Green investments and firm performance: Evidence from Irish industry

Topic:Environmental regulation is increasing in scope and stringency as the ‘polluter pays’ principle is accepted and international consensus on climate action evolves.  The introduction of the European Union Emissions... [ view full abstract ]

Topic:

Environmental regulation is increasing in scope and stringency as the ‘polluter pays’ principle is accepted and international consensus on climate action evolves.  The introduction of the European Union Emissions Trading Scheme (EU ETS) in 2005 is one such regulation. The EU ETS regulates enterprises with high energy use by setting an overall limit of greenhouse gas (GHG) emissions permissible and, within the limit, the enterprises must trade emission allowances.

Firms react to environmental regulation through a combination of increased current expenditures, allowance trading costs and/or increased capital expenditure in environmentally friendly (‘green’) technologies (Böhringer et al. 2012). Classical economic theory suggests that environmental compliance imposes additional costs on industry without increasing output level effecting many aspects of business including profitability, competitiveness, prices, demand, innovation and investment decisions (Kozluk and Zipperer, 2013; Ambec et al. 2013; Dechezlepretre and Sato, 2017; Muuls et al. 2016). However, the Porter Hypothesis states that properly designed environmental regulation drives innovation and efficiencies (Porter and van der Linde, 1995). The ‘strong’ version of the Porter Hypothesis states that innovation and efficiencies offset the costs of regulation resulting in increased business performance. No clear consensus on the Porter Hypothesis exists in the literature.

Aim:  This paper presents an empirical examination of the relationship between green expenditure, resource efficiency and competitiveness at the enterprise level in Ireland. Specifically, the paper examines if expenditure on green investments can increase resource efficiency within the firm and ultimately benefit firm competitiveness.  It tests the empirical validity of Porter’s hypothesis in the Irish context following the introduction of EU ETS.  

Methodology: 

We employ a three-stage model using panel data containing measures of green expenditures, resource efficiency and firm performance.  The panel data set was generated specifically for this study using secondary data gathered through the annual Irish Census of Industrial Production 2006 to 2014 (i.e. The period after the EU ETS was introduced). To test first order effects, a probit model was estimated to identify whether perceived regulation stringency (captured by ETS Phase) significantly impacted the firm’s probability of expending on three types of green investment (i.e. current expenditure on pollution, capital expenditure on pollution control and capital expenditure on clean technology). Current expenditure includes expenditure on monitoring, reporting and verification (MRV) but leaves processes unchanged. Capital expenditure on pollution control focuses on pollution abatement but involves minimum change to processes. Capital expenditure in clean technology involves a move to low-carbon operations, reducing polluting inputs, and results in fundamental changes in production methods. We use the predicted probability of green investments, in addition to other firm-specific characteristics, as determinants to assess second order effects in a resource efficiency model estimated using fixed effects panel estimation.  Third order effects on performance are estimated through considering the effect of significance and sign of predicted resource efficiency on firm competitiveness measured by gross value added per worker (GVA) in a final fixed effects panel estimation to garner whether the stronger or weak version of Porter’s hypothesis is evident. We repeat the analysis for sectors with different levels of emissions and for firms with different levels of fuel-intensity to consider the robustness of the findings for these subgroups.

Findings: In examining the first order effect of perceived regulation stringency on green expenditure we find there was decreased probability of current and capital expenditure in Phase 2 of the EU ETS compared to Phase 1 indicating that ETS Phase II was not perceived to be stringent. Older and larger firms were found to have an increased probability of current expenditure on pollution.  We find that the probability of capital investments decreases with age, foreign-ownership and exporting, but that larger firms are more likely to spend on capital investments.

In exploring second order effects, we find that the effect of green expenditure on resource efficiency depends on the type of investment. Current expenditure on pollution has a negative influence on resource efficiency. Investment in pollution control does not significantly affect resource efficiency. Investment in low-carbon technology has a positive impact on resource efficiency. We find that subsequent EU ETS phases, after Phase 1, have a positive impact on resource efficiency. This supports the ‘weak’ Porter Hypothesis that regulation drives efficiencies and that innovative green investments can increase resource efficiencies.

When the determinants of resource efficiency are examined by sectors with higher levels of emissions we find that expenditure on capital clean technology is positive for firm resource efficiency across sectors with different levels of emissions. However, investment in cleaner technologies by firms with high-fuel-intensity in high emitting sectors had a negative impact on resource efficiency.

In exploring third order effects we find that resource efficiency has a positive impact on competitiveness. In our analysis a 1% increase in resource efficiency resulted in a 0.7% increase in GVA. This supports the ‘strong’ Porter hypothesis that investment in innovative clean technology results in resource efficiency that offsets the investment costs and impacts positively on business performance. 

Resource efficiency is also found to be a positive determinant of competitiveness for firms operating in sectors with different levels of emissions except for the very-high-emitters where all efficiencies are likely to extracted already.  Resource efficiency is a strong determinant of GVA for firms with high-fuel-intensity however this is achieved through capital investment in pollution control rather than clean technology.

Our study shows a very low level of green capital investment. It appears that to date many firms have responded to regulation with low commit responses rather than capital investments. These types of minimal responses are unlikely to be sufficient as increased stringency is applied in future EU ETS Phases.

Contributions:  This paper contributes to the existing literature in several respects. 

The results provide insight into the drivers of green investments of Irish firms. The paper benefits from having direct data on green investment rather than using a proxy such as patent activity. The analysis investigates three different types of green expenditure associated with different inherent levels of innovation.

This paper offers useful policy implications from testing the link between environmental regulation and competitiveness. Few papers to date have employed a stepwise progression designed to avoid endogeneity to test the ‘Strong’ Porter Hypothesis as conducted in this study. This is particularly significant as regulation implementation must balance environmental outcomes, encourage green capital expenditure and minimise the effect on business performance. The results of this analysis reinforce the concept that when regulation results in a new economic advantage it must address an existing market failure (Lanoie et al. 2011; Ambec et al. 2013) and resource efficiency in particular (Rexhauser and Rummer, 2014). We have extended the analysis based on sector-emission-levels and firm-fuel-intensity, rather than the usual sectorial analysis, to provide some overarching conclusions based on these descriptors.

In addition, there has been very little ex ante research into the effect of the EU ETS on driving clean technology and on competitiveness at the firm level in Ireland. The studies that have been conducted mainly consider the impact of the early years of regulation introduction (Jaraitė et al. 2010; Anderson et al. 2011; Doran and Ryan, 2012; Haller and Murphy, 2012). In our paper we include the three EU ETS phases as determinants in our analysis. 

References

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Anderson, B., Convery, F., and Maria, C. D. (2011). Technological change and the EU ETS: the case of Ireland. IEFE Working Paper Series 43.

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Dechezleprêtre, A. and M. Sato (2017). The Impacts of Environmental Regulations on Competitiveness. Review of Environmental Economics and Policy, 11(2): 183-206.

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