The Threat of Offshoring on the Environmental Regulation

Abstract

This paper aims to analyze how the threat of offshoring can lead policymakers to adopt more lenient emissions tax policies. This study focuses on analyzing the relationship between the stringency of environmental policies and firms’ strategic offshoring decisions when a government is concerned about the negative effects of increased offshoring such as domestic job losses. The analysis is based on an archetypal proximity concentration framework that has been enhanced by considering environmental regulations and abatement technology. The results imply that the threat of offshoring is more likely to impact emissions tax rates when firms experience higher productivity, or when offshoring leads to a significant level of domestic unemployment. That is, in these cases, the threat of offshoring is more likely to make the government lower emissions tax rates more than the optimal tax rate. Although the direct impact of offshoring on environmental policies is studied in many related works, the indirect impact of offshoring-that is, the threat of offshoring- on environmental policies has been seldom studied.

KEYWORDS:

• Offshoring threat
• emission tax
• environmental protection
• foreign direct investment

JEL Classifications:

• F18
• F23

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been corrected with minor changes. These changes do not impact the academic content of the article.

Notes

1 There are several different expressions regarding foreign production such as offshoring, foreign direct investment, and multinationals. This paper uses ‘offshoring’ instead of other terms because we want to focus on the location of production rather than the ownership structure. 

2 Extensive research has been devoted to verifying the pollution haven hypothesis; some studies suggested that more stringent environmental regulations may deter the inward FDI, confirming the pollution haven hypothesis (e.g. List & Co, 2000; Keller & Levinson, 2002; Xing & Kolstad, 2002; He, 2006). On the other hand, some recent studies have argued that there is no consistent evidence proving the pollution haven hypothesis (Smarzynska & Wei, 2002; Levinson, 2010; Kirkpatrick & Shimamoto, 2008; Manderson & Kneller, 2012).

3 This idea is also closely related to effect of offshoring threat suggested by several studies regarding the impacts of offshoring on the labor market. They argue that the possibility of offshoring may provide more options as well as bargaining power to firms, correspondingly affecting the domestic labor market.

4 This study's analytical framework may help explain the recent trend of manufacturing reshoring and changes to environmental policy in the United States. In particular, the United States has declared its withdrawal from the Paris Climate Change Agreement (2017), and there are concerns that international efforts to protect the environment have deteriorated. While the recent trends of manufacturing reshoring and environmental policy changes may be seen as separate, politically-motivated phenomena, the two phenomena may be economically related. Furthermore, the new United States administration has publicly stated that strong environmental policies can weaken incentives for potential industrial growth, as a result of which the environmental sector has been subjected to regulatory reform. This perspective held by regulatory authorities regarding environmental issues may provide incentives for entrepreneurs to use offshoring decisions strategically.

5 Since $\sigma =1/(1-\beta )$, $\sigma \beta =\sigma -1$, $\sigma -1=\beta /(1-\beta )$, and $\beta =(\sigma -1)/\sigma$.

6 The presented model could be modified to a Melitz (2003)-type model assuming the heterogeneity of firms in productivity. Although there are benefits to the Melitz model, this paper assumes the Krugman (1979)-type monopolistic competitive market with homogenous firms because of its tractability.

7 For simplicity of notation, labor productivity $\phi$ is omitted in the function forms in this paper.

8 The technologies used by Copeland and Taylor (1994, 2003) and Hwang (2012) are essentially equivalent to abatement technology (3). Consider the following abatement technique that is a simplified version of Copeland and Taylor (1994, 2003) and Hwang (2013): $z(l^A,x)\equiv \frac{1}{v(s)}{\left(\frac{z^{max}(x)}{{(z^{max}(x)+\phi l^A)}^{1-\alpha }}\right)}^{1/\alpha }=\frac{1}{v(s)}{\left(\frac{x}{{(x+\phi l^A)}^{1-\alpha }}\right)}^{1/\alpha },\text{for}\alpha \in [0,1]$where $s$ is the fixed cost for a firm to meet the environmental standard and $v(s)$ is a function that represents the impact of $s$ on pollutant emissions. Assuming no enforced fixed cost, $v(s=0)=1$, and the given abatement technique can be rewritten as: $z(\gamma ,x)=(1+\gamma {)}^{\frac{\alpha -1}{\alpha }}x$Redefining $\eta \equiv \alpha /(1-\alpha )$, we can obtain abatement technology (3).

9 Alternatively, it can be assumed that a firm's entry/exit decision is conducted in the second stage and that the fixed cost $f_x$ is incurred in this stage. Then, after the entry/exit decision, the abatement effort is assumed to be chosen by firms. This four–stage scenario is more popular in literature regarding Krugman-type monopolistic competition, but the analysis using four stages is similar to that being used in this paper.

10 Equivalently, the firm chooses its abatement efforts to maximize monopoly profit (6).

11 The second order condition for the minimization is satisfied: ${\frac{{\mathrm{\partial }}^2\overline{mc}({\gamma }^{\ast },\tau )}{\mathrm{\partial }{\gamma }^2}|}_{{\gamma }^{\ast }}==\frac{\tau }{\eta }\left(\frac{1+\eta }{\eta }\right)(1+\gamma {)}^{-1/\eta }\ge 0.$

12 The second order condition is held because $\beta \le \zeta$: ${\frac{d^{2}u(n)}{d{n}^2}|}_{n_{bm}}=\left(\frac{\zeta -\beta }{\beta }\right)\frac{{x_{bm}}^{\zeta }}{\beta }{n_{bm}}^{\frac{\zeta -\beta }{\beta }-1}<0.$

Additional information

Funding

This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government [NRF-2019S1A5A2A01041165].

Notes on contributors

Chul-Woo Kwon

Chul-Woo Kwon is a professor in the Department of Economics, Kyungpook National University, Daegu, Republic of Korea, and was previously a senior economist of the Bank of Korea. He specializes in the international trade and offshoring.

Uk Hwang

Uk Hwang is an economist and a professor in the Department of Economics, Kyungpook National University, Daegu, Republic of Korea. Hwang was previously a research fellow at KEI(Korea Environment Institute). His research interests are political economics and issues of international trade policy implementation.