metadata: authors: 0: author: Sorsa, Piritta
1: author: DEC
count: World
docna: 0: docna: Competitiveness and environmental standards
            : some exploratory results
docty: Policy Research Working Paper
subtopic: Construction Industry,Common Carriers Industry,Food & Beverage Industry,General Manufacturing,Pulp & Paper Industry,Plastics & Rubber Industry,International Trade and Trade Rules,Energy Demand,Energy and Environment,Energy and Mining,Business Cycles and Stabilization Policies,Global Environment
teratopic: Environment,Macroeconomics and Economic Growth,International Economics and Trade
abstracts: cdata!: Contrary to common perceptions, higher
            environmental standards in industrial countries have not
            tended to lower their international competitiveness, the
            author contends.  There has been little systematic
            relationship between higher environmental standards and
            competitiveness in environmentally sensitive goods (those
            that incurred the highest pollution abatement and control
            costs in the U.S. in 1988).  Among the author's
            findings about what determines trade flows in
            environmentally sensitive goods: (a) environmental spending
            has been a small share of total spending -- so it is
            unlikely on its own to have caused shifts in comparative
            advantage in most industries; (b) differences in
            environmental spending among industrial countries seem to
            have been minor; (c) environmental spending has been
            concentrated in a few basic industries under heavy pressure
            to structure the international division of labor; (d) energy
            use and environmental spending are closely linked; and (e)
            positive adjustment and increased comparative advantage in
            environmentally sensitive goods were more pronounced in
            countries where environmental policies encouraged investment
            rather than current spending. The costs of environmental
            standards depend not only on physical characteristics but
            also on the policies chosen.  The reductions industrial
            countries have achieved in the main pollutants differ
            greatly across countries.  In the United States, which has
            some of the highest private environmental spending (as a
            share of GDP), investments have been a declining share of
            spending.  The United States also has some of the lowest
            reductions in abatement, which may mean that it has
            succeeded less than other countries in internalizing
            environmental costs.  Compliance with higher environmental
            standards is not a zero-sum game.  Higher environmental
            standards to reduce the social cost of pollution is a new
            source of permanent structural change. Countries that adjust
            early and invest in environmental protection technology can
            maintain and even create comparative advantage in
            environmentally sensitive industries.  Private costs
            incurred to reduce the social cost of pollution may, apart
            from the social benefit of lower pollution, also bring
            private benefits.  Adjustment can mean shifting to producing
            less pollution-intensive goods.  Pressures toward this end
            are likely to increase as environmental awareness becomes
            more common. Instead of lobbying for protection, industries
            struggling with environmental spending should lobby for
            better environmental policies -- that is, policies and
            standards that encourage efficient abatement.  Demands for
            protection because of differences in environmental spending
            are likely to be counterproductive and to retard adjustment
            toward a new way of competing. Ecodumping duties could do
            little for the environment but much harm to the trading system.
repnme: repnme: Competitiveness and environmental standards
            : some exploratory results
display_title: Competitiveness and environmental
            standards : some exploratory results
listing_relative_url: /research/1994/02/698626/competitiveness-environmental-standards-some-exploratory-results
topicv3: Manufacturing Sectors m1326521 1281,Energy and Extractives m1326595 507,Trade m1326924 698,Environment, Natural Resources and Blue
            Economy m1327391 566,Iron m1503514 2931
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Environment,Macroeconomics and Economic Growth,International Economics and Trade
origu: UNKNOWN
no_of_pages: 42
model_extractions: OIC(RY **RI-SARCHII** WORKIM( PAPIR 12419

# Summrnary findirgs

> ontrary to commlrnon percep:2)ris, higher civironiiTiiiit ii (mitrics III tite C i '2 ',, V 1. **I 4'** 1' _t2_ ,tiI of.itAIi **in** f idListri lI cotnIItri-s hiave nIOt tendt ! f L'' to tlis-st pl au: ( .l''A I I( **i5** osvr tlieIc i It w I t riI t i. t **i** )II l n ir t tlsIv cII S r..L 1 1, !. (1 ), ' I I I f ! i.t e t 1 !4 'I **,** Q(oitctids. Ihcre has been littlc svstetl, . ro-larlo hil)sii sf p I Ii Ig I te 1' iti5 I **_'I._** is )' t thl' 1 ***v'** i:tvWeeI highilCIe ('1lsir,,n ilir ! Staiiel'irI aI..d .rili I. o!ii;;,, il 'i,'1't, sxK,} i'' 1 % **:l L . t** it **t'** !V **11.!S** ciflpCttitivCelcss ini environmitenitally scitsitivc gifdl ss v Ld je i , tK r tt'' i( **'t** 1 v kil (thlose that inc'lurred thie highest p(Il[iU t l iliCrlictiIt ltdL **i. i** .r2ltImc!l ! ")S2>" contrul CoStS ill tllC U.S ili 1988). (Collili,int ,th fll)ghet **;s:** ini ;i. l.Jiids

(Collili,int ,th fll)ghet **;s:** ini ;i. l.Jiids IS ii,t3i!lr-sLi2il g.lili. I lightI T Csiti!kO l tt.tl i ! iih t l tei- tl **Su** l w'iI t If f pK111 (1v **Is** iE I ,si',! ' ,,! p)5ritinil&vt si **t** i.tr lII vr l( ti, IJ).lt f 1 Ald iVeVSt 1'1 ttiCt,utital **_p_** ut2t 'c'tr il.liit o 121 eitiJ i * te 2 4) it *- i' **>1!i'** iI: ens)t niet **_5Kv_** notise i2dt-triis.

Alinorig S'rsa's findings about 'VIlAt LIC rIt1i1itin hu!h **tiov.s** in environnmi'ntally senSitive g d;o.Js: ' ltvs'iroilrcrit'Zal spctidirig hills bc,: a i siate ot total spending- -- **So** it is nlkik'ly Orl i:S OwSJn 1 as **_L_** CaLIscd shifts ifl ccomparativc adv.trict iri rlSt irindistries.

* D)iffercriccs in enr i%i rimstiti;ll Sp-lr:diti,g IT'vtiiig imdustr'al COUIltriCS Stllni to illi henC T 1Iii1I.k ' v IViro iIt nta le I spcIndinig II ha et-I I L cctO teK it .i L' **_fcw_** basic i ndustrics unrder hc.avy press cre rn .rr n **o'** .:ra! i the initernation.al divisiotn of mla(or. * lnergy usc anld onvironmientl spenKii! ;', chiselv tk(','1v likcd

viri O1i't hi t 5 e4 L si : i .i '' n 'tI **i'** vis . .- t-K h ' < i' **s** **_K_** g ! v. : sh'tivp ti 0I:.4' ;!; I' en te *,ws 'ii It.sti- I h t v'2 v' I Ihs, i'v'i' ' **-** !r3i LII f **551 i'V'--i'l'** Pt o **'-d** i ,','.v,L th i I i 'nd ' '' nIt 2 ' , H'!' ?Tt!'' '''t -' 'T ht **'i** ' 0' **.** 52 ' i!"( % !i **L,** ,l! **I** L **A;** } &;M ,......;,, **..** .!j!t D.K:; s... h a it i s v':

* 1)sitlVCe adCjU'2 rTIClt arnd incirea.cd ii co pa t t( advantage in enviriminent-Illy sst: , v't-m.' e g' sh k re pront)urncCed in CI lI tI'rS 'where r':irvC n ii' tieli' (eniieiraged iilssehtil!iti rather thatl. evrr (n:i'iPf' t I11 **Oi** ( - (3STAII.II l,,V(lk **do.., l 1;\1I(I',** I)li onC ph sical char.cteristics but also on tic pSl i, l( r. **Chosen. 'Ihle** xc(ilction:s ! .r:,e a C.ui achicvedk. Inl thec rriin pihhl',Itnts diftter (_!'23t1V or05.Ksr'

This pa ecr-i product ofthec interntrionah Tr:de Divisicn, ?lterintr oa Fcono)i&s ID)c2 **l** m-i:rt ar I t, r in thc department to analyze the links hetw-en trade and the civironmient. (optss ol tile paper are **Iv., iahc** fre fuin the World Ban;k, ISIS H Strect NW, WVashington, DC 204:33, Pleac con tact Paulintc Kokila, room 7.-(.O(i, etpio ri 1 (35 pages). Febrtiary 1994.

> **_F'he Policy Resepa'ch_** _Torking_ **_1'aper Series dotssemtnizes_** _the_ **_findings iof uirrk in_ jirnt7S** **_s t)_** _en4(ur7jve_ **_bik *xjru.k_** _':ve z14,-,_ **_if .1k_** _It_ **_dezLwormwnt:. ,wo5 .n_** _A_ **_beecar'e (1:he ske. is_** it _get_ **_xke finIrn's lut_** auv _S /-en ('_ y.-,e . **_. rc_** _ir iban i -l oPe Ik e_ **_japercarry the nMeS of t,e aNOrs anJ 'h,uid be ued an -rd_** ,, **_o',rdn_'N 1k-_** _'C.Mi._ **_ni_ '** **_auitors'C-hLn and_ shiou,i** **_rPvr, be arwirhuie'd i- ihe_** _WrIld_ **_.IwinJ its . II s-_ ui** **_wi_** _e_ **_.,if_** _1_ **_Ou_ ),i-** **_.s:.f_** _:_ **_mr_** _*_ **unI** **_rer_**

Produced by the Policv Rcscarch Dissemnination Cerntce
# COMPETITIVENESS **AND** - ENVIRONMENTAL **STANDARDS**

# **Some Exploratory Results**

_Piritta Sorsa Senior Economist World Bank_ _*The views in the paper are those of the author and do not reflect those of the World Bank Group, its Board of Directors, its management, or any of its member countries. The author wishes to thank Mr. R. Duncan, Mr. V. Nehru, Mr. Panos Varangis and participants in seminars in Vienna, Helsinki and Geneva for helpful comments on earlier drafts._
# Summary

It is a common perception that higher environmental standards in industrial countries tend to lower their international competitiveness. This argument has frequently been put forward by opponents of NAFTA or other international agreements aiming at liberalizing trade such as the Uruguay Round. A look at data on trade flows and environmental expenditures to date show that there has been little systematic relationship between higher environmental standards and competitiveness in environmentally sensitive goods. In Germany, Japan and the United States correlations coefficients between changes in world export shares in environmentally sensitive goods and changes in environmental expenditures were not significant. For Austria the coefficient was positive.Environmentally sensitive products are defined as those having incurred highest pollution abatement and control costs in the US in 1988. Environmental expenditures are financial outlays both private and public that OECD governments have reported as related to pollution abatement in water, waste, air, noise, and other pollution. The study analyses trade flows in environmental sensitive products and environmental expenditures in seven industrial countries all claiming to adhere to high environmental standards - Austria, Finland, Norway, Sweden, Germany, Japan, and the United States.

Industrial countries have maintained competitiveness in environmentally sensitive goods in general - their index of revealed comparative advantage (RCA) in these goods has remained around one. The index measures comparative advantage within an industry in the context of a country's overall share in world markets. Among the industrial countries, overall performance in exports of the sensitive goods varied greatly among countries despite re!atively uniform standards in most industrial countries. Furthermore, among the industriai countries, there are both gains and losses in world market shares of the different sensitive industries. Imports of these goods from lower-standard developing countries have not invaded home or third country markets of industrial countries that have raised environmental standards. Their performance in these goods was in line with their increasing share in total world trade, but was inferior to their performance in manufactures. Product level data shows increases in developing country RCAs in most categories of these sensitive industries. Other factors are likely to have been more important than differences in environmental expenditures in explaining trade pattems in environmentally sensitive industries. Competitiveness is influenced by a complex interaction of a number of macro- and micro-economic factors.

Performance among the industrial countries is diverse. Japan on the one hand, and Austria and Finland on the other are the two extremes. Austria and Finland, with high shares of environmentally sensitive goods in their exports and some of the highest environmental expenditures among industrial countries, have increased their world market shares in these goods. For example, Austria's and to some extent Finland's, environmental policies seem to have encouraged investment and innovation, which is showing especially in higher investment shares in total environmental expenditures. But other factors, including macro-economic management during the 1970's and 1980's, are likelv to have been more important for their good performance. Germany, Sweden and the US were successful in maintaining competitiveness of their environmentally sensitive industries, despite increases ir, environmental expenditures in the 1980s, especially in Germany, and overall losses in total world exports and especially those of
manufactures. Japan has opted out of trade in many environmentally sensitive goods. Its market share in these goods has been halved. Although its environmental expenditures first rose in the 70s, they have declined in the 80s. High cost of energy especially in the 70s is more likely to have contributed to the change in comparative advantage - Japanese electricity costs are among the highest in industrial countries. Japan has also been most successful in reducing pollution. It is competitive in production of machinery for environmentally sensitive industries.

In its analysis of determinants of trade flows in environmentally sensitive goods the study notes that: i) environmental expenditu,res are a small share of total expenditures and therefore unlicely .o cause shifts in comparative advantages in most industries on their own; ii) differences in environmental expenditures among industrial countries seem to be minor; iii) environmental expenditures are concentrated in a few basic ineustries which are under strong pressures for structural change from the international division of labor; iv) energy use and environmental expenditures are closely linked; and v) positive adjustment and increased revealed comparative advantage in environmentally sensitive goods were more pronounced in eountries where environmental policies encouraged investment rather than current expenditures. Apart from physical characteristics the costs of environmental standards alsc depend on what policies are chosen - the reductions achieved in the main pollutants by the industrial countries have been quite different across countries. The US with one of the highest private environmental expenditures in GDP has a declining share of investments in its expenditi-.. !t also has lowest reductions in abatement which may mean that it has had less succ **ss** in internalizing environmental costs.

Compliance with higher environmental standards is not a zero-sum game. Higher environmental standards to reduce the social cost of pollution is a new source of permanent structural change -countries adjusting early and investinig in environmental protection technology can maintain and even create comparative advantages in environmentally sensitive industries. Private costs incurred to reduce the social cost of pollution may, apart from the social benefit of lower pollution, bring private benefits as well. Adjustment can also mean shifting to producing less pollution-intensive goods. Pressures towards this end are likely to increase as environmental awareness becomes more and more part of the landscape.

Instead of lobbying for protection, industries struggling with environmental expenditures should lobby for better environmental policies, i.e. standards and policies that encourage efficient abatement. Demands for protection on account of differences in environmental expenditures are likely to be counterproductive and retard adjustment to a new way of competing. Protection will not solve problems of non-competitiveness -- the causes of poor performance are likely to lie elsewhere.
# 1. **Introduction**

Does compliance with highei vnvironmental standards impair an industry's or a country's competitiveness in world markets? In some countries industry is calling for border protection for differerices in environmental standards and expenditures across countries. The paper argues that to date there has been little systematic relationship between trade performance and increases in environmental standards or expenditures. Correlation analysis showed no negative correlation between trade shares and environmental expenditures in Germany, Japan, and the United States. In Austria the correlation was positive. This is because environmental expenditures have been a small share of total costs, net private expenditures are reduced by various private benefits from environmental investments, and competitiveness is a .esult of an interaction of a complex set of macro- and micro-economic factors. Protection from imports from countries with different standards is not justified, nor would it help competitiveness. It is also argued that higher standards can contribute to improving competitiveness in environmentally sensitive - ods'.

This paper will analyze: i) developments in trade of environmentally sensitive goods over the past two decades; and ii) the links between environmental expenditures and trade in environmentally sensitive goods in a number of countries that claim to have high environmental standards - Austria, Finland, Germany, Japan, Norway, Sweden and the United States. The paper co- ares world trade shares in the sensitive goods over the past two decades, calculates revealed comparative advantage indexes for the various countries within the sensitive industry. It then discusses past environmental expenditures at the country and industry levei.

The analysis in this paper is exploratory and subject to many difficult data problems. The definitions of environmentally sensitive industries can be questioned (it is based on US environmental expenditures), reported environmental expenditures at the country level do not always follow similar definitions making comparisons especially at the industy level difficult,

> Thesc are defined as in Low-Yeats (1991). Annex Table I shows the compositionof products included in the sample: pulp and paper, petroleum products, organic chemicals, inorganic chemicals, other inorganic chemicals, coal, fenilizers, other chemicals, veneers and plywood, wood manufactures, paper and paperboard, articles in paper, cement, iron and steel, non-ferrous metals, metal manufactures. The environmentally sensitive industries are those that in 1988 incurred the highest pollution control expenditures in the US in 1988.
2 or the countries' present and past environmental policies can be deemed deficient. Country comparisons are also made difficult by the lack of comparable data for some indicators.

# 2. World trade in environmentally sensitive goods

Competition for world markets has been keen over the past twenty years. While industrial countries seem to have more or less maintained their share in total exports, a major change has happened in manufactures. Developing countries'<sup>2</sup> share in world exports of manufactures rose from 8 to 18% between 1970 a.nd 1990 (Annex table 2). The role of lower environmental standards and expenditures in developing countries than in industrial countries in this is likely to be small. The average share of environmental expenditure3 in industrial countries has been a modest share of GDP, around 1-1.5%. Differences in labor, capital and other resource endowments are more likely to have contributed to the international division of labor between industrial and developing countries. Policy reforms in developing countries have- also increased productivity and efficiency. Total trade shares and those of the sensitive categories during the past twenty years were also influenced by changes in commodity and especially in oil prices.<sup>4</sup> Only about half of the environmentally sensitive goods belong to the manufactures category as traditionally defined in international trade statistics.

The share of environmentally sensitive goods in total exports varies greatly among countries (Table 1). High shares of sensitive goods in exports can make a country's overall export performance more sensitive to changes in environmental standards at home and abroad. In the Nordic countries environmentally sensitive goods are a very high share of total exports -

> Developing countries in the paper refer to all countries not included in the industrial country category.

> Environmental expenditure indicates all public and private expenditure for pollution abatement and control as reported to the OECD Secretariat by its member countries. It is defined **as** the first-order, out-ofpocket expenditure of those economic entities that inplernat control measures and undertake compliance activities. The reporting is done according to guidelines provided by the OECD to help comparability. Categories included are water, waste, **air,** noise, other pollution. The data excludes expenditure on nature protection. For more detail on definitions see OECD(1990, 1993). Despite the efforts at OECD for comparability of data crosa-country definitions and reporting vary **a** great deal and therefore cross-country comparisons of data should be done with much caution.

- 4 Data for 1980 is distorted by the oil price increases in the 70's and is therefore left out. The share of petroleum productu in the sensitive category was 11% in 1970, 24 % in 1980 and 16 % in 1990 based on data on world imports of the goods.
3 up to a half of total in Finland. In Austria, a quarter of total exports are in environmentally sensitive p' ;)Cucts. The lowest shares among the seven countries are in Japan and the US - about one tenth uf their total exports.

Overall export performance among industrial countries is diverse (Annex Table 2). Given the endowments of natural resources, competitiveness is influenced by many other factors such as productivity growth, and macro-economic stability. These are likely to matter more fo,r total export performance than increases in environmental expenditures. Finland and Austria with high environmental standards and shares of sensitive goods in total exports have increased or maintained their world shares both in total and manufactures exports over the past decade. The fact that Germany, Sweden, Norway and the United States have lost world markets in manufactures is unlikely to be due to excessive environmental expenditures. Germai.y and Norway increased their shares in total world trade.

Table 1: **Share** of environmentally sensitive goods in total merchandise exports and imports In 1970 and 1990

|Regiona/Counaies|Exports:<br>1970|1990|**Inports:**<br>1970|1990|
|---|---|---|---|---|
|**World**|22|18|(percent)<br>21|IS|
|**InbW**|23|**18**|21|**18**|
|**AuVts**|**28**|25|19|14|
|**Finland**|54|47|22|22|
|Norway|47|26|22|25|
|Sweden|35|31|26|23|
|**Genmany**|21|**1s**|23|20|
|**Japan**|25|1 1|14|17|
|Us|16|14|22|**l1**|
|**Devlopjig**|**18**|19|**nG.**|**nU.**|

Source: Derived **from Unitd** Nationa COMTRADE **datAbass.**

**Trad1e** flows **in** sensitive goods. The share of environmentally sensitive goods in total exports declined in all the sample countries, and in industrial countries as a whole (Table 1). In
4 developing countries the share of environmentally sensitive goods increased slightly from 18 to 19% in total exports. The uniform decline in industrial countries suggests tha. this is likely to be due to expansion of non-sensitive goods in world trade, and increased specialization rather than a loss of advantage in these goods. The most substantial decline in the share of environmentally sensitive goods in total exports occurred in Japan and Norway. Jn Norway this reflects the increase of oil in total exports. As many of the enmironmentally sensitive goods are resource-intensive, it would be natural for the resource-poor Japan to specialize in ofther goods. With the exception of Japan and Norway the share in imports of these products also declined. In Japan and Norway the share of the sensitive goods in total imports increased slightly during the twenty-year period.

Worid market shares in environmentally sensitive goods have not changed dramatically over the past two decades, despite the introduction of higher environmental standards ir mnost industrial countries. The trends in trade shares (see T'able 2) indicate that there has been no across-the-board decline in the market shares of environmentally sensitive goods in the higher standard industrial countries. Measured as shares in world exports the share of industrial countries sh-re was about the same in 1970 as in 1990. Measured by world imports the share of industrial countries declined slightly between 1970 and 1990.' The bulk of world exports of environmentally sensitive goods continue to originate in industrial countries - over 70%. **6**

> **Data** on world **import.** of environmentally sensitiv- goods captures better the share of developing countries in **world** trade. TMis **is** because many developing countries have not reported data to the **UN** trade data bank, which underestimates their **share** in world exporta. Compared to earlier versions of the study **based** on world export **data,** this paper **uses** world imports for the world **and** developing country totals in the calculations. Export **data** underestimates the **share** of developing countries by about 5-10%.

> **As a large** part of the **sample** of environmentally sensitive goods especially from developing countries **are** commodities, **especia"y** oil, **the trade shares are** Ukely to **be** very ensitive to developments ni conunodity prices. Further **resrch** on **the** impact of price changes in **these** trade flows would be useful.
**S**

**Table 2: Share In world trade of envirommentaliy s2nsitive goods, 1970-90**

|Rsgiona/countrier|Share inw<br>1970|orldimportu<br>1990|Por mfrence:<br>Shtrein worl<br>1970|<br>dexporu<br>1990|
|---|---|---|---|---|
|**Industr1**|**_78.2_**|72.9|_P._3|81.1|
|**AuAtxi**|1.3|1.v|1.3|2.0|
|Finland|2.0|2.1|2.1|2.4|
|**_Norway_**|1.9|1.5|1.9|1.7|
|**Sweden**|3.9|3.0|4.0|3.4|
|**Germany**|11.7|12.1|12.1|13.3|
|<br>**Japan**|7.8|5.3|3.0|6.0|
|US|11.2|_8.9_|11.6|10.1|

**Soure:** United **Nations** COMTRADE data **base.**

Changes in trade shares among industrial countries in the sensitive goods are diverse. There are both gainers and losers amcng them. Given that most industrial countries introduced higher environmental standards over the past two decades, the diversity in trade performance in the sensitive goods indicates that other factors are likely to have been more important than environmental standards. Austria, Finland, and Germany have increased their market share in the sensitive goods Austria nearly doubled its share between 1970 and 1990 (Table 2). As mentioned earlier Austria and Finland also had a good overall performance of competitiveness measured by their increased/maintained world market share in world exports of manufactures or total trade (Annex table 2). In both countries, overall competitiveness and that in the sensitive goods improved more than the average for industrial countries despite the high shares of the sensitive goods in total exports and increasing environmental expenditures in Austria (see below). Germany increased its market share of sensitive goods, despite losses in worid markets for manufactures and increases in environmental expenditures (see below) during the 80s.

Japan, Norway, Sweden and the US lost markets in the environmentally sensitive goods between 1970-90. Norway, Sweden and the IJnited States have also lost market shares in both total exports (except Norway because of oil) aid in manuf:cturcs s-ggesting poor overall
6 competitiveness in wo:lzi markets. Curiously, in these countries, expenditures on the environment were generally among the lowest of the industrial countries and even declined in the oOs (sec table 9 below). This would suggest no systematic link between trade performance in the sensitive goods and environmental expenaitures. The reason for changes in market shares is likely to lie outside the changes in environ,mental standards. Japan switched away from environmentally sensitive goods and spe .ialized in other products with impressive gains. Its env<sup>4</sup> -onmental costs were the highest of all industrial countries in 1980, but have since declined considerably as share of GDP (Table 9).

The lack of negative impact of higher environmental expenditures on trade performance in environmentaliy sensitive goods is confirmed by correlation coefficients between changes in wurld trade shares of the sensitive goods and changes in envirunmental expenditure. While crosscountry comparisens are unreliable because of the considerable differences in the measurement of environmental expenditures, reasonable time series data for the trade and expenditure variables are available for Austria, Germany. Japan and the United States. Correlation coefficients were calculated for both total and private environmental expendi,ure in GDP, when available (Table 3). The correlation coefficient for Austria and Germany was positive, 0.7 and 0.12 respectively. For Germany it was not statistically significant, but for Austria the positive correlation was very significant at 2.5% level. The US coefficient was negative, but stat '4cally insignificant. For Japan the coefficient was negative, failed to be s'atistically significant. This means that only in tht case of Austria was there any correlation between environmental expenditures and trade performance.
7

**Ta1bie 3: Correlation of Share in World Trade ot EnvironmentaBy Sensitive Goods with the Share of Environmental Expenditures in GDP for Selected Industrial Countries**

|Correlation<br>Coefricient<br>**(total env.exp.)**|Confidence<br>**teit (2.5%)|**)**<br>|Correlation<br>coefricient<br>**(private env.exp.)**|Confidence<br>**test**(2.5%)|
|---|---|---|---|
|**Austria**<br>**n.a**|**n.a**|**0.7**|**10.56**|
|**Germany**<br>**0.12**|**1.63**|**0.14**|**2.24**|
|**Japan**<br>**-0.33***|**3.91**|**n.a.**|**n.a.**|
|**United States -0.05**|**0.90**|**-0.07(0.05)****|**1.33(0.89)**|

***) For Japan the dta refers to public expeaditurci only. **) For the Unit&! States nuribers in parenthesis refar to** data **on** private expunditure **reported by the US** national **sourcos and the other number is b&ed on OECD defonition.** *4*) **If the number below** is **larger than S.02 the coefficient** is **significant at the 3 % level.**

The increase in the share of developing countries in world exports of the sensitive goods reflects their increased overall participation in world trade. Their exports of environmentally sensitive goods increased much less than those of manufactures. Export growth from developing countries in the sensitive goods may have been influenced by trade barriers. As many of the prouLcts of industries included in the sample of sensitive goods are experiencing structural difficulties in the industrial countries (iron and steel, some chemicals) from over-capacity or from lower labor-costs in developing countries, protection from imports in some sectors may have influenced import growth. Although tariff barriers in the sensitive goods are low, a large share of imports of environmentally sensitive goods is subject to non-tariff barriers (Table 4). Developing countries face lower duties than industrial countries, but more of their imports are subject to non-tariff measu, es especially in the United States and Japan. However, the measure gives l.ttle indication on the protective impact of the non-tariff barriers. Estimates of their tariff eq&,valents are not available. A more likely explanation for the slower export growth of developing countries in the sensitive goods is the low income elasticity of many of these goods cempared to other manufactures and the declining material intensity of production. This is particularly true of the metals, steel, nickel, manganese etc. Also energy intensity of production has declined substantially since the oil price hikes of the 1970's.
8 Table 4. Level of Protection in Environmentally Sensitive Goods In Main Industrial Country Markets (1988)

||Teriffs(|weighted average)|Non-tar|iff barriers(% of importc covered)|
|---|---|---|---|---|
|Country|World|Developing|World|Developing|
|EEC|1.5|0.7|9.0|9.0|
|**Japan**|**2.8**|2.3|43.5|48.1|
|United States|2.7|2.7|16.2|32.7|

Source: World Bank SMART **data base.** Revealed comparative advantage (RCA) indexes. Another way to analyze changes in comparative advantages or trade patterns in specific products is through calculating indexes of revealed comparative advantage<sup>7</sup> . Traditionally it has been used to analyze a specific country's revealed comparative advantage in different industries. In this study it is used to measure different countries' RCA's within a specific industry. The RCA measures changes in the share of a country's exports of a product in world exports of the product compared to changes in the country's total share in world exports, i.e, relative to the size of the country. The index allows taking account of the impact of changes in a country's or countries' overall importance in world trade on changes in trade shares in a specific industry. If the ind;x is above one, a country is deemed to have a comparative advantage in a product, i.e. its share in the market of a product was larger than its overall share in world trade. Calculated RCA indexes are presented in Table _5._ The indexes confirm many of the results of the analysis of trade shares. Industrial countries as a whole have maintained their comparative advantage in environmentally sensitive goods (index around 1.0), while that for developing countries has remained below one at 0.9. The aggregate data hide large differences between countries. Austria, Finland and Sweden have 7 The formulae used for calculating the RCA index is RCAji - (xji/Xjt)/(rit/Xtw) where j i industry, i country, w world and t total. The index goes up, for exmnple, when the country inceases itu **share** in **the** world market of the product; it can go down if the country's other export go up or if the country **share** in world trde declines. The RCA ignorec the impact of some protectionist barriers in distorting trade patterns between altenative source of supply, or tade not taking place because of protectionist barriers. This study used total trade in the denomninator versus manufactures, because mAny of the environrnentally sensitive goods are outuide the traditional definition for mnanufactures (SrrC 5-9 less 68, 67). The share of mAnufactures in the sensitive goods **was** 40% in 1970, which increased to 54% in 1990. The use of manufactures **as** total has been justified in other studies due to the distorted nture of world trade in igriculture.
9 a comparative advantage in environmentally sensitive industries, which was increased/maintained over the period. Sweden maintained its comparative advantage in the sensitive industries while losing markets in total and manufactured goods. The US has never had a comparative advantage in these products. The index for the US and Germany remained stable. The sensitive industries did better in world markets than total or manufactured exports in these countries. Japan has clearly lost its comparative advantage in environmentally sensitive goods, with its index falling from 1.2 to 0.6 during the period. The larger relative decline in the RCA compared to its market share suggests that the increase of other exports in Japan is responsible for much of the decline. Norway is still competitive, but has lost markets since 1970. For Norway this is likely to reflect the increase in oil revenues in total exports (denominator).

**Table** **_5:_ Revealed comparative advantage indexes in environmentally sensitive goods, 1970-90**

|Regions/Countries|1970|1990|
|---|---|---|
|**Industrial**|1.1|1.0|
|**Austria**|1.3|1.4|
|Fuiland|2.7<br>|2.9<br>|
|Norway|2.3|1.5|
|Sweden|1.7|1.7|
|crrmany<br>|**1.0**|1.0|
|Japan|**1.2**|0.6|
|Us|0.8|0.8|
|Developing|0.8|0.9|

Souirce: Derived from United Nations COMTRADE database. World exports based on world import data.

At the product level there are gains and losses in comparative advantage. This, in itself, suggests that factors other than environmental standards have been more important for trade performance in environmentally sensitive goods. As the goods in the sample are assumed to have been subject to high environmental standards, if these were to have an effect on trade performance one would expect a more uniform pattern. It is notable that in many countries certain sensitive industries lost competitiveness, while others gained it (Table 6).
10 Among the European countries, Austria maintained the number of industries with an RCA index above one in 22 from a total of 38 three-digit SITC industries. Competitiveness improved in 27 categories. It has done best in industries such as paper and wood, metal manufactures, and iron and steel. Chemicals and metals industries have the highest environmental control expenditures within manufacturing in Germany yet it has maintained its comparative -dvantage in these industries and it has lost markets in others. Germany is strong in various chemical products, metals, iron and steel and refined paper articles. Its losses have been in fertilizers. Finland is particularly competitive in several wood-based industries, but has also become competitive in iron and steel. It has lost its comparative advantage in chemicals. The changes among industries reflects moves to a higher degree of transformation and diversification within the industrial sector. Sweden is competitive in processed wood and paper products, some chemicals, and iron and steel. Despite its losses in manufactures, Sweden managed to improve competitiveness in several of the sensitive categories despite environmental regulations. For Norway, wood and paper, non-ferrous metals (aluminum), fertilizers and petroleum products are among the industries with comparative advantages. Its losses have been in paper products and construction materials such as cement. Norway also has clearly more losses (RCA decreased in 26 categories) than gains. The explanation is more likely to lie in the appreciating real exchange rate from the oil boom than in higher environmental costs.

In the US the number of industries with a revealed comparative advantage declined from 14 to 10. It has lost comparative advantage in most metal products, and wood and paper products while improving its position in pulp production. In Japan the data again show a clear shift away from the sensitive industries. Japan lost comparative advantage in ten sensitive industries and maintained it in eight in 1990, mostly in iron and steel. The largest declines have been in basic wood industries like veneers and plywood and wood manufactures. Other losses were in chemical industries and metal manufactures.
11

**Table** 6: **Changes in RCA indexes in environmentally sensitive goods, 1970-90**

|Regionr/Countries|**RCAs**<br>above I<br>1970|1990|Goods in which RC<br>Increased<br>1970-90|As<br>**Decreased**<br>1970-90|
|---|---|---|---|---|
|InduMral|28|23|(no.)<br>8|30|
|**Austria**|21|22|27|10|
|Fnand|13|14|24|13|
|Norway|20|16|11|26|
|Sweden|15|16|23|14|
|Gerrany|18|**18**|16|'I|
|**Japan**|**is**|S|8|**30**|
|US|14|10|17|21|
|Developing|10|15|30|7|

**Scurce: DeAived** from United nations COMTRADB **datbase. Includes a** total of 3S thred4iit SrrC **categories as** defind in **footnaote** I **nd annex table 1.**

Product level analysis gives some indication of a shift in trade towards developing countries in a number of products included in the category of sensitive goods. Although industrial countries continue to have a comparative advantage in more of the categories of sensitive goods studied (23), the index declined in 30 categories. This means that developing countries increased their index in most categories. Between 1970 and 1990 the number of industries in developing countries with indexes above one increased by half (Table 6). Developing countries are gaining market share in industries like iron and steel, fertilizers, wood products, and chemicals. This is likely to reflect both their increasing participation in world trade and increasing production in the developing countries of many of the basic industries that belong to the sensitive category. As mentioned the share of non-industrial countries in world exports of manufactures, for example, increased from about 8 % in 1970 to over 18 % in 1990. The role of lower environmental costs in this is likely to be negligible. Many of these industries, such as iron and steel, tend to be part of early stages of industrialization.

Data on foreign direct investment (FDI) flows of environment-sensitive industries do not suggest any systematic trend towards an increasing pollution intensity of foreign direct
12 investment in developing countries. s For example in Japan, Germany and Sweden the share of environmentally sensitive industries in total outward FDI declined between mid-70s and late 80s. In the US it first increased in the 70s but declined slightly in the 80s. Data for many developing countries shows that in a number of countries the share of environment-sensitive industries in inward foreign direct investment has decreased somewhat in the 80s (UN 1992).

**Direction of Trade.** Industrial countries continue to export environmentally sensitive goods to other high standard countries suggesting that, overall, the industrial countries have been able to meet the higher standards in their export markets. Successful exporters, such as Austria and Germany have increased the share of other industrial countries in their exports of environmentally sensitive goods (Table 7). Only Japan and the United States have increased the share of developing countries in their total exports. This could mean that the Europeans have better adjusted to the changed product market conditions. Or it could just be a reflection of the growth in importance of the Asian market to the United States and Japan.

Changes in the developing countries' share in industrial country imports of environmentally sensitive goods was mixed in the sample countries. Among the European countries developing country share in imports of environmentally sensitive goods went down in most countries. Curiously, developing country share was substantially up only in Japan and the United States despite the higher share of non-tariff barriers than in Europe, and lower levels of environmental costs than many European countries.

I **For a** discusaion of **a** number of studies **and** recent data **see** World Investment Report (1992).
13

**Table** 7: **Share of developing countries in industrial country exports and imports of environmentally sensitive goods,1970-90**

|Regiona/Countries||In expozU|**_In_import.**||
|---|---|---|---|---|
||1970|1990|1970|1990|
|of-<br>**Iadustrial**|**22**|**20**|(percent)<br>**IS**|**17**|
|**Autris**|25|14|12|10|
|**Finland**|13|9|6|9|
|Norway|7|6|11|10|
|**Sweden**|10|9|11|7|
|**_Goennny_**|19|15|13|11|
|<br>**Japan**|45|61|34|40|
|US|34|39|22|33|

**Source:** Derived ***rom** United nations COMTRADE database.

# 4. **Environmental expenditures and competitiveness**

The dade pattems in environmentally sensitive **goods** suggest that the factors explaining the trade flows are diverse. The level and changes in environmental control expenditure incurred is only one factor among many. For policy analysis it is also important to underline that costs of environmental policies also depends on the type of measures chosen. Good policies can achieve abatement targets at lower cost than bad policies. Available data indicate, for example, that there are substantial differences in results in abatement of main pollutants among industrial countries for relatively similar levels of costs incurred. In comparing the expenditure data, one also has to keep in mind that differences in environmental standards and expenditures can reflect differences in environmental endowments. A country may have a comparative advantage in environmentally sensitive goods due to the fact that its natural conditions permit a greater ability to absorb pollution.

This section will explore the nature and extent of environmental expenditures in general and by industry. The impact of environmental expenditures on competitiveness can depend on the level of environmental standards across countries. High shares of investment in total expenditures can be an indicator of the internalization of environmental costs, or the
14 development of new products and processes. A high share of public funding of environmental costs can indicate a lower impact on industry competitiveness, although the cost will ultimately be more widely shared via higher taxes.

As environmental policies and related expenditures are not new to most industrial countries, the use of data starting in 1970 is justified. In many OECD countries, environmental policy making started in earnest in the early 1970s with a main focus on national problems. 't reached a new peak in the late 1980s and early 1990s with greater emphasis on global problems. Available data on the costs of these policies to industry or to the ecor -my at large is patchy and subject to many definitional and measurement problems. The following expenditure estimates, nevertheless, show a number of interesting features among countries on how the policies may or may not have affected competitiveness (see Table 8).

**Table 8: Environmental expenditures as a share of GDP, industrial countries, 1980-90**

||1980|1990|
|---|---|---|
|(O)|||
|**Industrial**|**0.9-1.8**|**0.9-1.9**|
|**Austria**|**1.2**|1.9|
|**Finland**|1.3|1.1|
|_Norway_|**_1.3_**|0.6|
|Sweden|1.0|0.9|
|Genrany|_1.5_|1.7|
|Japan|**1.8**|1.0|
|US|1.6|1.4|

* Range in mid-1985, as total industrial country estimates **are** not available for 1980 or 1990. Source: OECD (1990), Blazejczak (1993).

The overall level of environmental expenditures in industrial countries is moderate and, from country to country, not radically different. Although, as mentioned, considerable caution has to be exercised in making cross-country comparisons with the available data. Existing data suggests that higher standards are not forcing industries to much higher costs than their competitors in other countries. Estimates of expenditures range between 1 and 2% of GDP. Over the past ten years these expenditures have increased in some countries and decreased in others as share of GDP, reflecting differences in timing and types of policies. Some of the
15 diffe-ences may reflect different physical conditions, or differences in the demand for a cleaner environment. Population densities, for example, tend to increase the severity of environmental problems. The sparsely populated Nordic countries may have a much higher pollution absorptive capacity than densely populated Japan. This may explain their lower level of expenditure despite high shares of the sensitive goods in total exports and in economic activity.

Data on environmental expenditures in developing countries is sparse. Their present expenditures can be ass -ned to be lower than those in industrial countries, because of lower demand for a cleaner environment. One available estimate (World Bank, World Development Report, 1992) calculated that to do away with the main pollutants and to reach the present level of environmental technology in industrial countries, developing countries would have to invest annually 0.6 to 0.8 % of their GDP over the next ten years. This gives a rough yardstick on how their present costs and standards compare with those in industrial countries.

The impact of environmental standards and expenditures on competitiveness can also depend on who bears the financial costs. By absorbing part of the cost, government can reduce the static impact of higher standards. Table 9 shows that many governments have borne a large part of total environmental expenditures. The **public'** share of total environmental expenditure in the mid-1980s was highest in Japan, over 90%. In other industrial countries the government's share fluctuated around _50%_ - with the US having the lowest share at 40%. In the Nordi - countries a large share of environmental expenditures, nearly two-thirds in Sweden and Norway - has been incurred by the government.

> ' Public expenditure **in** the OECD(1990) survey include **all budgetary d** extra-budgetary expenditure by **all** levels of government (central, local, **state** or provincial). Public enterprises whose nuin function **is** to provide pollution **control** services **such as waste water management** etc. **are** included in the public ector. For **more** detailed definition **ee** OECD(1990).
16

**Table 9: Share of public expenditures in total environmental expenditures, selected industrial countries, mid-1980's**

|-(percent)-|
|---|
|**Autrbia**<br>50|
|**Fimahnd**<br>45|
|Norway<br>67|
|Sweden<br>72|
|Gernany<br>51|
|<br>Japan<br>94|
|<br>US<br>41|

Source: OECD (1990).

The exact amount of actual subsidies in this expenditure is difficult to assess. In countries where utilities, for example, are owned and run by governments their expenditures on pollution control would count on the public side, whereas the opposite would hold in countries with privately run utilities. The actual existence of subsidies would depend on whether these entities operate under market principles and how the costs are included in prices to users etc. General subsidies are included in the data only to the extent that governments classify them as "environment-related".

Depending on how potential subsidies are implemented, they may carry the risk of reducing the incentives for internalization of pollution-control expenditures and the incentives to innovate. This hypothesis does not seem to hold for Japan. In Japan, much of the public money was spent on supporting joint research projects with industry to develop new processes and technologies (Fukasaku, 1992). The measures appeared to have reduced pollution drastically (Annex Table 3) as Japan now has one of the lowest levels of major pollutants among the industrial countries. But despite the fact that the government bore the bulk of the environmental expenditures, Japan lost markets in most of the environmentally sensitive industries during the past two decades.

Despite the difficulties in extracting subsidies from the data, it suggests that private costs of abatement have been highest in the United States. Lower private costs in Europe than in the United States can reflect different laws, differences in absorptive capacities, or the higher share of public expenditures in total expenditure. For Japan, complete industry-level data for private
17 costs is not available, but the high public share would suggest that private industry costs have been lower than those in the United States and Europe. These numbers should be treated with caution, however, as existing statistics make it difficult to compare industry level data across countries, because of differences in coverage or definitions of industry.'" How much of the total private costs are borne by industry or the manufacturing part of it, depends on country circumstances. One study on the United States (Low 1991) indicated that in 1988 0.5% of manufacturing output was spent on pollution abatement. German data suggests that 0.7% of manufacturing output in 1990 was devoted to environmental expenditures. These and other estimates (see Table 10, Ugelow 1985) show that environmental expenditures are a small share of total industry costs - compared to costs of energy or labor, for example.

**Table 10: Levels of private environmental expenditure, selected industrial cauntries, mid 1980s**

||Private<br>environmental<br>exp. in GDP|For reference:<br>Shares in maan<br>Energy(1990)|ufacturing<br>costA of:<br>Labor(1990)|
|---|---|---|---|
|||percent||
|Fuband|0.8|3|20|
|Norway|0.3|**na.**|19|
|Sweden|0.3|n.a.|n.a.|
|Germany|0.7|2|25|
|uS|0.9|na.|**n.a.**|

Source: OECD (1990), National statistics.

Most environmental costs are concentrated in a few basic industries. In Germany, for which complete data is available (Annex Table 4), the industries with the highest environmental expenditures are either in mining and utilities (10% of industrial output in 1990) or in basic industries like iron and steel, chemicals, petroleum and metals (24 % of industrial output). In mining and utilities, environmental expenditures were over 4 % of the value of output, while the t **Comparisona** of environmental **cost are** made difficult by uneven coverage acrou countries or differences in **classification. Some** countries equal private cost to those of industry (Japan), while others report a much more comprehenaive coverage (US). **As** utilities account for a large share of environmental expenditures, definition of industry can be important proper accounting of expenditures. Nordic countries do not include utilities in industry costs, whereas Japan, the US and Gernany do. Mining is sometimes included in definitions of indusry. 7his makes any comparative assessments especially at the industry level difficult.
18 manufacturing average was only 0.7%. In the basic manufacturing industries the expenditures ranged between 1% and 2.2% of output in 1988. These have increased in Germany in recent years where many basic industries have allocated 10-16% of their investment to environmental protection. Nevertheless, their overall of expenditures remain moderate. Despite the higher than average environmental expenditures in the sensitive industries and the overall increases in recent years the trade data and correlation analysis (see above) show little impact on export performance. Germany maintained competitiveness in the sensitive goods (Table 2) over the past two decades.

In other countries as well trade data shows little impact of these costs on trade performance in these sensitive industries (see above). As private environmental expenditures seem to be lowest in Japan and total expenditures have declined, the fact that Japan has lost comparative advantage in many environmentally sensitive industries is unlikely to have been due to higher environmental costs. A more likely explanation could be that Japan decided to move out of energy-intensive smelting and refining industries. These were also the most polluting.

In the United States there has been no major shift in con., rative advantage in the sensitive industries (RCA index remained at 0.8), despite the relatively ligh private environmental costs. Despite an increase in total environmental costs in Austria during the 1980s, it increased competitiveness in environmentally sensitive industries. The correlation between environmental costs and competitiveness was even positive. In the Nordic countries the public share is relatively high and environmental costs declined overall during the 80s. But this is unlikely to explain the increased market shares in these products.

The Japanese case suggests that pollution-intensity and **energy-intensity** are highly correlated. The link can be direct or indirect. environmental expenditures can have an indirect impact on energy costs, and vice versa. In Japan and Germany, for example, in the mid-1980s electricity and utilities accounted for over half of total environmental investments in industry. In Germany, the electricity and mining sectors devoted nearly 20% of their investment to environmental protection in 1990. As utilities tend to have the highest environmental
19 expenditures (Annex Table 4), part of this can feed into higher electricity prices: during the 1980s the real price of electricity in Europe rose by 3 % while most other energy prices declined bv 10-27%.

In Japan the sharp increase in energy costs especially after the oil shocks in the 1970s is likely to have contributed to the decline in environmentally seiisitive exports through the general shift to less energy intensive production. For example, in 1990 the price of electricity for industry in Japan was three times higher than that in the United States, and five times higher than in Norway (see Table 11). Although the costs estimates can be greatly influenced by yearly changes in exchange rates. the table gives some indication of the relative price levels of energy in different countries. The differences reflect relative endowments in addition to differences in efficiency, structure of energy production (nuclear or hydro-power) etc. that influence overage costs of production. Differences in taxes on electricity for industry are minor. Norwa.. has ample hydro energy resources while Japan has very few. It would be more efficient for Japan to specialize in less energy intensive production than for Norway to do so.

This also shows how irrational it would be to require equalization of expenditures across countries. Equalization of taxes would not result in equalization of prices and should not. The low price of electricity in Norway coupled with lower environmental expenditures have not resulted in its invasion of world markets in environmentally sensitive goods. Its comparative advantage index in these goods declined from 2.3 to 1.5 between 1970 and 1990. The appreciating exchange rate from the oil boom is likely to have influenced the competitiveness of other sectors and their exports more than any change in environmental standards.

The level of energy costs can also help identify industries that could be vulnerable to future increases in environmental expenditures especially in terms of carbon taxes. Their impact on competitiveness will depend on industry characteristics and whether other countries apply similar measures. If energy costs on average are 2% of manufacturing costs - as they were in German manufacturing for instance in 1990 - a 25% tax would amount to one-half of one percent of the value of total output, assuming nothing else changes. Most industries would be
20

**able to absorb** this without difficulty, while the impact in sonie industries such **as** iron and steel or paper would be higher eteris paribus, 2 to 3 % of output price in Germany. Such an increase could aggravate their existing structural problems. At present in many countries rea; energy prices are also about 30% below their levels ten years ago.

**Table 11: Prices of electricity for Industry ln selected OECD countries, 1990**

||**Electricity**<br>**USclu/1000lkWb**|
|---|---|
|**OECD**|**71**|
|**Auguia**|**65**|
|<br>**Filand**|**63**|
|**Norway**|23|
|**Sweden**|**56**|
|**_Gernany_**|91|
|**Japan**|126|
|**USA**|**48**|

# **Source: OECD**

The OECD data indicates that European countries and Japan devote more of their environmental expenditures to investment than the United States (Figure 1 and Table 12)." Despite the difficulties related to its classification and measurement (see footnote 8), the share of investment spending on environmental-control expenditures can be one indic tor of internalization of pollution-control costs, and of promoting the positive impact of higher standards through technological change and innovation. It can also help generate private benefits that reduce the net impact of expenditures on competitiveness. In the United States in the early 1980's the share of investment in total industrial pollution expenditures was above 50%, but declined steadily thereafter and in the mid-1980s accounted for less than 30%. Austrian investment on environmental control was high in the 1970's and has increased further since the

> In **the** OECD classirication investment expenditure covers construction or **acquisition** of plant **and** equipment, contixuction **or** acquisition of buildings, improvements, acquisition of land. **They** refer to actual costs incurred in the year in question. Running **costs** include operation **and** maintenance on labor, energy, materials other than energy, services, rents, **repairs.** Sec OECD (1990) for further details. The dividing line between the two types **of** expenditure is **often** blurred. For example, investments in human capitAl in training, preparation of new guidelines, new ways of disposing **waste** etc., which are likely to be included in running cosu could be considered capital expenditures.
21 mid-80s. Germany's share has been 35 to 45 % over the past two decades. Japanese data on private operating costs are not available. Investment expenditure is likely to dominate, however, as most public environmental expenditure was in the form of investments (91 %). In the Nordic countries, estimates of the share of investment in total expenditure are poor. The share of investment in total expenditure in manufacturing in Finland has been around 40% in the 1980s. For Sweden and Norway, few estimates are available. In the mid-1980s the share in Sweden would have been above 50% and in Norway around 30%.

**Table 12; Sh 're of investment in public and private environmental expenditure, seiected industrial countries, mid-1980's**

||Public|Private|
|---|---|---|
|||**(%)**|
|Austria|**n.a**|56|
|**Fuiland**|44|48|
|Norway|32|33|
|Sweden|32|53|
|**Gerrmny**|47|42|
|**Japan**|96|**na.**|
|US|38|**38**|

Source: OECD (1990).

The higher share of investment in total environmental expenditure in European countries in recent years as compared to the United States can explain their increased competitiveness in many environmentally sensitive goods and machinery. In Austlia, wliich showed positive correlation between trade performance and environmental expenditures, the share of investments in total has also increased. Better trade performance in environmentally sensitive goods in Europe coupled with success in reducing major pollutants (see below) suggest ,..at the European countries may have been more successful in internalizing environmental costs and promoting technological change in environmentally sensitive products. But the high public investment in Japan did not improve its comparative advantage in environmentally sensitive industries. They can, however, explain Japan's success in developing appropriate technologies and exporting machinery to the sensitive industries (see below).
22

**Success in pollution abatement.** Success in reducing the major pollutants can be another indicator of internalization of environmental costs and the efficiency of policies. Among the sample countries, Japan has been most successful in reducing pollution despite having the lowest total and private costs of environmental protection. Measured by the reduction in the level of the four main pollutants (Annex Table 3) Japan is first both in terms of the largest reductions achieved over the past 20 years and having the lowest present level of emissions. The United States had, and continues to have, the highest levels of each pollutant per unit of GDP. Germany is in between. For Austria, no data are available. The Nordic countries have managed to achieve considerable reductions in the main pollutants - especially in sulfur-based pollutants - at relatively modest cost to their economies. Its present levels of most pollutants are among the lowest in most of the sample countries.

The United States seems to have had the highest private costs of abatement with the poorest results in reducing pollution. High-cost policies do not equate with most efficient policies. Most of the US expenditure would have gone to pay for operating costs (or legal suits as exemplified in the Superfund Case) and less to developing new products or processes. The share of investment in total US pollution control expenditure has declined and is now lower than in many European countries or Japan. Low levels of investment expenditure may suggest poor results in internalizing costs. Japan invested heavily with public support in pollution control in the 1970s. Being a small area, Japan has less absorptive capacity than the United States. However, its comparatively modest total expenditure has had the most impressive results in terms of abatement. Western European countries began to invest heavily only in the 1980s, perhaps explaining the slower results in abatement of pollutants.

Despite the high share of environmentally sensitive goods in total exports and production in the Nordic countries, expenditures on the environment have been moderate. Nevertheless, their success in reducing emissions of the main pollutants has been better than that of the United States or Germany. This may suggest that the relatively lower environmental expenditures in the Nordic countries do not reflect lower standards but their better absorptive capacities as sparsely populated countries.
23

# 4. **Private benefits from higher standards and competitiveness**

Higher environmental standards can bring private benefits having a positive impact on competitiveness. Environmental standards are aimed at reducing the social cost of pollution. The private costs incurred in complying with environmental standards bring social benefits to society in terms of lower pollution. But in addition many of these expenditures also bring private benefits which reduce the net private expenditure to industry. Apart from the social benefit **of** lower pollution from higher standards, the process of reducing the initial social costs can create new products and new sub-sectors of industry. These reduce the potential impact of private environmental expenditures on competitiveness.

Too often the discussion of environmental policy and competitiveness has portrayed a static, gloomy image of higher private environmental expenditures leading to market losses by enterprises. Compliance with higher environmental standards to reduce the social cost of pollution is presumed only to increase private costs of production or costs of doing business in general, increase prices and reduce demand at home and abroad. The only assumed gain is the social benefit of lower pollution or lessened environmental degradation. Unless other countries follow similar policies to correct similar distortions, international competitiveness of the highstandard country is assumed to be seriously impaired. Protection from imports from lowerstandard countries is thought to be necessary for survival.

The above may be true in a very static context and under strict assumptions, but the situation can be quite different in a dynamic world with continuous change and innovation. Positive dynamic effects can go a long way towards canceling the initial static costs. First, higher costs tend to bring about resource-saving innovation. Cost savings arise from more efficient use of polluting materials or processes. Second., in the environmentally-aware 90s the environmental record of a company can become an asset or a liability. This can have an important impact on costs. As environmental clean-ups or law-suits are costly, the probability of environmental damage will influence insurance premiums. The likelihood of environmental
24 disasters affects expected earnings and asset values of companies. Investment in cleaner technologies will pay off in lower risk-premiums or higher asset values. Third, increased environmental awareness has and will continue to influence demand towards cleaner and higher quality products for which consumers are willing to pay a premium. This allows companies to cover environmental expenditures.

Fourth, innovations can improve or even create comparative advantages when rivals either fail to perceive the new way of competing or are unwilling or unable to respond. Innovators not only respond to possibilities for change, but force it to proceed faster. The early adopters' advantages and the new market opportunities are multiplied, if higher environmental standards are perceived as a permanent source of structural change. Increased environmental awareness in most OECD countries is already shaping how products are packaged, produced, etc., and the trend is likely to continue. Countries are also increasingly committing themselves to international agreements on the environment with various consequences for production processes. Early adopters can gain an edge against competitors in a world where all eventually have to adapt"<sup>2</sup> .

Fifth, higher environmental standards can also contribute to the development of new markets. These can be markets for secondary materials like metal scrap, waste paper, consulting services, and new types of equipment. In Germany, environment related investments now account for close to 10% of total industrial investment in many sectors. In Japan, the share ranges from 4 to 7 %. The International Finance Corporation (1992) has estimated that the world-wide market for environmental goods aiid services is expected to double from the present US$ 300 billion to US$ 600 billion by the year 2000. The OECD(1992) estimated the present market as US$ 200 billion and growing to US$ 300 billion by the year 2000. According to the European Commission (1992) the environmental goods and services industry already employs 1.7 million in the OECD countries.

> 1 Innovators and early adopters gain advantages auch **as** being first to reap economics of scale, reducing **cost** through cumulative learning, establishing brand names and customer relationships without competition, getting their pick of distribution channels, **and** obtainii g the best locations for facilities or the best sources of raw materials or other inputa (Porter, 1990 p.47)
25 The net impact of the positive and negative private costs and benefits of higher environmental standards on competitiveness is also influenced by a number of external or structural factors. These can be the nature of the industry, the size of the domestic market, or the overall economic climate. The static view is more likely to prevail in declining industries that have little scope for price differentiation, or work at the edge of profitability. JHigher environmental costs, although modest, may aggravate an existing situation cf poor competitiveness. Innovation as a response to change is more likely in growing indistries, in industries able to price differentiate and those with a tradition of investing in technological change. The introduction of higher standards is also easier in a cyclical upturn than in a recession.

The role of the government in making and enforcing environmental standards is important because of the public good nature of environmental quality. For industry, government regulations can contribute to creating and upgrading of comparative advantages. Particularly beneficial are policies that anticipate standards that will spread internationally. It is also important that regulations are rapidly, efficiently and consistently applied. Transparency and certainty in their introduction is also important. Policies that encourage internalization of costs tend to promote innovation and technological progress. Regulations can also undermine competitiveness; for example, if a nation's regulations lag behind those of other nations. Industry costs depend also on the level of standards chosen, the time path for reaching them, how the costs are financed, and the policy instruments used. The World Bank 1992 World Development Report concluded that environmental expenditures can be reduced by: i) choosing standards appropriately and concentrating on options with the highest net benefits; ii) choosing instruments that encourage flexibility and cost-effectiveness (market-based versus command and control instruments); iii) preventing damage from the outset and avoiding clean-up costs later; and iv) building them into new equipment.

**New industries.** To get some indication on whether higher environmental standards have created new comparative advantages in industries that are the suppliers of equipment incorporating environmentally-friendly technology this part computes revealed comparative
26 advantage indexes for a number of supplier industries. Other likely beneficiaries are service industries such as consulting. A recent OECD study pointed out that various forms of technology licensing are likely to form a large part of the trade in environmentally sensitive goods (OECD, 1992). For example, a Japanese enterprise having developed an environment-friendly process sells the license abroad. Data for the non-merchandise trade flows are difficult to obtain, however.

To get some insight into supplier industries, RCA indexes were calculated for industries that can be assumed to supply machinery to environmentally-sensitive production. Table 13 identifies nine categories of machinery used in industries like pulp and paper (2), metals (3), power generation, heating and cooling equipment, cleaning machinery, and non-electrical 3 machinery".

From Table 13, industrial countries clearly have revealed comparative advantage in a larger number of industries which are suppliers of machinery to environmentally-sensitive industries. Among the developed countries, Austria and Japan have improved their comparative advantage in five and three categories, respectively. Although Japan is exporting less of environmentally sensitive goods, it has gained markets in machines that are used by these industries. This would indicate that investments to reduce social costs of environmental damage would have brought private benefits in terms of development of new technologies and industries. Germany has maintained its traditionally strong position with some minor market declines. Finland maintained its competitiveness during the period in five industries, and RCAs increased in five categories. Norway shows as being non-competitive in machinery exports. Sweden was an important supplier of all categories covered, but has lost its comparative advantage in two industries. The US has lost comparative advantage ia some industries. As with exports of environmentally sensitive goods, developing countries are slowly increasing their shares in all categories of machinery exports.

I **hein are** SrrC (Rev2) 725, 726, 728, 736, 737, 741, 745, 749, 773.
27

**Table** 13: **Changes in RCA indexes in machinery supplied to environmentally sensitive industries, 1980-90**

||RCAs<br>above I<br>1980|1990|RCAs<br>incrmased<br>in 1980-90|
|---|---|---|---|
||_____-|_number-e||
|**IzzduatrW**|_9_|9|0|
|Austia|a|9|5|
|**Fia'ad**|S|_5_|5|
|Norway|0|0|2|
|Sweden|9|**7**|1|
|**_Germany_**|9|9|0|
|Japan|6|7|3|
|US|7|**_S_**|1|
|Developing|**0**|1|8|

**Source:** United Nations COMTRADE **database.**

The likely positive impact of higher standards on competitiveness of supplier industries in Japan and in Europe is also confirmed by the direction of exports. High shares of exports to industrial countries suggest that the machines comply with their higher environmental standards. The share of industrial countries in the machine exports of Austria and Germany has increased from two-thirds to four-fifths over the past ten years. Japan also exports more environmentally sensitive machines to other industrial countries, contrary to its pattern in the sensitive goods. The US has maintained an export share of about 40% to developing countries with no major change over the period. Developing countries increasingly supply each other with machinery for environmentally sensitive industries.

# 5. Policy implications.

The lack of a systematic relationship between environmental standards/expenditures and trade performance in environmentally sensitive goods suggests that restricting trade to compensate for differences in environmental standards would do little to improve competitiveness in environmentally sensitive industries. As higher environmental expenditures
28 have had no noticeable effect on trade performance, the reasons for poor or good performance are likely to lie elsewhere. Furthermore, the observation that there is no systematic link between the level of environmental expenditures and success in reducing pollution reinforces the importance of good least-cost environmental policies for competitiveness rather than trade measures.

The above also suggests that high environmental expenditures may not necessarily be reflection of high environmental quality. If countries with inefficient and costly policies were allowed to impose the costs of their poor policies on outsiders through trade restrictions or compensatory duties, a likely result would be the export of bad policies and little environmental improvement. A better option is competition among countries adopting standards that are appropriate to their circumstances and that minimize costs of compliance. In some cases coordination of country policies, especially of those that cope with global environmental issues help flexible adjustments.

Eco-dumping duties could do little for the environment, but much harm to the trading system. The most likely impact of compensatory duties is more protection for domestic producers. There is no a priori reason why environmental standards or costs should be the same across countries. Furthermore, there is also no reason why environmental expenditures should be the same across companies facing the same environmental standards in the same country. Differences in costs reflect differences in efficiency, innovativeness, etc. One company is likely to be more efficient or innovative than another - that is human nature. In this context arguments for cost equalization seem untenable.

Most vulnerable to such actions will be developing countries where environmental issues have received less attention. However, a closer look at the tax proposals reveals that their introduction could be a shot in the foot for the industrial countries themselves. At present, differences in taxes or prices of energy, for example, across industrial countries are notable. Gasoline taxes in the US are a fraction of those in Europe or Japan. Given the revealed reluctance of the US Congress to agree to any increases in energy taxes, setting them at a level
29 equal with Europe, meaning a near doubling of the price of gasoline in the US, seems utterly impossible. US trade partners would have an easy target for trade harassment. What is the appropriate price or tax on energy anyway? Such issues are likely to be better resolved in a cooperative setting, rather than by obscure trade rules.

# 6. Conclusions

The essentially exploratory analysis in the paper shows that there is little systematic relationship between higher environmental standards and competitiveness in environmentally sensitive goods. Correlation analysis between changes in world market shares and changes in environmental expenditure show no correlation in Germany, Japan and the United States. In Austria the correlation was positive. Industrial countries have maintained their comparative advantage in environmentally sensitive goods in general. Imports of environmentally sensitive goods from lower-standard developing countries have not invaded home or third markets of industrial countries that have increased environmental standards over the past two decades. There share in the sensitive goods has moved in line with their overall increase in world trade. Other factors are likely to have been more important than differences in environmental expenditures in explaining trade patterns in environmentally sensitive goods.

Industrial countries with high environmental standards have both gained and lost competitiveness in environmentally sensitive industries. Japan on the one hand, and Austria and Finland on the other are the two extremes. Austria and Finland, with high shares of environmentally sensitive goods in their exports and one of the highest environmental expenditures among industrial countries in Austria, have increased their world market shares in these goods. Germany, Sweden and the US have maintained competitiveness in environmentally sensitive exports despite increases in environmental expenditures in the 1980s, especially in Germany, and against overall declines in world markets shares in manufactures and total exports in all three countnes. In Norway the growth of petroleum production and exports reduced comparative advantages in environmentally sensitive goods. Japan is the clearest case of lost comparative advantage in the sensitive goods. But Japan is competitive in production of
30

# machinery for environmentally sensitive industries.

In its analysis of determinants of trade flows in environmentally sensitive goods the study noted that: i) environmental expenditures have been a small share of total expenditures and therefore unlikely to have caused shifts in comparative advantages in most industries on their own; ii) differences in environmental expenditures among industrial countries seem to be minor; iii) environmental expenditures are concentrated in a few basic industries that are under strong pressures for structural change from the international division of labor; iv) energy use and environmental expenditures are closely linked; and v) there is some indication that success in abatement and increased comparative advantage in environmentally sensitive goods can be more pronounced in countries where environmental policies encouraged investment rather than current expenditures. Apart from physical characteristics the private costs of environmental standards also depend on what policies are chosen - the reductions achieved in the main pollutants by the industrial countries have been quite different across countries. In the end competitiveness is determined by a complex set of macro- and micro-economic factors.

Compliance with higher environmental standards is not a zero-sum game. Higher environmental standards is a new source of permanent structural change - countries adjusting early to internalize costs of pollution and investing in environmental protection technology can maintain and enhance comparative advantages in environmentally sensitive industries. Adjustment can also mean shifting to producing less environmentally sensitive goods. Pressures towards this end are likely to increase as environmental awareness becomes more and more part of the landscape.

Instead of lobbying for protection, industries struggling with environmental expenditure **s** hould lobby for better environmental policies. Demands for protection on account of differences in environmental expenditures are likely to be counterproductive and retard adjustment to a new source of structural change. Protection will not solve problems of noncompetitiveness -- the causes of poor performance are likely to lie elsewhere. Instead, adjustment can be aided by appropriate timing and design of environmental policies.
31 Annex Table 1. Product composition of environnmentally sensitive goods, in 1970 and 1990

|SINc<br>||1970|1980|1990|
|---|---|---|---|---|
|251|Pulp**and**paper|4.3|2.9|3.2|
|332|Petroleum products|11.1|23.7|15.3|
|512|Organic chemicals|7.4|9.2|12.5|
|513|Inorganic chemicals|2.8|2.3|2.7|
|514|Other inorganic chemicals|_1.5_|1.5|_1.5_|
|515|Radioactive materials|0.3|1.5|0.9|
|521|Coal|0.2|_0.5_|_0.5_|
|561|Pertilizers|2.2|2.7|2.3|
|599|Other chemicals|4.4|4,3|5.3|
|631|Veneers, plywood|1.9|1.7|1.9|
|632|Wood manufactures|0.7|0.9|1.2|
|641|Paper**nd**paperboard|7.3|5.3 S|S'|
|642|Articles in paper|1.3|1.4|2.1|
|661|Cement, etc.|1.0|_1.5_|1.3|
|67|Iron and sel|23.9|18.3|17.4|
|63|Non**ferrous**metals|15.6|10.6|3.2|
|69|Metal nanufactures|14.3|10.3|14.3|
|||100.0|100.0|100.0|

Source: UN COMTRADE data base.

Annex Table 2. Share in total world exports and in manufactures, selected industnal countries, 1970-90

||Total||Manufa|ctures|
|---|---|---|---|---|
|Regions/countries|1970|1990|1970|1990|
||--|<br>~|~(%)-||
|Industrial|743|72.7|91.3|813|
|Austria|1.0|1.3|1.3|1.6|
|**Finland**|0.8|0.8|0.9|0.9|
|Norway|0.8|1.0|0.8|_0.5_|
|Sweden|2.3|1.8|2.9|2.0|
|Gemmany|11.7|12.2|17.2|15.2|
|Japan|6.6|8.8|10.2|11.3|
|United States|14.5|11.4|16.9|12.3|

Source: United nations COMTRADE data base.
32 Annex Table 3. Pollution Indicators per Unit of GDP, In 1970 and 1989, at 1985 prices and exchange rates

||Sulfur (S02) Emissions (k2/1000 USS)||
|---|---|---|
||1970<br>1989|A|
|Funland|15.5<br>4.2|-69|
|Gerwany|8.3<br>2.2|-73|
|Japan|7.2<br>0.5|-93|
|Norway|5.5<br>1.0|-82|
|Sweden|12.2<br>1.8|-85|
|U.S.|10.8<br>4.6|-57|
|OECD|11.4<br>4.0|-65|
||Nitrogen (NO2) Emissions (ke/1000 USS)||
|Finland|4.8<br>4.2|-13|
|Gaenmny|5.3<br>4.3|-19|
|Japan|2.4<br>0.8|-67|
|<br>Norway|_5.1_<br>3.7|-27|
|Sweden|4.0<br>2.9|-28|
|U.S.|7.0<br>4.4|-37|
|OECD|5.7<br>3.6|-37|
||Carbondioxide (CO,<br>Emissions from Energy Use (|kg/USS)|
|Finland|0.45<br>0.28|-38|
|Gerwany|0.46<br>0.29|-37|
|Japan|0.31<br>0.18|42|
|Norway|0.22<br>0.14|-36|
|Sweden|0.36<br>0.19|-47|
|U.S.|0.46<br>0.32|-30|
|OECD|0.43<br>0.29|-33|
||Ener-v<br>Intensitv*||
|Fmnlnd|0.58<br>0.49|-16|
|Germany|0.53<br>0.41|-22|
|Japan|0.38<br>0.27|-30|
|Norway|0.57<br>0.44|-22|
|Sweden|0.58<br>0.52|-10|
|U.S.|0.60<br>0.44|-27|
|OECD|0.54<br>0.41|-24|

* TOE per 1000 USS, pri.asry energy requirements per unit of GDP.

Source: OECD (1991)
33

# Annex Table 4. Cost Structure In German Industry (1990)

||||||Share o|f env.|
|---|---|---|---|---|---|---|
|Sector||Costs|Labor<br>Cosrt|Energy<br>in toul<br>investments|Openn<br>*|eu Environmental<br>cosu(1988)|
|||||()|||
|* Man|ufacturer|25.2|2.2|4.8|29|0.7|
||Raw Materials and<br>||||||
||Production Goodl|20.4|4.4|11.3|28|U.S.|
||Iron & Steel<br>|24.7|10.1|13.7|34|na..|
||Chemicals|24.5|3.8|12.9|42|2.2|
||Petroleum|3.2|1.1|15.3|4|1.1|
||Paper<br>|18.0|8.6|10.3||n.s.|
||Metau|16.0|_5.1_|12.3|29|1.6|
|(lal.|iron, basic metals)||||||
||InveamntfGona|30.1|1.1|1.9|38|na|
||Machinery|32.5|1.1|1.4|44|0.3|
||Consumotion Goods|27.2|2.2|2.7|20||
||**_Ceramics_**<br>|43.7<br>|4.9<br>|3.1|33|**n.a**|
||**Glau**<br>|29.6|6.2|6.2|30|**na**|
||Paper<br>|23.2|2.2|2.4|IS|_)_|
||Clotbing<br>|23.0|0.7|2.4|20|_)_0.7|
||Textiles|24.7|2.9|0.6|29|<br>_)_|
||.Food|12.8|1.6|2.7|9|0.4|
|Minina||44.8|10.4|20.7||3.9|
|**E**lectric|itv etc.|13.4|-|18.1||4.2|

Source: Statisiaches lahrbuch, _Germany_ **various** isues, Ausgewahite Ergebnisse zur Umweltokonomischen Gesamtrechnung 1975 bis 1990, Statisches Bundesamt. * openness is defind **as** the share of exports in total sales (%).
# Figure 1. Investment shares in total

<!-- Start of picture text --> private environmental costs<br><!-- End of picture text --> <!-- Start of picture text --> (%) 65<br>60<br>55<br>50<br>45<br>40<br>35<br>30<br>25 1 l l 1lll6<br>1972 194 1976 1978 1980 I 1982 I 1984 1986<br>1973 1975 1977 1979 1981 1983 1 95 1987<br>0 FinlaLnd + Ger many O USA A Austria<br><!-- End of picture text --> Source: OECD (1990).
# **ZDBLIOGRAPEY**

- Commission of the Eurooean Communities, (1992), "Industrial Competitivenees and Protection of the Znvironment", Communication of the Commiesion to th Council and to **the** European Parliament, Brussels.

- Blazerczak. Juroan, (1993), "Environmental Policies and **the** Decision of Enterprises to migrate", **mimeo.**

- Fukasaku, U. (Mai 1992), "Environment Policy, Research **and** Innovation in Japan, An Overview", in CSI - L'Environement au Jacon.

- Intornational Finance Corooration, (1992), Investina in the Environment, Washington.

- Low, P. (1992), "Trade Measures and Environmental Quality: The Implications for Mexico's Exports", in P. LCw (ed.): International Trade and the Environment, World Bank Discussion Paper 159, pp. 105-120.

- Low, **P.** /Yeats. A. (1992), Do **"Dirty"** Industries Migrate?", in: P. Low **(ed.) International TSade and the** Environment, World Bank **Discussion Paper** 159, pp. 89-104.

- OECD (1983), **Positive** Adiustment **Policies,** Managina Structural Chanoe, Paria.

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- OC, (1992), The OECD Environment Industry: Situation, Prosoects and Government Policies, Paris.

- Porter, M.F., (1990), The Competitive Advantaae of Nation, New York Free Press.

- Statiotisches Dundesamt, (1991), Ausgewahlte Ergebnisse zur Umweltokinomischen Gesamtrechnung 1975 bis 1990, Heft 18 der Schriftenreihe Auagewahlte Arbeitsunterlagen zur Bundeestatistik, Wiesbaden.

- The World Bank, World Development Report, 1992, Oxford University Press.

- Uaelow. J.L., (1982), A Survey of Recent Studies on Costs of Pollution Control and the Effects on Trade, in S. Rubin (ad.) Environment and Trade, New Jersey.

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|**Title**|**Author**|**Date**|**Contact**<br>**for paper**|
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