Reproduced, with permission, from:
U.S. Office of Technology Assessment. 1992. Trade and the environment: Conflicts and opportunities. Report no. OTA-BP-ITE-94. Washington, D.C.: Government Printing Office.
There have been attempts to assess the competitive impacts of environmental regulation on U. S. manufacturing at least since the early 1970s. A number of studies were done in the early to mid-1970s; after a period of reduced interest, the topic appears to be gaining scholarly and government attention today.[1] The U. S. Government was involved early and continues to work in this area.
The majority of studies dealing with this question have concluded that environmental regulation does increase the costs for U. S. producers, but that these increases are relatively small. Some studies have failed to find a relationship between environmental regulation and trade and investment. However, other studies have found an effect, but have judged the overall effect to be small. In certain sectors facing high environmental control costs, the effects on trade performance were larger.
However, serious problems with both the data and the methodology make anything but limited and/or tentative conclusions problematic. Limitations of the research methodologies make valid assessments difficult. Many of these studies may underestimate the total costs of environmental regulation, particularly for some industries; at the same time, they may neglect the benefits of regulation, such as increased energy and materials efficiency and increased public health.
Moreover, it is important to note that much of the research dates from the 1970s, and thus many of the conclusions about the effect of environmental regulation on trade come from a time when U. S. industry was just beginning to feel the competitive pressures that have so greatly intensified in recent years. As a result, what were modest impacts on a competitively strong industry then could be more significant today when competition as a whole is more intense. Thus, while the studies generally concluded that the effects were small, this does not mean that these effects are currently insignificant and should not be addressed.[2] This is particularly true given the new and stricter environmental regulations which will go into effect in the 1990s. In an era of heightened competition, increased environmental costs can diminish trade performance, and when combined with other effects (e.g., cost of capital, foreign industrial policies, etc.) may contribute to significant competitiveness difficulties. But, as other OTA reports have shown, factors such as capital availability, a well-trained workforce, and strong development and diffusion of commercially oriented technologies remain important determinants of competitiveness.[3]
Economic theory suggests that the increased environmental control costs borne by U. S. producers would reduce their competitive advantage in global markets as they face increased competition from producers in nations with lower environmental control costs. Many of the empirical models of the effect of environmental regulation on trade hypothesize that increased environmental control costs will worsen U. S. trade performance.
While studies have been done on the relation between environmental regulation and economic growth, only a few have assessed the cost of environmental regulation and examined its impact on international trade and investment.[4] Overall, the studies are difficult to summarize and offer somewhat mixed conclusions.
Virtually all studies agree that environmental regulation increases the cost structure of firms producing in the United States.[5] For example, the U. S. Bureau of the Census reports that in 1988 the average cost of environmental regulation for 445 manufacturing industries was 1.1 percent of value added.[6] Some other estimates are higher.[7] For example, world business leaders surveyed by Organization for Economic Co-operation and Development (OECD) report that environmental costs average 2.4 percent of sales income and are anticipated to rise to 4.3 percent by the end of the decade.[8]
While relatively small overall, the costs of environmental regulation are higher for certain industries. For example, 14 percent of 445 industries have environmental regulation costs of more than 2 percent of value added.[9] Copper smelting or refining, petroleum refining, steel, and cement all have relatively high costs from environmental regulation. Dow Chemical estimates a 2.5 to 3 percent price increase because of environmental capital investments.[10] When compared to the trade shielding effects of tariffs, environmental regulation costs are by no means trivial.[11]
Even though environmental regulation imposes expenses on U. S. producers, it is another matter to show whether these costs negatively affect trade performance. To do this, economists usually rely on economic models that include a number of variables, including the cost of environmental regulation, to either measure or predict trade performance and overseas investment.
Some studies find that it is impossible to isolate the effect of environmental regulation on trade, particularly because other variables, such as the cost of capital and exchange rate fluctuations, overshadow the effects of increased environmental regulation costs. For example, in 1979 the U. S. Department of Commerce concluded that its studies "have disclosed no evidence of either significant out-migration of U. S. industries to `pollution havens' or of trade pattern dislocations directly attributable to pollution control costs."[12] They expected any cost differentials to be masked by other factors affecting the state of the economy.[13] Similarly, a later study, looking at net exports in five pollution-intensive industries, found no trade impact from environmental control costs.[14]
However, other studies have found more evidence of impacts--albeit small. A 1978 OECD study concluded that the general increase in prices due to environmental regulation is not highly significant, "but is nevertheless sufficient to trigger some reduction in private consumption and in exports."[15] Another study found that "pollution abatement regulations have a negative and fairly significant effect on trade performance (in the 1970s)."[16]A third study found that a 1 percent increase in cost due to environmental regulation would result in a net reduction of the U. S. balance of trade of $6.5 billion in 1982.[17] While the study concludes that this is a small effect, if the impact was the same in 1990, it would result in an $8.6 billion worsening of the U. S. merchandise trade deficit of $101 billion. Yet another study found that a pollution tax imposed on Mexico equal to the value of environmental control costs of the counterpart U. S. industries would lead to a 1.2 to 2.6 percent reduction in Mexican exports to the United States.[18] This would reduce U. S. imports from Mexico by approximately $375 million a year.
While assessments generally conclude that the economy-wide effects are minor or nonexistent, some studies suggest that sectoral effects are more significant. For example, the Commerce Department concluded that while it could find no relationship between environmental control costs and overall trade patterns, environmental regulation in 1979 did add $7.30 more per ton to the costs of U. S. bleached kraft pulp (paper) over that of Sweden or Canada for a 5.8 to 8 percent increase.[19] Because U. S. producers already held a competitive cost advantage, the study concluded that the impacts on trade would be minimal. Similarly, the Commerce Department found that environmental control costs averaged 6.6 cents per pound in the U. S. copper industry, but only 2.7 cents in Canada, and 0.5 cents in Peru and Chile. The report predicted that U. S. copper imports would rise from 167,000 tons in l974 to 661,000 tons in 1987, and that 16 percent of this increase (79,000 tons) would be attributable to additional environmental regulatory controls on U. S. copper producers.[20] The Department classified these impacts as small. By contrast, in 1988, OTA concluded that the cost to the U. S. copper industry, particularly copper smelting, of environmental regulation "has been large, with substantial negative impacts on competitiveness and capacity."[21] Another study estimated that water pollution control expenditures would lead to differential trade impacts, for example, an increase of shoe imports of less than 1 percent, but an increase in steel imports of 6 percent.[22] Because the products of many industries with high control costs tend to be highly standardized intermediate goods purchased by other industries (e.g., chemicals, petroleum, minerals) with high price elasticity of demand, small changes in price may cause larger changes in sales.[23]
Finally, one study found that between 1973 to 1982 the United States increased its net imports of goods more from industries with higher environmental control costs than from those in which such costs were lower.[24] In other words, as a ratio of imports to exports, the United States increasingly imported goods in industries that had high environmental control costs. However, the ratio did not change for imports from Canada, a country whose environmental regulations are similar to those of the United States.
In addition to affecting trade directly, some argue that uneven regulation may induce U. S. firms to migrate to countries with lower levels of regulation--the so-called pollution haven effect. Studies of the location impacts of environmental regulation are inconclusive, but suggest that the effect is modest. There are reasons to suggest that the migratory effect of environmental regulation is likely to be less than the trade effect.
Unlike decisions to buy discrete items, U. S. overseas investment decisions are often driven by such considerations as foreign market access or savings in areas such as wages. For relocation decisions driven by cost considerations, the savings have to be large enough to overwhelm the costs of opening up a new plant (which can be substantial).[25] Many firm location decisions are not driven by low cost, as access to markets, skilled labor, and quality infrastructure may be more important. And usually savings from lax environmental regulations will be relatively modest compared to the savings from other factors, such as low wages. However, many countries with low labor costs also have low levels of environmental and worker health and safety regulations, which when combined, can result in even lower costs.
Most economy-wide studies suggest a low impact on investment from differing environmental regulation.[26] Leonard found no significant effects on investment of differential environmental regulation.[27] A study of U. S. "maquiladoras" plants (plants locating in Mexico near the U. S. border through a special Border Industrialization Program) found no relationship between the level of low Mexican regulations and U. S. investment.[28]
While economy-wide studies find no investment effect, anecdotal evidence, case studies, and surveys of firms suggest that lower environmental regulation does play a role. For example, one study found that 26 percent of maquiladora operators in Mexicali cited Mexico's lax environmental enforcement as an important reason for their relocation there.[29] The U. S. General Accounting Office found that between 11 and 28 wood furniture manufacturers in the Los Angeles area relocated to Mexico between 1988 and 1990, taking with them 960 to 2,547 jobs.[30] About 80 percent of the firms cited stringent air pollution standards as well as lower labor costs as major factors in their location decision. In Mexico, these firms faced no air pollution standards for the application of paint coatings and solvents.[31]
Case studies may find impacts because environmental regulation affects some industries more than others. For example, U. S. operations that moved to Mexico were either relatively labor-intensive light manufacturing operations and generally not highly polluting, or producers of hazardous waste such as asbestos.[32] A few industries more likely to relocate due to environmental regulation include some mineral processing, toxic products, and intermediate organic chemicals.[33] This is consistent with a finding that environmental regulation does not affect industry location in the United States overall, but that it may have some effect on the location of highly polluting industries.[34] For the subset of industry that is labor cost sensitive, is relatively footloose or is making new investment decisions, and has high environmental compliance costs, low environmental regulation can add to the cost advantage gained by low labor costs.
These studies do not provide definitive conclusions. Studies relying on economic models are limited by several factors. First, it is difficult to separate the effects of environmental regulation from other variables, such as wages and exchange rates, on overall trade patterns. OECD concluded that in relation to differing environmental costs among OECD nations, the fact that there have been no evident changes in competitive status does not suggest that environmental costs have not affected competitiveness, but that the totality of influences on competitiveness is such as to disguise any effect.[35]
Second, data limitations relating to the costs and benefits of environmental regulation make it difficult to accurately assess the competitiveness impact. Some of these limitations would suggest that the actual impacts are even lower than currently measured, but others would lead in the opposite direction, to suggest larger impacts.
None of the models include the benefits from environmental regulation and as a result may overstate the impact on trade. Firms may indeed accrue benefits from environmental regulation. For example, OTA found that environmental regulations accelerated steel industry modernization.[36] Pollution prevention efforts may increase competitiveness, if they result in firms paying closer attention to energy and materials efficiency and continuous process improvement.[37] Lower pollution costs may also be reflected in lower health care costs, increased agricultural productivity, and lower costs in other parts of the economy from reduced pollution.[38] Companies can benefit from these both directly and indirectly (cheaper supplies and inputs). Further, as other nations develop stricter environmental regulation, U. S. firms may receive some first-mover benefits as firms in other nations spend money to catch up. Finally, the United States may run a trade surplus in environmental protection products and services that acts to offset to some extent negative trade effects from environmental regulation-induced cost differentials (see app. D).
Third, it is not clear that the models accurately measure cost, either in the United States or other nations. Most of the studies rely on data on pollution abatement expenditures from a survey by the Bureau of the Census. However, there is some evidence that these surveys underreport environmental control costs.[39] For example, in the copper industry, Census data indicate that environmental control costs added 4 cents per pound to the price of copper in 1985.[40] However, at least four other sources, based on actual examination of copper smelting firms, found that the expenses were much higher, ranging from 7.5 cents per pound to 15 cents per pound.[41] The Census surveys may underreport true costs if the respondents do not have complete knowledge of all expenditures. Chapman found that survey results of the copper mining and smelting industry may not have included costs such as monitoring and planning activities, environmental activities that are part of the production process, interest expense on equipment, and productivity loss.[42]
Moreover, costs may be underestimated if other expenses are not calculated, including: administrative and legal fees and fines (these can be sizable in the Resource Conservation Recovery Act (RCRA) and Superfund proceedings);[43] costs of having to substitute new materials or processes; costs associated with bans on certain products or on production of certain hazardous products (e.g., zinc smelting, arsenic, benzidine-dye); increased costs of the effects of environmentally related industrial zoning; costs related to workplace health and safety protection; fees and taxes for permits; administration and recordkeeping; and research and development (R&D) for environmental controls.[44] In addition, some argue that the environment, particularly hazardous waste issues, occupies a significant portion of time for some top executives. Finally, even though costs may not be all that high now, new and stricter environmental regulations put in place in the l990s may change this picture, particularly for some industries. This all suggests that current estimates of U. S. environmental costs, based on surveys, may in fact be too low, which would lead to impacts that are underestimated.
Another limitation of the studies is that few include foreign costs of environmental regulation in the models, which leads to an overestimation of the impact of environmental regulation on trade and investment. The United States has among the most advanced environmental regulations in the world, although some other nations (Canada, Japan, Denmark, and Germany) have also developed strict and comprehensive approaches.[45] Other OECD nations, including France, United Kingdom, Switzerland, Spain, and Italy, have less strict standards, and non-OECD nations have even lower standards.[46] In addition, even among countries with similar levels of environmental regulation, there is wide variation in enforcement.[47] Moreover, countries differ in the forms of regulation employed and the relationship between government and industry in forming environmental policy. Some forms of regulation (e.g., tradable permits) may result in lower overall costs to industry while still achieving a stated environmental goal.
As a percent of gross domestic product (GDP), the United States spends more than any other nation (1.5 percent of GDP and $78 billion) on environmental goods and services.[48] Japan spends about half the U. S. rate (0.7 percent), northern European nations spend slightly more than half (0.9 percent), and southern European nations only one-third (0.5 percent).[49] The costs of regulation in less developed countries, including the newly industrializing countries (NICs), is significantly lower than in OECD nations. Table E-1 compares costs for different regions.
Even though many less developed countries have low or no regulations, this situation appears to be changing. Many countries, especially the NICs, are putting in place stricter environmental regulations.[50] Moreover, some argue that even though many less developed countries have minimal or no regulations, some multinational corporations (MNCs) may apply their high home country standards to their plants in less developed nations.[51] However, little systematic evidence has been presented to substantiate this claim. Thus, it is unclear the extent to which MNCs do this, particularly smaller firms that relocate to less developed nations. For example, while U. S. maquiladoras suppliers say that they don't illegally pollute, others dispute this claim and argue that sewage and other runoff from the area is often highly polluted with industrial wastes.[52] Even if the MNCs abide by home country standards, they may receive a cost advantage if local suppliers are unregulated.
Finally, the impact on U. S. firms can be even more significant because favorable tax treatments and subsidies in other nations for their firms can help offset these costs, and change the cost structure between nations.[53] Not all nations are as committed to the polluter pays principle (an OECD principle that says that polluters should bear the cost of complying with environmental regulations) as the United States.
Congressional concern about the competitive and trade impacts of U. S. environmental regulations is not new. Congress has on different occasions called on the executive branch to assess the impact of U. S. environmental standards on the competitiveness of American industry. It has also called on the executive branch to prompt other countries to raise their environmental standards.
Water Pollution Control Act Amendments of 1972
The Federal Water Pollution Control Act Amendments of 1972 directed the Secretary of Commerce to periodically study and report to Congress on the international trade impacts of the law. The Secretary, among other things, was asked to make a determination of the "probable competitive advantage" for foreign goods produced in countries without pollution control standards, or with lesser standards, or with subsidies or reimbursements for manufacturers' environmental costs.[54] In succeeding years the Secretary released four studies.[55] The last report focused on an industrial sector--aluminum-- that is among the most sensitive to environmental controls because of its high electricity demands. Why the reports were discontinued is not clear. A fifth report[56] was written in 1977 but not released because it was judged inconclusive.[57] The report compared pollution abatement expenditures and exports and imports for 47 manufacturing sectors between 1973 and 1976. According to its author, the study could not determine to what extent pollution control expenditures affected trade.
A 1979 Commerce Department status report on the congressionally mandated studies summarized the overall findings as having disclosed "no evidence of either significant out-migration of U. S. industries to `pollution havens' or of trade pattern dislocations directly attributable to pollution control costs."[58] The summaries of two sector-specific reports (pulp and paper, and copper) were less optimistic, stating that foreign imports may be slightly advantaged.
The amendments to the Water Pollution Control Act also directed the President, as a means of heading off competitive disadvantages, to negotiate "international agreements to apply uniform standards of performance for the control of discharge and emission of pollutants from new sources, uniform controls over the discharge and emission of toxic pollutants, and uniform controls over the discharge of pollutants into the ocean."[59] According to one analyst, President Carter unsuccessfully tried to implement this policy.[60]
1990 Amendments to the Clean Air Act
Competitiveness concerns were prominent in the debate about the 1990 Amendments to the Clean Air Act.[61] This law, the first major revision of Federal air pollution control requirements since 1977, significantly strengthened U. S. clean air requirements. Much of the burden of meeting the law's requirements will fall on U. S. business. Congress recognized this in section 811 of the 1990 Amendments, which noted (among other things) that U. S. business would need to make significant air quality investments and could incur additional costs in implementing the law's requirements.[62] Congress also expressed concern that complying with the act might make it difficult for American jobs, production, processes, and products to compete with countries with less demanding environmental requirements. Congress also found that mechanisms "should be sought through which the United States and its trading partners can agree to eliminate or reduce competitive disadvantages."
The law called on the President to report back to Congress within 18 months (May 15, 1992) with an evaluation of competitive impacts and a strategy for addressing such impacts through "trade consultations and negotiations." The strategy is to include options that might be employed to deal with competitive disadvantages caused by differences in standards among U. S. major trading partners. Examples of such options stated in the law were harmonization of standards and trade adjustment measures. A number of bills and proposals currently before the 102d Congress seek to promote foreign environmental standards through trade negotiations or measures (see app. B).
To respond to section 811, the EPA Office of Air and Radiation assembled an interagency team including EPA, Department of Commerce, U. S. Trade Representative, and the State Department that is preparing a two-part study. The first phase, which as of March 1 has been completed in draft form, compares air quality controls of United States with those of Canada, Germany, Japan, Korea, and Mexico. The report examines not only the different air pollution standards and regulations in each nation, but also the degree to which regulations are actually achieved and enforced. The second phase, which is underway, will identify and assess the economic effects of the Clean Air Act on four U. S. industries and calculate the likely effect on trade of the price increases. The reports are expected to be delivered to Congress on or before May 15, 1992. As of March 1992, evaluation of means to address the competitive impacts of the act through trade consultations or negotiations had not begun.
8 Preliminary information from OECD, 1991.
9 U. S. Trade Representative, ''Review of U. S.-Mexico Environmental Issues," February 1992.
19 U. S. Department of Commerce, 1979, op. cit., p. 12.
23 General Agreement on Tariffs and Trade (GATT), "Trade and the Environment," Feb. 12, 1992, p. 20.
35 Preliminary information from OECD, 1991.
46 Preliminary information from OECD, 1991.
49 Preliminary information from OECD, 1991.
53 For example, the Japanese give industrial grant aid to help reduce cost of compliance.
54 Public Law 92-500, section 6.
57 Loren Casement, U. S. Department of Commerce, personal communication, Jan. 28, 1992.