Environmental policies and economic outcomes

Ongoing empirical work sheds light on the economic effects of environmental policies

The effects of environmental policies on economic performance are a subject of heated debate. On the one hand, environmental policies have been argued to burden economic activity, as they raise costs without increasing output and restrict the set of production technologies and outputs. On the other hand, the Porter Hypothesis claims that well-designed environmental policies can encourage innovation and gains in efficiency and profitability, which can outweigh the costs of compliance.

The EPS indicator had been used in empirical analysis to gauge the effects on multifactor productivity growth, trade and competitiveness, investment and innovation at the macroeconomic, industry and firm levels. The work shows that environmental policies need not be bad for productivity and that in practice some aspects of their design can be made more friendly to entry and competition without compromising the stringency of the policy signal.

Joint work between the OECD Environment Directorate and the Economics Department on environmental policies and productivity growth has laid the ground for empirical analyses of the economic effects of environmental policies. It provided quantitative proxies measuring the stringency and competition - friendliness of environmental policies. In particular, the recently updated indicator of Environmental Policy Stringency (EPS) provides a comparable, cross-country and over-time measure of the aggregate stringency of selected environmental policy instruments.

The stringency of environmental policies has been increasing across countries

Source: Kruse, T., et al. (2022), "Measuring environmental policy stringency in OECD countries: An update of the OECD composite EPS indicator", https://doi.org/10.1787/90ab82e8-en

Further empirical analysis shows that more stringent environmental policies are effective at inducing innovation in low-carbon technologies in the directly regulated sectors, though not along the whole supply chain. In addition, increases in energy prices and in EPS increase the probability of firm exit from energy intensive sectors but have a positive effect on the employment level of surviving firms. Accelerated firm exit allows surviving firms to expand, boosting firm-level employment.

Also, evidence shows that higher energy prices are not key drivers of overall trade in manufactured goods, but were associated with tilting the comparative advantage away from pollution intensive industries. At the same time, a corresponding advantage in cleaner industries could be identified. Similarly, higher energy prices could indeed be associated with higher outwards FDI stock at the firmlevel. However, the effects were small with respect to other drivers of FDI.

Greener growth requires stringent environmental policies that are flexible and that minimise barriers to entry and competition.

International evidence, as captured by the indicator of the Design and Evaluation of Environmental Policies (DEEP), shows that the extent to which environmental policies create barriers to competition (i.e. administrative burdens and discrimination between entrants and incumbents) and the consideration given to their economic effects in their design vary notably across countries. Hence, stringent environmental policies can – and should - be designed in order to minimize barriers to entry and competition.

The DEEP indicator and measures of environmental policy stringency

Using a new indicator of Climate Policy Uncertainty, recent work shows that uncertainty in climate policy making can reduce firms’ investments, in particular in carbon-intensive industries. Clear policy trajectories are important to encourage investments into much needed low-carbon technologies.

Contact for more information

Key Publications and websites

• A framework to decarbonise the economy, OECD Economic Policy Papers (2022)

• Measuring and assessing the effects of climate policy uncertainty, OECD Economics Department Working Papers (2022)

• Assessing the Economic Impacts of Environmental Policies: Evidence from a Decade of OECD Research (2021)

• http://oe.cd/eps

• www.oecd.org/environment/tools-evaluation

• www.oecd.org/environment/greeneco/framework-to-decarbonisethe-economy/

Mauro Pisu

Economics Department

E-mail: Mauro.Pisu@oecd.org

Tobias Kruse

Economics Department

E-mail: Tobias.Kruse@oecd.org

Filippo Maria D’ARCANGELO

Economics Department

E-mail: FilippoMaria.Darcangelo@oecd.org