were changed25 to obtain cost of certification for different types of supplier countries (scenarios). Also the break-down of cost of certification criteria allowed for estimating costs of other legality verification mechanisms such as VLO and VLC.

25 Sizes of the operation covered small (less than 30 000 ha), medium (over 30 000 ha to

100 000 ha), and large (over 100 0000 ha) and types covered plantations (higher yields) and natural forest (lower yields). Levels of development were developed and undeveloped management systems.


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The share of the cost in the log price was calculated for each scenario to be included in the GTAP model as an export tax imposed on the exporter country (say 10 per cent for a high-risk country and 0.1 per cent for a low-risk country). As the cost is incorporated in the GTAP as a percentage and not as an absolute value there was no need to bring the estimates of costs and prices to a present value. This happens automatically.

In regards to multiplicative effects, the stakeholder asks if the export tax has been applied several times to the same product imported into Australia. For example if the product is produced in one country (incurring 10 per cent certification costs in the form of an export tax) is processed in another country (again incurring 10 per cent costs) and then transhipped to Australia through a third country (again incurring 10 per cent costs) before reaching Australia. The answer is no. The export tax is only applied to the product that enters Australia. Trade between other countries is not taxed with the compliance costs so the multiplicative effect of the example does not occur.

Conclusion

Based on the evidence and concerns raised by stakeholders, TheCIE sees no reason to change any of the compliance costs used in the Draft Report. The data from the preliminary ITTO report is much more comprehensive for the sort of analysis being conducted here than what was used in the ITTO final report. Although considerable uncertainty is acknowledged in the Draft Report and by stakeholders over the marginal compliance costs, the wide sensitivity band used in the Draft Report is adequate to cover this uncertainty. Moreover, the available evidence on price premiums from stakeholders and in both ITTO reports points directly toward compliance costs at least as high as those used in the Draft Report. There is also the important evidence from the submissions of several Australian industry groups with experience of importing certified product, and in getting certification for small producers, which points to the estimates being reasonable if not underestimated.

Enforcement Costs

Four stakeholders, 20 per cent of the total, expressed their concern on the lack of enforcement costs in the benefit-cost analysis. As stated in the draft RIS, the omission of these costs leads to an underestimation of the total costs of policy options (page 48).

Adding enforcement costs will lower the benefit to cost ratio, but given it is already well below 1.0, being precise about enforcement costs will not alter the conclusion about the benefit to cost ratio being well below the critical minimum level of 1.0.

Nonetheless, to demonstrate the broad magnitude of this cost, if we assume that customs were to undertake their normal minimum level of surveillance and


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inspection of 3.0 per cent of imports, this would cost around $12 million a year for non-furniture wood and timber imports. It would cost roughly double this if furniture imports were also included, that is around $24 million annually. Were similar treatment applied to domestic production, the estimate could treble to around $72 million annually. That said, domestic production may be cheaper to inspect. Were it half the cost to inspect, the annual surveillance and inspection cost could be around $50 million a year. On top of this would be costs of prosecution, storage and disposal.

To derive these numbers we have assumed that an average shipping container holds 30 cubic metres of product and it takes two hours to unload inspect and reload a container at normal Custom’s fees of $180 an hour. Imports make about a third of consumption.

Another cost not included is the potential opportunity costs to Australia of diverting Custom’s attention away from high priority areas relating to national security and human health to conduct surveillance and inspection of timber. Surveillance and inspection are not expected to be easy because legal timber looks the same as illegal timber, and many products are composite products with many and varied sources of timber used.

Trade diversion, substitution and leakage

High potential for trade diversion to other less discerning markets is one reason why the proposed policy is so ineffective in meeting its target. One stakeholder raises several queries about the assumption on leakage programmed into the GTAP model. This is captured in the rate of substitution between markets.

Typically for pure commodities like sugar and wheat, rates of substitution between one market and another are very high (almost infinitely high). Typically most products can be substituted between markets relatively easily. Few products are made specifically for one market and even if they were, production processes can be readily changed to alter products to switch them to other markets. For this reason, rates of substitution between markets are high for many products, particular commodity based products. Sawntimber, paper products and furniture are all in this class and this is wisely built into the standard version of GTAP. Substitution is the basis for international competition and trade and there is clear evidence in virtually all areas of trade that it is high –Japanese cars substitute readily for American cars for instance, but in timber products, even higher rates could be expected. Changing the rate of substitution over any plausible range would not alter the conclusions about the benefits cost ratio being below 1.0.

The stakeholder also asks how leakage changes with stringency of the policy. Leakages increases with stringency and decreases as we move from unilateral to plurilateral based policies as correctly speculated by the stakeholder.


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Intangibles

Forty percent of stakeholders (8) expressed concern about the lack of estimates on intangible costs and benefits to Australia. While some submissions, about 15 per cent, seem to suggest that the intangibles would be high, 20 per cent indicate that they are not likely to change the benefit-cost ratio around.

Moral obligation

A third of stakeholders commented on Australia’s moral obligation to act against illegal logging. This may be interpreted as an important intangible benefit from actions taken to reduce illegal logging. One stakeholder reported that in Europe a survey had suggested that 93 per cent of citizens polled responded that it is important that products sold are legally harvested and traded. However, other stakeholders noted that there appeared to be minimal to no willingness on the part of consumers to pay for certified products, which was interpreted as a reflection of little value being placed on the moral/intangible aspects of the issue.

Corporate reputation

Some stakeholders mentioned protection of corporate reputation and wood’s reputation as an intangible that needed to be accounted for. However, that other stakeholders indicate that there is minimal to no willingness on the part of consumers to pay for certified products, it is difficult to see that the commercial damage being inflicted is likely to be large. Especially given that illegal imports make up only about 10 per cent of imports and perhaps 3 per cent of domestic market sales. Also, it is not obvious that protecting reputation of commercial enterprises is an appropriate focus for government policy. Commercial enterprises have a range of strategies available to them to maintain reputation and they appropriate the benefits of such strategies. In other words, there is no market failure.

Quantification

Intangible costs and benefits are by their very nature difficult to quantify. That said, several factors are relevant to affecting their magnitude and to interpreting their meaning in the context of this RIS.

The first is that we have been able to quantify how big the intangible benefits would have to be to lift the estimated benefit to cost ratios to the minimum critical level of 1.0. The facts are that they would have to be between four and eight times the tangible benefits.

Another factor weighing on the value of intangible benefits is the very low level of effectiveness of the policy. This would appear to deeply compromise achieving objectives relating to intangible benefits and indeed could make them negative. For instance, if Australia wants to provide a role model to trading partners, or send a


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message to invest in measures to curb illegal logging or achieve a sense of morality, this could all be counterproductive once people discover how ineffective the measure really is. In that case it is unlikely that anyone will treat the measure seriously, raise respect for Australia or gain a sense of morality from it.

Moreover, if Australia is going to spend potentially hundreds of millions of dollars on trying to achieve such intangibles, it is likely that entirely different policies could achieve the objectives sought and at lower cost. Good, effective policy is more likely to earn Australia the respect and sense of morality it might be seeking than ineffective policy. Currently the Department of Foreign Affairs and Trade spends aroundA$900 million a year on their entire effort relating to all aspects of ‘The Advancement of Australia’s international strategic security and economic interests including through bilateral, regional and multilateral engagement on Australian Government foreign and trade policy priorities’26. Were Australia to decide to impose an additional $US170 to $260 million a year (say A$210 to A$325 million) cost on the economy for one proposed program (restricting illegal logging) it would want to be reassured the benefits would at least be around a quarter to a third of those currently generated from its entire effort. This seems extremely unlikely.

Another factor weighing on the value of intangible benefits are the intangible or unmeasured costs. These were not discussed in the Draft Report. Given the very low benefit to cost ratio, it was felt it was unnecessary to mention these in detail. However, there are several potential intangible and other costs omitted from the Draft Report. An example of an omitted cost is the costs of enforcement. As demonstrated, these could be sizeable.

Many generous assumptions have had to be made relating to costs in the study. For instance, we have assumed there is no increase in environmental or social costs associated with the increases in forestry and wood products production in Australia and other low risk countries that would arise from the policy. This may not be the case. We have also assumed that there will be no environmental costs associated with a substitution from wood products to aluminium, concrete and plastic products as consumption of wood products declines slightly. Environmental groups may properly argue that both of these assumptions are incorrect. If so, this would further reduce the effectiveness of the options.

We have also assumed that the policy is 100 per cent complied with and therefore is well enforced. However, 100 per cent effectiveness will not be achieved. We have also assumed that environmental and social costs are only associated with illegal logging. In reality there could well be environmental and social costs associated with legal logging in risk countries. Many stakeholders confirmed this to be the case in the

26 Department of Foreign Affairs and Trade: Agency resources and planned performance

http://www.dfat.gov.au/dept/budget/2009_2010_pbs/2009-10_DFAT.pdf


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first round of consultation. Were we to take account of the net difference in environmental and social costs between legal and illegal logging (which would be methodologically correct) this would further lower the environmental and social benefits that might accrue to Australians.

Another generous assumption is that Australian citizens (who will pay the price of the restrictions) fully value the environmental and social benefits that would arise from the reduction in logging in distant countries and, that these accrue only to Australians and not other citizens of the world. This almost definitely is not the case. Many of the environmental benefits are global public goods that will automatically accrue more to non-Australians than Australians. Australia will only be able to appropriate these as benefits if there is a mechanism by which Australia can count the emission reductions achieved as helping to achieve their emissions reduction targets. No mechanism currently exists. If Australians can’t appropriate the gains, an argument needs to be mounted that benefits are perceived by Australians. In reality, some Australians may not care about the benefits; others may value more highly achieving environmental or social benefits closer to home than in distant regions of the world where verification is difficult to achieve. Because we have ignored this reality, we have excluded an intangible cost.

Intangible costs

Intangible costs may also arise in how any message created by the proposed policy is interpreted among trading partners. Many stakeholders raised this in the initial round of consultation. Trading partners could retaliate against the restriction and restrict Australia’s access to their markets for other products. It may result in more international scrutiny of Australia’s own forest policies and definitions of legality by NGOs.

There may also be diplomatic costs incurred as trading partners retaliate by becoming less willing to cooperate with other Australian initiatives abroad. Some countries may relax their current legal requirements so as to meet the new Australian standards but in so doing undermine further the effectiveness of the Australian policy. During the initial round of consultation many stakeholders expressed doubt about Australia’s ability to be effective.

Concerns were also raised that those Australian importers who were making progress with foreign suppliers to achieve higher standards may be forced to abandon such sources and initiatives if they are unable to comply. This could be counterproductive to the first two elements of the government’s initiative relating to capacity building and supporting certification schemes. Far from achieving leadership and influence the opposite may occur. Causing legal imports to decrease would be another counterproductive and unintended outcome the results indicate could occur.


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Conclusion

Although some stakeholder hold concerns about intangible costs and benefits, TheCIE sees no reason to believe that a closer examination of intangibles will change the conclusion that the benefit to cost ratio is very low and well below 1.0. TheCIE can identify a number of reasons why:

intangible benefits are likely to be small relative to costs;

estimates of tangible benefits are already generous; and

several intangible and tangible costs have been omitted.

On closer consideration of all tangible and omitted benefits and costs, TheCIE believes that, in all probability, it has underestimated costs and overstated benefits. This strengthens the conclusion that the benefit cost ratio is well below 1.0.

Size of illegal logging

A third of stakeholders commented on the inconsistencies in the data available on the size of illegal logging. The problems with the data were referred to as follows.

Available data reports the ‘country of origin’ of the timber and wood-based products, not the ‘country of harvest’ of logs utilised to produce the products imported from the country of origin. Examples exist of timber and wood-based products imported from high risk countries that use timber from low risk countries or vice versa.

Risk of illegality is a combination of country of harvest risk as well as supply chain risk. The draft RIS only analyses the country risk.

Two stakeholders considered the size of illegal logging likely to be overestimated. The implication of this is that the size of the problem at issue may be commensurately smaller, so the gain from restricting illegal logging would be less than estimated.

Another stakeholder noted that a project to reassess earlier estimates and methodologies of deriving estimates of illegal logging imports is presently being completed for DAFF by Pöyry Consulting. The stakeholder argues that this seems to be a task that needs to precede the development of a policy proposal and the preparation of a RIS.

The sensitivity analysis conducted in the RIS covers estimation of the overall benefit-cost analysis under the assumption that global illegal logging is only half the size used for the main estimates. TheCIE considers this makes up for inconsistencies in the data available on the size of the problem.


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Policy options

Ninety per cent of stakeholders who made submissions27 commented on the policy options that the Australian government could implement to achieve the objective of tackling illegal logging (see box 8.2 for some of the comments from stakeholders). The answers vary but there seems to be substantial support for options that include capacity building, 45 per cent of stakeholders, and bilateral or plurilateral agreements with producer countries, 30 per cent.

8.2 Views of some stakeholders on policy options

Most stakeholders who put in submissions agree with maintaining Australia’s current bilateral, multilateral and capacity building efforts.

Four stakeholders broadly support a due diligence regulation supported by some form of mandatory requirement, while noting that all steps should be taken to minimize the cost impacts on business.

One stakeholder wants a system consistent with those being employed overseas but for Australia to mandate the legality verification standard to be met by importers and domestic suppliers.

Other submissions supported government taking action.

Radical regulatory options that could impose additional cost burden on the domestic industry and affect its competitiveness such as banning imports of illegally logged timber were discouraged by industry stakeholders. Australian forest producers already face strict legal, social and environmental requirements. Only three stakeholders demanded a ban to be imposed.

One stakeholder, who considers that the ultimate objective of the policy is stopping all illegally logged timber that enters to the Australian market (rather than to prevent environmental, social and financial damage in developing countries), proposes that the ban takes place as the final stage of a phased approach. Another three stakeholders support approaches that are phased-in from soft to firmer legal compliance requirements.

A mandatory Code of Conduct containing due diligence provisions was also mentioned by 20 per cent of stakeholders (4) as a potential option that will not affect Australia’s industry and trade relations so much. Some stakeholders appeared to positively embrace such an approach believing it to be superior to a co-regulatory approach that relied on one industry based standard. The impression is given in these submissions that a due diligence approach would allow more flexibility in the 27 It should be remembered that 75 per cent of stakeholders sent the Draft RIS did not provide

submissions.


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choice of standard to use to ensure legal verification. This may be so, however, once a code of conduct becomes mandatory it virtually becomes a case of co-regulation as it relies on government to enforce it. And typically government must enforce a standard. Under these circumstances, a mandatory code of conduct is likely to experience costs and benefits similar to that of a co-regulatory approach which was shown in the Draft Report to have costs far outweighing benefits.

The use of a due diligence approach might be able to be used to keep compliance, administration and enforcement costs lower than when using one strict standard, but this will depend on how it is enforced. The more stringently it is enforced the more expensive it will be, but the more effective it will also be in keeping illegally logged timber out. The less stringently it is enforce, the cheaper it will be, but also it will be less effective. There may also be questions relating to ensuring it is applied equally to imports as domestic production. TheCIE concludes in the Draft Report that under any options involving quasi-regulation (which might include a voluntary code of conduct), co-regulation or explicit regulation involving a due diligence approach, cost would far exceed benefits (see table 7.3).

Two representative bodies of small and medium enterprises in the wood products sector expressed concern on the costs of regulatory options for their members and stated they will only support self-regulation.

In the RIS, full certification (FC) was one of the mechanisms for demonstrating compliance with forestry laws under a co-regulatory approach. Stakeholders perceive this mechanism as a sufficient proof of legality but there was no explicit support for mandating it as a minimum requirement. Several stakeholders support forest certification principles and consider it important for the Australian government to promote but not mandate it.

One stakeholder expressed concern on the self- declaration of legal origin option, named SDL in the draft RIS. This was one of the possible mechanisms for demonstrating compliance with forestry laws under a co-regulatory approach. The submission suggests it to be removed from the analysis altogether as it is not considered acceptable. As reflected in the Draft RIS, page 74, despite being a low cost option, the effectiveness of it is also low in achieving the policy’s objective.

Two stakeholders considered inappropriate the options covered in the RIS. This relates to issues with the objective of the policy. The section on Policy objectives below provides more detail on those issues.

Twenty per cent of stakeholders indicated that they were expecting the Draft RIS to provide a preferred policy option. However, the RIS at its Draft stage was not intended to guide stakeholders towards a particular position but to provide a benefit-cost analysis of various options. The draft aimed to highlight the results of the benefit–cost analysis of options, but stopped short of providing conclusions or recommendation. It was intended to elicit feedback and reaction.


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Legal verification

Under a co-regulatory approach the Australian government can require operator to comply with one of various available off-the-shelf mechanisms for demonstrating compliance with forest law. Figure 4.1 in the RIS, page 43, provides a guide on the elements of legality compliance covered by each of the mechanisms available; self-declaration of VLO, third party monitoring (TPM) of VLO, TPM of VLC and TPM FC. The break-down of components is based on FSC certification principles for FC.

One stakeholder expressed concern about the component called monitoring and assessment.

It is not clear why ‘monitoring and assessment systems’ are listed as a compliance element in figure 4.1. Compliance elements are the substance that has to be complied with in a given standard, not the verification, monitoring and assessment procedures such as through SD, independent TPM and the COC.

TheCIE understands that monitoring and assessment are procedures undertaken in any level of verification (VLO, VLC, FC). However, our cost model is based on FSC principles (based on ITTO 2004 case studies) where principle 8 is specifically called Monitoring and Assessment. This principle relates to specific activities the forest management unit needs to undertake or systems it needs to have in place to assess the condition of the forest, yields of forest products, chain of custody, management activities and their social and environmental impacts. To comply with this FSC principle, forest managers should have research and data to monitor yields, growth rates, regeneration, changes in flora and fauna, environmental and social impacts of harvesting, costs, productivity, and efficiency of forest management. Documentation shall be provided by the forest manager to enable monitoring and certifying organizations to trace each forest product from its origin. The results of monitoring shall be incorporated into the implementation and revision of the management plan. While respecting the confidentiality of information, forest managers shall make publicly available a summary of the results of monitoring indicators28.

Monitoring and Assessment refers to a particular principle in FSC international standards for FCwhile this is not a criterion in the standards for VLO or VLC.

Policy objectives

Two stakeholders expressed concern about the policy objectives and the potential mix of goals and instruments in the five-element policy proposal.

28 http://www.fsc.org/fileadmin/web-

data/public/document_center/international_FSC_policies/standards/FSC_STD_01_001_V4_0_EN_FSC_Principles_and_Criteria.pdf


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One of them considers that the objectives of the policy are not clearly expressed in the ALP election commitment. It also has reservations about the five-element proposal as it fluctuates between restriction of imports, promotion of sustainability and action in the international sphere.

It suggests the focus of the policy to be on minimizing the adverse impact illegal logging has in the domestic industry and in the locations where it occurs, to reassure consumers they are not buying illegal product and to minimize the effects of regulation on domestic industry. Protecting the domestic industry is clearly not the ultimate expressed objective of the policy. Even if it were, the benefit cost analysis would indicate costs exceeding benefits by a larger margin than indicated in the Draft Report, because no value would need to be put on the benefits of reducing environmental, social and financial damage abroad.

Contrariwise, other stakeholder expressed that the objective stated in the ALP election commitment was correct but the draft RIS and other documents and statements by the Minister are not consistent with it. Other consultancies undertaken for DAFF in parallel to the RIS process are seen as mixed signals to industry, environment groups and the broader public.

In regards to this concern, TheCIE clarifies that the objective of the policy stated in the draft RIS was the official objective provided by DAFF to TheCIE.

The Issues paper made available to stakeholders in May has TheCIE perception on potential issues related to inconsistencies in the policy’s objective and elements. These issues refer to an objective that correctly targets sustainable forest practices but instruments focused on the legality of the products.

As to the RIS, the OBPR requires that the rationale underlying the policy be analysed. This involves looking at the economic objective that justifies government intervention and it involves assessing whether the economic welfare 29 of Australians is increased. The issues paper reflects such analysis of the policy’s economic objective.

29 By economic welfare TheCIE means environmental, social and financial welfare.


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9 Conclusion

Analysis undertaken for this report indicates that there is a potential benefit to the world from eliminating illegal logging. The key questions for this RIS concern what additional costs would be incurred as a result of measures to reduce illegal logging, how much of the benefit might be achieved as a result of measures that Australian can take, especially those targeted at reducing importation of products incorporating illegally logged timber, and how the measures might interact with other Australian and international initiatives.

Results indicate that, for Australia, there is an overall net cost from unilaterally implementing an import restriction and product disclosure measure. The results also make it clear that any unilateral action taken by Australia is likely to be ineffective because of the potential for trade diversion of illegally sourced timber products to less discerning markets. Largely this is due to the fact that Australia is such a small part of the global market.

Restricting imports

The analysis indicates that applying unilateral import restrictions would only stop production of about a tenth of the products incorporating illegally logged timber currently coming to Australia. The rest would be diverted to other markets and other products (export and domestic). Because so much timber is used domestically in the country of harvest, and because much of the trade in timber flows through countries with weak or no controls on the legality of imported timber, the scope for diversion is high. Further, while it is difficult to restrict all products that might incorporate illegally logged timber, if the product coverage of measures is small, illegally logged timber will flow into the non-restricted trade.

Because restricting imports has limited effect in reducing illegal logging, Australia incurs all the costs of restricting imports without achieving commensurate benefits of reducing the damaging effect of illegal logging. This reflects the inherent difficulty of constructing measures within Australia to affect behaviour in other countries.

The analysis shows that the measures are likely to cause welfare losses in Australia and in those developing countries from which Australia may currently be importing products incorporating illegally logged timber. However, national welfare would be increased slightly in countries such as New Zealand, the European Union and the United States, whose producers would expand export sales to Australia.


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The analysis indicates that costs of Australia’s policy approach are sensitive to legality verification compliance cost estimates for the four currently available schemes of legality verification (SDL, VLO, VLC and FC) and the proposed supply elasticity’s for the countries and regions exporting timber products to Australia. However, even considering wide changes in these parameters, benefit to cost ratios remain low because Australia’s effectiveness in reducing illegal logging through trade restriction measures remains low.

Whilst the results indicate that full certification for the widest range of timber products provides the most effective policy option in terms of reducing illegal logging, associated financial costs and capacity building requirements for compliance make it a very costly option. The lowest level of legality verification (SDL) offers a relatively lower cost option to industry and consumers, but with a correspondingly lower level of legality assurance.

Although an economic analysis of the tangible economic costs and benefits of measures indicates a low to very low benefit: cost ratio to Australia from unilateral action, there are intangible benefits and costs that could alter the ratio of benefits to costs. On balance, these would have to be very large to provide a positive net benefit, a fact compromised by the low level of effectiveness of the measures in restricting illegal logging and the various tangible and intangible costs omitted from the analysis such as enforcement costs.

Effectiveness of Australian initiatives — international context

An important issue shaping the results of the cost-benefit analysis is that while Australian measures to restrict imports of products incorporating illegally logged timber can be reasonably — although not completely — effective in limiting such imports, they are much less effective in reducing the amount of illegal logging occurring in the world.

A new Australian initiative would, however, be implemented in a context where some significant importers of timber products are also putting in place measure targeting importation of illegally logged timber. This could reduce the scope for diversion of illegally logged timber. Further, many source countries, such as the members of ASEAN, are responding to proof of legality requirements by developing their own legality verification and chain of custody schemes. Industry is also developing similar schemes, such as the TLTV for Papua New Guinea timber exports. Whilst the development of a multilateral agreement to combat illegal logging is probably a long way off, related initiatives such as those under the UNFF non-binding arrangement on the management of all types of forests and the UNCCPCJ resolution to combat international trafficking in timber products could contribute to the effectiveness of Australia’s policy to combat illegal logging.


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This analysis has tested whether the actions being taken or considered in the United States and members of the European Union would increase the effectiveness of an Australian restriction measure in reducing the extent of illegal logging. The results show that the effectiveness of Australia’s actions would be increased, but not enough for the benefits to exceed the costs. This is because opportunities for leakage would remain. This is not entirely unexpected because trade in timber products is only about 15 per cent of global production so a significant share of illegally logged timber (85 per cent) is consumed within the country where it is harvested. So any action aimed at trade is only likely to directly target about 15 per cent of illegal logging. It may have other flow-on effects to domestically consumed products, however, that said, even action targeted at the 15 per cent of timber products that is traded is unlikely to be 100 per cent effective in its enforcement. (It is possible that actions taken by governments in countries which are major markets for timber products may have demonstration effects within countries where illegal logging occurs or extensive use is made of illegally logged timber, to encourage a more rapid adoption of a culture of legal compliance. On the other hand it could also cause adverse, retaliatory responses. This study has not modelled these possibilities).

If a full — and effective — multilateral agreement were in place that included the main sources and users of illegally logged timber the scope for diversion of illegally logged timber in response to an Australian measure to restrict imports would be substantially reduced. To be effective such an approach would need to target domestic consumption as well as trade. Similarly, agreements and cooperative arrangements with developing producer countries, such as Indonesia, Malaysia and Papua New Guinea, and consumer countries, such as China, that are designed to improve forest governance, achieve sustainable forest management, forest certification and verifying the legal origins of timber products would also complement a restriction measure and increase the probability that it would be effective. This might also be true for initiatives for regional capacity building through overseas development aid. This analysis has not assessed the likely impacts of such complementary measures.

Product disclosure

In assessing the costs of disclosure of species, country of harvest and any certification at point of sale, it is reasonable to assume that the costs of industry complying with this requirement would only be marginally higher than the legality verification compliance costs associated with the import restriction measure if product disclosure is required at the point of entry into Australia. Essentially, the disclosure requirements will be verified from the forest through to the point of export and subsequently the point of import into Australia. To support this approach some form of data collection investment by the government would be required at the point of


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entry together with the expansion of the above-mentioned penalty regime to cover non-compliance with this requirement.

Requiring disclosure at the point of wholesale or retail sale would be expected to raise the cost to business relative to the legality verification compliance costs described in this chapter. A decision for government will therefore be the point along the supply chain for enforcing the disclosure measure. It is reasonable to assume that further along the supply chain that this measure is applied, the higher the cost to industry. For government, collecting the information required to support enforcement of the disclosure measure might be greater than the costs of collecting that information at the border, where it could be incorporated into the existing data collection systems of Customs and AQIS.

Recommendation

The analysis presented in this RIS shows that Australia faces many constraints in trying to reduce illegal logging in foreign countries by restricting imports of illegally logged timber into Australia. The main reason any Australian initiative focussed on imports will be so ineffective is due to two main facts:

world trade in timber products is only around 15 per cent of world timber product production, so 85 per cent of the production is unaffected by any such action;

Australia’s share of the 15 per cent traded is tiny, so Australia’s influence is equally tiny.

These two parameters mean illegal loggers can largely move to less discerning markets if Australia restricts imports. As a result, although Australia may restrict illegal imports completely, most (around 90 per cent) of these will be diverted to other markets, so Australia’s effectiveness in reducing illegal logging is inconsequential. That is, Australia’s effectiveness in reducing illegal logging is about 10 per cent of illegal imports.

Illegal imports of timber products are thought to make up around 10 per cent of imports and around 3 per cent of Australia’s consumption of timber products. If Australian action is only 10 per cent effective in reducing illegal logging in the country of origin, the percentage of Australian consumption Australia will influence is 0.3 per cent - a very small number. Meanwhile, any action Australia takes to restrict imports will impose costs not only on illegal imports, but also on legal imports and domestic production, that is on all products consumed. So costs will potentially affect all timber products consumed in Australia, while benefits will relate to less than one percent of total consumption. In assessing the effectiveness and efficiency of any regulatory policy aimed only at restricting imports, the mathematics of the market is stacked convincingly against success. Moreover, there is no evidence that the balance of intangible costs and benefits could change this. Indeed, because


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the effectiveness of the policy is so small, intangible benefits will be commensurately low.

For this reason, TheCIE recommends that Australia consider only non-regulatory policy options to combat illegal logging. Capacity building initiatives have the advantage that they are designed to tackle the problem of illegal logging at its source. That is, they are designed to change ambiguous laws and/or to see enforcement of laws closer to the source of the problem. At this level, Australia is likely to provide more direct leadership and to establish influence without creating reasons for retaliation or non-cooperation. It can also limit and contain costs by targeting action toward initiatives where it has a reasonable chance of success.

Bilateral and/or plurilateral agreements designed to tackle illegal logging by directly influencing the reform and enforcement of forestry laws in the country of origin of the problem may also hold promise. They too are targeting all levels of production in risk countries, not just a small amount of exports.


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References

American Forest and Paper Association 2009, ‘Policy Issues — Illegal Logging’, http://www.afandpa.org, Accessed 20 January 2009.

Bennett J, 2001, ‘Private Sector Business Opportunities in National Parks’ Agribusiness Review, Volume 9, Paper No. 5.

Binswanger, H.C. and Chakraborty, R.N. 2000, The Economics of Resource Management, University of St Gallen, Institute for Economy and the Environment, Switzerland.

Braat, L. and Brinks, ten P. (eds) 2008, The Case of Policy Inaction: The case of not meeting the 2010 biodiversity target, Brussels.

Brack, D. 2007, Illegal Logging, Briefing Paper, Energy, Environment and Development Programme EEDP/LOG BP 07/01, Chathman House, London.

Brown, D. and Bird, N. 2007, Convergence between Certification and Verification in the drive to Legality Assurance: Assessing the Pros and the Cons, Briefing Paper, Verifor.

Bulkan J and Palmer J, 2008, ‘Breaking the rings of forest corruption: steps toward better forest governance’, Forests, Trees and Livelihoods, Vol. 18, pp 103-131.

Contreras-Hermsosilla, 2001, ‘Illegal forest activities in the Asia Pacific Rim’, Markets for forest conservation, Pacific Rim Initiative.

Commonwealth of Australia 2008a, Australia’s Low Pollution Future: The Economics of Climate Change Mitigation, Canberra.

—— 2008b, Climate change mitigation policy modelling: Summary of assumptions and data sources, Canberra.

Curtin, T. 2007, ‘What constitutes illegal logging?’, Pacific Economic Bulletin, Vol. 22, No. 1, pp. 125–134, March.

DAFF (Department of Agriculture Fisheries and Forestry) 2009, ‘Illegal Logging’, http://www.daff.gov.au/forestry/international/illegal-logging, Accessed February 2009.

—— 2008, ‘Attachment A: ALP election commitments on restricting imports of illegally logged timber’, Australian Government Illegal Logging Policy Regulatory Impact Statement – Draft Terms of Reference, Canberra.

Department of Climate Change 2009, ‘International Forest Carbon Initiative’ http://www.climatechange.gov.au/international/publications/fs-ifci.html, Accessed 11 May 2009.

EUROPA 2008, FLEGT/FLEG, European Commission, http://ec.europa.eu/environment/forests/flegt.htm, Accessed on 8 December 2008.

FAO (Food and Agriculture Organization of the United Nations) 2009, ‘FAOSTAT’, http://faostat.fao.org/site/626/default.aspx#ancor, Accessed on 24 March 2009.

—— 2007a, ‘Deforestation and net forest area change’ Facts and figures, http://www.fao.org/ forestry/30515/en/, Accessed 10 June 2009.


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—— 2007b, ‘Forests and the environment’, Facts and figures, http://www.fao.org/forestry/ 28814/en/, Accessed 24 March 2009.

—— 2007c, ‘People and forests’, Facts and figures, http://www.fao.org/forestry/28811/en/, Accessed 24 March 2009.

—— 2007d, ‘Deforestation and net forest area change’, Facts and figures, http://www.fao.org/ forestry/30515/en/, Accessed 1 July 2009.

—— 2005, Global Forest Resources Assessment, Chapter 2: Extent of forest resources, pp. 11–36.

Forest & Wood Products Australia 2009, ‘Timber Chain of Custody Certification, Product tracking from the forest to the consumer’, http://www.fwpa.com.au/industry.aspx?s =2&pn=PN07.1055, Accessed 20 May 2009.

Friedman D. 1996, ‘Rational Criminals and Intentional Accidents: The Economics of Law and Law Breaking Chapter 20’, Hidden Order: The Economics of Everyday Life, Harper-Collins, 1996.

Global Forest Watch 2009, ‘Brazil’s forests in brief’, http://www.globalforestwatch.org/ english/brazil/forests.htm, Accessed 7 January 2009.

GTI (Global Trade Information Services Inc.) 2009, World Trade Atlas Trade Information System, online database.

Greenpeace 2009, ‘Deforestation — understanding the problem’, http://www.greenpeace. org/australia/issues/deforestation/overview, Accessed 20 January 2009.

Harrison, S. 2003, ‘Property Rights Issues in Small-scale Forestry in The Philippines’, Annals of Tropical Research, Vol 25, No. 2, pp. 77–87.

Hartman, R. 1976, ‘The Harvesting Decision When a Standing Forest has Value’, Economic Inquiry, Vol. XIV, pp. 52–59.

Hartwick J M & Olewiler N D 1986, The Economics of Natural Resource Use, Harper & Row, New York.

IKEA Wholesale Inc. 2008, ‘Written Comments on Implementation of Revised Lacey Act Provisions Docket number APHIS-2008-0119’, Correspondence to the Regulatory Analysis and Development, PPD-APHIS, December.

Indufor 2008, Assessment of the Impact of Potential Further Measures to Prevent the Importation or Placing on the Market of Illegally Harvested Timber or Products Derived from Such Timber, Final Report, Helsinki.

ITTO (International Tropical Timber Organization) 2008, Developing Forest Certification Towards Increasing the Comparability and Acceptance of Forest Certification Worldwide, Technical Series, 28 May.

—— 2004, Preliminary report on financial cost–benefit analysis of forest certification and implementation of phased approaches, Thirty-sixth session, Interlaken, Switzerland, July.

Jaakko Poyry Consulting 2005, Overview of Illegal Logging, Page 12

Nam Theun 2 Power Company 2007, ‘Resettlement action plan: Volume 1 General Information’, http://www.namtheun2.com/News/resettlement/ Resettlement%20Action%20Plan%20-%20Vol%201%20-%20General%20 Information.pdf), Accessed 9 July 2009.

Seneca Creek Associates, LLC and Wood Resources International, LLC 2004, ‘Illegal’ Logging and Global Wood Markets: The Competitive Impacts on the U.S. Wood Products Industry, prepared for the American Forest and Paper Association, November, Maryland, US.


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Stern, N. 2006, The Economics of Climate Change: Stern Review, HM Treasury, London, http://www.hm-treasury.gov.uk/sternreview_index.htm, Accessed 14 July 2009.

The Lacey Act 2008, ‘Amendments to the Lacey Act from H.R.2419, Sec. 8204’, Chapter 53 of Title 16, United States Code, http://www.aphis.usda.gov/plant_health/lacey_act/downloads/background--redlinedLaceyamndmnt--forests--may08.pdf, Accessed 16 July 2009.

The Prince’s Charities 2008, The Prince’s Rainforests project, A plan for emergency funding. Consultative Document, December.

Transparency International 2008, ‘Corruption perceptions index 2008’, http://www.transparency.org/policy_research/surveys_indices/cpi/2008, Accessed 12 January 2009.

Turner, J, Maplesden, F. and Johnson, S. 2007, ‘Measuring the impact of illegal logging’, ITTO Tropical Forest Update 17/3, pp.19–22.

UNFCCC (United Nations Framework Convention on Climate Change) 2005, ‘Sixth compilation and synthesis of initial national communications from parties not included in Annex I to the Convention: Inventories of anthropogenic emissions by sources and removals by sinks of greenhouse gases’, FCCC/SB1/2005/18/Add.2.

USDA (United States Department of Agriculture) 2009, FAS Forest Product Groupings (Defined) – Imports, Foreign Agricultural Service, USDA, Washington D.C., http://www.fas.usda.gov/ustrade/ustlists/ImFASCm.asp?QI=&type=1&code=120, Accessed 20 January 2009.

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World Bank, 2002, Forest Concession Policies and Revenue Systems, World Bank Technical Paper No. 522 (prepared by John A Grey), Washington DC.

—— 2006, The International Bank for Reconstruction and Development 2006, Strengthening Forest Law Enforcement and Governance: Addressing a Systemic Constraint to Sustainable Development, Report No. 36638-GLB, August, Washington.

World Rainforest Movement 2009, ‘What are the underlying causes of deforestation?’ http://www.wrm.org.uy/deforestation/indirect.html, Accessed 24 March 2009.

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WWF (World Wildlife Fund) Global Forest and Trade Network, 2006a, ‘Best practices for keeping illegally harvested timber out of your supply chain’, WWF: Gland, Switzerland.

—— 2006b, Keep it Legal: Best Practices for Keeping Illegally Harvested Timber Out of Your Supply Chain, July.

A p p e n d i c e s


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A GTAP model

To quantitatively assess the impacts of a policy to restrict trade, it is necessary to develop an understanding of how the proposed regulation might impact on consumption, production and trade of forestry products as well as the impact this might have on Australians’ incomes and welfare. It is also important to assess impacts to some extent on exporting nations because the benefits to Australia will accrue largely from the reduction in any environmental, social and economic costs occurring in exporting countries. A computer based market trade model is necessary to track the complex interactions that might occur.

For this exercise we have modified an existing model of global economy and products trade. The Global Trade Analysis Project (GTAP) model is used for assessing international diversions of trade that might occur. It is a general equilibrium model of the global economy developed by the Purdue University.

The GTAP model has two important components, a mathematic equation system describing the economic linkage between countries, between sectors, and between economic agents, and a database containing information of these relations and linkages. The latest GTAP database is Version 7 which identifies 113 countries or country groups and 57 sectors. This database represents the world economy in 2004.

For the purpose of this study we aggregated the countries into 22 countries or country groups but retaining identity of those countries with the most important trade relationship with Australia. Sectors were aggregated into nine to preserve detailed information on timber related sectors.

Table A.1 summarises the regional classification and table A.2 the sectoral classification.


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A.1 Region classification

New group Code Original GTAP region

Australia Aus Australia

New Zealand NZ New Zealand

Rest of Oceania Oceania Rest of Oceania

China China China

Japan Japan Japan

Korea Korea Korea, Republic of

Hong Kong and Singapore

HKSing Hong Kong; Singapore

Indonesia Indonesia Indonesia

Malaysia Malaysia Malaysia

Thailand Thai Thailand

Vietnam Vietnam Vietnam

Rest of Asia RoAs Myanmar; Taiwan; Rest of East Asia; Cambodia; Lao Peoples Democratic Republic; Philippines; Rest of Southeast Asia; Bangladesh; India; Pakistan; Sri Lanka; Rest of South Asia; Kazakhstan; Kyrgyzstan; Azerbaijan; Iran, Islamic Republic of; Turkey; Rest of Western Asia

Russia Russia Russia

EU 15 EU15 Austria, Belgium, Denmark, Finland, France, Germany, United Kingdom, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden

Acceding EU 10 ACEU10 Cyprus, Czech Republic, Hungary, Malta, Poland, Slovakia, Slovenia, Estonia, Latvia, Lithuania

North America Nam Canada and United States

Brazil Brazil Brazil

Latin America LatinAm Argentina; Bolivia; Caribbean; Chile; Colombia; Costa Rica; Ecuador; Guatemala; Mexico; Nicaragua; Panama; Paraguay; Peru; Rest of Central America; Rest of South America; Uruguay; Venezuela

West and Central Africa

WCAf Nigeria; Rest of Western Africa; Central Africa; South Central Africa

Rest of Africa RoAf Egypt; Morocco; Tunisia; Rest of North Africa; Senegal; Ethiopia; Madagascar; Malawi; Mauritius; Mozambique; Tanzania; Uganda; Zambia; Zimbabwe; Rest of Eastern Africa; Botswana; South Africa; Rest of South African Customs Union

Rest of World ROW Rest of North America

Source: TheCIE construction based on GTAP Database 7.


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A.2 Sector classification

New sector Code Original GTAP sector

Food and agriculture Food Paddy rice; Wheat; Cereal grains nec; Vegetables, fruit, nuts; Oil seeds; Sugar cane, sugar beet; Plant-based fibers; Crops nec; Cattle, sheep, goats, horses; Animal products nec; Raw milk; Wool, silk-worm cocoons; Meat: cattle, sheep, goats, horse; Meat products nec; Vegetable oils and fats; Dairy products; Processed rice; Sugar; Food products nec; Beverages and tobacco products

Forestry Forestry Forestry

Wood products WdPrd Wood products

Paper products, publishing

PPP Paper products, publishing

Furniture and other manufactures

FurOmf Manufactures nec (including furniture)

Manufacture Mnfcs Fishing; Coal; Oil; Gas; Minerals nec; Textiles; Wearing apparel; Leather products; Petroleum, coal products; Chemical, rubber, plastic products; Mineral products nec; Ferrous metals; Metals nec; Metal products; Motor vehicles and parts; Transport equipment nec; Electronic equipment; Machinery and equipment nec

Housing Const Dwelling

Construction House Construction

Services Svces Electricity; Gas manufacture, distribution; Water; Trade; Transport nec; Sea transport; Air transport; Communication; Financial services nec; Insurance; Business services nec; Recreation and other services; Public administration, defence, health and education

Source: TheCIE construction based on GTAP Database 7.


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B Methodology

Chart 1.1 in the main text summarises our analytical approach for this RIS. The analysis consists of three major components:

Evaluating the current situation including the size of illegal logging, existing policies dealing with the illegal logging problem, and the costs of illegal logging;

Formulating relevant policy options including the level of regulation, the coverage of the products in regulation, and the associated compliance costs of each option; and

Assessing the impact of options with emphases on the reduction in illegal logging activities in the high risk countries and the associated benefits and costs.

This appendix describes the methodology used in this draft RIS report.

Evaluation of the current situation

This part of the analysis is mainly drawn from the existing literature and stakeholder consultation. The GTAP model is also used to replicate and/or verify the findings of other studies.

The size of illegal logging

We have examined existing estimates of illegal logging shares in production and trade, and consulted stakeholders about the perceived size of illegal logging. One impression we have obtained is that the estimates of illegal logging shares differ from study to study, with those by government institutions at the lower end and those by environmental groups at the upper end.

The most comprehensive and widely cited estimates are those by Seneca Creek (2004) and Turner et al (2007). We base our analysis and discussion on the low and most likely estimates of Turner et al (2007) (see table 2.2).

The cost of illegal logging

Illegal logging may cause financial, social and environmental damages. It is widely held that illegal logging depresses prices of wood products, and causes losses in government and community revenues.


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Chart B.1 depicts demand and supply curves of logging in a risk country. The total supply of timber is a combination of legal and illegal logging. The difference between the total supply curve and the legal logging supply curve is illegal logging. The current market equilibrium is at E0 with production at Q0 and price at P0. Among the total production Q0, Q0l is the legal logging production and Q0-Q0l is illegal logging production.

B.1 Logging supply and demand Price

Quantity Q0l Q1

P1

P0

E1

B A

D

Legal logging supply

T

L

E0

Total logging supply

Q0

Illegal logging

Source: TheCIE.

Suppose we eliminate the illegal logging activity, the supply curve would be only the legal supply curve. With the same demand curve, the new partial equilibrium would be at E1, with production at Q1 and price at P1. Enjoying higher production and price, the legal loggers would gain producer surplus by the area of P1E1AP0. At the same time, illegal loggers lose producer surplus by the area of AE0DC and the downstream users and consumers lose consumer surplus by the area of P1E1E0P0. Note that the gain to legal loggers is part of the loss to consumers. The net loss to the society would be the area of CE1E0D.

This simple illustration shows that although eliminating illegal logging provides gain to legal loggers, it comes up with a net financial cost to society. Assigning a financial benefit to illegal logging does not mean it is justified because this economic benefit does not include the social and environmental costs associated with illegal logging. A sensible question is whether these social and environmental costs outweigh the financial benefit of illegal logging. A further question related to the illegal logging policy is whether the financial benefits foregone by reducing illegal logging are matched by the social and environmental benefits achieved by the reduction in illegal logging.


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Financial benefits and costs of eliminating illegal logging estimated by GTAP

The database of the GTAP model represents the total logging supply curve as depicted in chart B.1. Eliminating illegal logging would shift the total logging supply curve to the position of legal logging supply curve. To model the elimination of illegal logging we use logging production costs as an instrument to achieve the required reduction in logging production in the risk countries.

As shown in chart B.1, although illegal logging reduces by AE0, the actual reduction in logging product is only BE0, because legal logging increases by AB. To find the required reduction in logging product, we assume that legal logging has the same supply elasticity as the total logging and the demand elasticity is the same at the original and the new equilibrium. With these assumptions we are able to calculate the required reduction in logging production as follows:

illegalsd

d SAEBAEEBE

EBEBE ×+

=×∠+∠

∠=

εεε

0101

010 (B.1)

where dε and sε are demand and supply elasticities, respectively, and illegalS is the share of illegal logging in total logging production.

We start with the low estimates of illegal logging shares in Turner et al (2007). The low estimates imply the share of illegal logging in world production is about 8.2 per cent.

The impacts of eliminating illegal logging estimated by the GTAP model are summarised in table B.2.

B.2 Impact of eliminating illegal logging

Welfare change Forestry products Wood products

Total

Gain to legal

loggers Loss to others Price Production Price Production

US$ mil US$ mil US$ mil % % % %

Australia 65.1 334.0 -268.8 24.6 2.1 3.4 10.5

New Zealand 218.4 461.2 -242.8 21.9 10.2 4.8 -8.1

Other Oceania -187.9 170.3 -358.3 41.5 -23.0 4.3 -27.1

China -30971.8 18032.3 -49004.2 61.2 -16.1 7.8 -19.2

Japan -412.0 919.0 -1331.0 15.3 5.0 3.9 2.5

Korea -334.6 175.9 -510.5 22.1 -3.5 4.6 -2.8

HK and Singapore -21.5 8.6 -30.1 22.6 -2.6 3.1 20.2

Indonesia -2206.8 1109.7 -3316.5 56.0 -22.7 9.2 -35.4

Malaysia -281.2 870.4 -1151.6 26.4 -0.8 5.5 -44.5

Thailand -176.7 153.5 -330.2 32.0 -4.5 3.6 8.1

Vietnam -279.9 149.3 -429.2 19.6 -8.0 6.4 -33.0

Rest of Asia -6829.4 4633.1 -11462.6 30.7 -5.2 3.7 -1.5



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B.2 Impact of eliminating illegal logging (Continued)

Welfare change Forestry products Wood products

Total

Gain to legal

loggersLoss to others Price Production Price Production

Russia -1392.6 1897.6 -3290.2 30.3 -4.5 3.2 -8.2

EU 1347.8 5194.9 -3847.1 17.9 5.8 2.1 4.4

Acceding EU10 -1134.0 1282.9 -2416.9 21.4 -3.0 2.6 -2.4

Rest of Europe 167.5 1089.5 -921.9 19.0 4.3 2.1 2.7

North America 1618.8 5486.5 -3867.7 17.6 4.3 2.2 3.2

Brazil -287.1 369.9 -657.0 33.8 -4.8 0.7 17.2

Oth Latin America -2319.2 1668.2 -3987.4 24.4 -2.9 3.0 -1.6

W. & C. Africa -1609.1 951.1 -2560.2 36.8 -12.2 2.2 2.5

Rest of Africa 148.0 1256.6 -1108.6 18.3 3.5 1.7 5.9

Rest of the world 2.2 1.0 1.2 9.7 2.5 1.7 0.8

World -44876.2 46215.5 -91091.7 30.9 -2.8 3.0 0.2

Risk countries -48032.0 31472.9 -79504.9 43.2 -10.2 5.0 -9.7

Non-risk countries 3155.7 14742.5 -11586.8 17.9 4.9 2.3 3.7

Source: GTAP simulation.

The average world price would increase by 31 per cent for logging and by 3 per cent for wood products which is similar to the estimates by Turner et al (2007). One major reason forestry product prices rise by more than wood products due to the considerable lower value of forest products compared with expensive (value-added) finished wood products sold to consumers. Other reasons relate to the greater possibilities for substitution of wood products at the consumer end of the supply chain. In particular, the ability to substitute aluminium, plastics, ceramics and concrete for final wood product.

Legal loggers in both risk and non-risk countries gain from eliminating illegal logging, being at US$31.5 billion for risk countries and US14.7 billion for non-risk countries. In total, legal loggers in the world would gain by US$46.2 billion.

However, illegal loggers in risk countries lose, and downstream users and customers in both risk and non-risk countries lose because they face higher prices for wood products. The losses to illegal loggers, downstream users and customers in risk countries overweigh the gains to legal loggers in these countries, leading to net losses of US$48 billion. On the other hand, losses to downstream users and consumers in non-risk countries are less than the gains to legal loggers in these countries, leading to net gain of US$3.2 billion. Overall the world has a net financial loss of US$44.9 billion.

Sensitivity analysis

It is evident from the above discussion that the assumption of supply elasticities and illegal logging share affect the impact of eliminating illegal logging. To see how these


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assumptions affect the results, we carried out two more simulations with different assumptions of illegal logging share and supply elasticities. The results of welfare change are reported in table B.3.

It can be seen from the table that the direction of welfare change does not change with different assumptions for the parameters. That is, legal loggers gain while others lose, risk countries have a net loss while non-risk countries a net gain, and the world as a whole has a net financial loss.

The magnitudes of the results vary with different assumptions. More specifically, higher estimates of illegal logging shares lead to higher magnitude of impacts, and higher supply elasticities lead to lower magnitude of impacts.

Social and environmental costs of illegal logging

The non-market costs of illegal logging (see table B.4) are described in appendix C. Estimates of these social and environmental costs of illegal logging are mainly obtained from literature surveys. Generally, we use the share of illegal logging to estimate the costs or benefits to Australia and the world.

B.3 Welfare change of eliminating illegal logging: sensitivity analysis (US$ billion)

Low estimates of illegal logging in Turner et al (2007) Most likely estimates

Low supply elasticity Doubling elasticity Low elasticity

Total

Gain to legal

loggers Loss to others Total

Gain to legal

loggersLoss to others Total

Gain to legal

loggers Loss to others

Australia 0.07 0.33 -0.27 0.05 0.20 -0.15 0.10 0.53 -0.42

New Zealand 0.22 0.46 -0.24 0.14 0.25 -0.11 0.35 0.74 -0.38

Oth Oceania -0.19 0.17 -0.36 -0.13 0.12 -0.25 -0.21 0.20 -0.41

China -30.97 18.03 -49.00 -26.83 14.03 -40.86 -38.32 24.89 -63.21

Japan -0.41 0.92 -1.33 -0.16 0.44 -0.61 -0.65 1.39 -2.04

Korea -0.33 0.18 -0.51 -0.19 0.11 -0.30 -0.48 0.25 -0.73 HK & Singapore -0.02 0.01 -0.03 -0.01 0.01 -0.01 -0.04 0.01 -0.05

Indonesia -2.21 1.11 -3.32 -1.47 0.73 -2.20 -2.11 1.13 -3.24

Malaysia -0.28 0.87 -1.15 -0.18 0.58 -0.77 -0.31 1.35 -1.66

Thailand -0.18 0.15 -0.33 -0.11 0.10 -0.21 -0.23 0.22 -0.45

Vietnam -0.28 0.15 -0.43 -0.19 0.10 -0.29 -0.34 0.23 -0.56

Rest of Asia -6.83 4.63 -11.46 -4.33 3.10 -7.43 -8.88 6.57 -15.45

Russia -1.39 1.90 -3.29 -0.85 1.29 -2.14 -1.86 2.78 -4.64

EU 1.35 5.19 -3.85 1.13 2.49 -1.36 1.69 8.10 -6.41

Acced EU10 -1.13 1.28 -2.42 -0.64 0.74 -1.37 -1.45 1.87 -3.32

R of Europe 0.17 1.09 -0.92 0.13 0.54 -0.42 0.25 1.68 -1.43

N. America 1.62 5.49 -3.87 1.19 2.58 -1.39 2.33 8.68 -6.35

Brazil -0.29 0.37 -0.66 -0.16 0.23 -0.39 -0.33 0.51 -0.85



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B.3 Welfare change of eliminating illegal logging: sensitivity analysis (US$ billion) (Continued)

Low estimates of illegal logging in Turner et al (2007) Most likely estimates

Low supply elasticity Doubling elasticity Low elasticity

Total

Gain to legal

loggers Loss to others Total

Gain to legal

loggersLoss to others Total

Gain to legal

loggers Loss to others

Oth Latin Am -2.32 1.67 -3.99 -1.39 1.03 -2.43 -2.87 2.40 -5.27

W&C Africa -1.61 0.95 -2.56 -1.10 0.65 -1.75 -1.97 1.35 -3.31

Rest of Africa 0.15 1.26 -1.11 0.12 0.63 -0.51 0.24 2.03 -1.79

ROW 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

World -44.88 46.22 -91.09 -34.98 29.96 -64.94 -55.07 66.91 -121.98

Risk -48.03 31.47 -79.50 -37.58 22.82 -60.40 -59.40 43.77 -103.16

Non-risk 3.16 14.74 -11.59 2.59 7.13 -4.54 4.33 23.14 -18.82

Source: GTAP simulations.

B.4 Social and environmental costs of illegal logging

Category Components Scope of impact

Social Loss of non-wood forestry products

Displacement of forest-dependent communities

Challenge to law and order

Local

Local

Local

Environmental Loss of biodiversity

Loss of carbon sinks

Soil and water degradation

Local and global

Local and global

Local

Source: TheCIE construction.

Formulation of options

The benefit: cost analysis of the proposed restriction and disclosure requirements is based on modeling legality verification costs of three categories of product coverage and four tiers for verifying legality described in chapter 4.

The three product categories involve three GTAP sectors — forestry, wood products and paper products, printing and publishing. We use Australian imports value data from 2006 to 2008 to estimate the average shares of these product categories in Australia’s imports from each of the sourcing countries. The results are presented in table B.5.

On average, category I covers 5 per cent of forestry products, 14.7 per cent of wood products and 9.6 per cent of paper products. Category II further introduces 1.1 per cent of wood products and 47.9 per cent of product paper products but not any more product lines in the forestry sector. Category III introduces a further 43.7 per cent


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and 21.4 per cent of product lines in wood products, and paper products and publishing sectors, respectively.

To model the introduction of product categories, we work out the shocks under each product coverage phase using the average shares of each phase in table B.5 multiplied by the legal verification (SDL, VLO, VLC and FC) cost for each of the country groups as discussed above.

B.5 Average shares of product categories in GTAP sectors, 2006-08

GTAP region Phase Forestry Wood products Paper products and publishing

Oceania a Cat. I 100.00 94.04 2.03 Cat. II 100.00 94.04 76.78 Cat. III 100.00 96.34 77.19 China Cat. I 0.87 1.24 6.60 Cat. II 0.87 1.45 50.82 Cat. III 0.87 52.30 67.12 Hong Kong Cat. I 0.00 3.78 3.49 And Cat. II 0.00 4.23 51.43 Singapore Cat. III 0.00 67.07 67.12 Korea Cat. I 0.00 0.28 0.62 Cat. II 0.00 3.76 55.17 Cat. III 0.00 44.32 87.57 Indonesia Cat. I 4.53 30.34 2.83 Cat. II 4.53 30.38 44.81 Cat. III 4.53 71.15 65.27 Malaysia Cat. I 7.26 16.56 11.84 Cat. II 7.26 17.82 60.40 Cat. III 7.26 58.56 81.48 Thailand Cat. I 11.21 1.31 5.05 Cat. II 11.21 1.78 56.47

Cat. III 11.21 15.03 72.15 Vietnam Cat. I 0.00 0.06 12.00 Cat. II 0.00 0.07 23.23 Cat. III 0.00 73.34 36.20 Rest of Asia b Cat. I 1.93 0.80 30.76 Cat. II 1.93 0.81 64.92 Cat. III 1.93 68.23 77.06 Russia c Cat. I 0.00 58.98 24.08 Cat. II 0.00 58.98 38.22 Cat. III 0.00 89.32 56.15 Acceding EU10 d Cat. I 2.78 6.56 11.21 Cat. II 2.78 6.97 54.61 Cat. III 2.78 55.19 72.18 Brazil Cat. I 0.00 14.47 90.67 Cat. II 0.00 14.72 98.32 Cat. III 0.00 82.10 98.71 Latin America e Cat. I 0.00 0.00 0.63 Cat. II 0.00 0.00 32.07 Cat. III 0.00 60.52 39.90



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B.5 Average shares of product categories in GTAP sectors, 2006-08 (Continued)

GTAP region Phase Forestry Wood products Paper products and publishing

West and Cat. I 0.00 2.46 13.11Central Cat. II 0.00 13.44 57.68Africa f Cat. III 0.00 20.72 79.90New Zealand Cat. I 18.70 57.02 17.20 Cat. II 18.70 60.89 36.63 Cat. III 18.70 86.02 81.21Japan Cat. I 0.00 0.29 1.14 Cat. II 0.00 0.37 58.69 Cat. III 0.00 10.99 72.59EU Cat. I 0.22 9.69 2.65 Cat. II 0.22 13.00 57.77 Cat. III 0.22 59.38 82.17US and Canada Cat. I 14.92 37.45 14.05 Cat. II 14.92 37.86 63.40 Cat. III 14.92 60.86 80.82Australia g Cat. I 86.16 46.63 3.77 Cat. II 86.16 50.81 7.88 Cat. III 86.16 50.81 15.18

a Using shares of imports from Papua New Guinea; b Using average shares of imports from Taiwan, Laos, India, Brunei Darussalam, Saudi Arab and United Arab Emirates; c Average share of 2002-05; d Using average shares of Australian imports from major risk countries; e Using shares of imports from Mexico; f Using shares of imports from South Africa; f Domestic production share Source: TheCIE estimates based on data from World Trade Atlas and FAO.

Estimate of compliance cost

There are two types of compliance cost: costs of verifying legality using SDL, VLO, VLC, and FC and costs of chain of custody (CoC) certification. Appendix D describes our estimates of these costs.

Assessment of the impacts of options

Modeling policy options

Policy options are modeled by varying the compliance costs as inputs into the GTAP model.

The compliance costs are modeled in two different forms. For countries other than Australia they are represented as a special form of export tax on each country’s exports of timber products to Australia. For Australian producers, they are presented as a special form of production tax. These export or production taxes are treated as an increase in costs. That is, they are not counted as a part of the government revenues.

The magnitude of the tax rates (cost increases) are determined by the effective binding compliance cost expressed as percentage of the production cost, for what we have identified as the responsive group for each country or region in the GTAP.


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Exporters with prohibitively high compliance costs would not be competitive in the Australian market, but those with moderate costs, the marginal exporters, (or responsive group) will continue to supply the Australian market (albeit with lower profitability).

Estimate of changes in illegal logging

The GTAP model simulation gives changes in forest products outputs in risk countries. However, not all of the changes in forestry production are changes in illegal logging. Chart B.1 shows one possibility where changes in illegal logging lead to legal loggers increasing their production.

It is also possible that only part of the changes in logging are changes in illegal logging as some legal loggers may scale down their production due to higher compliance cost.

In some cases risk countries may increase their forestry production. This happens due to a substitution effect when the policy option is less demanding and the risk country has a relatively smaller share of illegal logging practices.

We compare the model simulated impacts on imports with the illegal logging share from each of the risk countries to calculate a factor to convert the change in logging into a change in illegal logging. The specific rules are set as follows:

If the imports of timber products from a risk country increase, we assume both legal and illegal loggers increase their production by the same rate. In other words, increases in illegal logging in any country are only a part of the total increase in logging and the converting factor is the illegal logging share for the country.

If the reduction in imports of timber and timber products from a risk country exceed the targeted illegal logging share, that is an overshooting occurs, we assume the changes in imports of illegally logged products are the share of illegal logging, and the converting factor is the illegal logging share to the simulated change in imports.

If the reduction in imports of timber and timber products from a risk country is lower than the targeted illegal logging share, we use a method similar to that presented around equation A.1 on page 112 to first estimate the reduction in imports of illegally logged timber products, more specifically,

orts total impchanges inportsillegal imchange in d

sd ×+

=ε

εε.

The change in illegal imports cannot exceed the illegal share. If the change in illegal imports calculated by the above equation is higher than the illegal share for the country, we use the illegal share as the change in illegal imports.


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Estimate of costs and benefits of policy options

The costs of the illegal logging policy are the foregone welfare resulting from restricting illegally logged imports. The GTAP model simulations give estimates of the welfare changes, equivalent variation (EV), for each country identified in the model. We are therefore able to calculate the costs to Australia, risk countries, and the world.

The benefits of policy options are calculated by applying the changes in illegal logging as discussed above to the total costs of illegal logging. As discussed before, most of these benefits are of a global nature.


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C Various estimates of the non-market (social and environmental) costs of illegal logging

Chapter 3 identified 6 key social and environmental impacts as well as the methodology of their economic costs of illegal logging. This appendix provides additional information on related issues.

Social costs

Illegal logging may impose a range of direct and indirect social costs on the community and country where it is occurring. Chart C.1 shows some of the main elements of social costs that may be associated with illegal.

As the chart shows, there may be direct costs to the communities where illegal logging is occurring, mainly due to the illegal appropriation of rights to forest resources and the loss of social, spiritual and cultural amenity that the forest provides to them. The presence of illegal activity may also threaten the security of local communities. Further, at the level of the whole society, there are costs associated with illegality. Resources are dissipated in the pursuit of the ‘ill-gotten’ gains from illegal logging, as illegal loggers engage in a whole range of activities to secure these gains.

Illegality may also be associated with corruption, which may have corrosive effects throughout society and reduce prospects for productive investment that could raise incomes and well being throughout the community.

This said, it has to be recognised that corruption may sometimes be a consequence of poor quality legislation and administrative arrangements, and broader cultural and institutional drivers.

As some commentators have pointed out, regulations surrounding legal logging are sometimes so burdensome that it is only with corrupt practices that logging can actually occur (Brack 2007). In some countries more sustainable logging practices may be achieved through illegal subsistence approaches which limit forest use than through legally sanctioned clearing felling of old growth forests. Brack (2007) notes that:


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In some countries, it may be difficult even to decide what is illegal; in others, the definition may depend on administrative fiat, or be easily changed by local or national governments seeking to maximize revenue. Even where the law is adequate, the compliance costs may be so high in terms of time or money that legal operations become uneconomic, particularly for small operators.

Illegal harvesting practices of timber can undermine the respect for the rule of law and for the government. In principle, the rule of law benefits society from establishing norms of conduct that are above all individuals equally and prevents arbitrary exercise of power.

The rule of law sets up a virtuous circle as, ideally, observance of appointed rights and responsibilities leads to good economic and institutional performance and vice versa. Illegal activities place particular interests on top of public ones and encourage arbitrary exercise of power from government officers.

Corruption is a cause and a consequence of illegal activities. In some countries illegal harvesting practices have been also linked to funding of armed conflicts.

Not all of these costs are amenable to quantification. The following paragraphs discuss estimates used in the analysis used for this report.

Loss of non-wood forest products

Another category of economic costs derives from the loss of non-timber forest products resulting from illegal logging.

FAO has valued global non-wood forest products at US$4.7 billion a year (FAO 2005). If 0.18 per cent of forest cover is lost per year and we assume, based on other sources that 10 per cent of deforestation is due to illegal logging, this suggests that the annual loss of non-wood forest products due to illegal logging could be around US$0.86 million a year.

Displacement of forest-dependent communities

Quantifying the costs of social impacts relating to illegal logging and displacement of forest-dependent communities requires some fairly detailed knowledge of a wide range of impacts and costs.

Immediate displacement, moving and re-establishment costs, which will be higher if populations have been moved on forcibly and without compensation.

Costs borne from losing ongoing access to the resource and to livelihoods, and losing an asset those communities typically pass onto future generations. These costs would be higher if property rights have not been recognised and compensation not provided.

Losses of the unique cultural and spiritual benefits associated with specific lands, regions and locations.


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Consideration might also need to be given to the extent to which stopping illegal logging may remove some communities association with the forest (for example in some countries, some forms of logging by indigenous communities are deemed to be illegal).

It might be possible to estimate some dimensions of the adjustment and transition costs associated with displacement of forest communities and their loss of forest based amenities. The World Bank estimates that 350 million people live in or near tropical forest areas and rely on its products for daily living and about 60 million indigenous people are fully dependent on forests for their livelihoods. In any one year, illegal logging affects a small proportion of these people. If their lives are disrupted, the scope of costs is substantial. The mitigation measures for the Laos’ Nam Theun 2 Hydroelectric Project in Lao Peoples’ Democratic Republic, which necessitates the resettlement of 6 200 people in the path of the dam offers some insight into the nature of these costs. The measures involved resettling all villagers short distances from their present homes. Most, if not all, will remain within their spiritual boundaries. Villagers would be provided with improved housing, infrastructure and services, in locations chosen with their active participation, with training and financial support to start their farms and other livelihood activities (forestry, fishery, livestock, small-scale business and non-farm employment, gathering of non-timber forest products) and education and medical facilities. Some of these measures are preparatory, transitional or longer lasting stability measures (World Bank, 2005 – Nam Theun 2 Social Development Plan). The likely substantial costs of these measures, per household, that aim to fully ameliorate the inundation, would be similar in scope to those borne where there is illegal logging.

We can use the costs of these mitigation measures as an (albeit partial) measure of the losses that communities incur when they are displaced from forest localities or forest based amenities.

FAO (2007d) estimate that each year, some 7.3 million hectares of forest cover are lost: roughly 0.18 per cent of total forest-cover of some 4 billion hectares. If 0.18 per cent of forest cover is lost each year, and we assume that the 60 million people are evenly distributed throughout these forests, then we might estimate that around 108 000 people are displaced each year. If, again, we use the estimate that 10 per cent of deforestation is due to illegal logging, then 10 800 people would be displaced each year due to illegal logging. Using the relocation and compensation cost figures form Lao PDR as a guide, we could estimate the loss associated with displacement and loss of amenity caused by illegal logging to be of the order US$6.6 million a year.


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C.1 Social costs of logging

All logging impacts

Illegal logging impacts

Dislocation costs

POTENTIAL IMPACTS ON SOCIETY GENERALLY

POTENTIAL IMPACTS ON FOREST-DEPENDANT COMMUNITIES

Loss of forest asset, access and

use

National security

deteriorates

Poorer governance

Cultural and spiritual

costs

EXTENT OF IMPACT EXTENT OF IMPACT

FACTORS

Nature of legal logging practice

Extent of malfeasance in logging regulation

Importance of logging industry in the economy

Nature of domestic conflicts

FACTORS

Initial circumstances of population: incomes, health and education status, etc.

Proportion of population affected by illegal logging

Nature of legal logging arrangements and practices

Degree of compensation and property rights recognition

Nature of alternative opportunities

Nature of social bonds

Role and status of women versus men

Land use intensity and pressures from economic development

Attachment to lands to bequeath to future generations Source: TheCIE.


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Broader social impacts — resources wasted in pursuit of gains from illegal logging

The discussion in chapter 3 suggests potentially high levels of wasted resources from illegal logging. Taking the World Bank estimates that illegal logging in developing countries causes losses in assets and revenues in excess of US$10 billion per year and that some US$5 billion per year of logging taxes and royalties is evaded, costs of wasted resources could be as high as US$15 billion – that is, illegal loggers could have US$15 billion of ‘excess profit’ to dissipate in securing the transfers associated with their illegal activity. However, in reality, loggers would not dissipate all of the excess profit – they would allocate resources to securing the transfers up to the point where the cost of an extra unit of illegal logging equals the transfer associated with that unit. So if the US$15 billion number is a plausible estimate of the losses imposed on the government and rightful owners of timber, it is likely to overestimate the total value of resources devoted by illegal loggers to securing the ‘excess profits associated with illegal logging. A more plausible estimate of the value of resources wasted might be half this figure, which is US$7.5 billion a year.30

Environmental costs

Greenhouse gas costs

Table C.2 indicates one way of estimating the annual greenhouse gas emissions caused by illegal logging, drawing on estimates of global emissions prepared by the Australian Government (Commonwealth of Australia 2008a), and estimates of the proportion of such emissions due to deforestation presented by FAO (2007a). The emission are then valued using a price of US$30 per tonne. (This price could be seen as an estimate of the cost that society is prepared to bear to achieve a reduction of emissions to the level built into reduction targets in the year 2022.) This method suggests that the greenhouse gas emissions caused by illegal logging could be imposing costs of around US$23 billion a year globally. However, this estimate is highly dependent on estimates of carbon emission prices and estimates of deforestation.

The Commonwealth of Australia (Treasury) modelling shows that the carbon price would be below US$30/tCO2-e before 2020 and below US$92/tCO2-e before 2050 for its CPRS-5 scenario which sets Australia’s medium-term target at 5 per cent below 2000 levels by 2020 and long-term target at 60 per cent below 2000 levels by 2050. Under the more demanding scenario, the Garnaut-25 scenario which sets Australia’s medium-term target at 25 per cent below 2000 levels by 2020 and the long-term target at 90 per cent below by 2050, the carbon price would be about US$52/tCO2-e by 2020

30 This assumes that the supply of effort to appropriate the gains has unit slope.


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and US$158/tCO2-e by 2050. (Commonwealth of Australia 2008a, carbon price from chart 5.2, pp. 94. The definition of CPRS scenarios is from pp. xi). Table C.2 also shows that at carbon prices of US$48 and 100/tCO2 the greenhouse gas emissions caused by illegal logging could be imposing costs of up to US$78 billion a year.

Another uncertainty is the share of emissions due to deforestation. The Commonwealth of Australia adopts the estimates by Intergovernmental Panel on Climate Change (IPCC) that the share of emissions due to deforestation is 18 per cent. Using this estimate, the cost of the greenhouse gas emission caused by illegal logging could be as low as US$21 billion a year and as high as US$65 billion a year (table C.2).

The estimates in table C.2 provide a plausible range of cost of greenhouse gas emission caused by forestry, but they also demonstrate some of the uncertainties surrounding the issue. Probably an estimate in the mid-range is most representative, say around US$43 billion a year. Higher end numbers should be treated cautiously because many generous assumptions have been made and the following points should be kept in mind:

some of the reduced logging activities in risk countries may be legal, and some of the logging activities in non-risk countries may actually be net carbon emitters;

according to United Nations Framework Convention on Climate Change (UNFCCC), land use change and forestry (LUCF) removes carbon in most of the non-Annex I countries, that is, developing countries, especially in Africa and Asia and the Pacific;

C.2 Estimating the benefits of eliminating greenhouse gas emissions associated illegal logging (2005 values)

Source Share of

emissions

Mega tonnes CO2

equivalent

Value of eliminating

at $30 per tonne


at $48 per tonne


at $92 per tonne

% Mt $million $million $million

Global emissions 100.00 39 100 1 173 000 1 876 800 3 597 200

IPCC estimate (deforestation 18% of emissions) Deforestation 18.00 7038 211 140 337 824 647 496

Logging (10 per cent of deforestation)

1.8 703.8 2114 33 782 64 750

Sources: Commonwealth of Australia (2008a), FAO (2007b), World Rainforest Movement (2009) and TheCIE estimates.

according to Stern (2006):

– if logging is limited to valuable, single trees, forest recovery through re-growth can, over time, offset the release of carbon from harvesting; and

– if the timber is used for long-lived wooden products it actually conserves carbon during the product lifetime.


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Lower end numbers are probably unrealistic given carbon prices will rise through time.

Costs associated with loss of ecosystem services and biodiversity

A similar exercise to that conducted around table C.2 for emissions could be attempted using estimates of the global costs of biodiversity loss due to logging. A recent study for the European Commission (Braat and Brinks 2008) developed estimates of the annual loss of ecosystem services in forested biomass due to land use change and loss of species caused by land and climate quality of some (say US$45 billion a year). Using a similar process to that used in table C.2 suggests that illegal logging might be imposing costs due to loss of forest ecosystem services of around US$4.5 billion a year. (It should be noted that the estimate covers only a limited set of costs of biodiversity loss, but does include estimates of the losses of carbon storage services. Table C.3 shows the services that are included in the estimates.)

Soil and water degradation

Agricultural GDP in countries in the humid and subhumid tropical areas of countries in the tropical zone may be as high as $500 billion a year (based on World Bank [2006] estimates of agricultural GDP). If degradation causes an annual loss equal to 10 per cent of that value, and we again use the estimate that 10 per cent of the problem is due to illegal logging, we generate and estimate of around US$5 billion a year for the loss caused by illegal logging.

C.3 Ecosystem services included in the estimate of biodiversity loss in forestry

Included Not included

Provisioning services Food, fibre, fuel Bio-chemicals, natural medicines, pharmaceuticals

Ornamental resources

Fresh water

Regulating services Air and soil quality maintenance

Climate regulation (such as carbon storage)

Water regulation

Water purification and wast management

Temperature regulation

Erosion control

Technology development from nature

Regulation of human diseases

Biological control and pollination

Natural hazards control

Cultural services Cultural diversity, spiritual and religious values, educational values, inspiration, aesthetic services, social relations, sense of place and identity, cultural heritage values

Recreation and eco-tourism

Living comfort due to environmental amenities

Source: Braat and Brink (2008).


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D Opportunity cost of complying with certification

In cases where legal verification and certification standards are to be applied to meet legality requirements, part of the forest is likely to be set aside for forest reserves and protection of environmental values, resulting in a reduction in the volume of timber available for logging. This has an opportunity cost. The GTAP model has the availability of forestry land represented as the availability of natural forestry resources in each country. We can use the GTAP trade model used in this study to estimate the opportunity cost associated with a one per cent decrease in the land component of the natural forestry resource. We solve for the opportunity cost that a reduction in that resource would impose. The idea is illustrated by chart D.1.

D.1 Supply and demand responses to lower resources availability Price

Quantity Q’ Q

P’

P

E’

B

A

E

D

S

S’

Source: TheCIE illustration.

The original equilibrium of the forestry market is at E, where the price is P and the quantity produced and demanded is Q. With less resources available, firms face higher cost to produce, that is, an upward shift in the supply curve (from S to S’). For a downward sloping demand curve (D), the new market equilibrium would be at point E’ with higher price (P’) and lower quantity (Q’). The GTAP model simulation tells the changes in price and quantity, and our task is to find the implied change in cost (BE), that is, how far the supply curve would have shifted. From the chart, we know:


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''

AEABAEAEABAEBE ×+=+=

Dividing both sides of the above expression by original price (EQ), we have:

ε

•••••+=×+=×+=+==

QPEPAE

EQABEP

AEPAE

EQABAEPEQAB

EQAE

EQBEC

''''''

''

where dotted variables are percentage changes in those variables, for example •C is

percentage change in cost; and ε is the supply elasticity (percentage change in quantity of a 1 per cent change in price).

The last column of table D.2 gives the percentage change in cost of a 1 per cent reduction in forestry resources for each of the high risk countries.

D.2 Changes of 1 per cent reduction in forestry resources

Supply elasticity

( ε )

Percentage change in

production

(•Q )

Percentage change in

price

(•P )

Implied percentage

change in cost

(•C )

Oceania 0.70 -0.39 0.08 0.63

China 0.05 -0.12 0.31 2.72

Korea 0.61 -0.24 0.19 0.58

Hong Kong and Singapore 0.78 -0.42 0.05 0.59

Indonesia 0.28 -0.16 0.16 0.73

Malaysia 0.16 -0.15 0.04 1.01

Thailand 0.30 -0.18 0.11 0.71

Vietnam 0.16 -0.18 0.05 1.18

Rest of Asia 0.25 -0.14 0.21 0.77

Russia 0.21 -0.20 0.08 1.04

Acceding EU10 0.22 -0.23 0.14 1.19

Brazil 0.23 -0.14 0.32 0.91

Latin America 0.13 -0.15 0.19 1.32

West and Central Africa 0.19 -0.15 0.07 0.87

Source: GTAP simulations and TheCIE estimates.


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E Cost of legality compliance

Apart from the opportunity cost of compliance considered in appendix D, studies available about the costs of verification/certification suggest the following elements are important (see for example ITTO 2004)

The costs of certification are higher for operations in tropical countries compared to temperate forests. Tropical forests present more complex ecologic and social conditions (ITTO 2004).

Auditing costs are typically higher in developing countries (ITTO 2004) and direct certification costs are likely to be lower for plantations than for natural forests.

In some countries, where certification bodies and systems are still in an early stage of development, the costs of certification are substantially higher than in countries with developed systems.

The main costs of certification relate to complying with environmental standards, but complying with legal requirements can also be significant.

Certification imposes many fixed costs elements that provide economies of size but which may work against small-scale forest operations.

A model for estimating costs of certification

Estimates of legality verification compliance costs have been derived from modelling certification costs for various sized businesses. These estimates are used to calculate the additional costs of legality verification for the responsive groups in the GTAP modelling. A stylized model of certification costs based on the ITTO (2004) study is presented below. Total costs of certification are divided into two components; direct and indirect. Direct costs include internal costs of administrating the process of holding a certificate, and external costs of assessment by an independent third party. Indirect costs correspond to setting up the systems for achieving and maintaining forest management practices within a forestry company. Indirect costs represent over 90 per cent of total costs when management systems and standards are undeveloped.

Costs are also split into fixed and variable components. Fixed costs relate to expenses that are independent of the operation size and relate mostly to initial investments required to implement the managing systems in the operation. Variable costs are expenses that are determined by the size of the operation.


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The data presented in the ITTO (2004) report suggest that the fixed costs could be around 60 per cent of the total when the management systems are in early stages of development. We have used this proportion in our model.

The criteria used in this model come from the FSC certification principles. The first two criteria in table F.1 refer to legality compliance, the second two refer to social aspects and the last three refer to sustainable forest management. Legality compliance criterion include all national laws related to forest operation, land use rights, payment of fees, royalties, taxes and other charges. It also includes compliance with international conventions and agreements, such as CITES and the Convention on Biological Diversity, among others.

Social aspects ensure that customary rights of indigenous people who own the forest resources are respected. It also considers well being of all local communities.

Sustainable management criteria aim for minimal environmental impact of the forest operation based on an appropriate administration of the natural resource.

It is assumed that there is a fairly even distribution of cost among the 7 certification criteria. Each criterion is likely to require similar amounts of internal and external (third party) resources to be reviewed.

A medium-cost scenario

This scenario is for a natural forest where the management systems in the company are undeveloped and the standards for forest management in the country are not well developed. In effect the establishment of the certification system (which covers legality verification) is a new cost for the forest manager. The results presented in table E.1 correspond to that scenario. The costs are based on those incurred over a five years period, but here they have been annualized and estimated on a per cubic metre basis. In other words, they are the average per cubic metre cost imposts that would be added to the unit costs of production.

Table F.1 refers to an operation involving about 90 000 hectares of natural forest and an annual output is of around 60 000 m3.harvested a year.

Total annual cost of certification is estimated as US$15.32 per m3 (2002 dollars) which is about 11 per cent of the log price of around US$140/m3 (both price and costs are 2002 prices).

We estimate that the criteria on legal compliance represent about 32 per cent of the US$15.32 m3 total costs on around US$4.90 per cubic metre. Social component accounts for 17 per cent (US$2.66 per cubic metre) and forest management criteria accounts for 51 per cent of total costs. Implementation of a forest management plan together with monitoring and assessment systems are the more challenging and costly components of certification (see chart E.2).


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E.1 Estimated annual costs of certification for a 5-year period certificate (US$/m3). Medium size operation. Native forest

Certification criteria Direct cost Indirect cost Total cost

Cost of certification

as a proportion of

sales

Fixed Variable Fixed Variable

US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 %

Compliance with national laws 0.04 0.02 0.45 4.03 4.54 3.24

Tenure and use rights and responsibilities

0.04 0.02 0.24 0.06 0.36 0.26

Indigenous peoples rights 0.04 0.02 0.36 0.09 0.51 0.37

Community relations and workers rights

0.04 0.02 1.67 0.41 2.15 1.53

Environmental impact 0.04 0.02 0.24 0.06 0.36 0.26

Forest management plan 0.04 0.02 1.18 0.29 1.53 1.10

Monitoring and assessment systems

0.04 0.02 4.66 1.13 5.86 4.19

TOTAL 0.31 0.15 8.80 6.06 15.32 10.94 Source: TheCIE based on ITTO (2004).

E.2 Composition of certification cost

0%

5%

10%

15%

20%

25%

30%

35%

40%


National and international laws

Community and worker's rights

Management plan

Indigenous rights

Tenure and use rights

Environmental impact

Data source: TheCIE.

The criterion on compliance with national and international laws has a significant component of variable indirect costs related to preventing illegal logging. This is shown in table E.1 above, and in some cases/countries it reflects operational costs of having guards at various security check points and frequent coordination with law enforcement officers. The costs presented in table E.1 are equivalent to a certification cost of $10.21 per ha/annum or a total of US$4.6 million over the five year period for the 90 000 ha forest.


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A low cost scenario

A completely different scenario may emerge in considering a plantation with well developed management systems and forestry practices. Total costs for this case are considerably lower than in the previous case. Assuming that the systems in the operation and the forestry laws are well established, indirect fixed costs are likely to be insignificant or zero. The total annual cost of certification in this case drops to US$3.39 per cubic metre for a 90 000 cubic metre per year operation (see table E.3). In this case compliance costs related to legal requirements drop to US$2.14 per cubic metre. Requirements on social and forest management criteria are US$0.35 and US$0.89 per cubic metre respectively. Many plantation-based operations may be very much larger than 60 000 cubic metres. Generally, with per annum wood volumes over 200 000 cubic metres costs drop below $1.00 a cubic metre.

E.3 Estimated annual costs of certification for a plantation with well developed systems for a 5-year period (US$/m3)

Certification criteria Direct cost Indirect cost Total cost

Cost of certification

as a proportion of

sales

Fixed Variable Fixed Variable

US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 %

Compliance with national laws 0.03 0.02 - 2.01 2.06 1.47


0.03 0.02 - 0.03 0.08 0.06

Indigenous peoples rights 0.03 0.02 - 0.04 0.09 0.07

Community relations and workers rights

0.03 0.02 - 0.20 0.25 0.18

Environmental impact 0.03 0.02 - 0.03 0.08 0.06

Forest management plan 0.03 0.02 - 0.14 0.19 0.14


0.03 0.02 - 0.57 0.62 0.44

TOTAL 0.20 0.15 - 3.03 3.39 2.42Source: TheCIE based on ITTO (2004).

The evidence presented here shows that the costs of certification decrease as the size of the operation (measured in terms of cubic metre of output per year) increases and depend on whether management systems are developed or not. Several other cost scenarios are presented in table E.4 and chart E.5, under the four standards described in chapter 4.

Large and medium size producers of tropical timber in countries such as Indonesia and Malaysia may be exposed to costs in the order of US$2.04 to US$2.27 per cubic metre if required to comply with self-declared legal origin. In the case of full certification standards, the costs of compliance could rise up to the range between US$6.41 and US$15.32 depending on how developed their management systems are


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(see chart E.5 for native forest operations costs). Costs of compliance for these producers will vary from 1 per cent to 11 per cent of the log price.

E.4 Cost of compliance for various types and sizes of operation, diverse standards

Type of forest Plantation Native

Management systems

Developed Developed Undeveloped

Operation size Large Medium Small Large Medium Small Large Medium Small

US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3

Self-declared legal origin (SDL)

1.03 1.03 1.06 2.04 2.05 2.09 2.18 2.27 2.76

As a proportion of log price

0.7% 0.7% 0.8% 1.5% 1.5% 1.5% 1.6% 1.6% 2.0%

Verified legal origin (VLO)

2.05 2.06 2.12 4.08 4.09 4.18 4.37 4.54 5.52


1.5% 1.5% 1.5% 2.9% 2.9% 3.0% 3.1% 3.2% 3.9%

Verified legal compliance (VLC)

2.45 2.49 2.73 4.78 4.84 5.19 6.53 7.56 13.34


1.8% 1.8% 1.9% 3.4% 3.5% 3.7% 4.7% 5.4% 9.5%

Full certification (FC)

3.32 3.39 3.80 6.41 6.52 7.13 12.09 15.32 33.51


2.4% 2.4% 2.7% 4.6% 4.7% 5.1% 8.6% 10.9% 23.9%

Source: TheCIE based on ITTO (2004).

E.5 Estimated unit cost of compliance under various standards, US$/m3 (scenarios)

-

2

4

6

8

10

12

14

16

Medium Plantation Developed Medium Native Developed Medium Native Undeveloped

US$

/m3

Self-declaration Legal origin Legal compliance Full certification



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Detailed cost scenarios under the most demanding standard, full certification, are shown in table E.6 and chart E.7.

E.6 Cost of compliance for various types and sizes of operation, full certification Type of forest Plantation Native

Management systems

Developed Developed Undeveloped

Operation size Large Medium Small Large Medium Small Large Medium Small

US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3 US$/m3

Compliance with national laws

2.05 2.06 2.12 4.08 4.09 4.18 4.37 4.54 5.52


0.07 0.08 0.14 0.11 0.12 0.21 0.26 0.36 0.93

Indigenous peoples rights

0.08 0.09 0.15 0.14 0.15 0.24 0.37 0.51 1.32

Community relations and worker’s rights

0.24 0.25 0.31 0.46 0.47 0.56 1.54 2.15 5.58

Environmental impact

0.07 0.08 0.14 0.11 0.12 0.21 0.26 0.36 0.93

Management plan 0.18 0.19 0.25 0.34 0.35 0.44 1.10 1.53 3.98


0.61 0.62 0.68 1.19 1.20 1.29 4.19 5.86 15.26

Total 3.32 3.39 3.80 6.41 6.52 7.13 12.09 15.32 33.51

Total cost as a proportion of log price of US$140/m3

2% 2% 3% 5% 5% 5% 9% 11% 24%

Source: TheCIE based on ITTO (2004).

E.7 Estimated unit cost of certification, US$/m3 (scenarios)

0

5

10

15

20

25

30

35

Small native undeveloped

Medium native undeveloped

Large native undeveloped

Medium native developed

Small plantation developed

Medium plantation developed

Large plantation developed

US$

/ m

3



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Legality verification compliance costs for the GTAP modelling

The various estimates presented in this appendix indicate that although it might not be possible to be precise about the complex and diverse costs of compliance, it is possible to generalise about the drivers and aggregate nature of the costs.

Applying legality verification compliance costs in the GTAP model

To model the impacts of legal verification, certification and chain of custody, it is necessary to identify the average legality verification compliance costs of the most responsive group for each country or region in the GTAP modelling. For developing countries with a relatively high risk of illegal logging, TheCIE assumes responsive groups are likely to be a medium cost group, comprising the medium to large sized producers harvesting native forest logs. The cost for this group are identified in table E.4 and range from 8.6 to 10.9 per cent for full certification, 4.7 to 5.4 for verified of legal compliance (VLC), 3.1 to 3.2 for verified of legal origin (VLO) and 1.6 per cent for self-declared legal (SDL).

Based on the fact that most developed country exporters to Australia will already be compliant with their in-country legality verification requirements and none are expected to face prohibitive costs, only (very low) compliance costs are expected and these were reported in chapter 5.

Alternative estimation of legality verification compliance cost

Indufor (2008) estimates compliance costs of implementing legality assurance systems under various scenarios (see table E.8).

The first scenario refers to the licensing system used in the VPAs between EU and supplier countries, where imports to the EU from a partner country will be prohibited unless they are covered by a valid licence issued by a Licensing Authority.

The second scenario refers to a situation where voluntary initiatives of the private sector are used for third-party audited verification of legality compliance.

The third scenario presents second-party audit of legality assurance for all products entering the EU. Authorities of the supplier countries will issue the certificates to be checked at the EU border.

The fourth scenario corresponds to a situation where all operators, EU and Non-EU, are required to obtain full third-party audited certification and chain of custody under currently available standards; PEFC,FSC or ISO 14001.

The scenario where a licensing scheme applies, exhibits the highest cost per cubic metre at US$0.45. Third party audited legality assurance could cost as much as US$0.36 per cubic metre. Certificate of legality issued by the government of the supplier country would cost US$0.29 per cubic metre (second party audited).


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E.8 Legality Assurance System (LAS) costs under various scenarios US$/m3

VPAa Voluntary private Border measures Prohibition of illegalb

Type of system

system used under the

VPAs

oluntary initiatives of the ate sector for third party

audited verified legal.

gality assurance under second party audited

systems

Third party audited

certificationnd chain of custody is

required

Private sector Non – EU 0.33 0.36 0.37EU 0.34

Government Non – EU 0.12 0.29 EU 0.01

TOTAL (avg per m3) 0.45 0.36 0.29 0.36

a Assumptions underlying this system are: Product coverage: round and sawn wood, veneer and plywood. Legality refer to compliance with forestry, land, labour, environmental and fiscal laws. Supply chain has three stages; harvesting, sawmill processing and further processing. System based on low tech (paper/ manual) and includes three steps; verification, licensing and third party monitoring. Calculations were made based on an average operator size of 75 000 cubic metres a year. b Costs under this scenario include establishment and management of control systems for the operator, third party auditing and government inspection at a frequency of 1 per cent of timber consignments. Source: Indufor (2008).

Although the costs do not seem to be high, compared to the price of logs at the mill gate ranging from US$60 to US$140 per cubic metre, costs for small and medium operators may represent sizeable imposts. Costs for them would be two or three times higher than for larger operations. For a micro operator, who produces about 5 000 cubic metres a year, the cost per cubic metre could be over US$3.00. Costs decrease substantially for operations producing over 25 000 cubic metres a year.

Costs of compliance for third party audited full certification are as low as US$0.36 per cubic metre on average for medium size operators. Enforcement costs for the EU government are provided for this scenario and are also low at US$0.01 per cubic metre. This is because cost estimates in the Indufor study assume that:

…governmental agencies of EU member states are responsible to systematically inspect the market operators to make sure they have adequate records of timber sources and chain of custody. The inspection frequency is set to 1 per cent of the timber consignments. (Indufor 2008)

It is interesting how compliance costs for the private sector under certification standards are almost the same for EU and non-EU operators. Producers in the EU operate in a totally different context to producers in non-EU supplier countries. As it was mentioned in chapter 5, the costs of certification are usually higher for native forest operations in tropical countries compared to plantations in temperate forests (ITTO 2004). Not only because native tropical forests are more complex than


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plantations, but because the management systems are in early stages of development in the main non-EU supplier countries.

Operators in non-EU countries may also need more effort than operators in EU countries to comply with certification criteria as environmental criteria are stricter than the ordinary forestry laws.

The estimation of compliance cost in the Indufor (2008) report may not be considering those differences in the starting point for operators in the EU and in the non-EU countries.

Other underlying elements of the cost estimation in the Indufor (2008) report are:

Reduction of harvestable area in supplier countries as a result of enforcing sustainable forest practices and its subsequent opportunity cost for those producers is not considered in the estimation of cost for the non-EU private sector.

Basis for estimation of costs of compliance in supplier countries is not detailed as per certification criteria, type or size of the forest operations. Although some estimations for small operators are presented.

Specific measures for combating illegal logging are not included in the cost of compliance for operators in supplier countries as in terms of increasing the number of guards and check points to reinforce the security.

The costs estimated by Indufor are difficult to reconcile with TheCIE estimates made in this report and with what is observable in the market place (based on evidence of stakeholders consulted in April). Costs are very small in all cases and do not increase with the complexity of the standard imposed. Were the costs truly so small, it is difficult to see why all wood product operators have not already obtained certification or verification. It would also suggest that the problem of illegal logging globally is a very small problem that can be fixed without imposing costs on any particular group. Clearly this is wrong. Market premiums for some certified products are sizeable (based on evidence of stakeholders consulted in April). The Indufor estimates are at variance with what most stakeholders indicated to TheCIE. Even the largest, most efficient producers reported costs higher than the Indufor estimates. The Indufor estimates of fixed annual costs are not dissimilar to those used by TheCIE, but the volume harvested is massive at 3 million cubic metres per annum. This reduces unit costs to very low levels. However, Indufor also indicate that medium sized operators are likely to have only about 75 000 cubic metres of output per year.

For the above reasons, we have preferred ITTO (2004) over Indufor (2008) data for our estimation of industry compliance costs under various standards of legality verification and certification.


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Costs of Chain of Custody (CoC) for a disclosure measure

CoC certification is based on five components: quality systems, material sourcing, production controls, transaction documentation and labelling. Requirements under these components aim to address internal procedures, record keeping, and material storage within the companies (see chart E.9). A CoC certificate has a life of five years.

E.9 CoC certification components

1 Quality

systems

2 Material sourcing

3 Production

controls

4 Transaction

documentation

5

Labelling

Source: Forest and Wood Products Australia (2009).

Activities involved in each certification component vary for each step/node in the supply chain. Primary and secondary processors may need to put more effort into production controls and source material management (storage, monitoring and identification). For sellers, certification requirements may be more straightforward and be reduced to maintenance of the paper trail, product identification and labelling.

Operators along the supply chain could potentially be required to have infrastructure and logistics for managing certified materials separately from the un-certified (investment cost), to maintain detailed records on transactions for certified materials (documentation), to identify certified material (labelling) and to implement training plans.

Because certified product is more expensive to handle, separate, track, process, administer, store and distribute than non-certified product, the extra cost of certification is not simply passed through as an added margin with additional small documentary costs added in. Instead, cost margins may be multiplicative to some extent.

Wastage and recovery rates in processing help explain part of this. If the cost of certification on logs is $15/m3 and the recovery rate in saw milling is only 50 per cent, two cubic metres of logs with $30/m3 of certification costs are required to produce one cubic metre of sawn timber, so the certification costs on sawn timber are twice those for logs in actual dollar terms. If the product is twice as valuable the percentage cost increase will remain the same. Even where wastage is sold as a certified product, the certification costs attaching to it are likely to be proportional to its value, which will be relatively low.


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Supply chain complexity may also add to the chain of custody costs. Supply chains with multiple intermediate operators may face significant costs for CoC certification if documentation costs expand with the number of stages/steps and suppliers per stage (see charts E.10).

– For example, a final product, perhaps sawn timber, that comes from two sawmills with each mill sourcing from two forests, would be required to have chain of custody based on six documents. Were there three wholesalers supplying a product to a retailer and each wholesaler had three sawmill suppliers who draw from three forests each, 39 pieces of documentation might need to be tracked

In addition to the costs mentioned, each operator in the chain will incur fixed costs involved with establishing and maintaining chain of custody certification. Estimates of these costs range from between $50 000 to $100 000 for establishment and around $50 000 a year for maintenance. For large operators such costs can be easily absorbed, for small operators these can represent substantial cost.

E.10 Example of a supply chain with 2 steps (nodes) and 2 suppliers per step FORESTS SAWMILL RETAILERS

Final product

22 + 21 = 6

4 + 2 = 6

Required number of documents to be tracked for final product

Data source: TheCIE


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F Stakeholders consulted

1. Jim Burgess, Timber Queensland

2. Joe Chapman, TLB Timber

3. Elizabeth Cox, Department of Primary Industries & Forestry QLD

4. Simon Dorries, Engineered Wood products Association of Australasia

5. Karen Johnston, Timber and Building Material Association (TABMA)

6. Gerry Gardiner, Queensland Timber Importers

7. Nicola Beynon, Humane Society International

8. Rhona Mcphee, AusAID

9. Hamish McNulty and David Butt, Department of Territory and Municipal Services (TAMS)

10. Matt Broszka, Department of Finance, Regulatory Frameworks

11. Susan Jones, Australian Customs and Border Protection Service

12. Peter Kanowski and Jim Douglas, ANU

13. Thomas Fuller, Cathy Raper, Department of Foreign Affairs and Trade (DFAT)

14. Geoff Gorri, Kayt Watts and Mark Edwards, Australian Forestry Standards

15. Allan Hansard, NAFI (National Association of Forest Industries)

16. Tanja Cvijanovic, Department of Prime Minister and Cabinet

17. Kristin Tomkins, Housing Industry Association

18. Gavin Matthew and Richard Stanton, A3P (Australian Plantation Products and Paper Industry Council)

19. Cynthia Piscitelli, Department of Environment

20. Jim Adams, Timber Communities Australia

21. Luke Wilson, Department of Primary Industries, Victoria

22. Ric Sinclair, Forest & Wood Products Australia

23. Aidan Flenningan, Forest & Forest Industries Council of Tasmania

24. Donald Riddell, Department of Infrastructure, Energy and Resources

25. Ferdie Kroon, Tasmanian Forest Contractors Association

26. Graham Wilkinson, Forest Practices Authority

27. Kwame Asumadu, Asumadu Pty Ltd.


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28. Lisa Marty, Victorian Association of Forest Industries

29. Allan Oxley, ITS Global

30. Nils Gunnersen, Gunnersens

31. Jason Wilson, Carter Holt Harvey Wood products Australia

32. Douglas Browing – Tony Wood, Australian Paper Industry Association

33. Marc Purcell, Oxfam Australia

34. Stephen Hawkins, Australian Paper / PaperlinX

35. Peter Roberts, Timber Merchants Association

36. Richard Brooks, Cabinet Makers Association

37. Adam Redman, Integrated Tree Cropping

38. Andrew Taylor, SCA Hygiene Australia

39. Simon Holloway, Steve Kozlowski and Malcolm Hall, National Timber Councils Taskforce

40. John Osmelak, Furnishing Industry Association

41. Luke Wilson, Deputy Secretary

42. Andrew Rouse, World Wide Fund for Nature

43. Norman Long, Australian Timber Importers Federation

44. Paul Elsmore, Simmonds Lumber

45. Colin Fitzpatrick, TABMA (Timber and Building Material Association)

46. Mark Zirnsak, Uniting Church

47. Warwick Ragg, Australian Forest Growers

48. Nick Roberts, Department of Primary Industries NSW

49. Bryan Tisher and David Angus, Boral – Australian Wood Panels Association

50. Stephen Mitchell, Timber Development Association

51. Ursula Antunez, SGS

52. Valerie Phillips, Greenpeace

53. Allen Broome, Decorative Wood Veneers Association

54. Armineh Mardirossian, Woolworths

55. Martin Lewis, Furnishing Industry Association of Australia (FIAA)

56. Mandy Wallace and Detlev Vogt, PIRSA Forestry, Department of Primary Industry and Resources of SA

57. Melissa Haslam and Bob Pearce, Forest Industries Federation, WA (FIFWA)

58. Richard Hart, GHD Consultants

59. Mark Gomm, Wesfarmers/Bunnings

60. John Treddenick, URS Forestry


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61. Matt Darcey, Department of Regional Development, Primary Industry, Fisheries and Resources, NT

62. Keith Low and Terry Jones, Forest Products Commission

63. Milo Foster, Kimberly Clark

64. Juel Briggs, Briggs Veneers

65. Carlton Frame, Gunns


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G Stakeholders that sent public submissions on the Draft RIS

1. Department of Infrastructure, Energy and Resources

2. LSE Ltd& the SRR Program

3. Australian Window Association (AWA)

4. Timber Queensland

5. Humane Society International

6. Greenpeace

7. Construction, Forestry, Mining and Energy Union (CFMEU)

8. Australian Plantation Products and Paper Industry council (A3P)

9. Uniting Church of Australia

10. Decorative Wood Veneers Australia (DWVA)

11. The Furnishing Industry Association of Australia (FIAA)

12. East Gippsland Shire Council

13. Australian Timber Importers Federation Inc. (ATIF)

14. National Association of Forest Industries (NAFI)

15. Australian National University (ANU)

16. Australian Forest Growers (AFG)

17. Window and Door Industry Council (WADIC)

18. European Commission

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