Effect of Environmental Management Measures on International Trade and Innovation

Yujing WANG School of Economy

Tianjin University of Commerce Tianjin, P.R. China

yjwang0303@yahoo.com.cn

Abstract— Environmental management measures are commonly used in international trade. Though they may have some restricting effects on export trade volume in short run, they can stimulate environmentally sound technology innovation in the long run. The innovation offset trigged by stringent environmental regulations will improve the firms international competitiveness.

Keywords- environmental management measures;trade; innovation; environmentally sound technologies

I. INTRODUCTION Due to the environmental externality of production, social

cost is higher than private cost while the social benefit is less than the private cost. To protect environment and natural resources, many countries implement various environmental management measures. Some argue that those environmental regulations will limit the trade flows and will limit the firm competitiveness. Though having some restricting effects on trade, environmental management measures and regulations will finally induce technology innovation in exporting country. It is especially important for developing countries to understand the stimulating effect on innovation and to implement diversified innovation so as to coordinate trade, environment and economy.

II. ENVIRONMENTAL MANAGEMENT MEASURES Environmental Management Measures (EMMs) refers to

those policies and measures regulating firms’ production activities in order to coordinate environment and economy. Normally, EMMs comprise of three sets: regulatory instruments, economic instruments and voluntary compliance or moral suasion.

Regulatory instruments are also called command and control instruments (CAC), which will restrict production process, consumption and producer’s negative externality by means of law, regulation, standard and administrative guidelines. Most common regulatory instruments are emission standards, environmental quality standards, product control, panning and building controls and extraction restrictions [1]. Due to the directness (clearly specified targets) and the conformity with ethical sense, regulatory instruments are advantageous to be adopted by the government. However,

measuring and monitoring pollution are quite complicated and some times can be problematic.

According to polluters pay principle, economic instruments include environment fee or tax, emission charges, tradable/transferable emission permit, and abatement subsidies or environment investment and loan which aiming to create incentive to protect environment.

Voluntary compliance consists of environment management systems such as environment standards, production packing standard, waste recycling, eco-labeling. Environment standards are the measures governing natural and manmade environment including requirements to protect health and safety of human and animal and plants and processing and production methods. Quality environment standard and processing and production methods (PPMs) are the common style of environmental standards. The former means that the quality of products must conform to environmental standard and can not have negative effect on environment when storing, using, consuming and dismantling. Forbidding using Freon as refrigerants in manufacturing refrigerators is one of the examples. PPMs control the inputs and outputs of products and require adopting environmental protecting production methods to reduce the green gas emission.

ISO 14000 environment management standard is well acknowledged owing to its transparency and coherence. ISO 14000 consists of Environmental Management System (EMS), Environment Auditing (EA), Environmental Labeling (EL), Environmental Performance Evaluation (EPE), and Life Cycle Assessment (LCA). In the operating, it is a dynamic managing process through material, energy, equipment, production and inspecting procedure and adheres to planning, doing, checking and acting [2]. Aiming at predicting and reducing or eliminating pollution, ISO 14000 can help the enterprises improve environmental quality and promote the harmony between environment and economy.

Environmental labeling or eco-labeling is a voluntary approach to environmental performance certification and labeling that practiced around the world. It is printed on a package or product that identifies a product complies with specified environmental performance criteria or standards. Environmental labeling or eco-labeling is awarded by an impartial third party organization and provides environmental

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information regarding some attribute of the product from its life cycle (from resource extraction to final disposal) including attributes such as recycled content, reduced packaging, non-toxic, etc.

The International Organization for Standardization (ISO) has identified three types of voluntary environmental labels.

Type I labeling programs are based on environmental multi-criteria selected by an independent third party. They authorize the use of environmental labels on products indicating overall environmental preference of a product within a particular product category based on life cycle.

Type II labeling programs are informative environmental self-declaration claims.

Type III labeling programs are voluntary that provide quantified environmental data of a product, under pre-set categories of parameters set by a qualified third party and based on life cycle assessment, and like Type I labels, require third party certification[3].

Usually, Type I and Type II environmental label are established for common markets and consumers. Type III is for professional purchasers. The application of environmental labeling or eco-labeling has many advantages. They are helpful for economizing energy and reducing the air and water pollution by using of materials. They will provide information on usage, installment and recycling for the consumers and will limit employing toxic materials in production. The most common adopted environmental labels are Blue Angel (Germany), The Nordic Swan (Northern Europe), Environmental Choice Program (Canada), Eco Mark (Japan)and The EU Flower, etc.

III. TRADE EFFECT OF ENVIRONMENTAL MANAGEMENT MEASURES

A The substitute effect of environmental label for tariff In the implementation of environmental labeling system,

the transparency, openness and easy obtaining of information on package standard and recycling are very important for the effective execution. In addition, whether environmental labeling has formed non tariff barriers is quite controversial. In fact, the adopting of environmental labeling system has substituted for tariff to some degree in international trade. Suppose there are two countries, X and Y; country X is exporter while country Y is importer. Country X enforces environmental labeling system instead of imposing import duty. In Fig.1, PW is the world price and PT and PE are the prices when imposing tariff and adopting environmental label respectively. When PE after environmental labeling is higher than the price of levying tariff, the consumer surplus of importing country reduces the area of (B+H) while the producer surplus increases the area of B. The national income and total surplus reduce the area I and the area (I+H) respectively. It is obvious that the consumers worsen off and producers better off after enforcing environmental labeling system [4]. The substitute effect of environmental label for tariff will weaken when PE is less than PT.

Figure1. The substitute effect of environmental label for

tariff

B Trade restricting effect on exporter As shown in Fig.2, before implementing EMMs by importing country, the export volume is (Q2-Q1) and the export value is (Q2-Q1) × P1. After implementing environmental measures, the production cost increases and the supply curve S shifts upward to S1 as the exporting country must meet the importer’s environmental standards. The output in exporting country is Q3 and the export volume and value become (Q3-Q1) and (Q3-Q1) ×P1 respectively. It can be seen that (Q3-Q1)×P1＜(Q2-Q1)×P1.Therefore, EMMs restrict the exporting country’s trade volume.

Figure2. Trade restricting effect on exporter

Besides restricting the export volume, environmental

measures will influence export price. The inspection and certification fees result in the increased cost of exports cost and decreased market competitiveness. Without tariff or other non tariff barriers, the unit price of exports in importing country market is P1 and the cost is C. With the environmental barriers related expenses E, the export cost has increased (C+E). If (C+E)＜P1, the unit proceeds of exports will decrease C while if (C+E)＞ P1, the exporter will withdraw. Therefore, the EMMs will influence both the exporting volume and price and reduce the trade flow.

S

D

P

Q

PW

PT

PE

A

B

E

G H

I J F

S S1

D Q

P

Q1 Q3 Q2

P1

C Trade restricting effect on importer The trade effect on imports is mainly embodied on the

declining demand on exports without environmental certification or label. In Fig. 3, S is the supply curve in exporting country and D is the demand curve in importing country. Without environmental regulation, the equilibrium price and quantity are PE and PQ and the trade volume is (PE×QE) respectively. After environmental measures, the demand to the product reduces to D1 due to the demand preference to environmental friendly products in importing country. The importing equilibrium price and quantity change to P1 and Q1 while the importing trade volume shifts to (P1 × Q1) accordingly. It is obvious that (P1×Q1) ＜(PE×QE). If the EMMs are so strict that the exporting products cannot meet the environmental requirement, the importing demand will continue to decline, say, to D2. At this point, the demand will be zero and exports will withdraw. The trade restricting effect will become prohibiting effect [5].

Figure3. Trade restricting effect on importer

D The long run dyanmice effect In short run, EMMs has restricted trade flow and

negatively influenced the net welfare. However, in long run, the technology progress and increasingly strong environmental awareness of exporters will breakthrough the environmental barriers. According to Michael V. Posner’s technological gap model, technology change is a dynamic ever-changing process. Suppose EMMs appear in the product standardization stage, the exporting volume will decline due to the influence of EMMs. But if exporting country executes technology innovation, the exporting volume will augment. Repeating this process, technology innovation will promote the exporting volume increase. Furthermore, the dynamic effect will shift S rightward and environmental friendly product will shift D rightward and thus new enlarged trade volume will generate.

IV. INNOVATION OFFSET OF EMMS STIMULATION AND ENVIRONMENTALLY SOUND TECHNOLOGY

Pollution is the emission of toxic materials to environment in the production process and non-optimal use of resources and

energy. According to Porter and Van der Linden, faced with the strict EMMs and higher abatement costs, firms will invest in innovation activities to find new ways to meet the EMMs requirements. The resulting new production process or new product specifications will reduce pollution and lower production costs at the same time [6].

EMMs can stimulate the enterprises to raise resource efficiency and to reduce the waste emission. In short run, the new production method will raise the costs. However, with the technology progress, technology innovation can improve the production efficiency and reduce the long run production costs. EMMs can also spur the corporations to discover ways and means that transforming the wastes to saleable products and bring proceeds. Consequently, the strict EMMs can bring innovation offset, which proceeds will exceed the EMMs cost and result in the improved firm competitiveness.

The innovation offset triggered by EMMs can be categorized as product offset and production process offset. The former means EMMs not only reduce the pollution level but also produce more high quality products which are low-cost and safe or can be recycled or resold. The latte refers to EMMs can bring the improvement of production efficiency. All the offsets are co-related and when one purpose is achieved so are the others. The way firms respond to EMMs is very important. Businesses innovate in response to tighter emission regulation in order to modify products and process and to generate less effluent air or waste. One example is EU chemicals regulations. A Wildlife Fund report on the effect of EU chemicals regulations on innovation found that the regulations were likely to promote innovation by encouraging the replacement of risky and less sustainable chemicals with safer alternatives [7].

Many empirical studies indicate that the ratio of strict environment measures and regulations costs in the total cost is not as high as imagined. In US manufacturing sectors cost structure, the costs of executing environmental regulation only account for 1% to 3% in the total costs. The US data of more than 20,000 manufacturing firms show that the enterprise profit with bad environmental protection performance is lower than that with good environmental protection performance. It is indicated that the stringent and tighter environmental measures have no negative influence on competitiveness [8].

The key to this argument is that environmental regulations can stimulate enterprises innovation by changing production method. The first adopting environmentally sound technology will have first mover advantage and enhance competitiveness. Indeed, this innovation can allow an industry to be more competitive internationally because the resultant products are in greater demand.

The concept of environmentally sound technologies (ESTs) was first put forward by Brawn and Wield in 1994[9]. The definition of Environmentally Sound Technologies is based on Agenda 21, which arose from the UN Conference on Environment and Development (UNCED), otherwise known as the Earth Summit, held in 1992. ESTs compass technologies that have the potential for significantly improved environmental performance relative to other technologies. These technologies have the following characteristics [10]:

S

D

D1 D2

E PE

P1

Q1 QE

P

Q

--protect the environment;

-- are less polluting;

--use all resources in a more sustainable manner;

--recycle more of their wastes and products; and

-- handle residual wastes in a more acceptable manner than the technologies for which they are substitutes.

Environmentally sound technology innovation (ESTI) integrates the ideas of ESTs and innovation and is the dynamic process from R&D to production and to technology innovation diffusion. ESTI comprises clean energy technology, clean production and technique, end-pipe pollution disposal and recycling. It can be classified as two types. The one is environmental product innovation, which means to develop energy and resource saving, no or low hazardous or recycling products. The other is environmental technique innovation, which refers to clean production technology and abatement technology that can reduce pollution on environment. Environmentally sound technology innovation is not a mere technological concept but reflects the eco-centered value and coordinates the technology innovation to the ecological system so that the firms can harmonize economic and ecological benefit and can achieve sustainable development.

V. CONCLUSION Environmental management measures can be applied in

many aspects such as air, water and solid waste, sanitation, land and traffic congestion etc,. The emergence of environmental management measures is the reflection of pursuing harmonious relationships between the human beings and nature. In international trade, they should not be regarded

as obstacles to exporting countries unless they become the disguised and discriminatory trade restriction. Innovation, especially environmentally sound technology innovation can upgrade the industry structure and competitiveness. In order to protect environmentally sound technology innovation, it is essential to establish proper institution to protect intellectual property rights. This will ensure the innovator can obtain innovation offset benefit and get rid of free riders.

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