Multinational firms headquartered in countries with strict environmental policies choose to conduct their polluting activities in foreign countries with relatively weaker policies. These effects are stronger for firms in pollution-intensive industries and firms with poor corporate governance. But while firms based in countries with strict policies are more likely to export pollution abroad, they nevertheless produce fewer overall carbon emissions globally.

These are among the findings of a new research report by Itzhak Ben-David (Ohio State University), Stefanie Kleimeier (Maastricht University) and Michael Viehs (University of Oxford). Their results highlight the importance of collective action to combat climate change given the global scale of many firms’ operations.

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Pollution and the emission of greenhouse gases is an undesired externality of manufacturing activity that contributes significantly to the changing climate around the world. This externality is costly to avoid. As a result, firms are likely to find ways to circumvent costly carbon pollution abatement requirements.

One strategy for firms operating in multiple locations could be to transfer manufacturing activities that produce carbon dioxide to countries where environmental regulations are less stringently defined and enforced than in the firm’s home market – a concept known as ‘carbon leakage’.

This study sheds light on the argument using a novel dataset comprising firm-level carbon emissions data. The authors find a strong pattern that firms indeed locate their carbon-emitting activities in countries where environmental regulation is less developed and less stringently enforced: Scope 1 and Scope 2 carbon emissions levels are significantly higher abroad when environmental regulation in the home market is more stringent than abroad.

These results hold in a standard firm-level framework as well as in a disaggregated firm-country-level context. More specifically, the researchers find that firms emit less at home when headquartered in countries with stricter regulations. These firms, however, pollute more abroad, typically in countries with weaker regulations.

The combination of push and pull factors can explain the main finding that firms perform their production activities in countries with looser environmental regulation relative to their home country. The results suggest that tightening environmental policies in home countries, not the laxer policies in foreign countries, provide incentives for multinational firms to shift polluting activities abroad.

In addition, the study documents that tightening domestic environmental regulations has a strong impact on firm behaviour related to pollution transfer, while relaxing them does not have the opposite impact to the same degree. This result underscores the possibility that, without global coordination, strengthening domestic environmental policies could create an unintended negative externality, pushing firms to pollute elsewhere.

On the positive side, the higher foreign emissions levels do not completely outweigh the reduction at home. Thus, individual countries can make a difference. But the findings overall highlight the need for collective action to bring down global emission levels further.

The 2015 Paris Agreement on climate change was an important step toward achieving this goal. If no coordinated effort is undertaken to address climate change, major stakeholders, such as large firms, will find ways at least partially to circumvent strict environmental regulations in certain parts of the world and move their production activities elsewhere.

The results further suggest that policy-makers might be most effective if they focus on curbing the ability of pollution-intensive industries to export pollution to countries with laxer environmental regulations.

For multinational firms with production facilities around the globe, these results imply that – depending on how quickly and effectively countries implement the Paris Agreement and the European Green Deal – they may continue to benefit from the regulatory arbitrage opportunities documented in this study or they should be prepared to invest in pollution-abatement methods and techniques.

Whether these international agreements will harmonise national environmental regulation enough that firms will no longer have an option to locate operations purely based on concerns about the strictness of environmental regulation in a particular country remains to be seen.

‘Exporting pollution: where do multinational firms emit CO2?’

Authors

Itzhak Ben-David (Ohio State University)

Stefanie Kleimeier (Maastricht University)

Michael Viehs (University of Oxford)