The Importance of Environmental Regulation for Economic Growth: A Path to a Brighter Future? Prof. Tim Swanson

What is the role of environmental regulation in forging a path into China’s future? China has had extraordinary growth (10%+) for a decade This has provided better lifestyles and real employment for many millions in China But many of the environmental resources (air, water, forests) have become degraded in the process Resulting in the demand for regulation

Role of Regulation - Forging a Path What impact does this regulation have? Are jobs and lifestyles under threat? Is it possible to provide environmental quality and still growth? Where does this path lead?

What is Impact of Environmental Regulation on Growth? Four Views 1) Standard View – Static Constraint 2) Induced Innovation View - Dynamics 3) Market Transformation View – Diffusion 4) Technology Leadership View – Dominance

#1:Standard View of Regulation and Growth – Static Constraint Environment regulation acts as constraint Restriction may advance social welfare by restricting access to environmental resources But impact on growth and production is unambiguously negative Only question is the CBA question: Do social benefits outweigh production costs?

Environmental Regulation as Constraint on Production Product A(K,L,E) Product B(K,L) Production Possibility Frontier

Problems with the Static View Evidence that environmental regulation does not always harm growth

Problems with Static View Evidence that environmental regulation can work through policy-guided innovation

#2: Induced Innovation View – Regulation as Dynamic Incentive Environmental regulation defines problem for industry, and response is R&D and technological change in that direction Product A(K,L,E) Product B(K,L) Production Possibility Frontier

Question of whether dynamic incentive outweighs static constraint Evidence: Static Effect Exists e.g. US Productivity Decline attributable to Regulation

Induced Innovation View – Dynamic Impacts Evidence of R&D Spending (5% of US business abatement cost on R&D - Jaffe et. al. 1995)

Induced Innovation View Large reductions in ex post abatement costs (Oosterhuis et. al. 2005)

Induced Innovation View Insignificant Impact upon Competitiveness

Aggregate Effect? Much & Mixed Evidence

Induced Innovation View 1)Environmental reg creates constraint 2)R&D spending occurs to relax it 3)Technological change occurs 4)Abatement costs decline 5)Cost-Efficiency in Resource Use  Increased Innovation and No Significant Impacts on Competitiveness

#3) Market Transformation View – regulation as diffusion Environmental regulation as a means of diffusing first-best technology throughout industry (removing worst and moving rest) Product A(K,L,E) Product B(K,L) Production Possibility Frontier Firms i,j,k

Market Transformation View Case Study: Energy Labelling Inefficient firms producing a range of energy-using appliances Consumers unable to perform computations to determine efficient appliances (price of appliance plus energy consumption x price of energy)  Range of appliances exist on market

Market Transformation View Nature of Market Failure: Info Problem Current Price vs. Total Life Cycle Cost

Market Transformation View Role of Regulation is to diffuse technology- directly or indirectly Label with Energy Use (help consumers with computation) Standards for Energy Use on Products (solve computation for consumers) Imposition of Technology Requirements (direct requirement of technology adoption)

Market Transformation View Labelling Case Study (EU Energy Use Labels) – Impact on Consumer Choice

Market Transformation View EU Labelling Case Study Impact on Diffusion of Best Technology

Market Transformation View EU Labelling Case Study Impact on Competitiveness (ave. UK prices)

Market Transformation View Energy Labelling Study - Reduced Consumer, Producer, and Social Costs

Market Transformation View 1)Market Failure (here, information) enables inefficient firms to persist 2)Environmental Regulation solves the information problem (here, label) 3)Consumers demand better appliances 4)Inefficient producers leave industry or adopt efficient technologies 5)Competitiveness of industry increases 6)Efficiency of market improved (benefits)

#4) Technology Leadership View – regulation for innovation (rents) Environmental regulation as policy-directed innovation in specific directions to anticipate future scarcities Product A(K,L,E) Product B(K,L) Production Possibility Frontier

Technology Leadership View Current technologies and current production is responsive to current prices Some future trends may be anticipated (e.g. future price changes in energy, future price changes in carbon) Anticipatory policy to induce technological investment may result in early innovation and patents  Environmental egulation as a means of capturing innovation rents

Technology Leadership View Japanese Anticipatory Regulation Case Study: Japanese 1970s Sector-based Energy Conservation Laws Anticipated higher energy prices Demanded technological change for energy efficiency on sectoral basis  Resulted in 28 distinct energy-saving programmes in auto industry and anticipatory patents in many (e.g. hybrid engines – at bottom)

Technology Leadership View

Japanese case study (catalytic converters): Minor lead in policy  possible patent leadership

Technology Leadership View – Japan case study Japanese patent leadership in automotive air pollution

Technology Leadership View Case Study: Danish Wind Turbine Tech In 1970s Denmark adopted a policy subsidising a substantial wind turbine industry in that country Through: Subsidies to R&D Commitments to purchases

Technology Leadership View Denmark’s early development of industry

Technology Leadership View Later Diffusion of Technology Worldwide

Technology Leadership View Denmark’s Industrial Competitiveness in WT

Technology Leadership View 1)Expected changes in prices or resource scarcities (energy, carbon etc) 2)Anticipatory policies encouraging innovations in industries to conserve on these resources 3)Establishment of early lead in technology and rights to technologies via patents 4)Dominance of industry through patents – sales or (more likely) licensing

Impact of Environmental Regulation on Growth – 4 Views First view, environmental regulation introduces a constraint on the economy & this constraint has costs for the enterprises concerned e.g. in the US, abatement costs in response to environmental regulation have been estimated at 1-1.5% in impacted industries

Second view - dynamics Secondly, the impact of regulation may be to cause the industry concerned to consider ways to conserve on its use of the resource (to relax the constraint) Resulting in: Increased R&D spending (5% of costs) Reduced abatement costs (half as much) Reduced impact of original constraint

Third view - diffusion Thirdly, the impact of environmental regulation may be to solve particular market problems that prevent firms from being efficient: Uniform standards may address existing problems in the market or industry (information deficiency, poor local reg) Removing inefficient firms or diffusing tech Improving competitiveness of industry Case Study: EU Energy Labelling

Fourth view - dominance Fourthly, the role of environmental regulation may be to develop leads in technologies and industry dominance: Anticipatory policies result in R&D R&D results in innovative technologies Early lead in technology results in patents Patents results in industry dominance Case Study: Denmark Wind Turbine Industry

Four Views, One Path Environmental regulation plays the important role of enabling the state to exercise Technological Leadership For purposes of: Technological Dynamics Technological Diffusion Technological Dominance Nothing in the market provides for technological change (due to information appropriation problems and diffusion problems) States that solve these problems are those that lead industries and dominate in terms of competitiveness The Chinese government will need to learn how to solve these problems  to regulate industry to push it down the path of better technologies The Path to a Brighter Future is one in which future change is more managed by the Chinese government to generate max benefits from industry