The Environmental Goods and Services Industry - CiteSeerX

January 2008

The Environmental Goods and Services Industry

Bernard Sinclair-Desgagné1 HEC Montréal, CIRANO, CIRAIG École polytechnique - Paris

This paper examines the role of pollution abatement goods and services suppliers in the implementation of environmental policies. It first provides a short history of the sector, in order to identify its main segments and understand their specific structure. The impact of particular policy instruments, such as emission taxes, abatement subsidies and technical standards, on key features of industry structure (notably the size and elasticity of demand, and the degree of concentration), is then studied, together with the subsequent consequences on compliance costs. Conclusions are drawn for the appropriate design of environmental policy and for current trade negotiations concerning the liberalization of environmental services. JEL Classification no.: Q50, L51, L69, L89

1

This document was mostly written while I was visiting the London School of Economics and the Judge Business School of the University of Cambridge in academic year 2007-2008. Aida Alaoui, Guillaume Carriou and Samer Hobeika had previously provided diligent and able research assistance at HEC Montréal and CIRANO. My view of the subject owes a lot to the ongoing research collaboration with Joan Canton, Maia David and Alain-Désiré Nimubona. It also benefitted from the suggestions and comments of several colleagues and seminar participants, in particular Brian Copeland, Guy Drouin, Mathieu Glachant, Olivier Godard, Anthony Heyes, Andrew Leach, Philippe Mahenc, Michel Moreaux, Daniel Normandin, Martin Pesendorfer, Réjean Samson, and John Sutton. I am finally grateful to Henk Folmer and Tom Tietenberg for inviting me to write this paper, and for subsequent suggestions that significantly improved its content and presentation. All errors and eventual omissions, however, are mine.

2

“The domestic industry that provides environmental products and services is one of the least understood sectors within American industry, despite its size and economic importance. Yet, its influence on environmental quality and sustainable U.S. economic growth is great.” – Berg, Ferrier and Paugh (1998, p. 7)

1. Introduction Over the past decades, the provision of goods and services to abate pollution or manage environmental resources has by and large become the core business of specialized private firms. This so-called environmental goods and services (EGS) industry is now matching the aerospace and pharmaceutical sectors in size, with an estimated 2005 global market of US $ 653 billion that is expected to reach US $ 776 billion by 2010.2 Accordingly, government bodies and policy makers are now paying extra attention to it: not only does it account for a significant number of jobs, but it is also seen as a key ingredient of industrial competitiveness, trade advantage and social stability in a world where the pressure to protect environmental resources is mounting.3 Apart from a handful of papers, however, the economic literature has so far remained startlingly silent about the environmental goods and services industry. As David and Sinclair-Desgagné (2005, p. 142) pointed out, “(…) pollution abatement is consistently assumed to be set only by polluters, based in turn on relevant technological, regulatory or output market considerations, but absent any explicit market or bilateral relationship with actual suppliers.” This enduring discrepancy between the prevailing mindset in the profession and reality makes one wonder if, after all, economists should be interested in studying the eco-industry. Actually, there are a number of reasons:

2

These figures are from Environmental Business International (2006), a private firm which has been collecting and publishing data on the environment industry since 1988. As I shall explain shortly, other organizations might use different industry definitions and come up with different statistics. The numbers shown here give nevertheless a reliable order of magnitude for the size and growth of the EGS market.

3

According to UBS/DIW (2004), a German think tank, the eco-industry employed 1.5 million people across the European Union in 2002, a figure which then accounted for 3.8% of total employment. Representative policy papers about the EGS industry in different parts of the world include the European Commission (1999), International Trade Centre (2001), US Department of Commerce (2001), Katti (2005), Kennett and Steenblik (2005), People’s Daily Online (2006), and Europe Innova (2006).

3 • To better understand compliance costs. Such costs are complementary to enforcement costs (whose role has been emphasized by Heyes 2000). They are primarily determined by technology, a subject on which there is already a substantial body of knowledge (which is partly covered in U.S. Congress 2004, for instance). They depend as well on organizational design and capabilities, a topic that has received increasing attention since the beginning of the 1990s (see, e.g., Reinhardt 2000 or Lesourd and Schilizzi 2001). But they also relate to the prices polluters have to pay when they outsource abatement products and services, prices which rest on the structure of EGS markets. • To advance environmental regulation and policy. Environmental regulation is obviously the main driver of demand for environmental goods and services. As we shall see below, each policy instrument (emission taxes and quotas, subsidies, technical standards, voluntary agreements, etc.), through its specific impact on demand for EGS, commands the size and number of competing environment firms, hence the market prices of environmental measures and the polluters’ ensuing abatement efforts. Proper regulatory design would now require taking this into account in order to achieve the objectives of environmental policy. • To grasp and foster environmental innovation. There is a large and expanding literature on technological change and the environment, which centers on polluting firms (see Jaffe et al. 2003 for a survey). More than ten years ago, however, Lanjouw and Mody (1996) observed that a worldwide proportion of only 20% of all the patents introduced to abate pollution came from the polluters themselves. This suggests that environmental innovation relies rather heavily on a standalone ecoindustry. • Because policy makers and the public at large finally expect, not unreasonably, environmental economists to know something about the supply of EGS. Considering its fair size and growing relative weight in the global economy, the eco-industry certainly deserves as much attention from scholars as, for instance, the aerospace, the telecommunication or the pharmaceutical industries. Sound industry studies would particularly benefit competition authorities, and also inform current trade negotiations on the liberalization of environmental services.

4 This paper’s raison d’être is to further substantiate these motives. The following section highlights certain definitions and stylized facts so as to fix ideas for economic modelling and future empirical work. Section 3 next considers the somewhat necessary revision of environmental policy, namely the choice, design and combination of regulatory instruments like emission taxes, subsidies or pollution quotas in the presence of an eco-industry. Section 4 then turns to the existing theoretical analyses of particular elements of industry structure, such as entry or mergers and acquisitions. Section 5 takes on the important and timely subject of international trade of EGS. Section 6 concludes finally the paper, stressing some specific research questions. 2. What is the eco-industry? This part of the paper will now sketch some of the main features of the EGS industry. The upcoming subsection first draws a brief (and rough) history of the sector. Attempts to define the eco-industry and its main segments are next presented and discussed briefly. Some current figures and trends are finally given and commented upon. 2.1 A short history Environmental activities, such as waste disposal, cleanup and reuse, are probably as old as the advent of the first human settlements, 12 000 years ago. Back in the classical period, Ancient Rome also had sophisticated water and sewage systems. But the habit of outsourcing EGS delivery to private parties truly began with the second industrial revolution, at the end of the nineteenth century. In response to dreadful living conditions and recurrent epidemics in their overcrowded growing cities, public authorities in Europe and North America would then often turn to public-private partnerships in the vital largescale management of urban trash and wastewater. In Europe, most large cities had implemented regular garbage collection by the end of the 1890s.4 Permission to recover domestic waste was frequently granted to some farming associations which would use it as compost. Two decades later, as farmers

4

The usual French word for garbage can – “poubelle” – comes actually from Eugène Poubelle, the top public official (or “Préfet”) responsible for the Paris region who, in 1884, mandated the use of standardized garbage cans throughout his jurisdiction.

5 switched to chemical fertilizers, local communities resorted regularly to hiring some of the newly constituted truck companies, which would then burn collected litter in the first existing incinerators or in open landfills. Municipal garbage collection and treatment finally came to be privatized to a large extent, although the degree of private firms’ participation still varies across activities and countries (see Table 1). Country

Collection

Treatment

Spain Germany U. Kingdom France Holland Italy Sweden Finland

75 60 35 50 30 40 45 100

90 90 80 70 40 25 10 5

Table 1. Percentage of the total weight of domestic waste managed by private firms (Davies 2003)

In the U.S., Col. George Waring, the newly appointed Streets Cleaning Commissioner of New York City in 1894, organized solid waste management around engineering units operations such as street sweeping, refuse collection and transportation, resource recovery and disposal (Louis 2004). This approach was followed nationwide, encouraging the introduction of motorized street sweepers and other innovations. New York City stopped collecting commercial waste in 1957; this forced businesses to contract private companies to take their garbage away. Municipal solid waste across the nation was henceforth largely managed by municipalities, which (as in Europe) kept relying to a variable extent on private service providers. Initial incumbents in the waste management industry had several other business activities. The steady augmentation of the volume and diversity of trash after World War II made this less necessary. The industry is now served by many specialized small and medium-size enterprises, together with a few large firms - such as Waste Management Inc., Allied Waste Industries, Onyx, Sita, Remondis, etc. - accounting for more than 50%

6 of the global market.5 This peculiar industry structure – a multi-product oligopoly with a competitive fringe – can be attributed to certain factors. First, thousands of municipalities and local communities form a sizeable pool of heterogeneous customers, allowing for sustainable market niches while conferring at the same time a competitive advantage to a few large suppliers able to generate economies of scope. Second, the industry lives on specific entry barriers, some raised by organized crime (Carter 1999), some due to laws and regulations which often set severe constraints on treatment and disposal (particularly on the number and location of landfills, and concerning hazardous and toxic waste). Traditional government interventions in waste management were mainly directed at enhancing the supply of goods and services. By contrast, most environmental policies launched in the 1960s and 1970s were instrumental in creating demand for EGS. Requirements such as the 1975 Waste Framework Directive and Waste Oil Directive in Europe, the 1976 Resource Conservation and Recovery Act in the U.S., and the 1972 “bottle bill” in Oregon (to be followed the same year by similar legislations in nine other U.S. states), for instance, clearly raised the need for recycling services. Beforehand, scrap cotton and linen rags had been routinely salvaged and turned into paper throughout the nineteenth century, wartime shortages had made it worthwhile to sort out and recycle glass bottles and metallic objects, and the aluminum industry had become increasingly keen on recycling since the opening of the first aluminum can recycling plants in Chicago and Cleveland in 1904. But the explicit and lasting commitment of public authorities gave the activity a major impetus. Nowadays, according to the U.S. Environmental Protection Agency, more than 30% of the 240 million tons of trash produced annually in the United States (including 90% of car batteries and more than 25% of plastics) are recycled. Equipments and services are provided on every continent by a thriving but extremely heterogeneous industry. The relative height of entry barriers varies considerably across segments: entry into the collection and sorting of scrap metals, for example, may be restricted by organized crime, while incumbents in the hazardous

5

Market shares may differ across regions of course. After it merged with USA Waste in 1998, Waste Management Inc. alone held 25% of the US overall market. In Europe, medium-size firms such as AGR (Germany), AVR (Austria), and Essent (The Netherlands), which are owned by municipalities, are also holding significant ground.

7 (notably nuclear) waste recycling business are limited in number due to significant regulatory and technological constraints. Since the 1960s, the cleaner air legislations enacted, extended and progressively reinforced in all industrialized countries have also made manufacturers and energy producers look for specific air monitoring and pollution abatement technologies. Specialized providers soon appeared in the newly constituted market branches corresponding to the different types of emissions to be abated (mainly sulphur dioxide, carbon monoxide, and NOx). In the technologically-driven competition, some companies like Research Cottrell, Combustion Engineering, and Western Precipitation came out among the overall leaders of U.S. industry until the mid 1980s. Research Cottrell was next acquired by Hamon, a Belgian company founded in the early 1900s which deals with dust emissions control, acid gas removal, and flue gas treatment (in addition to offering products and services for cooling systems, heat exchangers, and chimneys), while Alstom, a French multinational that makes trains, electric turbines, and thermal power plants took over Combustion Engineering, and the American engineering and construction firm McDermott got hold of Western Precipitation. As they expanded further, several segments of the U.S. market became at that time strongholds for other major players, such as Engelhard in catalytic converters, BOC Edwards in industrial exhaust systems, and Marsulex in the treatment of sulphur dioxide and hydrogen sulphide.6 Pulled by ever extensive, technical and compound regulations, the industry never ceased meanwhile to harbour a large number of small and medium enterprises providing very specific know-how in narrow niches. Demand for equipment, materials and services to measure, control and abate noise similarly received a definite thrust when the Noise Control Act was passed in the U.S. in 1972.7 Although the program was abandoned at the federal level nine years later, the issue was then tackled by local and state governments, and many European countries, such as the Netherlands in 1979, France in 1985, Spain in 1993, and Denmark in 1994, successively took it on. The private sector responded with hundreds of new dedicated 6

In 2006, the German chemical giant BASF bought Engelhard for $5 billion, while Edwards parted from the BOC Group which was purchased by the German industrial group Linde for $14.4 billion.

7

The United Kingdom and Japan had already adopted noise control laws in 1960 and 1967 respectively. These measures had a narrower scope and focused mainly on workplace and construction noise.

8 firms serving mainly aircraft, airport, highway, train and car builders, together with appliance manufacturers and the construction industry.8 Competition in the activity has remained rather stiff (at least in the U.S.), despite its sometimes significant technical requirements and the continuing presence of trade barriers. Site remediation is another service that became widely sought-after following the 1980 implementation of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) in the U.S, also known as “Superfund.” Thousands of abandoned sites containing hazardous waste were then identified, and hundreds of them designated for immediate cleanup. Remediation operations were to be supported by taxes or liabilities collected from polluters and put in a special trust fund.9 Most industrialized countries endorsed similar programs in succeeding years. From the beginning, contrary to what happened for instance with other EGS linked to waste and noise abatement, contaminated site owners (mainly petroleum and chemical companies, but also the military and some government bodies) procured all remediation technologies from external suppliers. High market barriers, caused by legal and financial uncertainty, long horizons (remediation projects often last more than 20 years), and very specialized training and know-how have subsequently allowed some remediation firms to retain considerable market power (more than 70 percent of the site remediation market in Australia, for example, is held by one firm – Thiess Services).

Finally, the creation in 1970 of the Occupational Safety and Health Administration in the U.S., and the progressive strengthening of industrial safety regulations in both the U.S. and Europe (through the 1986 Emergency Planning and Community Right-to-know Act and the 1982 Seveso I Directive, respectively), launched a sizeable market for ergonomics, hazards assessment, safety audits and other professional services. As targeted firms were then focusing more markedly on their respective core competencies,

8

It can actually be difficult to tell apart activities related to noise control and abatement from those involved within client industries (especially the construction industry). However, experts dealing with noise measurement and reduction seem to share a genuine professional culture, as the presence of associations like the National Council of Acoustical Consultants (NCAC) and the Acoustical Society of America (which exists since 1929 and has more than 9,000 members) might illustrate. 9

Over five years, US$1.6 billion was collected. CERCLA was later amended to increase the amount of the 'Superfund' to US$8.5 billion (Robinson et al. 2006).

9 these services became increasingly outsourced, fostering the growth of a noticeable environmental consulting industry. In 1996, the eco-industry totalled US$ 452 billions in revenues. Yet, the slower introduction of new environmental measures had brought the American EGS industry on the verge of crisis: the sector’s growth had come from an average of 11% throughout the 1970s and 1980s to a mere 1% (Berg et al. 1998).10 At the same time, Europe’s ever more demanding environmental policy was taking a new stance, less favourable to end-of-pipe abatement which then made up virtually all the earnings of the environment industry. These contrasting situations both resulted in the rapid expansion of process and product design, pollution prevention technologies and cleaner production. These new segments seemed indeed more likely to deliver value for managers increasingly pressured by global competition, tougher stakeholders (notably NGOs), and exacting standards of business practice (encoded, for instance, in the 1996 environmental management norm ISO 14000, or the 1995 Environmental Management and Audit Scheme – EMAS), while fitting new requirements (such as extended producer responsibility) based on life-cycle thinking.11 The 1990s ultimately saw policy makers pay increasing attention to the EGS industry: not only was it key in determining the quality of urban infrastructure and the cost of complying with environmental regulation, but thousands of jobs and a significant amount of international trade depended directly on it. The only available data on the ecoindustry, however, had to be purchased from private organizations that often produced dissimilar figures because they used different definitions, categories and methodologies. A major attempt to improve the situation was therefore made by the OECD and Eurostat, which proposed in 1998 the classification that will now be presented.12

10

An additional reason for the overall trouble might have been the shift away from command-and-control towards market-based regulation, for (as it is shown in the next section) the latter confers less market power to environment firms.

11

Extended producer responsibility, also known as “product stewardship” or “shared product responsibility,” means that manufacturers must bear from then on some or all of the costs of handling and disposal of their products when those reach the end of their useful life. Policies in this sense are now being adopted in a growing number of countries, in order to slow down the accumulation of trash (particularly of obsolete computers, home appliances and cell phones). For a first economic analysis, see Walsh (2003). 12 The OECD had previously undertaken exhaustive studies of the environment industry, which can be found in OECD (1992) and OECD (1996).

10 2.2 Definitions and classifications The definition of the EGS industry that was introduced in the OECD/Eurostat (1999) report reads as follows: The environment industry consists of activities which produce goods and services to measure, prevent, limit, minimize or correct environmental damage to water, air, and soil, as well as problems related to waste, noise and eco-systems. This definition intends of course to cover all activities which are naturally associated with environmental goods and services. The report divides them into three groups.13 • THE “POLLUTION MANAGEMENT” GROUP A) Environmental goods: Air pollution control, i.e. activities that deliver equipment, technology or specific materials for the collection, treatment or removal of exhaust gases and particulate matter from both stationary and mobile sources. Examples include dust collectors, filters, catalytic converters, scrubbers, odour control equipment, and some specific fuels. Waste water management, which denotes activities that produce equipment, technology or materials for the collection, treatment or transport of waste water and cooling water. This comprises chemical treatment and recovery equipment, oil/water separation systems, and sewage treatment equipment. Solid waste management, which refers to equipment, technology or specific materials for the collection, treatment, transport, disposal and recovery of hazardous and non-hazardous solid waste. The former includes low level, but not high level, nuclear waste. The manufacture of new materials from recovered scrap and the subsequent use of such materials are excluded. Remediation and cleanup of soil, surface water and groundwater; this class comprises absorbents, chemical and bioremediators for cleaning-up, and any technology to reduce the amount of pollutants previously deposited in soil or water (including sea water). Noise and vibration abatement, which means any equipment or materials to reduce the emission and propagation of noise and vibration both at source and dispersed. The most common examples are certainly mufflers and silencers. 13

This description of the classification borrows without restraints from the actual OECD/Eurostat (1999) report.

11

Environmental monitoring, analysis and assessment, which includes instruments and machines for measuring polluting emissions, data acquisition equipment and environmental information systems. B) Environmental services: Services pertaining to Air pollution control, Waste water management, Solid waste management, Remediation and cleanup of soil, surface water and groundwater (notably emergency response and spills cleanup systems), and Noise and vibration (such as the design and management for acoustic sound-proof screens and street covering) are hereby covered, in addition to the following ones. Environmental R&D, i.e. creative scientific efforts for the development of cleaner products, processes and technologies, together with non-technological research to enhance knowledge on ecosystems and the impact of human activities on the environment. Environmental contracting and engineering, which includes work to investigate, design and manage environmental projects, as well as consulting and auditing. Analytical services, data collection, analysis and assessment, in other words all services to sample, measure, and record various environmental characteristics. This comprises site monitoring, analytical laboratory services, as well as health, safety, and toxicology studies. Weather stations are excluded. Education, training, information, that is, education and training to disseminate environmental information and which is conveyed by specialized institutions or suppliers. What goes on in the general education system is of course left out. C) Construction: this category includes any activity for the construction and installation of facilities for air pollution control, waste water management, solid waste management, remediation and cleanup of soil, surface water and groundwater, noise and vibration abatement, environmental monitoring, analysis and assessment, etc. • THE “CLEANER TECHNOLOGIES AND PRODUCTS” GROUP Cleaner/resource efficient technology, i.e. technologies that decrease material inputs, reduce energy consumption, recover valuable by-products, lower emissions, and minimize waste disposal problems.

12 Cleaner/resource efficient product, i.e. products reducing material inputs, energy consumption, waste disposal problems and emission during use. • THE “RESOURCES MANAGEMENT” GROUP Indoor air pollution control, which designates any activity that delivers equipment, technology or specific materials, designs, constructs or installs, manages or provides other services for the treatment and renewal of indoor air to remove pollutants. This does not comprise air-conditioning. Potable water treatment and distribution, or works to collect, purify and distribute potable water to household, industrial, commercial or other users. Recycled materials, which includes efforts to design, construct or install, manage or provide services for manufacturing new materials or products identified as recycled from recovered waste. Renewable energy plant, which refers to the generation or collection of energy from renewable resources, including biomass, solar, wind, tidal, or geothermal sources. Heat/energy saving and management, i.e. the provision of services to minimize heat and energy loss; this includes equipment, technology or specific materials to reduce climate change. Sustainable agriculture and fisheries, meaning any activity that diminishes the environmental impact of agriculture and fisheries, including certain biotechnologies. Sustainable forestry, which encompasses any services, programs or projects for reforestation and forest management. Natural risk management, or any activity related to technologies, constructions or services for systems to prevent or reduce the impact of natural disasters (storms, floods, volcanic eruptions, etc.). Eco-tourism; this last class includes any activity consisting in managing or providing services for the sort of tourism that involves the protection and management of natural and cultural heritage, or some education and interpretation of the natural environment. Although it provides a helpful anchor for data collection and further analyses on the EGS industry, this classification is unfortunately not consensual and remains exposed to several criticisms. First, it encroaches sometimes considerably on other well-know industrial sectors; one may find it questionable to having, for instance, windmills, ethanol

13 and solar cells (why not hydro-electricity, by the way?) considered as being part of the environment industry rather than the energy sector, eco-tourism classified as a “resource management” service rather than simply another component of the tourism industry, certain construction activities labeled as “pollution management” rather than plain construction, or some biotechnologies figuring in the “resource management group” under “sustainable agriculture and fisheries.” Second, the line to be drawn between environmental and non-environmental activities is still fuzzy, especially in the definition of cleaner technologies. Labeling a good or service as an EGS is, by the above definition, closely linked to its environmental impact. But should just-in-time manufacturing, which saves considerably on the natural resources necessary to hold and manage inventories, be put in the “Cleaner/resource efficient technology” category? Few people will ask for this. The distinction between environmental “goods” and “services,” furthermore, continues to be a matter of disagreement in international trade negotiations, where the two entities are not subject to the same regime. For example, some argue that “potable water treatment and distribution” must not be seen as an environmental service; others say it should not be considered a service at all but rather the production of a public good; and others would rather consider potable water as an exhaustible natural resource (Vikhliaev 2003). The European Union (whose firms actually dominate the sector) favors putting water provision and treatment on the list of environmental services; on the other hand, it proposes to exclude design, engineering, R&D and consulting, which are already classified elsewhere under the General Agreement on Trade in Services (GATS).14 As far as economic analysis is concerned, finally, it might be more meaningful to adopt a narrow definition of the environment industry, and to put the considered activities together into two main classes: ■ INFRASTRUCTURE GOODS AND SERVICES, which includes household, industrial and hazardous solid waste disposal, potable water, sewerage management, and recycling; 14

For an excellent account on the issue, see Chaytor (2002) or Kirkpatrick et al. (2006). According to the latter, “The narrow GATS classification framework defines environmental services as end-of-pipe public infrastructure services that largely focus on waste management and pollution control. The main instrument used in the WTO is the Services Sectoral Classification List (W/120) which is based on the Provisional United Nations Central Product Classification (Provisional CPC). (…) However, no classification is obligatory and WTO members are free to use any classification they prefer or to develop a classification of their own, as long as they provide a `sufficiently detailed definition to avoid any ambiguity as to the scope of commitment´.” [emphasis added]

14 ■ POLLUTION MANAGEMENT, which comprises air and water pollution treatment and control, noise abatement, soil and water remediation, consulting and engineering, instruments and information systems, testing and analysis, and industrial processes and product design to prevent pollution. As the previous historical account indicated, different key stylized facts seem indeed to characterize these two groups. In the former, clients are local communities or municipalities, demand for EGS existed before public intervention, and this demand appears limited only by financial constraints. The purpose of regulation has then traditionally been to enhance the supply of (and access to) EGS, often directly by having a public body own or manage the provision of potable water and the collection/treatment of domestic waste, often indirectly through regulating a local monopoly. Many private firms in this segment thus owe their existence to privatization, and the market is currently dominated by a handful of large companies. In contrast, demand for EGS to manage pollution has been traditionally pulled by environmental regulation and policy, while supply has relied exclusively on private business. Most clients are regulated industries; and the number, complexity and heterogeneity of environmental directives make the sector highly fragmented, some segments (noise abatement, consulting) giving ground to monopolistic competition while others (site remediation, air pollution) harbor oligopolies. 2.3 Current figures and trends When the present decade began, end-of-pipe pollution abatement and infrastructure goods and services made up (by far) the most important EGS markets. The largest sectors of the eco-industry (see Table 2) were indeed waste management (adding up solid and hazardous waste, equipments, and recycling) and water treatment/distribution (including equipments), followed by air pollution abatement (i.e., anti-emissions equipment) and site remediation. These facts, however, should not lead one to understate prevention activities: for most efforts to tackle the causes of pollution probably occurred within polluting firms (as they still do), while the amount of such activities which is outsourced (namely production and prevention technologies, and cleaner energies) closely matches the expenses on site remediation.

15 Equipments

Billions US$

Equipment and chemical products for water treatment

43.0

Anti-emissions equipment

34.0

Instruments and information systems Equipment for waste management Production and prevention technologies

6.6 32.6 3.0

Services Solid waste management

120.7

Hazardous waste management

17.8

Consulting and engineering

31.5

Site remediation

29.4

Analyses Water treatment

3.8 78.6

Ressources Water distribution

87.0

Recycling

35.7

Clean energy

23.9

Table 2. EGS global market sizes (Environmental Business International 2004) As expected, most expenses on EGS take place in richer countries. In 1999, the United States was the biggest market for environmental goods and services, with expenditures amounting to US$ 196.5 billion, as well as 1.4 million jobs and 117,000 companies engaged in the sector (Brock and Boadu 2004). But a country’s GDP only imperfectly reflects its consumption levels and performance in specific segments of the eco-industry. Water distribution and treatment are relatively bigger activities in Europe, and European firms currently dominate the sector. On the other hand, the United States has so far spent more and its private firms now hold some competitive advantage in site remediation, while Japanese environment companies are somewhat ahead in air pollution abatement (see Table 3). Such disparities can plausibly be attributed to history. Public-

16 private partnerships in managing water resources have long taken place in Europe (particularly in France); meanwhile the United States lead the way in dealing with contaminated industrial sites, and Japan’s laws and regulations to curb polluting emissions have consistently been among the most demanding.15 The comparative advantages different countries enjoy in the provision of EGS are of course a chief reason for observing (and encouraging) international trade. Indeed, following further trade liberalization and uniformly stricter environmental regulations across countries, trade in environmental goods between 1990 and 2002 has grown more than twice (14%) as fast as total merchandise trade (6%). The overall exports of environmental goods in 2002 amounted to about US$ 238.4 billion, which represents between 3.6 to 4.0 per cent of world exports; this corresponds to a third of the size of chemicals trade and a tenth of trade in machinery and transport goods. The top five exporters of environmental goods were (in decreasing order) the European Union, the United States, Japan, China and Mexico. The top five importers were (in decreasing order) the United States, the European Union, China, Canada and Mexico. The first 20 exporters of environmental goods accounted for about 93% of world exports; according to Bijit and Teh (2004), “this degree of concentration is greater than in overall merchandise trade where the top 20 exporters in 2002 accounted for just a little over 82 percent of world exports.” The most traded goods in 2002 concerned waste water management (34% of all EGS trade), environmental monitoring, analysis and assessment (15%), solid waste management (13%), noise and vibration abatement (12%), and air pollution control (10%).16 Major firms in these segments have naturally become multinationals, although the solid waste sector has produced a notable exception: the largest player in this area – Waste Management Inc. – had actually sold most of its foreign subsidiaries (but the Canadian ones) by the late 1990s to focus on (and shield) its home U.S. market.

15

The first articles in the economic literature to acknowledge the existence of the eco-industry intended actually to explain why certain countries had better-performing environment firms. Baumol (1995) provides empirical evidence emphasizing start-up costs. Alternatively, Feess and Muehlheusser (1999) argue formally that a country’s traditionally stricter environmental regulation allowed home environment firms to move farther on the learning curve. 16

The data reported in this paragraph come from Bijit and Teh (2004).

17

Country or High growth regional Area Northern Europe Monitoring

Moderate growth

Low growth

Potential advantage

Land remediation

Waste management

Monitoring

Germany

High-tech products Recycling

Air pollution

Water treatment Waste management

Waste-water Waste treatment Land remediation Measurement and analysis

France

Waste management

Monitoring Noise reduction

Air pollution

Waste-water Recycling

Monitoring

Air control Waste management

Waste-water Waste management

Air pollution

Waste-water Land remediation

Waste management

Air pollution

Waste management

Water quality

United Kingdom Waste-water

Land remediation Waste management Waste management

Italy

Southern Europe Water and

waste-water

United States

Waste management Land remediation

Air pollution

Water and waste-water

Monitoring Remediation: Nuclear, mining, agriculture, chemicals. Biotechnologies Air pollution

Canada

Waste-water

Air pollution

Waste management

Toxic emissions: industrial/resources

Japan

Air pollution

Waste management

Water and waste-water

Air pollution: urban/industry

Australia

Mine remediation Consultancy Water and waste-water

Industrial remediation Clean production Air monitoring

Air control Solid waste Management

Mine remediation Consultancy

Table 3: National growth prospects and potential trade advantages (OECD 1996)

18

While they might come up with different numbers, all forecasts agree that the global market for EGS will get significantly bigger in the upcoming years. Overall growth in developed countries will be modest, reaching about 3 to 5% annually. These countries will rather see the relative weight of several segments vary throughout the next decade in terms of revenue, imports and exports (see Table 3). Pollution prevention goods and cleaner technologies, for instance, are likely to face relatively greater demand, as the cost of energy keeps rising and extended producer responsibility requirements spread. So are air pollution abatement and monitoring, following the enforcement of the Kyoto protocol and further regulations of greenhouse gases emissions, as well as remediation of contaminated soils and ground water, as E.U. countries’ legislations catch up on this matter with those in the United States.17 Developing and transition economies, on the other hand, will see their environmental sector increase by 10% to 15% a year. Accelerated industrialization and chaotic urbanization in Asia, Africa and Latin America are creating glaring needs of infrastructure EGS as well as air pollution control goods. Sooner or later, Central and Eastern European countries will also have to cope with the polluted land sites inherited from collectivism. In this context, governments in countries like China and India are now explicitly seeking to upgrade their national eco-industry. By the end of 2004, China’s home environment industry already added up to 11,623 firms employing 1.595 million people (People’s Daily 2006). In India, the Confederation of Indian Industry listed between 350 and 400 pollution control equipment manufacturing and environmental consulting firms in 2004, a quarter of which had formed joint ventures or concluded technology transfer agreements with foreign partners (Katti 2005). As these indigenous firms pick up steam and eventually internationalize their activities, competition and trade patterns in global EGS markets will evolve substantially. In the foreseeable future, environmental public policy will certainly remain a key element influencing demand for EGS, but someone would predict other factors to also play an increasing role. Public pressure, for instance, through credible threats of 17

According to the U.S. Commercial Service (2006), for example, the French market for the remediation of contaminated land sites, which carried revenues amounting to US$ 1.24 billion in 2004, will grow by 12 to 15 percent annually over the next fifteen years, as the European Directive for environmental responsibility, prevention and reparation of the environment, which first explicitly mentions sites, soils and ground water, is being embedded into French law.

19 damaging publicity campaigns and widespread boycotts, is now frequently acting as a surrogate for traditional government regulation.18 Non-governmental organizations (NGOs) are also giving various parties a say on firms’ practices and their actual consumption of EGS (thereby enhancing the market for environmental assessment, auditing and monitoring). The general business culture, finally, is changing, as the implementation of strategic objectives pertaining to “sustainable development” and “corporate social responsibility (CSR)” now figures prominently in shareholders meetings, corporate board agendas, managerial training rooms and business press articles. The precise (separate or combined) impact of these factors on the structure of the eco-industry, however, remains largely to be spelled out. All studies available at this point are theoretical and center mainly on environmental taxes, building on models that fit the stylized facts of the air pollution and (to a lesser extent) site remediation segments.19 These studies will be presented in the upcoming sections.

3. Environmental policy The initial purpose of explicitly modelling the structure of the EGS industry was to understand whether and how a benevolent regulator wishing to correct pollution externalities should take this structure into account. Considering various regulatory instruments - emission taxes and quotas, design standards, and voluntary agreements - in the presence of an imperfectly competitive environment industry, David and SinclairDesgagné (2005, p. 141) first pointed out that each instrument “has a specific impact on the price-elasticity of the polluters’ demand for abatement services, hence on the market power of the eco-industry and the resulting cost of abatement.” It follows that imperfect competition between EGS suppliers might indeed change the relative effectiveness and welfare properties of different policies. Let us now examine this more closely.

18

Tietenberg and Wheeler (2001) explore the rationales of empowering the larger public to police polluters. They actually anticipate the approach to spread further, calling it the “third wave” of environmental regulation, after “command-and-control” and “market-based” regulation.

19

Brock and Boadu (2004)’s empirical work, to be summarized in Section 5, constitutes a notable exception.

20 3.1 On the design of policy instruments In the simplest setting (with no uncertainty or asymmetric information), David and Sinclair-Desgagné (2005) consider a price-taking polluting industry which contracts out abatement goods and services from identical suppliers competing à la Cournot. They then proceed to investigate separately three policy instruments: the emission tax (which in this context is equivalent to an emission quota), the technical standard, and a particular voluntary approach. ► EMISSION TAXES Let the representative polluter’s profit be given by Px – C(x) - q·a – te(x,a) , where x and P are respectively the amount and price of the consumption good being produced, a and p are respectively the procured quantity and price of abatement goods and services, e(x,a) denotes the pollutants emitted as a function of production and abatement, and t is a tax imposed by the regulator per unit of emissions. It is assumed that e(x,a) increases in x but decreases in a, that the second-order partial derivatives exx and eaa are positive, and that the cross-partial derivative exa = 0. The latter means that the emission function is additively separable and can be written as e(x,a) = k(x) – w(a). This eases calculations without changing the qualitative results. It is also consistent with endof-pipe abatement which, by definition, does not affect the pollution each unit of production generates. One supposes, finally, that aw´(a) is decreasing, or in other words that the emission function is only moderately convex with respect to abatement effort. In order to maximize profit, the representative polluter must now produce and abate at respective levels xt and at that satisfy the first-order conditions (1)

P – C´(xt) – tk´(xt) = 0 ,

(2)

- q – tw´(at) = 0 .

The superscripts indicate that the chosen levels depend on the emission tax t. As expected, it can be checked that the amount of consumption goods produced xt goes down while more abatement goods and services at are purchased when the regulator raises t. Equation (2) entails, moreover, that (3)

∂at/∂q = -1/t w″(at) ,

21 so the polluters’ requests for abatement goods and services become less price-sensitive when the emission tax is higher. The same result was simultaneously discovered in environmental R&D outsourcing by Requate (2005), who described it as follows (p. 194): “(…) raising the tax rate makes the new technology more attractive to polluting firms, and thus increases their willingness to pay for new technology.” As Greaker and Rosendhal (2006) next showed, however, this finding may not hold if the price of abatement can be passed on to consumers and downstream demand P(x) takes a special shape (concave or isoelastic). Equation (3) nevertheless constitutes a benchmark assertion (one with empirical content, moreover) linking environmental taxation to not just the size but also the price-elasticity of demand for abatement goods and services. Reckoning this conclusion, David and Sinclair-Desgagné (2005) establish that a benevolent regulator must then charge an emission tax equal to

(4)

┌ │ k´(xt) dxt/dt + w´(at) dat/dt t* = υ │ ──────────────────────── │ k´(xt) dxt/dt + [at w″(at) /n + w´(at)] dat/dt └

┐ │ │ , │ ┘

where υ > 0 is the social cost per unit of pollutant and n stands for the number of abatement suppliers. If n is infinite, meaning basically that there is perfect competition between environment firms, then the optimal tax t* corresponds to the marginal social cost of pollution υ; this is of course Pigou (1920)’s classical prescription. If n is finite, on the other hand, then t* > υ. The intuition behind the latter is the following. The price of abatement goods and services charged by oligopolistic suppliers equals their marginal cost of production plus a markup. Therefore, were the emission tax set at the unit social cost υ, polluting firms would not reduce their emissions enough to maximize social welfare. A higher tax is actually necessary to bring pollution abatement at the right level. Canton et al (2007) and Nimubona (2007) show that this conclusion must be qualified if

downstream producers only behave as price-takers on the abatement market, while they compete à la Cournot to deliver the consumption good. The regulator then trades off the loss in consumer surplus entailed by an oligopolistic polluting industry, which supports an emission tax smaller than υ according to Buchanan (1969)’s and Barnett (1980)’s well-known articles, with the lower abatement efforts induced by an imperfectly

22 competitive eco-industry, which in turn justifies a tax bigger than υ. The appropriate policy will now be to set (5)

> t* = υ


where m is the number of competing polluters, X = mxt and A = nat are the total amounts of consumption and abatement goods respectively sold, P(X) and q(A) are the resulting prices in the downstream and upstream markets, and εP(X), εq(A) represent demand elasticities. Whether or not t* is superior or inferior to the marginal social cost of pollution thus depends on the relative ability of firms to exercise market power on their respective buyers: if m is large and n is small while the elasticities εP(X) and εq(A) are respectively high and low (so environment firms are relatively more powerful than polluting firms), for instance, then we should observe t* > υ. This recommendation obviously ignores redistribution issues between polluting firms and their providers of abatement goods and services. It also relies on the assumptions that environment firms are similar and there are no newcomers in the eco-industry. These points will be discussed shortly. ► TECHNICAL STANDARDS Consider now the case of a regulator who mandates an abatement effort ā (through enforcing the implementation of a specific abatement technology, for instance). This command-and-control measure would make demand for abatement perfectly inelastic, up to the point where the price is so high that polluting firms would simply leave. Such a situation is illustrated in Figure 1. In this context, if competition in the relevant segment of the eco-industry is weak (this segment is held by a monopoly, say), then the price of abatement qs will be set so that the representative polluter’s participation constraint (6)

Pxs – C(xs) - qs· ā ≥ 0 ,

where xs solves the first-order condition C´(x) = P, is binding. All polluting firms’ benefits are thereby extracted. As David and Sinclair-Desgagné (2005, p. 149) remark, this “tends to explain why mandatory design standards often meet with strong resistance on the part of polluters.”

23 q

qs ○

●

ā

Abatement supplier’s marginal cost

a

Figure 1. Demand for abatement under some mandatory abatement level ā

► VOLUNTARY APPROACHES A different situation occurs when the regulator does not enforce an abatement standard ā, but threatens instead polluters with imposing an emission tax τ if their pollution reduction effort does not match this level. To be sure, demand for abatement is then more price-elastic than in the previous case. Polluters will choose voluntarily to comply by the standard if the price qv charged by abatement suppliers in this case makes it more profitable than having to pay the emission tax. This is expressed formally by the following inequality: Px - C(x) - qv· ā ≥ Pxτ - C(xτ) - qτ aτ - τe(xτ,aτ) ,

(7)

where xτ, aτ and qτ are respectively the production, abatement and price levels arrived at by profit maximizing entities under a tax regime. A monopolistic abatement supplier will now compare the maximum benefits achievable while respecting constraint (7) to those realized if polluters are rather subject to the emission tax. It will normally support the voluntary scheme, thereby asking for a price consistent with inequality (7), if this yields higher profits. Formally, letting G(a) represent the cost of delivering a quantity a of abatement goods and services, this happens when (8)

qv· ā - G(ā) ≥ qτ aτ - G(aτ) .

24 The latter clearly constitutes a participation constraint the regulator must now take into account, together with the polluters’ one given by (7), when choosing which abatement level ā to ask for. But this constraint has so far been overlooked in the literature on voluntary approaches (see, for example, Carraro and Lévêque 1999). In addition to the policy instruments covered so far, the regulator’s toolbox includes another typical means to cope with market failure: environmental subsidies. A recent paper by David and Sinclair-Desgagné (2007) has just re-examined this instrument in the presence of an imperfectly competitive EGS industry. ► SUBSIDIES Subsidies have long been proposed to correct environmental externalities (Pigou 1920), and they are everywhere to be found in economic life. Economists, however, have turned quite critical of them (see, e.g., Fischer and Toman 2000, or Barde and Honkatukia 2004). In general, environmental subsidies tend to create vested interests and encourage rent-seeking behaviour. They also run contrary to the polluter-pays principle and, as such, invite new polluting businesses to settle in, which might ultimately increase overall pollution (Kohn 1992). The latter criticisms are essentially directed at abatement subsidies. Yet, David and Sinclair-Desgagné (2007) investigate the combination of a tax on polluting emissions with such a subsidy, for common wisdom deems the use of both instruments necessary to deal optimally with the two market imperfections we have here – the environmental externality and imperfect competition in the eco-industry. In principle, a tax-subsidy scheme (t**, s) of the form (9)

t** = υ ,

s○ = q - G´(a*/n) ,

in which the subsidy given to polluters for each unit of abatement effort covers the ecoindustry’s mark up at the socially optimal abatement level a*, would indeed achieve the first-best. Under this policy, however, profit-maximizing abatement suppliers would inflate their price q to the point of using up the regulator’s whole budget. A less expensive scheme that still implements the first-best might actually be the following: (10)

t** = υ ,

s* = - (υ w″ (a*)) a*/n ,

25 where the subsidy s* is obviously bounded and is granted this time directly to environment firms. Note that s* decreases as the cost of pollution υ falls, the function w(a) becomes less concave (which means that the abatement technology is more effective), or the number n of environment firms goes up (so competitive pressure increases in the eco-industry). The latter suggests that, while policies that subsidize abatement expenses are often spoiled by the arrival of new polluters, a policy that subsidizes environment firms might actually work even better once entry barriers in the eco-industry are brought down. Other common policy instruments, such as tradable emission permits, remain to be studied when the provision of abatement goods and services is outsourced. Once the optimal design of each separate instrument is clear, the next topic, which I will now briefly look at, is to make comparisons in terms of social welfare and allocations. 3.2 Instruments comparison Whether the abatement goods and services industry is perfectly competitive or not turns out to matter for the comparison of regulatory instruments. Were the environment industry perfectly competitive, for instance, using an emission tax t = υ would implement the first-best, but the voluntary approach studied here would be a second-best instrument because a polluter’s output decision xv in this case does not internalize its environmental cost. If the eco-industry is imperfectly competitive, on the other hand, a tax on polluting emissions also becomes a second-best policy. One can infer, moreover, that a* ≥ ā > at while xv > xt; or in other words, the abatement level reachable by way of the above voluntary approach is always greater than the one achieved through the optimal tax t* (it can even attain the first-best), yet more polluting consumption goods are delivered via this voluntary approach than under the optimal emission tax (David and SinclairDesgagné 2005). This makes it impossible to say whether taxes are generally better or worse than voluntary approaches in contributing to social welfare. Much remains to be said, therefore, on the normative part of environmental policy when abatement goods and services are outsourced from an imperfectly competitive

26 environment industry. As to the positive analysis of environmental regulation, however, it is only just starting. 3.3 Political economy Throughout the 1990s, puzzled by the fact that national governments often adopted different approaches to treat similar environmental problems, economists have investigated the political underpinnings of environmental policy. The political economy of environmental regulation now constitutes a well developed and still growing body of literature.20 One phenomenon that has so fart been overlooked, however, is the emergence and ongoing influence of powerful lobbies from the eco-industry (see Berg et al. 1998 and Michaelowa 2004, for examples of the actions undertaken by such lobbies). As I already pointed out, the analysis of subsection 3.1 suggests that environmental policy choices can have a strong impact on the distribution of rents between polluting firms and suppliers of abatement goods and services, particularly when the latter can exercise market power. This certainly provides environment firms with the incentives to apply pressure on policy makers. Does this justify studying eco-industrial lobbies explicitly, instead of considering them as part of environmental lobby groups in general? Clearly, the EGS industry will favour tighter environmental regulation. However, it might disagree with environmentalists on the precise content of environmental policy. A monopolistic environment firm will like technical standards, for example, because they confer the greatest market power, while green lobbyists might push instead for marketbased policies that deter polluting activities more effectively. Oligopolistic suppliers of EGS will also resist any dismantling of entry barriers in their industry segment, but environmentalists will rather foster entrepreneurship and entry in the eco-industry to make compliance with environmental regulation cheaper. In dealing with trans-frontier pollution, finally, the eco-industry might even side at times with polluters in promoting the international adoption of certain technologies (such as catalytic converters). This singular situation has been recently analyzed by Canton (2007), who thereby put up a first political economy model encompassing the eco-industry.

20

Good literature reviews are available in Oates and Portney (2001) and Stavins (2004).

27 The upshot of this section, in sum, is that environmental policy determines the market power and profitability of the eco-industry, which in turn influences back policy making. To lay emphasis on this point, all the works surveyed so far kept the ecoindustry’s concentration unchanged, whatever the adopted regulation. This assumption will now be lifted.

4. Industry structure and firm behaviour The historical account of Section 2 stressed the importance of environmental regulation in creating demand for pollution abatement goods and services. The articles covered in Section 3 highlighted next that environmental policy not only increases the size, but reduces the price-elasticity, of demand for pollution prevention and treatment. This section will now focus on how regulation can also affect other characteristics of industry structure and firm behaviour, such as entry or mergers and acquisitions. 4.1 Entry The models to be discussed in this subsection and the next both consider the effect of an emission tax and assume that polluters are price-takers while the eco-industry forms a Cournot oligopoly. In recent papers, David et al. (2006) and Nimubona (2007) amend David and Sinclair-Desgagné (2005)’s initial framework by making the production of abatement goods and services subject to a fixed starting cost F. Entry in the eco-industry is then governed by the zero-profit condition (11)

q(A,t)aj - G(aj) - F = 0 ,

where A is the total quantity of abatement goods and services delivered, aj is the individual amount of such goods produced by firm j, and q(A,t) = tw´(A) is the inverse demand function for abatement. It can be seen, as expected, that the number of environment firms n and total output A increase with the level of the emission tax t. The individual output (or absolute size) of environment firms, however, can actually grow or shrink after a higher tax is imposed. To see how the latter can happen, recall that raising the emission tax from t to t+ entails an upward shift and a clockwise rotation of the

28 demand for abatement curve. This at the same time confers the eco-industry a bigger market, which prompts additional suppliers of abatement goods and services to come in, and more market power, which induces the typical firm to produce less in order to further augment prices. As Figure 2 illustrates, the net result might well be that each environment firm provides less abatement than before. aj 45○

aj

aj

=

n ai ≠ j /(n-1)

aj

=

n+ ai ≠ j /(n+-1)

aj+

∑ ai ≠ j Figure 2. Reaction functions and individual abatement supplies under emission taxes t+ > t

In this figure, the downward sloping curves depict firm j’s reaction to the total quantity produced by its competitors; such a curve will move up following an increase in the emission tax, as the number of firms n and total output A = naj expand respectively to n+ and A+ = n+ • aj . The upward sloping lines, on the other hand, are the locus where all abatement suppliers deliver the same quantities; such a line will turn clockwise around the origin as the number of producers gets larger. Since environment firms are identical, any equilibrium must sit at the intersection of a reaction curve and the corresponding quantity line. In this graph, the reaction curve does not go up far enough following the tax increase, so the individual amount of abatement goods and services settles at aj+ < aj .

29 The regulator here must then handle two distortions simultaneously: the pollution externality, of course, and the entry of environment firms which might ultimately be excessive (Tirole 1988). The optimal emission tax t* will thus be such that (12)

> t* = υ


so we have a more (less) stringent tax t* > υ (< υ) when the ensuing increase in abatement supply, given by dA/dt, compensates for (does not counteract) the excessive duplication of the fixed setup cost, which is measured by (A/n)dn/dt. An alternative to lowering the emission tax if there are too many abatement suppliers, however, is to allow them to merge. This option will now be considered. 4.2 Mergers and acquisitions At the end of May 2006, the German chemical manufacturer BASF announced it had finally got hold of U.S. catalysts producer Engelhard in a hostile takeover that ended up costing more than US$ 5 billions. This acquisition constitutes BASF’s largest such transaction in its 140-year history. BASF also makes catalysts to reduce car emissions. According to Jurgen Hambrecht, the company’s CEO: “[following the acquisition] customers will benefit from the accelerated development of products with superior performance through the combined R&D capabilities of the two companies.” Similar stories abound in the eco-industry. In a recent paper, Canton et al (2006) investigate their rationale and welfare consequences. Their model assumes that a merger creates a new entity with lower production costs (because of synergies between previously separate firms). On the other hand, it is shown that a merger increases concentration in the eco-industry, which causes lower quantities and higher prices of abatement goods and services. In terms of welfare, therefore, mergers between environment firms are not desirable if the social cost of pollution is large. When pollution generates major damages, though, it is reasonable to expect that the regulator will adopt a more stringent environmental policy, henceforth putting a higher tax on emissions. In an important proposition, Canton et al. (2006) establish that such a tax would accordingly make mergers in the eco-industry less likely, in the sense that a

30 given merger must then implicate a greater number of firms in order to be profitable. This key statement seems empirically testable. Its underlying intuition runs as follows: a more stringent tax decreases the price-elasticity of demand for abatement, so outsiders to a merger benefit even more from the larger residual demand and higher prices brought about by the merger.21 Environmental policy thus bears a rich set of ramifications for the structure of the EGS industry. Some implications – such as the ones just seen, that tighter regulation deters mergers and might trigger too much entry – certainly depart from those predicted (and observed) for polluting industries.22 As we shall now see, other significant specificities can be brought up as well in international trade.

5. International trade Paragraph 31 of the Doha Ministerial Declaration following the 2001 World Trade Organization meeting in Qatar stresses “(…) the reduction or, as appropriate, elimination of tariff and non-tariff barriers to environmental goods and services.” A similar objective was actually endorsed earlier in several regional trade organizations, such as APEC – the Asia-Pacific Economic Cooperation – which embraces 21 countries and about half of international trade. Most policy makers and government officials uniformly believe, indeed, that the lower prices of abatement goods and services resulting from liberalizing trade in the sector will enhance environmental protection worldwide and benefit developing as well as developed countries. This view may provide another argument to convince those who think that international trade harms the environment.23 Empirical support, moreover, can be found in the article by Brock and Boadu (2004). This paper estimates the U.S. exports of some

21

Mergers in general are naturally not a new topic in the economic literature. The idea rediscovered here that outsiders to a merger might benefit more from it than insiders dates back at least to Stigler (1950). In environmental economics, Hennessy and Roosen (1999) offer a good analysis of polluting firms’ incentives to merge when they are subject to tradable emission permits.

22

See, for instance, Requate (2006) for an up-to-date, exhaustive and elegant survey of the relationship between environmental regulation and the structure of polluting industries.

23

Copeland and Taylor (2004) and Ulph (1997) offer a rather complete account of the debates involving economists on this issue.

31 environmental goods (namely water pollution control products, air pollution control goods, solar energy equipment, and monitoring instruments) into various countries between 1992 and 1996, as a function of several factors: per capita GDP, the exchange rate relative to the US$, the level of foreign debt service payments, an index of political and civil rights, economic freedom, access to safe water, per capita carbon dioxide emissions, and socio-economic development. Regression results show economic liberty to be very significant in explaining demand for imported EGS. The authors conclude that: “If one associates liberalized regimes with an open world trading regime, then the estimates would seem to refute the popular concern that a liberalized world trade regime would lead to a dirtier world.” Theoretical research, however, remains ambivalent. On the one hand, larger export markets and greater competition (together with more stringent environmental regulations) can make environment firms become more efficient, thereby decreasing the price of abatement goods and services (Fees and Muehleusser 1999 and 2002, Greaker and Rosendhal 2006). On the other hand, as its importance for the national economy grows, the EGS sector, like other industries, can be subject to strategic trade manipulations that may thwart the predicted environmental benefits of liberalization. To enhance its trade balance (while at the same time protecting its domestic polluters), for example, a country that is a net importer of abatement goods and services might adjust to the liberalization of EGS by making its environmental policies less severe (as shown by Copeland 2005, Canton 2007, and Nimubona 2007 in different contexts).24 This brings us back to political economy, and the voice local environment firms and other stakeholders may have to prevent such an adjustment from happening.25 The issue is therefore not settled. Further understanding calls again for studying explicitly the structure and behaviour of the eco-industry.

24

It must be mentioned here that, unlike the other works presented so far, Copeland (2005)’s paper assumes monopolistic competition instead of Cournot competition.

25

Brock and Boadu (2004) actually find that the degree of democratic development, as measured by the index of political and civil rights, is also very significant in explaining import demand for EGS.

32 6. Concluding remarks This paper started by pointing out the virtual absence of the environment goods and services industry in the environmental economics literature. It then stated four basic reasons why this should change. The rest of the paper aimed accordingly to show the economic importance and originality of the eco-industry (from its history, growth, and main structural features), and to draw attention to its specific, yet significant, implications for the analysis and design of environmental policy. The largest section (Section 2) was entirely descriptive, which is certainly not inconsistent with the actual state of knowledge on the subject. The other sections briefly summarized the handful of analytical works which have come out so far, hoping thereby to wet an economic researcher’s appetite for further investigating this topic. This survey should therefore raise many questions and look very short in definite answers. Among those questions, there is certainly the necessity to address the infrastructure part of the eco-industry (i.e. solid waste disposal, potable water, sewerage management, and recycling), which the analytical work presented above does not cover, to consider other forms of competition between environment firms, such as monopolistic or Bertrand competition, to introduce a clearer distinction between environmental goods and services, to consider other regulatory instruments, such as polluting permits and other types of voluntary approaches, and to endow polluting firms as well with some market power in the abatement goods and services market. Future research will likely draw from the literatures on vertical integration, outsourcing, and especially vertical relationships. This should not be seen as a trivial exercise in re-labelling existing models, however. Purchases of EGS arise mainly from a desire to comply with social demands and current or future regulations (be they mandatory or voluntary), not from the actual composition of a particular end product; hence, abatement goods and services may not constitute “productive” inputs in the traditional sense.

33 REFERENCES Barde, Jean-Philippe and Outi Honjatukia, “Environmentally Harmful Subsidies,” Chapter 7 in The International Yearbook of Environmental and Resource Economics 2004/2005 (T. Tietenberg and H. Folmer, eds.), Edward Elgar, 2004 Barnett, Andy H., “The Pigouvian Tax Rule under Monopoly,” American Economic Review 70 (1980), p. 1037-1041 Buchanan, James M., “External Diseconomies, Corrective Taxes, and Market Structure,” American Economic Review 59 (1969), p. 174-177 Baumol, William J., “Environmental Industries with Substantial Start-Up Costs as Contributors to Trade Competitiveness,” Annual Review of Energy and the Environment 20 (1995), p. 71-81 Berg, David R., Grant Ferrier and Jon Paugh, “The U.S. Environmental Industry,” US Department of Commerce – Office of Technology Policy, September 1998 Bora, Bijit and Robert Teh, “Trade and Tariffs on Environmental Goods,” Workshop on Environmental Goods, WTO Secretariat, Brock, Avery and Fred O. Boadu, “Global demand for U.S. Environmental Goods and Services,” Journal of Agricultural and Applied Economics 36 (2004) Canton, Joan, Eco-Industries – An Imperfect Competition Approach, unpublished doctoral dissertation, GREQAM – Université de la Méditerranée, June 2007 ______, “Redealing the Cards: How the Presence of an Eco-Industry Modifies the Political Economy of Environmental Policies,” Working paper no. 25.2007, FEEM, February 2007. ______, “Environmental Taxation and International Eco-Industries,” Working paper, GREQAM – Université de la Méditerannée, October 2006 Canton, Joan, Maia David and Bernard Sinclair-Desgagné, “Environmental Regulation and Mergers within the Eco-Industry,” Working paper, HEC Montréal, January 2007 Canton, Joan, Antoine Soubeyran and Hubert Stahn, “Environmental Taxation and Vertical Cournot Oligopolies: How Eco-Industries Matter,” Environmental and Resource Economics (on line), October 2007 Carpentier, Chantal Line, Kevin P. Gallagher and Scott Vanghan, “Environmental Goods and Services in the World Trade Organization,” Journal of Environment and Development 14 (2005), p. 225-251 Carraro, Carlo and François Lévêque (Eds.), Voluntary Approaches in Environmental Policy, Kluwer, 1999 Carter, Timothy S., “Ascent of the Corporate Model in Environmental-Organized Crime,” Crime, Law and Social Change 31 (1999), p. 1-30 Chaytor, Beatrice, “A Primer on Environmental Goods and Services: Definitional Challenges to the Negotiation of Further Liberalisation,” Study commissioned by the Royal Society for the Protection of Birds, United Kingdom, 2002 Copeland, Brian, “Pollution Policy and the Market for Abatement Services,” Mimeo, University of British Columbia, 2005 _________ and M. Scott Taylor, Trade and the Environment: Theory and Evidence, Princeton University Press, 2004 David, Maia and Bernard Sinclair-Desgagné, “Environmental Regulation and the Eco-Industry,” Journal of Regulatory Economics 28 (2005), p. 141-155

34

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