Market Redirection Leakage in the Palm Oil Market

Tropical deforestation and forest degradation (DD) are linked to international trade in commodities like palm oil, and implicated in biodiversity loss and global greenhouse emissions. Regulations to save these forests, including embodied DD tariffs or bans on unsustainably produced imports, are typically fragmented, permitting DD activities to find coverage gaps and create DD leakage. The forestry literature has focused on the competitiveness leakage channel, with DD implicated production shifting from strictly to laxly regulated jurisdictions. Less recognized is the market redirection channel. Production need not move. Instead, sales are rerouted to less selective markets. Using the example of palm oil, we develop a model in which one importing region imposes an embodied DD tariff. Some exporters may face transaction costs to switch to low DD production. With a common DD tariff policy across all importers being both improbable and burdensome to exporters, we investigate unilateral approaches. Contrary to a unilateral ban, or tariff, on unsustainable imports, which creates market redirection leakage, the second best optimum combines the unilateral damage based tariff with an output subsidy. The output subsidy encourages exports to the tariffed market.