The Myths of Environmental Compensation in Indonesia : Lessons from the Sidoarjo Mudflow

Compensation mechanisms and liability play an important role in environmental management. Compensation, through liability or other mechanisms, provides not only protection for the victims of environmental damage, but also incentives for the potential polluters to take an ex ante optimal level of care. Ideally, compensation should be first provided through liability (combined with liability insurance). If this system does not work properly, alternatives to liability insurance, i.e. a risk-sharing agreement, first-party insurance, and environmental damage insurance, should be developed. Finally, the system of compensation funds should also be promoted whenever a liability system, liability insurance, and alternatives to liability insurance are likely to fail to provide enough protection for the victims and incentives for the potential polluters to take the optimal level of care. Unfortunately, compensation in Indonesian is ill-structured, leaving the victims of pollution with liability rules as the only viable way to get compensation. The Sidoarjo mudflow case clearly illustrates the impacts of such an ill-structured compensation system