Tougher environmental policies can create economic winners

| June 4, 2021

No longer concerns for a distant future, climate change and environmental degradation are an urgent challenge facing the planet. And they’re happening now.

According to the 2019 United Nations Climate Change report, between 1990 and 2016, global aggregate greenhouse gas emissions increased by 46.7 per cent. In 2018, the global mean temperature had risen about 1°C above the pre-industrial baseline.

The Australian government has committed to a gas-fired recovery rather than a green one. 

Countries around the world have experienced climate-related disasters including extreme weather like hurricanes, storms, heatwaves and bushfires, as well as slow onset impacts like sea level rise, soil degradation and coral bleaching.

As the US and EU move forward with their green recovery, there was little talk of the climate crisis or the environment in Australia’s 2021 Federal budget.

While Australia’s largest trading partners make bigger and bolder commitments to decarbonisation and use their COVID-19 recovery budgets to maximise the opportunity to boost a clean energy transition, the Australian government has committed to a gas-fired recovery over a green one, pouring billions into fossil fuel projects.

Instead of adopting a wide range of more effective and efficient environmental policies, like price and tax mechanisms, the government has pinned its hopes on a low-emissions technology plan.

The Morrison government’s increasing support for fossil fuel projects seems to have some elements in common with former US president Donald Trump’s 2020 Executive Order which allowed US federal agencies to bypass environmental protection laws and fast-track pipeline, highway and other infrastructure projects.

Trump declared regulatory delays would hinder “our economic recovery from the national emergency”.

Likewise, in 2017, Trump withdrew the US from the Paris Agreement for international climate action for the same reason. The Agreement, he said, would undermine the US economy “and put us at a permanent disadvantage to the other countries of the world”.

Environmental regulations and policies boost a country’s productivity in the long run. 

All of these recent policy moves seem to be made with the notion that greater action on environmental policy harms a nation’s productivity growth. But experts like Australian economist Ross Garnaut argue that taking greater action on climate change now could actually benefit our economy in the long run.

And this is a position our recently published research supports.

Our study looked at the environmental policies of 22 countries belonging to the Organisation for Economic Co-operation and Development (OECD), alongside their productivity growth, finding some positive evidence of the economic effect of environmental policies.

Using the OECD’s Environmental Stringency Policy Index, we rated each nations’ environmental policies including Australia and the US, between 1990 and 2007, in order to investigate the impact of greater environmental policy actions on a nation’s productivity.

These policies include taxes on carbon and subsidies for renewable energy, as well as regulations like limits on sulphur content in diesel.

The model we used is flexible enough to capture country-specific effects of taking greater environmental action on a nation’s productivity growth.

We can also identify the causal impact of environmental policies on productivity by exploiting the time-series variation within each country, which basically measures the movements of productivity caused by changes in policy stringency.

Environmental regulations prompt industries to actively look for and purge inefficiencies in their production processes. 

Our research, published in Energy Economics looking at 22 OECD countries, found that all of this group had gradually tightened their environmental regulation between 1990 and 2007.

Using the example nations – Australia, Germany, United States and United Kingdom – against the OECD average, Denmark had the highest and Germany the second-highest average score over the 17 years of all 22 OECD countries (see Figure 1).

And Australia had the worst.

By examining short and long-term effects, our results show that while environmental regulations do increase the cost of production initially – for example, a carbon tax makes coal more expensive, which increases the costs of metal production – adopting tighter environmental policies boosts a country’s productivity in the long run.

This positive effect is more noticeable in countries that showed leadership on environmental protection and adopted tougher environmental policies.

According to our estimates, during the 17-year sample period, if an average OECD country had increased the stringency of its environmental policies by one unit, its annual productivity growth rate in three years’ time would have increased by about 0.71 percentage points from -0.09 per cent to 0.62 per cent.

Germany had the second-highest average score over the 17 years of all 22 OECD countries. This graph looks at three countries as an example alongside the OECD average. 

By applying our estimates to a theoretical country whose environmental policies were as strong as Germany’s (so stronger than the OECD average), if it had increased the stringency of its environmental policies by one unit, it would have seen its annual productivity growth rate increase by 1.14 percentage points in three years’ time.

The positive effect of adopting tougher environmental policies on a country’s productivity growth could in part be due to the fact that a cleaner environment in the long run increases the quality of various production inputs – like better workforce health and better quality of water or air.

It’s also feasible that environmental regulations prompt industries to actively look for and purge inefficiencies in their production processes and, as a result, boost their productivity in the long run.

For instance, an economy-wide carbon price would increase the cost of manufacturing with high carbon emissions. This would provide them with a strong incentive to find or develop technologies as efficient and as clean as possible to reduce their production cost.

As a result, fewer fossil fuels will be needed to maintain the same level of production.

The impact environmental policies have on production technology and productivity is an important question of our time, but the lack of a fully-fledged pollution trading market or detailed production information at a sector level makes it difficult to examine this effect thoroughly.

Our findings show that while there might be a short-term hike in cost, countries whose governments implement strong environmental regulations reap the productivity – and economic growth – rewards in the long term.

This article was published by Pursuit.

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