This column argues that laxer
environmental standards significantly explain the location choice of polluting
affiliates. Both globalization and corruption open the door of Pollution
Havens.
------
Fabien Candau, Elisa Dienesch
With
the withdrawal from the Paris climate agreement, Donald Trump opens a dangerous
Pandora's box for the environment. Is it possible that the world’s second
largest emitter of greenhouse gases also becomes the world's new favorite
pollution haven?
It
is beyond the scope of this column to predict firms behaviors on that topic and
to analyze the American case in particular, but in a recent paper (Candau and Dienesch, 2017, JEEM), we characterize the main features of pollution havens: lax
environmental regulation, good market access to high-income countries and
corruption opportunities. We analyze the location choice of European-controlled
enterprises and we find new results concerning the Pollution Havens Hypothesis (PHH).
When
considering the impact of environmental standards on relocation of
multinational firms, economists tend to dismiss their significance. Some
authors have even advocated that the flight of physical capital in countries
with laxer environmental standards is a "popular myth" or a delusion. They argue that 1) the cost of environmental
norms is too small to cause relocation 2) countries with lax environmental
standards have repulsive characteristics such as poor institutions and bad
governance which represent a cost for multinational firms.
We
revisit this question, showing instead that pollution havens are a reality fostered by globalization and bad
governance.
Pollution
Haven, from the myth to the reality
In
the early 2000s, it was quite common to dismiss the existence of pollution
havens by underscoring that there is no evidence of this hypothesis. Laxer
environmental standards could not significantly explain the location choice of
polluting plants.
However
a growing number of articles have successfully found this effect for inward,
outward, and outbound foreign direct investments (FDI) in the context of the
United States (see Rezza (2014) for a meta-analysis). While the discussions on
PHH have thus far relied to a great extent on data from the United States, a
similar analysis for Europe has been neglected. This is surprising since the
European environmental policy has been quite active over the past few years.
Furthermore, Europe and its neighborhood have changed; post-communist economies
(central and eastern European countries, Russia, and China) as well as partners
in Maghreb (e.g., Tunisia and Morocco) have now reached an intermediate level
of bad governance - good enough to conduct business (e.g., without risk of
expropriations) but still poor enough to allow businesses to pollute with
unspoken license. Lastly, access to the European market has been vastly
improved thanks to multilateral, regional, and preferential trade agreements,
which make relocation outside Europe and/or at its periphery less costly. As a
result, Europe is the perfect field to analyze the PHH and its interaction with
governance and trade integration.
Market
Access
Countries
with stringent environmental rules have advantages that can overtake the
environmental cost (e.g. better infrastructures, larger market size, better
endowment in human capital etc). In order to operate in the largest markets,
firms agree to pay the highest environmental costs, but if these costs are excessive,
they move out of their “green fortress,” particularly if they can secure access
to consumers from a peripheral location and follow laxer environmental
standards.
By
improving market access to developed countries from pollution havens,
globalization erodes the advantage of locating plants close to the point of
consumption. Market access is thus a central variable to understand the reason
behind the change in locations of polluting firms.
Our
results show that firms are motivated to reach new markets through the market
potential offered by the partner while a good market access from Europe retains
activities. There are multilateral gains provided by the destination.
Relocation is also clearly motivated by the market potential offered by
European nations themselves in their own markets, matching the fragmentation
process and the need to re-import cheaper inputs from abroad.
Corruption
It
is true that countries with lax environmental standards have repulsive
characteristics such as poor institutions and bad governance which represent a
cost for multinational firms. However, for polluting firms, this negative and
direct effect, is balanced by a positive and indirect one: corruption can be a tool to reduce the
stringency of environmental policies (we call this the "Corruption Paradise Hypothesis").
Challenging
the potential endogenous bias of environmental regulation and the ambiguous
role of corruption on location choices with an original two-step procedure, we
find evidence that corruption indirectly increases the number of relocations of
polluting firms to pollution havens
Conclusion
Market
access matters to explain Pollution Havens, this leads to a logical question: does protectionism the cheap way
to reduce relocation? We are skeptical, according to our estimate, the
protection of the European market (e.g., a carbon tax on imports) to stop
relocations to pollution havens must be high (a decrease of the European market
for Morocco and Tunisia equivalent to 13%) not to say prohibitive (31% for
China), which will have substantial effects on firms competitiveness and on
consumers welfare. A global agreement on environmental standards is the obvious
solution, but it is also obvious that it is an utopia. More certainly local
fights and solutions can be found, but the future looks definitely less bright
with validations of the Pollution Haven Hypothesis than without.
Reference:
F
Candau, E Dienesch, Pollution Haven and Corruption Paradise, Journal of Environmental Economics and Management, Volume 85, September 2017, Pages 171–192.
(Working paper available here, older version at ideas)
(Working paper available here, older version at ideas)
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