Environment and trade: Do stricter environmental policies hurt export competitiveness?

Editor's Notes

• #4 This graph shows the high and increasing role of global value chains in international production. Global production patterns are highly fragmented, and this fragmentation has increased over the past two decades. Therefore, it has become increasingly easy to offshore elements of production. Any policy (or development) that affects domestic costs may tilt the balance between producing something domestically or outsourcing it. Backward participation measures the value of imported inputs in the overall exports of a country (the remainder being the domestic content of exports). This indicator provides an indication of the contribution of foreign industries to the exports of a countries by looking at the foreign value added embodied in the gross exports. Forward participation measures the share of exported goods and services used as imported inputs to produce other countries' exports. This indicator gives an indication of the contribution of domestically produced intermediates to exports in third countries.
• #5 At the same time, environmental challenges are pressing. Just to give an example: As reflected in COP21 willingness to act on climate change Health costs of air pollution costs are high globally – estimated to range around 4% of GDP in OECD countries and much higher in China and India. Plenty of other environmental issues, such as water scarcity, biodiversity loss, etc.
• #6 Over the same past two decades, governments have been responding to environmental pressures with environmental policies. The immediate question that springs to mind is what effect had that had on economic competitiveness of domestic production? Explanation: Graph presents the OECD’s proxy of environmental policy stringency. Its based on measuring the stringency of individual environmental policies, primarily for air pollution and climate, and covering mainly upstream sectors (energy, transport). This is an example, but similar results could be drawn from other proxies (though we would claim this one is the one to use ;): Stringency varies across countries It has been increasing in all countries covered over the past 20 years (both OECD and BRIICS) The stringency in BRIICS is still below OECD average, and significantly below the most stringent in OECD (in this case Denmark, Germany and Switzerland – which have the highest stringency over the entire sample). Stringency is defined as the (relative) cost of polluting behaviour (implicit or explicit). Ie a higher environmental tax or a lower emission limit. - The UK, in the sample over which our paper was conducted (2008/2009), was slightly above OECD average. Currently somewhat above. This presents the “extended” EPS indicator – ie the one with the modifications that were necessary to include briics, and that is used in the paper. There will be a brochure at the back of the room (the one with a bee on the cover) describing both the “original” 2014 vintage of the EPS as well as this one.
• #7 Globally, subsidies and tax breaks to fossil fuels represent around USD 600 billion annually. The value of budgetary support and tax expenditures for fossil fuel consumption and production in OECD countries and key emerging economies stood at around USD 160 billion in 2014, ranging between that and USD 200 billion a year over the 2010-14 period (OECD Inventory of Support Measures for Fossil Fuels 2015). The remainder represents price-driven subsidies for the consumption of fossil fuels or fossil-fuel-generated electricity in mainly emerging and developing countries (i.e. IEA WEO data on fossil fuel subsidies). That’s around five times the amount governments spend on support for renewable energy being spent in a way that actually encourages carbon emissions. WEO 2015: Fossil-fuel subsidies were $493 billion in 2014, but would have been $610 billion without reforms since 2009. Recent changes prove reform is possible: low oil prices give net importers the room to reform and reinforce the need for exporters to do so. (IEA World Energy Outlook 2015).
• #8 Looking forward, there is need for further tightening of environmental policies, as current policies are not enough to bridge the gap between where we are (or where we are heading) and were we want to be. Example from the IEAs World Energy Outlook on the projected evolution of global CO2 emissions. The IEA have looked at INDCs (Intended Nationally Defined Contributions) to address climate change, which were put forward by countries for COP21. In some cases they took intentions, where countries have not submitted INDCs by their cut-off date: - Graph shows energy related CO2 emissions (Gt CO2-eq) The IEAs projection of emissions under this scenario is the blue line. This is somewhat more ambitious than current policies scenario, as it takes into account what some of the major emitters planned or communicated to in the future. But global energy-related emissions do not peak. The green line is the 450 Scenario i.e. the 2 degree scenario. This can be seen as somewhat less ambitious than the COP21 agreement which stated “well below 2 degrees” Even taking these two, looking over the mid-term, so roughly the next two decades or so, there is a huge gap between the trajectories. To close it, will need climate policies. The situation is similar for many environmental areas (eg air pollution), even though problems may be less of a global nature. Moreover, low fossil fuel prices are not helping make “green” attractive. So, bottom line – quite likely we will see action on increasing environmental policy stringency. To different extent and with various goals across countries, but there will be an urge to do so…
• #9 But obviously environment is not the only consideration. The recovery from the crisis has not been satisfactory. In OECD countries, one can hear loudly voiced considerations about environmental policies being too stringent, and that further tightening should be resisted – in particular if not coupled with similar action in developing countries… At the same time, large polluters, who happen to be “important” for the economy, often manage to secure preferential deals (exemptions/reductions from environmental policies), on precisely these types of competitiveness concerns. Many developing countries probably have more pressing goals, with high levels of poverty and hundreds of millions of people globally without access to basic environmentally-related amenities. Here one hears arguments such as that environmental policies – yes, but once they get richer. Hence across the globe, environmental policies are often resisted based on arguments on their negative economic impacts. However, the evidence on competitiveness effects of environmental policies is weak and context-specific. This makes it difficult to draw conclusions regarding the right balance….
• #10 New evidence for the past two decades (1995-2009) coming from an OECD working paper: Using exports and domestic value added exports (domestic production embedded in exports – most directly relevant/affected for domestic environmental policies!) Across sample of OECD and BRIICS, 10 sectors, high and low pollution intensity…. FINDS NO EVIDENCE of effects on country-level competitiveness: competitiveness for the country as a whole, has not been affected despite the ongoing tightening in the EPS. However, there are SIGNIFICANT effects of environmental policies. They change the relative prices of inputs in production – environment becomes more expensive. As a consequence, they tilt the comparative advantage away from more polluting sectors (and hence probably firms, though this is not assessed) However, this is a relative phenomenon. So EPS also turn the comparative advantage towards less polluting sectors (and firms). As a consequence, highly polluting or energy intensive sectors (such as ) are identified as losing from tightening EPS. But importantly, low polluting sectors (such as ) are found winner. Yet the effects are small
• #11 SO yes, we can say that the Pollution haven effect is confirmed. there are winners and losers, but effects for each group, even if significant, are very small. Note: The effect on trade flows (exports from country i to country j) associated with a change in the EPSgap from the situation where environmental policies are equally stringent (median) in the two countries to a situation where the difference in stringency is at the 75th percentile of the EPSgap distribution (exporter i stringency is higher than that of importer j). Effects shown for three industry examples: high pollution intensity (Chemical, rubber, plastics and fuel products), medium pollution intensity and low pollution intensity (Manufacturing n.e.c. and recycling). The red point represents the point estimate, while the ranges report 90% confidence intervals.
• #12 Another way to put it: The magnitude can be compared to overall growth in trade – here in domestic VA in exports terms. Reported in USD for 2008, relative 1995 (i.e. Exports in 2008 – exports in 1995). The figure shows exports from the three most stringent countries (Denmark, Germany, Switzerland) to BRIICS. They have grown tremendously over the years (blue)! For the pollution intensive sectors (ISIC rev. 3.1. 2325: Manufacture of coke, refined petroleum products and nuclear fuel; Manufacture of chemicals and chemical products; Manufacture of rubber and plastics products and 2000: Manufacture of wood and of products of wood and cork, except furniture; manufacture of articles of straw and plaiting materials) - this is the blue bar on the left with growth by 11 bln USD in nominal terms. But if it was not for the tightening of policies, they would have been 370 million USD higher – the “dotted red” area which is equivalent to some 3% of the total change. So the lost was tiny, compared to gains from other factors, like market sizes, tariff liberalisation, improvements in factor endowments or globalisation. Moreover, at the economy level this was not the only effect. Taking an example of less pollution intensive sectors (2933: Manufacture of machinery and equipment n.e.c.; Manufacture of office, accounting and computing machinery; Manufacture of electrical machinery and apparatus n.e.c.; Manufacture of radio, television and communication equipment and apparatus; Manufacture of medical, precision and optical instruments, watches and clocks; 3637: Manufacture of furniture; manufacturing n.e.c.; Recycling) of the 12 billion USD increase, again some 370 million (3%) can be attributed to EPS.
• #13 The flip side – exports from BRIICS to high EPS countries. yes, BRIICS have “gained” from keeping EPS lower over the time – their exports in pollution intensive sectors increased. But the gain is tiny the green bar on top, left hand side. And, it has been compensated – by a competitiveness loss in the less intensive sectors. Albeit also very small compared to overall growth of exports–see red dotted element. Sectors are the same as in previous slides, growth that can be attributed to EPS is respectively +3% and -2.5%. In absolute terms, the values are different, but this depends a lot on what sectors we choose. I tried to take fairly broad and representative ones.
• #14 Of course, this is a simple exercise, which cannot account for all. firstly, innovation and new technologies can change industries and firms over time : Industries and firms can become cleaner, and regain the advantage, even despite high EPS. However, while this is optimistic, there is also the issue that EPS may need to increase much more. If so, and if unprecedented – difficult to address empirically, However, the evidence is very robust: different specifications, including EPS proxy and the classification of sectors into high and low intensity, etc. So yes, there will be losers. But there is an increasing evidence there are winners. And in such a case, even without an overall economic gain, improving the environment should stand a case.
• #15 On winners and opportunities related to environmental polcies: Another piece of OECD research found a significant correlation between EPS and the countries revealed comparative advantage in so-called environmental goods. While the labelling of these is perhaps controversial, they are likely to contribute to less pollution than average goods. So, the EPS induces such specialisation – and as show in this Figure – it is a category of goods that is growing notably higher than the total goods trade. So advancing on more stringent policies, aside from a better environment may be providing a first-mover advantage in a rapidly expanding market ….
• #16 Other evidence: We also have evidence that on average, more stringent environmental policies are not found to hamper productivity growth. Again, there is an underlying winner-loser story – as in the case of probably any structural adjustment! In this case, OECD work from 2014 found that most advanced firms and sectors actually gain (in terms of productivity growth) from more stringent policies. Laggards however, see a temporary fall in productivity growth. Reasons may be many, among them entry and exit. A large strand of work, from our hosts here, from Antoine Dechezlepretre (He will be the discussant, so he may want to say more on this), finds the links from more stringent policies to innovation – similar to some older OECD work. Several themes seem to emerge – but environmental policies don’t seem bad for innovation. They redirect innovation, to “greener” innovation, and potentially to innovation with more spillovers.
• #17 Simulated effect of one year effects of a median increase in environmental policy stringency, i.e. 0.12 change in the value of the EPS index in one single year (equivalent to the change in annual average tightening from the level in Italy or Greece to that of the Nordic countries). High (low) pollution intensity is defined as an industry with the highest (lowest) pollution intensity on seven selected key pollutants with respect to value added. (3) High productivity is defined as the country-industry pair (or firm) on or close to the estimated global industry (or firm) productivity frontier. Low productivity is defined as country-industry pair (or firm) at the 75th percentile of distance to the global industry (or firm) productivity frontier. 90% confidence intervals are reported. Effects are estimated to last for three years after the policy change and then fade away. No lead effect is found. Bear in mind, that most productive firms in the dirty sectors gain too. However there may be several reasons: first they have access to best technologies – they are global leaders. Second, there may be a composition effect – even in “dirty” industries, there will be relatively clean firms – the most advanced are likely to be the case. Finally, these are often top mne’s – part of the productivity increase could be due to outsourcing – something we are working on right now. Finally, bear in mind that firm level effects are not the only explanation for what we see on the trade side. One thing could be general equilibrium effects – changes in comparative advantage favouring cleaner firms. This highlights the importance of facilitating reallocation of resources across firms to be able to benefit asap from the developing advantage…
• #19 So there are opportunities, not just costs. But making good use of them is not a given. How can we make the most out of the increase of environmental policies? Well, the answer is before you: policy design. First, but not only environmental policies. They need to flexible, to the extent possible (Eg market based) allowing firms to chose their way (technology) of complying. They need to be flexible and minimise barriers to entry and competition – avoid protecting incumbents and old, dirty ways of doing things. But its good if they are also giving some stability for the future, so that investment risk due to policies is minimised. Second, they need to be part of a broader, structural reform package. This includes good framework policies for innovation, for young, rapidly growing firms, for investment. It also means aligning policies that have little to do with environment as such, but create wrong incentives – eg in the tax system, in land-use or infratstucture (in line with recent Aligning policies for a low-carbon transition project between OECD, IEA, NEA, ITF). Finally, it means good supporting policies, to make sure labour market impacts (remember – winners and losers!) are contained. That resources are made best use of, not forgotten or idle, increasing the costs and resistance to environmental policies. Only a complete environmental and structural package can help obtain jointly economic and environmental objectives.
• #20 Thanks