Pollution is Moving to Less-Regulated Countries

New research shows that Western countries, which have tighter regulations, have forced companies to move their pollution-related activities to other domiciles. That can be good news for environmental, social and governance -(ESG-) based investors, who reward those companies with a lower cost of capital.

Itzhak Ben-David, Yeejin Jang, Stefanie Kleimeier and Michael Viehs contribute to the sustainable investing literature with their November 2020 study, “Exporting Pollution: Where Do Multinational Firms Emit CO2?” They examined the impact of environmental policies on multinational firms’ polluting activities both at home and in foreign countries in the 2010s. Combining firm-level data about multinational firms’ carbon dioxide (CO2) emissions in each country and information about the country-level environmental regulations and enforcement, they assessed the impact of home- versus foreign-environmental policies on firms’ pollution allocations.

Their dataset included 1,970 large multinational public firms headquartered in 48 countries and their CO2 emissions in 218 countries during the 2008-2015 period. They began by noting: “As signs of climate change accumulate, countries around the globe are taking action, yet the strictness of their environmental policies vary significantly. Diversity and lack of coordination in regulations across countries can lead to ‘carbon leakage,’ meaning that firms decide strategically where to locate their production based on existing environmental policies.” Following is a summary of their findings:

  • There has been a general improvement in environmental regulation over time. However, it remains weak in several large regions, especially in developing countries in Africa, South America and Asia.
  • Firms headquartered in countries with strict environmental policies perform more of their polluting activities abroad in countries with relatively weaker policies.
  • These effects are largely driven by tightened environmental policies in home countries that incentivize firms to pollute abroad (they are “pushed”) rather than lenient foreign policies that attract those firms (versus “pulled”).
  • A one-standard-deviation increase in the strictness of environmental policies in the home country was associated with a 29% reduction of CO2 emissions at home, but it was also associated with up to a 43% increase in emissions abroad. These results lend support to the concern that strict environmental policies may lead to carbon leakage.
  • Although firms headquartered in countries with strict domestic environmental policies are more likely to export pollution to foreign countries, they nevertheless emit less overall CO2 globally. Thus, stricter environmental policies at home are associated with a partial, but positive, impact on reducing overall pollution.
  • For firms that have strong governance, the positive effect of strict regulations on pollution is more pronounced – when the home country sets strict environmental policies, well-governed firms produce fewer emissions domestically and export fewer emissions to foreign countries.