Empirics and the Pollution Haven Hypothesis (PHH)October 12 2006Empirical questions related to PHH• Do investment flows respond to differences in environmental standards?• Has trade liberalization increased pollution intensity in developing countries?• Have tighter standards in developed countries led to loss in pollution-intensive industries?• We do not attempt to determine whether countries use environmental policies that are too weak, in order to attract investment or increase market share of dirty goods.What is a statistical model?• We are interested in relation between net exports and pollution control costs.• We know that net exports depend on other variables (e.g. supply of factors – remember the HOS model and Rybczynski theorem)• If we have data on these variables we can estimate a relation between exports and pollution control costs, while “controlling” for other variables (e.g. supply of factors).• We are (usually) interested in sign and magnitude of coefficient on pollution control costs, and on whether the coefficient is statistically significant.The empirical evidence• Early studies use US data to categorize industries into dirty and clean sectors (based on emissions per $ of output, or per employee, or on abatement costs)• The statistical exercise looks for link between dirty and clean good trends in production or export (share) and country characteristics such as income, income growth, and openness.• Are developing countries “moving toward” dirty industries?• This type of exercise ignores possible changes in technique -- it assumes that changes in composition translate directly into changes in pollution. Also ignores other explanatory values, such as factor endowments.Early evidence• Early research found that a rise in environmental control costs in North was positively correlated with increases in dirty good share of exports from developing countries, and decreases in dirty good share of exports from rich countries. • The Lucas and Wheeler study found that toxic releases per unit of output (measured by GNP) fell as countries became richer, due to changes in composition. Poorer countries had the largest increases in toxic intensity.• Birdsall and Wheeler found that pollution intensity increased most rapidly in Latin American countries after OECD pollution regulation became stricter.Interpretation of these results• These findings are consistent with PHH, and with model of changes in factor endowments (capital accumulation). • Evidence for the importance of capital accumulation:(i) Over 90% of dirty good production in 1988 was in OECD countries, suggesting that location of dirty good production reflects more than weak environmental regulation. (ii) If stricter environmental policies in rich countries were responsible for reallocation of dirty good production (as in PHH) then we would see an increase in the relative price of dirty goods; if capital accumulation in South caused the reallocation, the relative price would fall. Data does not show a clear upward or downward trend in relative price. (iii) All studies show that poor countries alter their mix of production toward dirty goods, the more open countries have a cleaner mix. Pollution intensity grew most rapidly in the more closed economies.Early studies of trade effect of pollution control costs• Tobey uses cross country data on exports of 5 dirty commodities and country-specific factor endowments and measures of environmental stringency. • Few “degrees of freedom” (not much data). Coefficient on environmental stringency insignificant, but so are most of the coefficients on factor endowments.• The statistical model does not explain much …of anything.The relation between trade flows and measures of environmental stringency• Link net exports (as share of value of industry production) to industry-specific measure of environmental stringency (e.g., abatement costs) and industry characteristics (such as cost shares of labor, capital, and maybe tariff rates).• The PHH implies that the coefficient on the environmental stringency variable should be negative (more stringent environmental policies lower net exports.) • Studies do not find a significant negative relation between environmental stringency and trade flows.Statistical reasons why these studies might incorrectly reject PHH• Small sample leads to lack of statistical significance.• Several reasons why models might produce biased estimates:(i) Measurement error(ii) Endogenous explanatory variables(iii) Omitted explanatory variables that are correlated with included variables• Three examples follow. In the first, a statistical model correctly identifies relation between pollution control costs and trade. In the second two examples, statistical model leads to biased estimates. The bias could go in either direction.Example 1: statistical model correctly identifies a relation between pollution control costs and trade• Draw a downward sloping (industry) demand curve for pollution (the pollution tax is on vertical axis).• Suppose that there is an exogenous increase in pollution tax (maybe preferences become more green). The higher tax increases abatement costs per unit of output.• Since production costs (inclusive of abatement) increase, domestic supply (as a function of output price) shifts in. • At a constant relative commodity price, net exports fall. Here more stringent policy lowers exports (or raises imports) of the dirty good, as the PHH predicts.Example 2: statistical model understates relation between abatement costs and trade (or gets sign wrong), due to endogenous explanatory variable• Suppose that the pollution tax is endogenous; it is determined (optimally) by the intersection of a (industry) demand and (society’s) supply function for pollution.• An increase in factor (e.g. capital) used intensively in polluting industry shifts out demand curve for pollution.• This change leads to a higher pollution tax, and higher abatement costs. • However, the increase in the factor also shifts out domestic supply function of dirty good. (Higher tax and larger supply of factor “cut in the opposite direction.) Net exports increase.• Here pollution taxes are positively correlated with net exports, contrary to PHH. • The higher pollution tax does not cause the increased export of the dirty good. Instead, the exogenous growth in a factor leads to higher output of the
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