New Investment and its Impact on the Environment: A Survey of the Literature March 2001

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Abstract
New Investment Study
Structure of Investment

Portfolio Equity Investment
Debt
Foreign Direct Investment

FDI offers the most Potential Leverage of any other Form of Private Investment
Impact of Environmental Protection on Investment Decisions by the Firm-Spatial and Sectorial

Traditional Factors versus Environmental Regulations
Regulatory Gap - Induced "Pollution Havens?"- Do They Exist?
Globalization - A Race to the Bottom?

Environmental Effects of International Competition for FDI � Are Policy Makers "Stuck in the Mud?"
Impact of Environmental Standards on Investment Decisions by the Firm � Competitiveness, Technology Development and Diffusion

Competitiveness
Pollution Prevention vs. Compliance

Types of Investments Which Promote Environmental Performance
Small And Medium-Sized Enterprises
Informal Sector
Conclusions
References

Abstract

This paper provides a survey of the literature on investment and the environment. Much of the existing literature focuses on foreign direct investment (FDI) and its impact on the environment. Although most studies concentrate on FDI and the role of multinational enterprises, much of the analysis can apply to the domestic sector as well.

FDI is an increasingly important engine for sustainable development in many countries. In 1999 it accounted for 82% of net private flows into East Asia. And, of all the forms of private capital flows, the greatest potential leverage is over foreign direct investment given its longer time-frames and more direct environmental effects. Multinational enterprises (MNEs) are important vehicles for both technological innovation and technology transfer. FDI undertaken by MNEs typically results in standardization of "best practices" within the global operations of individual MNEs. In addition there is a tendency for positive spillover effects on the technological characteristics of national firms and their suppliers.

Integrating environmental considerations into investment promotion programs will not drive most foreign direct investors away. In fact, such integration can help optimize economic development and environmental protection, and may actually help attract investors for the following reasons:

  1. Non-environmental factors (access to resources, markets and labor) are the most important considerations for most foreign direct investors when deciding to invest.
  2. Most foreign direct investors prefer consistent application of clear investment frameworks, including environmental standards, to uncertain rules.
  3. Poor local environmental conditions can reduce business productivity and a location�s attractiveness to foreign investors.

Drawing heavily on a number of country study examples, the conclusions drawn are traditional factors such as markets, labor and materials remain predominant in manufacturing-location decision making, despite an added dimension of environmental regulations. Environmental regulations did not rank among the most important factors considered; when such regulations were of some significance, uncertainties about obtaining the necessary permits and the time required to do so were more important than the direct costs of providing the necessary pollution control equipment.

Even though environmental regulations had very little impact on firm level locational decision studies have shown how strict standards can and should promote resource productivity and, in turn, competitiveness. However, in cases where there was some level of "regulatory flexibility" companies were able to focus on the production process itself, not just on the secondary treatment wastes.

The literature shows there is little statistical evidence of either a "pollution haven" or "a race to the bottom." However, pollution zones of poorer people where firms perform worse and where regulations are less effective may exist.

The literature also suggests the current "no rules" governance system on investment has created intense competition among governments for FDI creating negative environmental impacts. And, in an effort to secure FDI governments are "stuck in the mud" or reluctant to raise environmental standards for fear they will lose investors.

Finally, the literature acknowledges the lack of statistical data on SMEs. However, if generalizations can be made they are: SMEs are largely ignorant of their environmental impacts and the legislation that governs them; they are cynical of the benefits of self- regulation and the management tools that could assist them in tackling their environmental performance; and, they are difficult to reach, mobilize or engage in any improvements having to do with the environment.

New Investment Study

Environmental degradation in East and South East Asian countries is a consequence of both production and consumption patterns within countries and in their export markets. Apart from regulations and corporate strategies, the environmental effects of investments depend on a combination of macro and micro factors. At the macro level, these include the structure of investment: portfolio equity investment, debt or direct investment. And, the profile of that investment: domestic versus foreign, multinational enterprise versus small and medium-sized enterprise (SME), and new facility versus old facility. At the micro level, factors include decisions that the firms make with regard to their management of production activities and the application and diffusion of environmentally sound technologies. Each of these factors is examined in this review with specific reference to the impact of new investment on the environment, and how can we influence it to maintain and enhance environmental quality.

Structure of Investment

There are three major types of private capital investments: portfolio equity investment, debt and direct investment. Each can either be domestic or foreign and each type varies in its environmental implications. Discussions about the environmental impact of investment or capital flows often center on foreign direct investment. Virtually no analytical work exists on the environmental implications of domestic investment in developing countries. Part of the problem stems from a lack of relevant statistics. However, most of the analytical work which has been done on international capital flows may apply to domestic investment.

Portfolio Equity Investment

International equity investment constitutes the most volatile of capital pools. Portfolio equity flows more than doubled in 1999 to $19 billion from $8 billion in 1998 and represented 25% of the total 1999 private flows to East Asia of $89 billion (World Bank, 2000). Portfolio investment consists primarily of institutional investors (pension funds, mutual funds, insurance companies, etc.) purchasing shares in local companies which are publicly traded on domestic stock exchanges or the exchanges of other countries.

Portfolio investors tend to be highly mobile and short term in their investment horizon. While the relationship between environmental issues and foreign portfolio investment in companies� shares is less obvious than FDI, pressure for short-term profitability in these investments may create incentives to reduce the environmental performance of host firms.

Debt

The traditional form of private capital transfer from industrialized to developing countries is debt. In 1990 net debt to developing countries totaled $20 billion. The Asian financial crisis prompted a reversal of these flows. Debt flows recovered from a negative $18.4 billion in 1998, to negative $15.4 billion in 1999 (World Bank, 2000). Though foreign banks have been cautious in returning to the region, an uptick in gross lending indicates that credit conditions are loosening modestly. With investment still largely depressed in most of East Asia, the demand for funds has been modest and local liquidity has been sufficient to meet demand.

Debt and environmental performance is an important consideration in lending to private companies insofar as a borrower�s financial success or failure may be affected by environmental considerations. Other debt holders, such as investors in government-issued bonds, are less attentive to environmental performance because the connection between government environmental performance and the ability to repay is somewhat remote (Gentry,1996).

Foreign Direct Investment

The largest amount of international foreign investment in developing countries hase taken the form of FDI, which accounted for 82% of net private flows into East Asia or $61.5 billion in 1999. Global FDI inflows and outflows in 1997 were nearly twice what they had been in 1990, and some sevenfold of their volume in 1980. Even the Asian financial crisis did not halt this trend, as 1998 FDI inflows increased to $644 billion and FDI outflows to $648 billion (Friedman, 1999). FDI still remains the most stable form of international private investment in developing countries.

According to UNCTAD (1998), the major properties that account for this relative stability are FDI�s:

  • longer-term profit horizons;
  • longer-term assessment of market potential;
  • lower susceptibility to "herd" behavior because of the different investment motivations at work; and
  • difficulty of being pulled out of the country once invested.

FDI is primarily financed out of multinationals� internal funds, either retained earnings or general borrowings. The investment is generally made to acquire a lasting management interest (usually at least ten percent of the voting stock) in an enterprise operating in a country other than that of the investor. FDI tends to be medium- to long-term in nature, with at least three- to five-year investment horizons. The long-term nature of these investments is characterized by low liquidity and relative insulation from short-term variation in local financial conditions.

The number of foreign direct investors based in developing countries continues to grow. A significant number of these investors are small and medium-sized companies. Their presence challenges traditional theories that only large companies can engage in FDI and only when they have a competitive advantage to exploit.

FDI offers the most Potential Leverage of any other Form of Private Investment

Of all forms of private international finance, FDI is the largest type most directly implicating environmental matters (Gentry, 1998a). FDI:

  • makes up the largest component of private flows to developing countries;
  • has the most direct environmental impacts;
  • faces the most severe financial pressures from environmental concerns: and, therefore,
  • should offer the best window on the links between private investment and the environment.

FDI often goes directly into resource extraction, infrastructure or manufacturing operations, with all the potential environmental impacts they raise. These potential impacts, in turn, generate commercial pressures on foreign direct investors to integrate environmental issues into their investment decision-making in ways not shared by most other investors. Portfolio investors in equities are generally one step removed from the actual operations and can transfer their interests more rapidly (Fernandez,1998). Commercial banks can face similar environmental pressures in long-term, real estate backed lending, but are often looking at short-term working capital loans facing fewer environmental risks (Ganzi, 1998). The results include greater opportunities for leverage over environmental aspects of private investment decisions with FDI, as well as greater potential for affecting - either positively or negatively - environmental conditions.

It is also worth noting, one third of the world�s FDI is owned by only 100 corporations representing 0.3 percent of all MNEs. A total of 40,000 MNEs control 80% of trade and 90% of patents worldwide. An additional sign of the economic concentration of power is the fact that one third to half of FDI is directed towards mergers and acquisitions. It is significant that while portfolio investment dropped following the Asian financial crisis, mergers and acquisitions of companies in developing countries have increased sharply from around $20 billion annually between 1994-1996 to $50 billion in 1997 and $60 billion in 1998 (Franco, 1998). 

Impact of Environmental Protection on Investment Decisions by the Firm-Spatial and Sectorial

Traditional Factors versus Environmental Regulations

The costs and risks of environmental consequences from industrial production depend on the concentration and location of that production. The literature suggests operating costs, including environmental costs, seem to be only one factor among many location decisions, and the significance of environmental factors will vary significantly by industry. In fact, many operating costs will actually be lower where environmental quality is high, for instance, water filtration costs, risks of incurring clean-up costs for past environmental damage, and worker health plans (Gentry,1996).

For the most part, MNE�s invest overseas based on a number of different factors. According to a recent survey of top executives (A.T.Kearney, 1998) the most important considerations are:

  • market size;
  • political stability;
  • GDP growth;
  • regulatory context; and
  • profit repatriation regime.

A study by Stafford (1985) concluded that traditional factors such as markets, labor and materials remain predominant in manufacturing-location decision making, despite an added dimension of environmental regulations. Environmental regulations did not rank among the most important factors considered; when such regulations were of some significance, uncertainties about obtaining the necessary permits and the time required to do so were more important than spatial variations in the direct costs of providing the necessary pollution control equipment.

Stafford�s study indicated that environmental regulations have no consistent effect on the size of the search area, the number of sites considered, or the sizes of facilities built. In sum, environmental regulations will not lead to major shifts in locations of industry since traditional location factors remain predominant.

The study by Stafford does point out how environmental regulations may, for several reasons, reinforce the preference of many manufacturers for expanding production at existing facilities instead of building new plants. First, because they can attain economies of scale in waste disposal, larger operations can absorb environmental control costs more easily than can smaller operations (Shriner,1972). Second, it is probably easier to get permission to expand production in an area where one is already operating than to obtain permits for new production. Time is money, so affected firms favor locations in areas with pro-business attitudes and expeditious bureaucracies. Third, any additional pollutants would represent a smaller percentage increase in pollution level at the existing location than they would at a new site. Fourth, changes in the social economic characteristics of the area around a facility are only incremental when a facility is expanded. Fifth, environmental controls, searching for alternatives, delays, and so on, increase the cost of locating a new facility. This also increases uncertainty, which can be more easily reduced through the expansion of an existing operation.

Jaffe, Peterson, Portney and Stavins (1995) looked at case studies in the United States and concluded the spatial pattern of economic activity is partly a function of resource endowments and the location of markets. And, although firms may locate where production costs are low and market access is good, there are benefits to firms that locate where other firms have previously located - in terms of existing infrastructure, a trained workforce, potential suppliers and potential benefits from specialization.

Wheeler and Moody (1992) found that U.S. multinational firms appear to base their foreign investments decisions primarily upon such things as labor costs and access to markets, as well as upon the presence of a developed industrial base. Interestingly, corporate tax rates appear to have little or no appreciable effect on these investment decisions. To the extent that environmental regulations impose direct costs similar to those associated with taxes, one could infer that concerns about environmental regulations will be dominated by the same factors that dominate concerns about taxes in these investment decisions.

Regulatory Gap - Induced "Pollution Havens?"- Do They Exist?

One of the liveliest debates about the environmental consequences of investment, in particular FDI, focuses on "pollution havens" or the race to the bottom (Zarsky,1999; Esty, 1994; GATT, 1992). The assumption is that in OECD economies stricter regulations mean polluters pay more - for pollution control equipment, conversion to cleaner processes, or penalties for unacceptable emissions. This regulatory gap between developed and developing countries could, in principle, produce "pollution havens" analogous to "low wage havens." Therefore, pollution-intensive industries might join labor-intensive industries in the migration from OECD countries to open developing economies, if the latter remained unregulated and environmental pricing were a significant determinant of comparative advantage.

Mani and Wheeler (1997) found a pattern of evidence that does not seem consistent with the pollution havens theory. First, surveying outward FDI flows from selected OECD countries shows that the share of pollution-intensive manufacturing industries did not exceed 16% in 1996 and since 1990 this share has been fairly stable. Second, surveying inward FDI flows over time for a number of host countries, no particular pattern emerges for either developed or developing countries in either FDI in pollution intensive industries or in manufacturing FDI. Most of the dirty-sector development story is strictly domestic. What the data suggests is that when it comes to the industrial composition of investment, the ratio of pollution intensive industries appears to be highest in domestic investment, in both developed and developing countries. Third environmental regulations increase continuously with income. Any tendency toward formation of a pollution haven is self-limiting, because economic growth brings countervailing pressure to bear on polluters through increased regulation. Essentially, pollution havens are as transient as low wage havens.

Zarsky (1999) surveys several studies and determines that the studies suggest that first, differences in environmental standards and/or abatement costs have not made a significant difference in firms� location decisions. Second, firms both domestic and foreign, are incrementally improving their environmental performance in many parts of the world, primarily in response to effective national regulation and/or local community pressure. Therefore, there is little statistical evidence of either a "pollution haven" or a "race to the bottom."

However, she notes there is little statistical evidence that foreign firms consistently perform better in developing countries, especially once the firms� size is taken into account. Futhermore, foreign links, including export markets and ownership of plant, seem to make little difference to firm performance.

In terms of an investment decision by foreign direct investors, Zarsky points out there is evidence that policy makers are sensitive to potential effects of higher environmental standards on foreign investors. They may not weaken standards, but they don�t enforce them..

Globalization - A Race to the Bottom?

In a later study Wheeler (2000) asks the question, "Could globalization trigger an environmental race to the bottom, in which competition for investment and jobs relentlessly degrades environmental standards?" Wheeler considers the underlying assumptions behind the race to the bottom model and concludes that in fact they must be flawed and unrealistic.

First, pollution control is not a critical cost factor for most private firms. Research in both high and low-income countries suggests that pollution control does not impose high costs on business firms. Jaffe (1995) and others have shown that compliance costs for OECD industries are surprisingly small, despite the use of command-and-control regulations that are economically inefficient. Therefore, pollution control costs do not provide firms a strong incentive to move offshore.

Second, low-income communities penalize dangerous polluters, even when formal regulation is weak or absent (Pargal, Hettige, Singh and Wheeler, 1997; Hettige, Huq, Pargal and Wheeler, 1996; Pargal and Wheeler, 1995). Where formal regulators are present, communities use the political process to influence the strictness of enforcement. Where regulators are absent or ineffective, NGOs and community groups pursue informal regulations based on convincing polluters to conform to social norms.

Third, rising incomes strengthen regulations for the following reasons.

  • Pollution damage gets higher priority after rising wealth has financed basic investments in health and education.
  • Higher income societies have stronger regulatory institutions.
  • Higher incomes and education empower local communities to enforce higher environmental standards.

Consequently, this results in a very close relationship between national pollution and income per capita.

Fourth, local businesses control pollution because abatement reduces costs. Social concerns may move a minority of managers to control pollution; however, most managers are bound by pressures from formal regulations and pressures from the market.

Fifth, large multinational firms generally adhere to OECD environmental standards in their developing country operations. This is partly attributed to the close scrutiny multinational firms face from consumers and environmental NGOs. And, it is partly attributed to multinationals staying ahead of the curve. In developing countries governmental interpretations and enforcement of environmental standards are characterized by fluidity and inconsistency and because firms wish to avoid the possibility of expensive future retrofitting manufacturers may be inclined to install the most stringent requirements to their affiliates in all locations (Stafford, 1985).

A recent study of 89 US-based manufacturing and mining multinationals with branches in developing countries found that nearly 60% adhere to stringent internal standards that reflect OECD norms, while the others enforce local standards (Dowel, Hart and Yeung, 2000). Controlling for other factors (i.e. physical assets, capital structure), the study found that firms with uniform internal standards had an average market value $10.4 billion higher than their domestic counterparts. To illustrate this point further, an audit of Indonesian factories undertaken in 1995 (Afsah and Vincent, 1997) showed how almost 70% of domestic plants failed to comply with Indonesian water pollution regulations, while around 80% of the multinational plants were fully compliant.

Environmental Effects of International Competition for FDI � Are Policy Makers "Stuck in the Mud?"

In reviewing all of the evidence Zarsky argues (Zarsky, 1999 and Zarsky, 2000) why the current investment regime does not channel FDI towards more socially just and ecological sustainable development.

First, the majority - 71.5% in 1998 - of FDI inflows are among rich, developed countries. Of the share going to developing countries, East and South Asia receive over 40% while Africa only 1.6% of the global flows in 1998. She notes that even though FDI can bring both positive and negative social and environmental impacts foreign capital is essential to the goals of sustainable development.

Second, the mixed evidence of positive, negative and neutral effects of FDI militates against any overarching conclusion about its effects. Studies, in fact, have shown that factors other than foreign ownership (such as regulation - formal undertaken by government or informal undertaken by community groups or NGOs) are more important in improving firm-level environmental performance in developing countries.

Third, the current "no rules" governance system creates intense competition among states and sub-national governments for FDI. Zarsky argues that the lack of supra-national investment rules creates bad governance at the local level, including opaque decision-making, rent-seeking behavior, corruption and unaccountability.

Fourth, because of this intense competition for investment capital, local and national policy makers face disincentives to substantially raise standards. They might not lower standards. However, they are reluctant to unilaterally raise standards substantially and/or widen the scope of socially responsibility.

This results in policy makers being "stuck in the mud" and thus MNEs themselves determine their environmental performance. Zarsky argues that this has resulted in a wide band of positive and negative impacts. She notes how some firms are committed to "best practice" while others engage in technology dumping and "double standards." Therefore, the fundamental debate is whether a liberalized investment regime brings better global performance by disseminating "best practice" or worsen it by encouraging "double standards."

  • Best practice suggests that superior technology and management along with the demands by green consumers at home, make FDI, particularly from OECD firms, a vehicle for better environmental performance in developing countries. The assumptions are first, MNEs are generally committed to "best practice"; and second, they do not change standards in different countries, but have global standards throughout the firm.
  • Double standards suggests MNEs, including from the OECD, perform worse in developing countries than they do at home. The assumption is that companies perform worse either because it reduces their internal costs of production or because external supporting infrastructure is lacking. Likewise, the assumption suggests FDI does not necessarily transfer new technology, but is a vehicle for "technology dumping."

Zarsky argues, whether or not FDI brings "best practices" or "double standards" may depend to some degree on the particular sector and on the nature of competition within the sector. However, even under the best of scenarios the widespread diffusion of "best practice" will deliver too little, too late. "The logic of global market competition will continue to press for convergence of standards, and the lack of global regulation will continue to generate performance impacts in a wide band. To shift the entire band of convergence upward requires the global coordination of environmental standards based on new, performance-based approaches to regulation." Ultimately, she points out, a system of global governance of investment is needed to both "raise the bar" in terms of average industry environmental performance and narrow the band between best and worst practices.

And finally, although pollution havens cannot be proven, there is a discernible pollution pattern, one not based on differences in national environmental standards, but on differences in income and/or education of local communities. These are not "havens" but "pollution zones" of poorer people where firms perform worse and where regulation is less effective.

Zarsky contends that what is needed is an overarching, coherent, sustainability-enhancing governance framework for investment to heighten investor environmental responsibilities. This framework of regulation should not only target foreign investment, but investment as a whole. Such a framework would help diffuse �best practice" more rapidly. And finally, beyond regulation there is a need for corporate accountability mechanisms. Effectively, environmental governance norms are the key to a performance-based approach to regulation which drives continuous improvement and rapid technological change. Accountability is the key to good performance. And, information is the basis of accountability. This includes both measuring and monitoring environmental impact, verifying the credibility of environmental information and disclosing environmental information to the people who can use it to drive improvements.

Impact of Environmental Standards on Investment Decisions by the Firm � Competitiveness, Technology Development and Diffusion

Competitiveness

Porter and van der Linde (1995) examined the issue of environmental regulations and competitiveness. They noted how properly designed environmental standards can trigger innovations that lower the total cost of product or improve its value. Such innovations allow companies to use a range of inputs more productively - from raw materials to energy to labor - thus offsetting the costs of improving environmental impact. Ultimately, this enhanced resource productivity makes companies more competitive, not less.

In other words, they argue that firms need to frame environmental improvement in terms of resource productivity. They must shift their attention to include the opportunity costs of pollution - wasted resources, wasted effort, and diminished product value to the customer. Porter and van der Linde have surveyed data showing how the costs of addressing environmental regulations can be minimized, if not eliminated, through innovation that delivers other competitive benefits.

Porter and van der Linde observe how the problem with regulation is not its strictness, but, in fact, strict standards can and should promote resource productivity. However they point out that the problem with the current environmental regulatory regime is the way in which standards are written and the sheer inefficiency with which regulations are administered. For example, regulations which concentrate on cleanup instead of prevention; regulations mandating specific technologies; regulations setting compliance deadlines that are unrealistically short and subjecting companies to unnecessarily high levels of uncertainty. They add, in cases where they observed regulations which permitted a more flexible approach, companies were able to focus on the production process itself, not just on the secondary treatment of wastes.

Porter and van der Linde recognize two critical principles of good environmental regulations; first, create maximum opportunity for innovation by letting industries discover how to solve their own problems; and second, foster continuous improvements, do not lock in on a particular technology or the status quo. Ultimately, they contend, the resource productivity model, rather than the pollution-control model, must govern decision making. 

They suggest a list of principles for regulatory design that will promote innovation, resource productivity, and competitiveness.

  1. Focus on outcomes, not technologies.
  2. Enact strict rather than lax regulations.
  3. Regulate as close to the end user as practical, while encouraging upstream solutions.
  4. Employ phase-periods.
  5. Use market incentives.
  6. Harmonize or converge regulations in associated fields.
  7. Develop regulations in sync with other countries or slightly ahead of them.
  8. Make regulatory processes more stable and predictable.
  9. Require industry participation in setting standards from the beginning.
  10. Develop strong technical capabilities among regulators.
  11. Minimize the time and resources consumed in the regulatory process itself.

Palmer, Oates and Portney (1995) disagree with Porter and van der Linde�s claim that environmental regulations are necessary to spur the innovation that will add to profits. They assert in a global economy, with increased foreign trade, wider markets in nearly every industry and thriving merger and acquisition activity, surviving firms are lean, mean and innovative without regulation.

Pollution Prevention vs. Compliance

Boyd�s (1998) study on-the-other-hand supports Porter and van der Linde. Boyd frames the issue from the point of view of a "pollution prevention" (P2) approach versus a "compliance driven" approach. Boyd�s case study analysis concludes regulations and the avoidance of regulatory costs were in all cases a driver that motivated the firms� search for pollution prevention. And, a firm�s failure to pursue P2 is usually best explained by a project�s lack of expected profitability.

Boyd notes, the problem is not how to convince firms of the profitability of a P2 investment, once detected private sector firms are capable of evaluating for themselves the profitability of a P2 opportunity. Instead, a more fruitful approach is to focus on barriers to P2s profitability.

What policy changes are likely to enhance P2�s profitability? First, the cases reveal regulatory barriers of varying significance. The desire to experiment with P2 innovation is often impeded by rigid media and technology specific regulations. The rigidity of many regulations is understandable given the difficulties of environmental enforcement. However, efforts to promote "regulatory flexibility" and innovations should be embraced as a means to foster the corporate sectors ability to develop environmental innovations.

Boyd adds a caveat. Care must be taken not to confuse "flexibility" with lack of regulatory stringency. Flexible permitting, at the aggregate level, can be very stringent. But flexible permitting allows firms to meet even stringent aggregate targets in the way they best see fit.

Second, performance-based - as opposed to technology-forcing - regulation is likely to be a better way to promote private sector P2 innovations. P2 increasingly calls for firms to engage in the redesign of complex products and processes in ever changing product markets. Performance-based regulations, which allow greater latitude for technological experimentation and longer time-horizons for compliance, allow firms to meet targets in the largest variety of ways. In contrast, existing regulations feature substantial regulatory influence over technologies used by firms. Not only are specific technologies often mandated, but technical constraints also arise because emission standards are applied to individual substances rather than broader categories of effluent. Because of this, limits on the output of a single substance can significantly constrain the design or redesign of a production process.

Furthermore, because of an emphasis on specific abatement procedures for specific effluent streams, firms must continually re-permit as their production processes change. This re-permitting is a costly and time-consuming exercise in and of itself, particularly for firms whose production processes must change frequently. Therefore, performance-based environmental permitting should be explored as a means to lower these barriers and constraints.

Boyd acknowledges, performance-based regulation is not without limitations of its own. Monitoring and enforcement issues are a particular problem. The uniformity or inflexibility of standard command and control regulations is an attribute, since it is easier to monitor technology or emissions standards that are fixed and common to many firms. However, given the unique characteristics of most firms, the constrains imposed by uniform standards should be viewed as a potentially significant barrier to P2 innovation.

Finally, Boyd contends, flexible, performance-based regulation has another important consequence - namely, it enhances the private sector�s demand for improved environmental accounting information. Rigid regulations do a particularly poor job of encouraging the private sector�s demand for, and development of, better environmental accounting information and methods. End-of-pipe, single-media, and technology-forcing regulations leave firms with little reason to innovate, and therefore even less reason to collect information that would reveal "environment-driven financial opportunities."

Better information helps firms only if they have the flexibility to act on - and benefit from - better information. Regulatory flexibility, by expanding the technological options open to firms, increases the value of information relating to those options. In the end, regulation that allows for a wide variety of innovative solutions is likely to be the best way to induce firms to invest in better environmental information and decision-making.

Types of Investments Which Promote Environmental Performance

New survey evidence has shown the effects of regulation, plant-level management policies and plant/firm characteristics on the environmental performance of firms. First, small enterprises are controversial in the literature on environment and development. The assumption is that pollution from large factories may overwhelm the absorptive capacity of the environment. Shumacher (1989) argues small plants are the agents of choice for sustainable development. In contrast, Beckerman (1995) argues that small factories are pollution intensive, costly to regulate, and, in the aggregate, far more environmentally harmful than large enterprises. Recent policy reports from the World Bank and other international institutions have tended to side with Beckerman, at least in noting the potential problems associated with small enterprise pollution (EA,1997; ENV,1997).

The study by Dasgupta, Hettige and Wheeler (1997) underscores the importance of strengthening enforcement. They noted how stricter enforcement raises the price of pollution and provides an important incentive for pollution reduction. However, their results also highlight the potential of programs that promote more effective environmental management and training within plants. The following are their principle findings:

  1. Process is important. Plants which institute ISO 14000-type internal management procedures exhibit superior environmental performance.
  2. Mainstreaming works. Environmental training for all plant personnel is more effective than developing a cadre of environmental specialists. Assigning environmental tasks to a general managers is more effective than using special environmental managers.
  3. Regulatory pressure works. Plants which have experienced regulatory inspections and enforcement are significantly cleaner than their counterparts.
  4. Public scrutiny promotes stronger environmental policies. Publicly traded firms are significantly cleaner than their privately held counterparts.
  5. Size matters. Large plants in multi-plant firms are much more likely to adopt policies which improve environmental performance.
  6. OECD influences do not matter. Analysis of pollution control in developing countries generally assume that plants linked to the OECD economies have superior environmental performance. However, there was no significant association with any OECD linkage: multinational ownership, trade, management training or management experience.
  7. New technology is not significantly cleaner. There was no evidence that plants with newer equipment have better environmental performance, once other factors are accounted for.
  8. Education promotes clean production. Plants with more highly educated workers have significantly greater environmental management effort and performance.

 

Small And Medium-Sized Enterprises

Definitions of what is meant by SME depend on where the enterprise is located and what standard of measurement is applied. For statistical and policy purposes, most countries use either an employment measure or a monetary measure (capitalization, sales, etc.) of size, or both. Generally, definitions vary widely. Under most statistical definitions, an SME can be as large as 500 employees or as small as zero employees. SMEs are not homogeneous, and so in terms of size it is useful to distinguish a range, as follows:

Micro or very small

Small

Medium

Large

0-19 employees

20-100 employees

101-500 employees

501+ employees

 

Definition of SMEs in Philippines and Taiwan.

By Employment

By capitalization/assets or sales

Philippines

Cottage 1-9

Small 10-99

Medium 100-199

Assets:

Micro:<P150,000

Cottage: P150,000-1.5million

Medium:P15-60 million

Taiwan

 

 

 

 

::::::

Mining, manufacturing and construction: <NT$40 million in invested capital;

Manufacturing and construction: <NT $120 million in sales;

Other industries, such as services: NT< 40 million in sales.

Small and medium-sized enterprises (SMEs) in Asia have played an important role in the economic development of these countries. However, FDI by SMEs and in SMEs is still a small part of total FDI flows in Asia; at most it makes up only about 10 percent or less of FDI inflows in many Asian countries and 10 to 20 percent of FDI outflows for major Asian investors, for instance, South Korea (UNCTAD, 1998).

Nevertheless, in the Asian region SMEs typically make up around 95 percent or more of enterprises, they create between 40 and 80 percent of employment, between 30 and 60 percent of GDP, and provide around 35 percent of direct exports (UNCTAD,1998).

The total environmental impact of SMEs is unknown. A figure of 70 percent is repeated frequently as SMEs contribution to pollution levels. Although unsubstantiated, it is quoted widely and seems to carry some weight. Generally, national economic statistics on SMEs do not tally with data collected on emissions, waste generation and effluents from firms, so it is doubtful whether smaller firms� contribution to pollution can be calculated at all. In fact, there is little hard data to determine the sector�s contribution to pollution load. The sector is under-researched. Little is known about its attitude to and control of its environmental impact (Hilary, 2000).

While at the national level their combined impact is unknown, in pollution terms their significance at the local level can be important. (Merritt, 1998; Holland and Gibbon, 1997; Rowe and Hollingsworth, 1996) reveal that small firms recognize that there are pressures to improve their environmental performance. Holland and Gibbons (1997) suggested that many small firms believe that their environmental impact is in proportion to their activities, i.e. small and minimal, and they found that SMEs responded quickly to environmental issues with relatively small impacts, but not to greater impacts.

Although SMEs make an important contribution to the economy both nationally and locally, they fall behind their larger counterparts in terms of environmental activity. However, SMEs are both concerned about the environment and are willing to address their responsibilities (Merritt, 1998; Smith and Kemp, 1998). They are also aware of the benefits of improved environmental performance in terms of improved customer relations, cost savings and competitive advantage.

There is a substantial gap between environmental awareness of SMEs and the business benefits they can gain. Merritt (1998) found that SMEs had little knowledge in the field of environmental management and that they had not introduced formal practices to manage the environmental performance of their business. In the study by Smith and Kemp (1998) they found that SMEs awareness of environmental legislation directly affecting their companies was poor and there was a general perception that legislative compliance would be costly.

Efforts by the government and business-support organizations to raise awareness of the cost-savings and competitive advantage that result from improved environmental performance have had little impact on SME behavior (Merritt, 1998). Despite the difficulty in engaging and influencing SMEs, they "would" be persuaded to change their environmental behavior by regulators, customers and insurers (Smith and Kemp, 1998). The supply chain was also considered to be a powerful tool in this respect.

The role of business support organizations in providing environmental management training and support was emphasized by Rowe and Hollingsworth (1996); however, SMEs made little use of these services, even when free or subsidized (Smith and Kemp, 1998). SMEs generally agree that they require external assistance to meet their environmental responsibilities, but this assistance should be locally accessible and include best-practice case studies relevant to the size and sector of the company. More work needs to be done to demonstrate to SMEs the cost savings they can make, including the avoidance of potential costs represented by environmental liabilities.

If generalizations can be made about SMEs, a vast and diverse sector, they are:

  • Largely ignorant of their environmental impacts and the legislation that governs them.
  • Oblivious of the importance of sustainability.
  • Cynical of the benefits of self-regulation and the management tools that could assist them in tackling their environmental performance.
  • Difficult to reach, mobilize or engage in any improvements having to do with the environment.

Informal Sector

The informal sector is large in Asia and has grown as a consequence of population growth, rural - urban migration, and regulation. Although often characterized as a collection of street merchants, the informal sector actually includes many pollution intensive activities such as leather tanning, brick and tile making, textile dying, dyestuff manufacturing, printing and metalworking. Given the sheer number of such firms in Asia, the aggregate environmental impacts can be very significant (Bartone and Benavides, 1993).

But controlling pollution created by the informal firms is especially difficult for a number of reasons. By definition, informal firms have few preexisting ties to the state. In addition, they are difficult to monitor since they are small, numerous, and geographically dispersed. Finally, they sustain the poorest of the poor. As a consequence, they may appear to both regulators and the public as less appropriate targets for regulation than larger, wealthier firms. Given these constraints, the application of conventional regulatory approaches is bound to be problematic, if not completely impractical (Blackman, 1999).

Blackman (1999) analyzed a number of country studies, the following is a summary of his results.

Policy Lessons

 

All

  • Where informal polluters are numerous or well organized, only combinations of policies with low private costs are likely to be feasible.
  • Private sector-led initiatives with strong public sector support may be best suited to informal-sector pollution control

Command & Control

Process standards

 

  • Registering informal enterprises and peer monitoring are common strategies for enhancing enforceability.
  • Registration alone is not sufficient to facilitate enforcement.
  • Third party monitoring is a necessary condition for enforcement and appears to be the most effective when carried out by local organizations.

Relocation

  • Imposes relatively high costs on polluters - including costs of purchasing land, rebuilding plant and equipment, and transporting labor and materials - and is therefore likely to meet with considerable resistence.

Economic Incentives

 
   

Green taxes

  • Easily evaded when informal polluters buy dirty inputs.

Green subsidies

  • Without careful monitoring, may simply encourage the resale of subsidized goods.

Boycotts

  • Enforcement is highly problematic.

Government Investment

 

Clean Technologies

  • Need not be cost-reducing to diffuse widely.
  • Subsidies to early adopters may heighten competitive pressures for further adoption.
  • Must be appropriate: affordable and consistent with existing levels of technology.
  • May be dominated by second-best strategies with lower environmental benefits and lower private costs.

Information-Based

 

Educational programs

  • May affect polluters� input choices and facilitate community pressure.

Conclusions

Environmental Performance and Environmental Management

  1. The level of environmental degradation from industrial activity is closely linked to the production efficiency of firms and their capacity to innovate.
  2. Environmental damage tends to be greatest in low-productivity operations working with obsolete technology, outdated work methods, poor human resource development, inefficient energy use and limited capital.
  3. There is much scope for firms to improve their environmental management systems by adopting environmental management systems that optimize process control, continuous improvement and organizational learning.
  4. Environmental performance is a function of the use of clean technology within an efficient environmental management framework.
  5. The evidence on the actual impact of FDI and the ability of host countries to protect their environment is mixed, for example, the impact of foreign firms is significantly different from that of domestic firms. In general, the issue of whether domestic vs. foreign ownership of facilities makes a significant difference when it comes to environmental performance is an unresolved issue. Other factors - such as size, age of plants, skill levels, technology, host country regulation � may well be as important or more so.
  6. Differences between foreign affiliates and domestic firms were found in the area of environmental management. Foreign-owned and joint venture firms are more likely to have a formal environmental policy, and to have designated a specific individual to take responsibility for environmental matters at the plant level. They are also more likely to have pursued or be pursuing international certification. This point indicates a more active pursuit of ongoing, incremental improvements in environmental performance in foreign affiliates relative to domestic firms.
  7. Foreign Direct Investment

  8. Foreign direct investment is the largest type of investment being made by MNEs, while portfolio investments in publicly traded shares are the smallest and most volatile.
  9. The greatest potential leverage is over foreign direct investment given its longer time frames, relative stability, and more direct environmental effects than most other private instruments.
  10. Integrating environmental considerations into investment promotion programs will not drive most foreign direct investors away. In fact, such integration can help optimize economic development and environmental protection, and may actually help attract investors for the following reasons:
    1. Non-environmental factors (access to resources, markets and labor) are the most important considerations for most foreign direct investors when deciding to invest.
    2. Most foreign direct investors prefer consistent application of clear investment frameworks, including environmental standards, to uncertain rules.
    3. Poor local environmental conditions can reduce business productivity and a location�s attractiveness to foreign investors.
  11. A crucial policy intervention point for governments is at the time of entry of an MNE, especially when it comes to large-scale projects and particularly in pollution intensive industries.
  12. Locational Decision

  13. Studies suggest that some host countries are willing to use lowering of environmental standards as a tool with which to attract FDI, or hesitate to raise them. This approach is a problematic response to the competition for FDI, if only because the empirical evidence shows that a number of other factors are more important for FDI locational decisions. In addition, in the new context, there is now an incentive for companies not to take advantage of such regulatory inducements.
  14. For most firm level locational decisions, environmental regulations did not rank among the most important factors considered; when such regulations were of some significance, uncertainties about when the necessary permits would be obtained were more important than spatial variations in direct costs.
  15. Environmental regulations have no consistent effect on the size of the search area, the number of sites considered, the sizes of facilities built, or the decision to expand existing plants versus building new plants.
  16. Environmental Regulations/Standards

  17. There is little statistical evidence of either a "pollution haven" or "a race to the bottom." However, pollution zones of poorer people where firms perform worse and where regulations are less effective may exist.
  18. Higher incomes and education empower local communities to enforce higher environmental standards.
  19. Typically MNEs adhere to OECD standards in their developing country operations in an effort to avoid expensive retrofitting in the future.
  20. The current "no rules" governance system on investment has created intense competition among governments for FDI creating negative environmental impacts.
  21. In an effort to secure FDI governments are "stuck in the mud" or reluctant to raise environmental standards for fear they will lose investors.
  22. Competitiveness and Technology Innovation/Transfer

  23. MNEs are important sources for both technology innovation and technology transfer. FDI undertaken by MNE�s is likely to result in some standardization of "best practices" among an MNE and its foreign affiliates, it should also promote positive spillovers effects on the technological character of national firms and their suppliers.
  24. Strict standards can and should promote resource productivity. The problem with the current environmental regulatory regime is the way in which standards are written and the sheer inefficiency with which regulations are administered. For example, regulations which concentrate on cleanup instead of prevention; regulations mandating specific technologies; regulations setting compliance deadlines that are unrealistically short and subjecting companies to unnecessarily high levels of uncertainty. In cases where regulations permitted a more flexible approach, companies were able to focus on the production process itself, not just on the secondary treatment of wastes.
  25. Two critical principles of good environmental regulations; first, create maximum opportunity for innovation by encouraging industries to discover how to solve their own problems; and second, foster continuous improvements, do not lock in on a particular technology or the status quo. Ultimately, the resource productivity model, rather than the pollution-control model, must govern decision-making. New technology is not significantly cleaner.
  26. There is no evidence that plants with newer equipment have better environmental performance, once other factors are accounted for. Education promotes clean production. Plants with more highly educated workers have significantly greater environmental management effort and performance.
  27. Regulations and the avoidance of regulatory costs is typically a driver that motivates a firm�s search for pollution prevention. And, a firm�s failure to pursue P2 is usually best explained by a project�s lack of expected profitability.
  28. Regulatory flexibility" and innovations should be embraced as a means to foster the corporate sector�s ability to develop environmental innovations.
  29. Performance-based � as opposed to technology-forcing � regulation is likely to be a better way to promote private sector P2 innovations.
  30. SMEs

  31. Small factories are pollution intensive, costly to regulate, and, in the aggregate, far more environmentally harmful than large enterprises.
  32. If generalizations can be made about SMEs, a vast and diverse sector, they are:
    1. Largely ignorant of their environmental impacts and the legislation that governs them.
    2. Oblivious of the importance of sustainability.
    3. Cynical of the benefits of self-regulation and the management tools that could assist them in tackling their environmental performance.
    4. Difficult to reach, mobilize or engage in any improvements having to do with the environment.

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