Tough environment policies are good for the economy

Nov 12, 2021
school climate change protest canberra
(Image: AAP/Lukas Coch)

Melbourne Institute research found that while there might be a short-term hike in cost, countries whose governments implement strong environmental regulations reap the productivity rewards and economic growth in the long term.

Key Insights

1. Australia ranked last in environmental protection stringency

We rated each nation’s environmental policies using the OECD’s Environmental Policy Stringency Index (EPS), developed in 2014. The index is a country-specific and internationally comparable measure of the stringency of environmental policy. Stringency is defined as the degree to which environmental policies (such as a carbon tax and pricing mechanism) put an explicit or implicit price on polluting or environmentally harmful behaviour. T

he EPS ranges in value from 0 to 6, with higher numbers being associated with more stringent environmental policies.

The 22 OECD nations considered in our study scored between about 0.5 and 3.3 from 1990 to 2007.

All the 22 nations had gradually tightened their environmental regulation between 1990 and 2007. Denmark had the highest and Germany the second highest average score over the 17 years,
and Australia had the worst. Figure 1 shows the trajectory of a few example nations — Australia, Germany, United States and United Kingdom — against the OECD average.

2. A benefit in the long run

We modelled how productivity would change respectively in one, two and0 three years if environmental protection regulations strengthened, while keeping everything else about the production
process (prices for material, cost of labour etc.) fixed at the average level of the 22 OECD countries, so that we can identify the change in productivity only attributed to change in environmental protection regulations.

The three-year result is shown in Figure 2. It shows the estimated total factor productivity (TFP) growth in three years, against a present EPS score, ranging from 0.6 to 2.1 which cover the scores of most countries observed in our data.

We found that tougher environmental policy in previous years, such as a carbon tax and pricing policy with more effective carbon rate, generally boosts a country’s productivity growth in the future.

From Figure 2 we can see that productivity growth in three years, on average, would have been higher if the adopted environmental policy setting had been stricter. In particular, from 1990 to 2007, if an average OECD country managed to increase its environmental policy toughness by 1 unit, say from 1.5 to 2.5, its productivity would roughly see an increase of 0.30 percentage points.

While environmental regulations can increase the cost of production initially — for example, a carbon tax makes coal more expensive, which increases the costs of metal production — our results show that adopting tighter environmental policies has a positive impact on a country’s overall future productivity growth.

3. The early bird gets the worm

From Figure 2, it can also be observed that if an average country had adopted an environmental policy setting that was strict enough (for example, with an EPSscore above 1.7), it would have seen a positive productivity growth in just three years’ time.

This observation indicates that countries demonstrating leadership on environmental protection and adopting stringent policies earlier would also expect to benefit from positive productivity growth sooner.

An important question of our time

The impact environmental policies have on production technology and productivity is an important question of our time.

Our findings show that while there might be a short-term hike in cost, countries whose governments implement strong environmental regulations reap the productivity rewards and economic
growth in the long term.

As the US and EU moved forward with their green recovery plans, there was little talk of the climate crisis or the environment in Australia’s 2021 federal budget.

As Australia’s largest trading partners make bigger and bolder commitments towards a decarbonised economy and use their COVID-19 recovery budgets to maximise the opportunity to boost a
clean energy transition, the Australian government has committed to a gas-fired recovery over a green one, pouring billions into fossil fuel projects.

In a very recent study, Best et al. (2020) examined data from 142 countries over a period of two decades and found clear evidence that the average annual growth rate of CO2 emissions from
fuel combustion has been around 2 percentage points lower in countries that have had a carbon price compared to countries without.

Instead of adopting a wide range of effective and efficient environmental policies, the Australian government has pinned its hopes only on a “low-emissions technology” approach including, for example, carbon capture and storage (CCS) as a priority technology, to achieve the net-zero emission target. The problems with this approach are most obvious in the context of CCS. For instance, a recent study examined 39 CCS projects in the US and found that more than 80 per cent ended in failure (Abdulla et al., 2021). Australia also has the disappointing experience with its only CCS project so far,

Chevron’s Gorgon gas field off Western Australia, which fails to deliver on the pollution deal, adding millions of tonnes of more carbon a year than it’s supposed to be.

If we want to reap the rewards, we need to act early on implementing policy approaches, such as a carbon tax and carbon pricing policy, which would be more effective and efficient.

Also, given the findings in our study suggest that countries demonstrating leadership on environmental protection and adopting stringent policies earlier would expect to benefit from long term positive productivity growth, the government should make more ambitious commitments to Australia’s 2030 emissions reduction target, to become a world leader in the race to achieve the zero-emission target.

Over a decade ago, Paul Krugman, the Nobel prize-winning economist, famously said: “Productivity isn’t everything, but in the long run it is almost everything”, which, together with our findings, indicates the urgent need for the Australian government to produce strong environmental protection policies. A more ambitious commitment to Australia’s 2030 emissions reduction target would be a good start.

This report was first published by the Melbourne Institute and is reproduced with permission.

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