Policy makers have long been conscious of the consequences of environmental degradation and the COVID-19 pandemic has further raised and renewed awareness of the inherent fragilities of our environment. Yet, their ambition to address environmental challenges such as climate change, pollution and biodiversity loss has often been held back by the perceived immediate costs of more stringent environmental policies on people and firms. Businesses and policy makers alike fear that differences in the stringency of environmental policies across countries would negatively affect the competitiveness of firms located in the most ambitious regions. Pollution-intensive production would shift towards countries or regions with less stringent regulations, altering the location of industrial production and the subsequent international trade and investment flows – and potentially curbing the environmental gains. These fears are particularly apparent in the case of climate change mitigation, where a large gap exists between globally stated ambitions – as laid out in the 2015 Paris Agreement – and the climate policies actually adopted around the world.

Governments have gradually adopted more stringent environmental policies to tackle challenges associated with rising environmental issues, such as climate change, air pollution, waste management or biodiversity loss. Between 1995 and 2015, the stringency of environmental policies related to air pollution, energy and climate change – as measured by a composite indicator developed by the OECD – tripled across OECD countries.

This chapter summarises the conclusions from the report and presents the main policy implications of these findings. It shows that environmental policies have become more stringent in OECD countries over the past decades, but at a different pace across countries. The empirical evidence in this volume shows that climate policies have been effective at reducing emissions from industry. At the same time, the policies had relatively small effects on economic outcomes such as employment, investment and productivity. The evidence suggests that well-designed environmental policies do not have large negative effects on the economy. The policies can however generate winners and losers. Policy packaging can help compensate workers and industries that may lose and strengthen public support for more ambitious environmental policies.

The link between environmental policies and productivity growth is the focus of this chapter. New regulations often impose additional costs on firms, thereby reducing their productivity. However, new regulations might also trigger productivity increases through a redesign of production processes or a reallocation of resources within firms. This hypothesis is known as the Porter Hypothesis and has been the subject of a number of empirical studies. However, the evidence is inconclusive so far, especially at the cross-country level as a comparable measure of environmental policy stringency was missing to date. This study uses the OECD EPS indicator, a cross-country indicator for environmental policy stringency, to provide new evidence on the Porter Hypothesis. Using an extended neo-Schumpeterian productivity model, it looks at productivity developments at the industry and firm level of 17 OECD countries over the period 1990 to 2009. The results suggest that better environmental protection is associated with a short-term increase in industry-level productivity growth in countries that are considered to be at the technology frontier. The firm-level analysis shows that only the most productive firms are able to reap productivity gains while the least productive ones face a productivity decline.

Employment effects of tighter environmental policies are the focus of this chapter. By increasing production costs, unilateral environmental policies might hamper the competitiveness of industries, leading to output contraction and job losses. The potential impacts on employment are probably the main concern for policy makers when implementing stricter environmental policies, but the empirical evidence on this effect is limited so far. This study provides an empirical evaluation of the impact of increased energy prices and more stringent environmental policies as measured by the OECD Environmental Policy Stringency (EPS) Indicator on employment. It uses a combination of firm- and sector-level datasets across OECD countries over the period 2000-14. The results at the sectoral level show a significant negative effect on average of changes in energy prices as well as of changes in the environmental policy stringency index. The magnitude of the effect is, however, small: a 10% increase in energy prices leads to a reduction of 0.7% in manufacturing employment. Energy-intensive sectors see a stronger decline in employment due to higher energy prices, but less energy-intensive sectors do not show any significant effect. The firm-level analysis shows that higher energy prices have a small positive effect on the employment level of surviving firms while increasing the probability of firm exit. Tighter environmental policies on the other hand show a small negative effect on the employment level of surviving firms while not affecting firm entry or exit.

Investment decisions of firms are the focus of this chapter. Adapting to new environmental regulations ultimately requires investment by firms. These could be investment in abatement capital or more environmentally-friendly/less polluting machines. Firms could respond by downsizing their capital investment or increasing investment and thereby modernising their capital stock. They might also shift more of their capital investment into foreign countries, circumventing stricter environmental regulations at home. The empirical literature on the investment responses of firms to stricter environmental policies has been inconclusive so far. This study sheds more light into this relationship by estimating a reduced-form model of firms’ capital demand. Using sector-specific energy prices as a proxy for environmental policies, this study analyses data on over 12 000 listed firms in 30 OECD countries over the period 1995 to 2011 and is able to differentiate investment effects across sectors as well as across domestic and foreign capital investment, contributing to the empirical evidence around the so-called Pollution Haven Hypothesis. The results show that higher energy prices are associated with a small but significant decrease in total investment, though in the most energy-intensive sectors, total investment increases. Differentiating between domestic and foreign investment shows that domestic investment of all sectors is negatively correlated with increasing energy prices, indicating that energy-intensive sectors offshore some of their investment to foreign countries.

Outward foreign direct investment (FDI) is the focus of this chapter. Globally, foreign direct investment increased substantially over the past four decades, particularly in the manufacturing sector. This sector heavily depends on energy as a production input and could experience a loss in competitiveness when energy prices rise because of more stringent environmental regulation. This chapter investigates whether firms have redirected investment towards foreign countries with lower energy prices and laxer environmental policies, thereby shifting polluting emissions – a potential consequence of asymmetric environmental policies, known as the pollution haven effect. Empirical studies on this topic have so far mostly focused on outward FDI from a single country. This study sheds light on the relation between industrial energy prices and FDI flows in a cross-country setting. The effect of higher energy prices on firm-level outward FDI is estimated for a sample of 3 364 listed firms operating in nine manufacturing sectors across 24 OECD countries over the time period 1995-2008, using an instrumental variable method. The results show that higher domestic energy prices relative to energy prices abroad are indeed positively associated with the share of foreign assets firms hold. This effect is, however, small in magnitude. Moreover, while firms increase their share of foreign assets following an increase in domestic energy prices, a decrease in domestic energy prices is not followed by an increase in the share of domestic assets.

Global value chains are the focus of this chapter. The increased fragmentation of production chains around the globe over the last decades, paired with varying efforts of environmental protection across countries, have reinforced fears of policy makers that industrial activity may shift towards jurisdictions with laxer environmental policies – an argument known as the Pollution Haven hypothesis. The empirical evidence on this hypothesis has focused on aggregate trade patterns so far. Using data on gross exports and domestic value added of exports in the manufacturing sector across 23 OECD and 6 BRIICS countries over the period 1990-2009, this study assesses how trade patterns are related to differences in national environmental policies of trading partners based on a gravity model of bilateral trade flows. The results of the study show that an increasing difference between the domestic and the trading partners’ environmental policy stringency does not alter overall trade but it does affect the specialisation of countries: tighter environmental policies in one country are linked to a comparative disadvantage in dirty industries and a comparative advantage in cleaner industries. These effects are, however, small in magnitude, when compared with other policies such as trade liberalisation measures.

The European Union Emissions Trading System (EU ETS) is currently the largest emissions trading system globally in terms of greenhouse gases covered. With an increasing number of emissions trading systems being implemented around the world, it is important to understand the environmental and economic impacts such a system might have. This chapter provides a causal analysis of the impact of the introduction of the EU ETS on regulated companies. To evaluate the impact on carbon emissions, installation-level data on CO2 emissions is used for four European countries, while the analysis focuses on the economic impacts on firms’ revenues, assets, profits and employment, it uses firm-level data for 31 European countries. The empirical analysis uses a matching methodology combined with a difference-in-differences estimation to provide a causal estimate of the policy’s impact. The analysis finds that the introduction of the EU ETS led to a reduction of carbon emissions by 10% between 2005 and 2012. The impact on economic outcomes is either insignificant or positive, suggesting that the potential fears in terms of competitiveness loss of the European industry have been exaggerated.

This chapter focuses on the environmental and economic effects of energy prices and carbon taxes in the French manufacturing sector. Like the previous chapter, it analyses the economic effects of environmental policies alongside environmental ones, focusing here on the effect of energy taxes. These taxes are a main policy instrument to reduce energy consumption and associated carbon emissions. France is one of several OECD countries that have introduced a carbon tax, which translated into higher energy prices. The study uses a unique micro-level dataset and an instrumental variable approach to evaluate the joint effects of changes in energy prices on the French manufacturing sector. The firm-level analysis shows that a 10% increase in energy prices results in a reduction of energy use by 6%, of carbon emissions by 9% and of employment on average by 2%. However, the effect on employment differs according to the size and energy-intensity of the firm. Small and medium-sized enterprises, which stay in business after the energy price increase do not decrease their workforce. The industry-level analysis shows that there is no change in the number of jobs at the sector-level, implying that jobs are not lost but reallocated. The reason for this absence of an effect at the sector level is two opposing factors: large and energy-intensive firms reduce employment in the short run, while smaller energy-efficient firms increase employment in response to output reallocation.

This chapter focuses on the environmental and economic effects of energy prices in the Indonesian manufacturing sector. In a similar vein to the previous chapter, this chapter evaluates the joint environmental and economic effects of changes in energy prices but this time focusing on an emerging economy. The study uses a rich national dataset, which covers the whole population of medium-sized and large Indonesian manufacturing plants and makes use of geographic, industrial and temporal energy price variations to pursue a causal analysis. The study finds that a 10% increase in energy prices leads to a decline in energy use by 5.2% and to a decline of CO2 emissions by 5.8%, alongside small, heterogeneous effects on employment. Smaller plants seem to increase their number of workers in response to higher energy prices while larger plants show a slight reduction in employment. Energy price shocks seem to trigger investment in more energy-efficient machinery. Moreover, the probability of plant exit rises particularly for energy-dependent plants in times when energy prices are rising. An additional analysis at the industry-level shows no effects on aggregate net job creation, suggesting that rising energy prices lead to a reallocation of workers but not to permanent employment losses.