Assessing the trade and innovation impacts of climate change policies: do they help UK firms or competitors abroad?

Lead Research Organisation: London School of Economics & Pol Sci
Department Name: Grantham Research Inst on Climate Change

Abstract

This project proposes the first detailed analysis of how climate change policies implemented in one region can simultaneously influence business decisions on innovation and trade activities. It uses UK firm level (micro-)data covering all manufacturing sectors, and asks if UK and EU climate policies indeed help regulated firms to boost innovation activity and exports as intended, or if firms instead react by shifting both production and innovation activity abroad. Specifically, I will focus on two research questions: Q.1 Is there evidence that climate change regulations in the UK cause manufacturing companies to outsource the production of pollution intensive input materials? If so, does outsourcing to low production cost countries lead to higher innovation in these countries (innovation leakage)? And Q.2 Do climate change regulations in the UK increase innovation in clean technologies in regulated companies, and if so, does it improve firms' export competitiveness?

Existing studies fail to find compelling evidence on whether climate policies lead to positive or adverse effects on firms' competitiveness. This is problematic because it makes the issue around competitiveness a highly politicised and contentious one, and prevents countries such as the UK from undertaking more ambitious climate policies to aid the low carbon transformation of their economies.

This project takes a new approach to examining the evidence. Existing research tends to assess impacts of climate change policy on a single measure of competitiveness, be it export volumes, employment or innovation activity. However, jointly assessing how policy simultaneously impacts multiple dimensions of competitiveness has been recently identified as a key gap in the literature (Dechezlepretre and Sato 2014). This is because in the real world, the same policy can have opposing effects on different indicators of competitiveness. This project quantifies the link between two economic adjustments - innovation and trade - as well as the trade-offs between them. This will mark a significant step in deepening our understanding of the highly complex business response to regulation and contribute to improving the design of climate policies, which requires fine-tuning in order to balance multiple policy goals with multiple impacts.

This project will construct and exploit a new and rich micro-database of over 40,000 UK companies in the manufacturing sectors through access to several channels including the host institution, the ESRC funded UK Data Service Secure Lab and the HMRC Datalab. I will construct two core datasets that combines trade (imports and exports), innovation (patenting activity) and basic firm characteristics (economic variables). Using microdata is advantageous not only because competitiveness impacts take place at the level of a company, but also because climate polices tend to concern only a small share of companies within economic sectors. Few other research papers have used the UK microdata in this field of research, making this research unique. The statistical analyses will use a range of data management and advanced econometric techniques which I have developed throughout my PhD and post-doctorate training (e.g. fixed effects panel data estimations, instrumental variables, propensity score matching and non-parametric matching).

The primary beneficiaries of this research are policy makers operating in the area of climate change mitigation. It will inform the design of more efficient policies to control industry emissions by illuminating where policy needs to be strengthened, whether it be more support for innovation or more robust measures against trade distortions. The outcomes of this research will provide new and valuable evidence to support a number of other discussions including the negotiations on liberalising trade in low-carbon goods and policies to boost innovation activity in low carbon technologies.

Planned Impact

Ultimately, this research aims to contribute towards combating climate change. Specifically, it provides empirical facts on the effectiveness of existing climate change policies regulating UK companies and the consequences on the geography of innovation and trade, to feed into discussions on improving the policy designs. The results therefore also relate to the economic competitiveness of UK industry during its low carbon transition.

The project design is focused around a deliberative process to maximise impact, through various platforms of exchange to engage a wide array of users and beneficiaries. The proposed engagement activities will A) ensure the relevancy of the research in the real world by involving beneficiaries in the development of my research and; B) make the results of my studies known, through dissemination and discussions with the wider stakeholder community. The impact activities will thus increase the quality and profile of this research, and raise my own potential to conduct work with strong societal and economic impact as a Future Research Leader.

The primary beneficiaries of this research are POLICY MAKERS operating in the area of climate change mitigation. Specifically, the findings will inform the process of improving the design of policies to control industry emissions, by illuminating where policy needs to be strengthened. The most direct impact will be achieved in the UK and the EU through strong and direct engagement as well as co-production of knowledge with policy makers. I will set up a scoping and advisory group of around 5 persons including policy makers (e.g. from the UK Department of Energy and Climate Change, Committee on Climate Change and the EU Commission's DG Climate Action) and industry stakeholders (some of whom having already expressed an interest in membership) who will advise me through formal and informal discussions, and ensure the validity and relevance of this work, and advise on opportunities to inform and influence policy. I will also organise a policy workshop half way through the funding period to discuss preliminary results and get early feedback to ensure that my on-going research is up to date with the evolving policy debate. Importantly, the timings of this research (2016-2018) will coincide with the reform process (2015-2018) of the EU Emissions Trading System post-2020 and the outcomes are intended to impact this process.

The results will also likely impact the reform process of climate change policies across all implementing countries (e.g. California, China and Quebec) where debates on the competitiveness impacts of climate policy also abound. I will invite INTERNATIONAL CLIMATE PRACTITIONERS (e.g. climate change representatives from various embassies) to the policy workshop and launch event, to ensure that my research findings obtained from the UK's experience with climate policy as an early adopter, can have far reaching impacts internationally. Communicating research results to climate policy makers worldwide using non-academic dissemination pieces (e.g. press releases, One page policy summary, Policy blogs and a Policy brief) will help in receiving international interest in my research.

If the evidence provided by this research leads to improved policy design that better supports businesses in transitioning towards greener production, the BUSINESSES regulated by climate change policies will also benefit. Initial conversations with my existing network of industry stakeholders confirmed their support for this research, as well as the importance and urgency of its implementation. Other beneficiaries include NGOs and INDUSTRY ASSOCIATIONS that influence the climate policy debate, as they can use the results to formulate their positions in national and international environmental advocacy activities. I will also disseminate the non-academic pieces to these stakeholders and invite key persons to the policy workshop and launch event.

Publications

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Dechezleprêtre A (2017) The Impacts of Environmental Regulations on Competitiveness in Review of Environmental Economics and Policy

 
Description The perceived threat of competitive disadvantage associated with stringent environmental regulation (leading to higher energy costs) is a major factor that curbs ambition in efforts to tackle climate change. On one hand, it is feared that ambitious climate policies may trigger firms to offshore or outsource production to countries with less ambitious policies. On the other hand, it is also argued that climate policies can encourage clean innovation and this could have a positive impact on firms' economic performance. This project has made significant contributions to advance the evidence base informing these long-standing debates, making a number of advances both theoretically and empirically.

First, I examined if climate change regulations are expected to drive manufacturing companies to outsource production of pollution intensive goods. To do so, I investigated how historically, patterns of cross-border investments respond to international differences in industrial energy prices. I tested the hypothesis that the bigger the differences in energy price, the higher the number of investments. I found the hypothesis is supported by the data for energy intensive sectors, hence the concerns around the adverse impacts of cross-border investments are warranted. However, the results also highlight the extent to which competitiveness concerns have been exaggerated.
Highlights are as below:
- Unlike previous studies that relied on limited geographical scope, I was able to test the effects of scale using a unique and comprehensive database of global bilateral cross-border investments in manufacturing sectors combining firm-level merger and acquisition (M&A) data from Thomson Reuters with industrial energy prices. The data covers 41 countries over 20 years (1995-2014), including around 22,000 cross-border transactions, and has not been used previously in this area of research.
- I significantly developed my econometrics skills, as this work required state of the art econometric analysis. The estimations used addressed two key limitations in previous work (controlling for other production factor costs and multi-lateral resistance terms), making a serious methodological contribution to the literature.
- Faced with a challenge to improve robustness of estimations and to overcome computational issues due to the large size of the dataset, this research required building a custom econometric estimator (high dimensional fixed effects PPML estimator extended to more than two fixed effects) . This new econometric tool will be made publicly available, representing an important methodological contribution.
- The results are robust and show that energy price differences do indeed impact firms' decisions on cross-border investments, but importantly the results also show that the magnitude of the effect is small. A 10% increase in the industrial energy price differential between two countries is associated with a 3.2% increase in the number of acquisitions of firms or assets located in the countries where the energy price is lower.
- Surprisingly, the effect is much larger (four times) for transactions targeting countries outside the Organisation for Economic Co-operation and Development (OECD) than for those targeting OECD countries.
- Less surprising is that the effect is much stronger for energy intensive sectors, however, this provides compelling evidence that it is necessary to protect these sectors from the risk of relocation or leakage, if large differences in carbon prices persist internationally.
- The working paper produced from the research won a best paper prize at the French Association of Environmental and Resource Economics Conference in September 2018.

Secondly, I examined the link between outsourcing and innovation, specifically testing if greater outsourcing leads to lower innovation in the UK. This novel research question fills an important gap in the literature, as previous studies examined the impact of environmental regulation on outsourcing and innovation separately, ignoring the links and trade-offs between the two dimensions of competitiveness. This has been problematic because in the real world, the same policy can have opposing effects on different dimensions. This research has revealed a number of new and interesting insights. Highlights are as follows:
- I found that there is a strong relationship between trade and innovation at the company level, but in unexpected ways. Firms' innovation activity goes up, as their outsourcing goes up (by increasing import varieties), if the trade is from high-cost countries. Simultaneously, as firms' outsourcing goes up, innovation goes up. This applies both to low cost and high cost countries. The results suggest that there are no adverse impacts on innovation activities in the UK, from firms engaging increasingly in international supply chain networks. This is good news for UK climate policy, as it appears there is limited innovation leakage (innovation activity leaking to low-cost countries as a result of UK policies).
- To conduct this research I was able to access and use a confidential database of UK firm-level international trade from the HMRC secure data lab. These data have not been used in environmental economics before, hence this study represents a truly novel contribution. I combined the new database with firm level patent data, for the period 2007-2016. Now that I have become an accredited researcher for the HMRC secure data lab, I hope to utilise it for further research on issues relating to trade and climate change - leading to long-term career benefits and contributions to scholarship.
- Through this work, and together with my mentor, I became actively engaged in bringing together a global network of researchers interested in environmental policy evaluation using government-owned secure firm level data. In July 2018, I co-hosted an "Expert workshop on the creation and uses of combined environmental and economic performance datasets at the micro level" together with the OECD. We invited over 35 international researchers and data providers, to share and learn from each others' experiences of using data laboratories including in Canada, USA, China and Europe. This is a promising new network which I hope to develop, to open future opportunities for collaboration on both research and fundraising.
Exploitation Route The results of this research are highly relevant to policy makers around the world to help improve climate policy design, by providing new (robust) evidence on a highly contentious issue. That is, the effectiveness of existing climate policies regulating energy intensive industries and their consequences for the geography of innovation and trade (particularly impacts on UK businesses). The impact related outcomes will be reported in the Narrative Impact section.

In terms of impacts on the research front, I envisage at least four ways in which this research will be carried forward.

First, the UK microdata inside the government secure data labs have been relatively under-utilised by research in climate and environmental economics, relative to for example the French, Mexican and US data, and also relative to other subfields such as labour and trade economics. I have demonstrated the potential value of this resource for investigating important questions surrounding climate policy, thereby paving way for further research. Specifically, this research merged firm level trade data with patent data and company data. Having performed this labour intensive exercise, the result is a valuable resource that can be used to explore other related research questions, which I plan to do going forward. I will also share the code with other researchers who are accredited to use these proprietary databases inside the secure lab.

Second, to overcome a number of issues with estimation in the previous literature, this research specified a novel and theory-consistent estimation method (a conditional logit model linking bilateral investment activity to relative energy prices, building on the application of discrete choice theory). I then demonstrated that this effect can be identified using an adapted gravity model estimation, using a global dataset. These major methodological contributions were widely recognised and I envisage that this methodology will be adopted as the norm in the literature.

Third, this research is one of the first studies that explored the link and trade-offs between multiple dimensions of competitiveness impacts, specifically testing the link between innovation and imports. A key issues highlighted is that of endogeneity - innovative firms are more likely to import, but importer firms are more likely to be innovative. By highlighting the importance of this issue early in the literature, I envisage that this research will improve the quality of the studies that follow. Furthermore, I proposed methods to overcome this issue to try to establish the causal impact of innovation on imports, using exogenous sources of variation.

Fourth, the new econometric method (a custom econometric estimator) built for this research resulted in a tool, which can potentially help any STATA software users (STATA is a very widely used statistical software package). Using high dimensional fixed effects has been an important advance in applied econometrics, and extending this tool will likely help advance econometric research in many fields.
Sectors Energy,Environment,Government, Democracy and Justice,Manufacturing, including Industrial Biotechology

 
Description This research contributes to the changing narrative on the competitiveness impacts of climate policy. The past discourse was characterised by concerns that early and ambitious climate action comes at the cost of hampering competitiveness of domestic industries that are subject to higher regulatory burden of reducing emissions. The growing empirical evidence base around these issues, including outcome of this project have helped to shift the focus towards a new narrative around the opportunities for growth in the low carbon transition. Specifically, my research and those of others have been able to show that adverse impacts of carbon pricing on carbon leakage and competitiveness are contained to a few sectors, and much smaller in magnitude than feared. This has contributed to focusing the debates on how to ensure effective leakage protection for the sectors most at risk. Another key finding is that carbon pricing has a positive impact on induced technological change, and that there is a positive relationship between trade and innovation. These findings have curbed fears that carbon pricing is leading to innovation leakage in the UK and other countries implementing carbon pricing policies, and enabled shifting the debate towards how to further enhance the effectiveness of carbon pricing while avoiding leakage and competitiveness risks. This change in narrative is occurring both in the academic and policy spheres. This is important because the fear of competitiveness loss and carbon leakage are major barriers to strengthening carbon pricing policies, which in turn is necessary in order to enable the transition to carbon neutrality. In order to achieve net zero carbon in these energy intensive sectors, it is imperative to move towards full carbon cost internalisation, but the current policy framework doesn't deliver this. As a result, capital investments are not yet shifting on a large scale from high to low carbon projects in industry sectors, because investors cannot recover the incremental costs of low carbon investments. The policy debate is now shifting from a defensive stance: "how do we prevent adverse competitiveness impacts of climate policy?" towards a more focused and future looking one: "how can we build a robust low carbon investment framework to enable the low carbon transition of UK's industry?". The findings from this project have enabled this shift, therefore has public policy, societal and economic benefits by helping to accelerate and improve the course of debate on policies to support industrial decarbonisation. This research is timely and represents an early empirical investigations that quantifies risks of competitiveness and leakage, and assesses the trade-offs between two international competitiveness dimensions of low carbon activities of firms. Results of this research are gaining traction, as I undertake interactions with my target audience (e.g. giving evidence to House of Lords Select Committee, and interacting with other policy makers, climate stakeholders and research beneficiaries) and my findings are disseminated. I expect to be able to continue leverage this research for further impact in the future.
First Year Of Impact 2019
Sector Energy,Environment,Government, Democracy and Justice
Impact Types Societal,Policy & public services

 
Description Industrial Heat consultation
Geographic Reach National 
Policy Influence Type Gave evidence to a government review
 
Description Member of Technical Steering Committee on "Services and Circular Economy" project by WTO, IISD and Sitra, funded by Finnish ministry of Foreign Affairs
Geographic Reach Europe 
Policy Influence Type Membership of a guideline committee
 
Description Member of expert panel for EU Court of Auditors Expert panel meeting on the free allowances within the EU Emissions Trading System
Geographic Reach Europe 
Policy Influence Type Membership of a guideline committee
 
Description Oral evidence to the House of Lords Select Committee on The EU Energy and Environment Sub-Committee on "EU Green Deal - Carbon Border Adjustment Mechanism"
Geographic Reach National 
Policy Influence Type Gave evidence to a government review
 
Description ESRC Centre Transition Funding
Amount £1,366,028 (GBP)
Organisation Economic and Social Research Council 
Sector Public
Country United Kingdom
Start 10/2018 
End 09/2023
 
Description MINES ParisTech 
Organisation Mines ParisTech
Country France 
Sector Academic/University 
PI Contribution I bring intellectual input and access to UK microdata to this collaboration.
Collaborator Contribution My collaborator brings intellectual input to this collaboration.
Impact Publications are forthcoming.
Start Year 2017
 
Description OECD 
Organisation Organisation for Economic Co-operation and Development OECD
Country France 
Sector Public 
PI Contribution I bring expertise on relevant topics, as well as access to microdata sets.
Collaborator Contribution My collaborators bring expertise on microdata analysis.
Impact Forthcoming
Start Year 2016
 
Description SciencesPo 
Organisation Sciences Po
Country France 
Sector Academic/University 
PI Contribution I bring expertise on analysis of competitiveness impacts of climate policies, as well as access to data (indicators of climate policy stringency).
Collaborator Contribution My collaborator brings expertise on microdata analysis as well as access to firm level mergers and acquisitions data.
Impact Saussay, A. and Sato, M. (2018). The impacts of energy prices on industrial foreign investment location: evidence from global firm level data. Grantham Research Institute on Climate Change and the Environment Working Paper, (No. 311).
Start Year 2016
 
Description VATT 
Organisation VATT Institute for Economic Research
Country Finland 
Sector Private 
PI Contribution I bring expertise on the analysis of trade and innovation, methods for identifying green economic activities, as well as access to UK microdata.
Collaborator Contribution My collaborater bring expertise on the theoretical and empirical analysis of trade data and access to Finnish microdata.
Impact Forthcoming
Start Year 2017
 
Description AMmeetingFeb2017 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Professional Practitioners
Results and Impact Discussions with two industry stake holders (energy intensive industry representatives) about my ongoing research lead to cogerneration or knowledge and useful inputs into analysis.
Year(s) Of Engagement Activity 2017
 
Description Discussions with SIngaporean policy makers on competitiveness impacts from carbon pricing on heavy industry, policies to support low carbon technologies, EU Emissions Trading System and international emissions trading markets. 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Policymakers/politicians
Results and Impact Knowledge exchange with representatives from Singapore Ministry of Trade and Industry, Foreign Economic Policy Division, Energy Division and 3 academics (NUS)
on topics related to carbon pricing and competitiveness impacts.
Year(s) Of Engagement Activity 2019
 
Description EAERE2017 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact Over 500 people attended this large conference mainly consisting of environmental economics academics, where I was able to get feedback on my research.
Year(s) Of Engagement Activity 2017
 
Description Expert workshop on the creation and uses of combined environmental and economic performance datasets at the micro-level 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Professional Practitioners
Results and Impact This expert workshop gathered around 30-40 experts on micro-data analysis in environmental economics together with data providers and policy makers, to discuss the benefits, challenges and potential for combined economic and environmental data at the plant/firm level to facilitate more robust analyses of joint environmental and economic outcomes of environmental policies. Experts were gathered from across Europe, Asia and North America, using official microdata to conduct research on environmental issues, as well as representatives from National Statistical Agencies. It focused on the creation and uses of joint environmental and economic performance datasets at the micro-level, to create a supporting community of practice and showcase the results from analyses that have successfully combined such datasets. From these discussions, recommendations were developed for improving existing secure data infrastructures, to enable cutting edge research and reliable policy evaluations.
Year(s) Of Engagement Activity 2018
 
Description FRData_feb2018 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Industry/Business
Results and Impact An afterenoon's discussion with representatives from private sector to discuss green economic activity data issues, which resulted in mutual understand of research activities and agreement on joint engagement activities in the future.
Year(s) Of Engagement Activity 2018
 
Description FSR2017 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact Around 60n people attended this small conference mainly consisting of academics and policy makers, where I was able to get feedback on my research and meet relevant stakeholders.
Year(s) Of Engagement Activity 2017
 
Description GWJan2017 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Schools
Results and Impact Around 30 academics and wider stakeholders attended my presentation, and this lead to knowledge exchange, and useful discussions afterwards.
Year(s) Of Engagement Activity 2017
 
Description HelsinkiMay2017 
Form Of Engagement Activity Participation in an open day or visit at my research institution
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact I was invited to attend a day's visit to VATT, Helsinki to discuss my research on trade, innovation and climate, with academics and students and to give a talk.
Year(s) Of Engagement Activity 2017
 
Description Nov2017workshop 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Discussion with UK policy makers on issues with climate, trade and innovation. Lead to knowledge exchange, and gained valuable contacts that would aid access to data and research resources.
Year(s) Of Engagement Activity 2017
 
Description ParisMay2017 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact Around 200 academics attended this conference, where I was able to get feedback on my research and engage in discussions on my research.
Year(s) Of Engagement Activity 2017