Multinationals and public policy - How to cope with environmental standards

Contents

List of Abbreviations

1 Introduction

2 Roots of Environmental Policy
2.1 Environmental Standards and their Level of Regulation
2.2 Implications of Economic Theories for Environmental Policy
2.2.1 Global Reach School
2.2.2 Internationalization Theory
2.2.3 Ecological Economics
2.2.4 International Trade Theory

3 Classification of environmental strategies on firm level
3.1 Overview
3.2 Non-Compliance
3.3 Reactive Strategy
3.3.1 Overview
3.3.2 End-of-Pipe Approach
3.3.3 Empirical Evidence of the Pollution Haven Hypothesis
3.3.3.1 Overview
3.3.3.2 “Inter-Country FDI Flow” Approach
3.3.3.3 “Single Country FDI Inflow” Approach
3.3.3.4 Endogenous Pollution Havens
3.4 Product Stewardship
3.5 Pollution Prevention
3.6 Environmental Leadership

4 Conclusion

References

List of Abbreviations

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1 Introduction

Environmental regulations may gain importance on different levels mainly according to their geographical scope and the effectiveness of their enforcement mechanisms. Environmental regulations influence the environmental strategies of multinational enterprises (MNEs), but they are not the only influencing factor of the attitude of enterprises towards environmental conduct. The industrial flight of polluting industries to less developed countries (LDCs) or transition economies due to less stringent environmental regulations is a main issue risen in the globalisation debate. This relocation of polluting industries is predicted in the pollution haven hypothesis. In order to examine the empirical evidence of the pollution haven hypothesis, the influence of environmental regulations on foreign direct investment (FDI) is examined. The theoretical background of the pollution haven hypothesis is explicated in the context of the international trade theory in part 2. In order to shed some light on the importance of the end-of-pipe approach and the empirical evidence of the implications of the “pollution haven hypothesis” the “pollution haven hypothesis” is taken up again in part 3. The importance of integrating the potential influence of corruption into an examination of the pollution haven hypothesis is underlined and explicated. The compliance behaviour of firms to environmental regulations as focused at in part 2 directs to the firm-level dimension of environmental regu-lations, but this very broad classification is not sufficient to describe the environmental policy of firms. Therefore part 3 features more specified environmental strategies.

2 Roots of Environmental Policy

2.1 Environmental Standards and their Level of Regulation

The need for regulations concerning environmental protection arose in the 1960´s due to the proceeding environmental degradation in industrialized countries, mainly the US. Today economic integration and economic growth boost the demand for effective environmental policies at the international as well as at the national level. An international cooperation in environmental protection has gained particular importance due to various environmental chal-lenges showing a transboundary character which remove the control from any individual na-tion.

One may differentiate between five levels of regulation concerning environmental standards: First, multilateral rules as those established under the General Agreement On Tariffs an Trade (GATT), second, regional level regulations in the context of regional integration efforts as the EU and the North American Free Trade Agreement (NAFTA), third, national state level rules, fourthly sub-national rules as state or provincial regulations and fifthly, municipal and local regulations if not under provincial or state jurisdiction.

The rapid growth of international environmental regulations may be explained by the follow-ing: First, the international or even global relevance and implications of environmental chal-lenges created the necessity for consideration of these problems at the same level. Second, even if environmental problems can be handled adequately at the national or sub-national lev-els, differences in regulations may influence the relative competitive position of domestic versus foreign firms. Third, the increase in regional integration has given rise to the integra-tion of environmental issues in regional integration policies. For example, “NAFTA is a major breakthrough since it is the first international trade agreement (other than international EU regulations) to explicitly incorporate environmental issues, and to establish a bureaucracy to administer trade and environment interaction, primarily through the NAFTA Commission on Environmental Cooperation (CEC). NAFTA and the CEC can be seen as benchmarks for analysis of other environmental organizations and agreements.” Fourthly, there is an incentive for governments to bring environmental issues to an international arena since the benefits of efforts being directed to environmental protection may often be experienced only in the far future. International environmental agreements may appear in the form of governmental ac-tions (multilateral and regional environmental regulations as mentioned above) as well as in the form of voluntary agreements among firms and stakeholders as in international institutions, environmental non-government organizations (ENGOs,) trade unions and professional organizations. Such voluntary guidelines comprise mainly of behavioural guidelines in form of codes of conduct. In the context of codes of conducts I refer to the global reach school, which pleads for such kind of environmental effort.

“At the level of the firm targeted by international environmental policies, the corporate re-sponse in terms of compliance depends upon its expected economic benefits” On this basis, Rugman and Verbeke developed a framework which allows for the classification of the dif-ferent types of international environmental policy regimes in terms of firm level compliance behaviour. Under this framework, four possible managerial responses have been proposed. First, “Performance-driven compliance”: There are high “net economic benefits of compliance” which results primarily from improvements in industrial performance due to compliance. In the context of this type of compliance behaviour international environmental regulation is welcomed since it eases global benchmarking. One of the most notable example of this is the Organization for Economic Co-operation and Development (OECD) non-binding envi-ronmental regulations, policies and principles which are regarded to as leading to such a “Per-formance Driven Compliance”. Second, “Non-Compliance”: In this Situation, compliance yields to low economic benefits, lack of administrative enforcement and a want of contribu-tion to industrial performance attributed to compliance. This is considered to be the case when “regulation is viewed by firms as political lip service to environmental pressure groups, without any serious government commitment to implementation” Cited as falling under the purview of “Non-Compliance” are international agreements with weak enforcement provisions such as the United Nations Conference on Environmental Development´s (UNCED´s) Rio Declaration (1992) and the Kyoto Conference (1997) In the context of non-compliance I also refer to part 3.2. Third, “Enforcement Driven Compliance”: This refers to a situation in which compliance is driven mainly by the economic benefits of avoiding costly sanctions . One prominent example of this is it is the environmental standards of the EU and its “eco la-bels”. Eco labelling enables customers to identify products being less detrimental to the envi-ronment than other rivalling goods within the same product category, either because of their composition, the way in which they are produced, or both. Multilateral environmental agreements (MEAs) with strong enforcement provisions such as the Montreal Protocol are another example of regulatory frameworks which induce enforcement-driven compliance. Fourthly, “Conditional Non-Compliance”: “This is in case of environmental regulations for which governments shows a genuine interest in implementation, but the design or operational-ization of an administrative enforcement apparatus is lagging because of a lack of resources or other implementation barriers” NAFTA- and GATT/World trade Organization (WTO) regu-lations may often lead to this type of compliance behaviour. However, the different compli-ance scenarios outlined above can not capture the full scope of strategic responses to envi-ronmental concerns at the micro-level. Part 3 will address and explore this concern in greater depth.

2.2 Implications of Economic Theories for Environmental Policy

In the interest of consistency I will utilize the nomenclature of the different theories employed by Hansen (1998).

2.2.1 Global Reach School

The term “global reach” refers to “the highly intrusive and sometimes destructive presence of transnational corporations (TNCs). The global reach school has roots in the American antitrust tradition, which essentially focuses on the adverse effects of corporate monopolies and oligopolies on national welfare and efficiency, and it stresses the negative externalities created by TNCs.” In the context of the global reach school it is argued that TNCs which operate in LDCs will use their market power in order to realize cost savings concerning environmental protection. The motivation for cost savings may result in the use of inferior environmental technologies and management practices in LDCs. Concerning this argument, I refer to 3.3.2 (end-of-pipe-approach). In addition, TNCs are assumed to have the bargaining power to ob-tain environmental concessions from LDC´s governments. In the context of the global reach school, international regulation of TNCs is postulated. In order to decrease the scope for TNCs activities, arm´s-length markets should be promoted.

2.2.2 Internationalization Theory

In contrast to the international trade theory, the internationalisation theory tends to downplay the significance of shifts to pollution havens. The internationalisation school goes further to answer the question of “why FDI is preferable to arms-length transactions on the markets” , which was left largely unanswered by the global reach school. According to the international-isation theory, TNCs will prefer arms length transactions and will turn to pollution havens only if the polluting industry cannot be organized locally when, for example the out-sourcing of the production might lead to firm specific advantages (FSAs) being dispersed to competitors. Generally, according to the internationalisation theory, FDI is mainly aimed to circumvent market imperfections and to guard FSAs. In addition and in contrast to, for example, the global reach school, the internationalisation theory assumes TNCs will use advanced envi-ronmental techniques and management practices in LDCs in order prevent damage to its envi-ronmental reputation. The potential implications for environmental policy due to the protection or improvement of the image of a firm is are explicated in part 3.

2.2.3 Ecological Economics

The literature on ecological economics- according to Hansen- viably criticises the neo-classical stance towards the role of FDI on economic development. Hansen asserts that “…ecological economics argues that any kind of human expansion, growth or development must observe and take into account the boundaries set by the earth´s carrying capacity. The principle aim of all economics is not in the first place to improve human well-being and living conditions, but rather to secure the sustainability of the earth´s carrying capacity.” According to Hansen, ecological economics does not focus explicitly neither on FDI nor on TNC theory. Rather, it argues that environmental degradation is mainly caused by the rise in international specialization and division of labour, thereby establishing a link to TNCs. An important insight of the ecological economics theory is that “the true environmental costs of production are not internalised in prices, especially in LDCs.” Ecologicical economics postulate that international trade should occur mainly in the way of barter trade. In order to prevent TNCs from shift production to LDCs, an “ecologized” economy “would require political intervention on an hitherto unpredicted scale, including, and maybe in particular, interventions in the activities and free reign of TNCs”

2.2.4 International Trade Theory

The pollution haven hypothesis can be viewed as a main contribution of the international trade theory to the theoretical background of MNEs environmental policies. In the late 1960s and early 1970s trade theorists turned their attention to the implications of FDI on the envi-ronment as a result of the contemporaneous occurrence of the following events: First, during this period, most OECD countries established environmental legislation and regulations on the basis of the polluter pays principle. Whereby a growing emphasis was put on environmental concerns resulting in the creation of regulatory bodies such as the Environmental Protection Agency (EPA) in the United States in December 1970, second, the world observed a rise of FDI which was in large quantity directed to LDCs, third, in some countries (especially in the USA) a shift from balanced trade to a permanent trade deficit had developed. These simultaneous shifts lead to the speculation, that differences in environmental regulations and their stringency might have an adverse effect on the competitiveness of nations and therefore direct the relocation of highly polluting industries being involved in international trade. When discussing the environmental effects of trade liberalization the focus is often on the composition effects. “Composition effects” is used to refer the specialization of nations in industries where they enjoy a comparative advantage. Natural resources were viewed as a factor of production. Two determining elements constituting the environmental endowment of a country are: first, the pollution-absorbing capacity of the natural environment being de-pendent on the current exploitation-level of environmental endowments and on the level of efforts made in order to increase the assimilative capacity of the environment and second, the attitude of the population and politicians concerning acceptable levels of pollution. The “in-dustrial flight” hypothesis and the “pollution haven hypothesis” can be imagined as two sides of a mirror, whereas the “industrial flight” hypothesis represents push factors and the pollution haven hypothesis depicts pull factors.

The industrial flight hypothesis focuses at explanations of the rapid decrease in environmental endowments in industrialized countries and so “pushing” industries to flee. Such push factors includes: first, the increase in the capital employed and production costs in heavy polluting industries as a result of the abatement costs imposed by new environmental legislation and regulation, second, the restriction on the ease and pace of new plant construction or expanding existing ones and third, strong impediments to the production of hazardous products or pro-ductions due to regulation being directed at workplace and public safety and health.

The pollution haven hypothesis reflects an environmental strategy which focuses on the spatial allocation of production facilities in LDCs as a result of differences in the relative envi-ronmental stringency between nations. This strategy may be specially applicable to high pol-lutant industries. The expression pollution haven reflects some theoretical parallel to the well-known term “tax havens” where countries offering less stringent pollution control procedures are called pollution havens. In order to explain the characterization of the pollution haven hypothesis as depicting a pull factor one could maintain two arguments to explain the higher abundance of environmental endowments in LDCs in comparison to OECD countries: First, the natural assimilative capacity in LDCs might be higher resulting from a low degree of in-dustrialization so that the environment might be have a higher absorptive capacity. Second, the “social” assimilative capacity in LDCs could be higher due to a greater need for economic development. In the context of the “international trade theory” the creation of economic wealth through the exploitation of environmental endowments is absolutely legitimate, in con-trast to the implications of ecological economics. According to the international trade theory a relocation of polluting industries to LDCs will result in a more optimal allocation of resources while offering under-industrialized countries an enhancement in development. The attraction of highly polluting industries may cause some environmental damage in less developed coun-tries in the short run, but in the long run it will enable LDCs to afford environmental measures in the future. According to the logic of comparative advantage, going against this relocation of polluting industries for example through the creation of international environmental stand-ards (as asserted by the global reach school) would drive up consumer prices, decrease the possibility for LDCs to develop and reduce overall FDI. Further, the decrease in transporta-tion costs results in increased mobility of firms so that LDCs might have more possibilities to attract industries. Many efforts have been made to implement the theoretical approach of the pollution haven hypothesis . There are not many theoretical drawbacks of the pollution haven hypothesis: since the cost effects of the relocation of polluting industries may be negligible or an increase in environmental quality might induce a decrease in employee compensation. The other way round this would mean that industries would have to pay higher wages when relocating high-polluting industries to LDCs. In an equilibrium, there would be no cost-reducing effects for MNEs when following the predictions of the pollution haven theory. Concerning the empirical evidence of the pollution haven hypothesis I refer to part 3.2.2.

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