Environmental standards as a strategy of international technology transfer

environmental science & policy 38 (2014) 192–206

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Environmental standards as a strategy of international technology transfer Eri Saikawa a,*, Johannes Urpelainen b a

Environmental Sciences and the Rollins School of Public Health, Emory University, 400 Dowman Drive, Math and Science Center, 5th Floor, E512, Atlanta, GA 30322, United States b Department of Political Science, Columbia University, 420 W 118th Street 712 IAB, New York, NY 10027, United States

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abstract

Article history:

Political scientists have shown that regulations diffuse from importing nations to exporting

Received 29 April 2013

nations through international trade channels. However, this exporter–importer logic cannot

Received in revised form

explain why some key developing countries, such as China, have adopted automobile

28 November 2013

emission standards despite their local manufacturers’ inability to compete in international

Accepted 29 November 2013

markets. We develop a theory of environmental regulations as a strategy of international

Available online 7 January 2014

technology transfer. We argue that developing countries benefit from adopting environmental regulations if they enjoy substantial foreign direct investment (FDI) inflows in the

Keywords:

concerned economic sectors and hold promise as automobile markets for foreign producers

Environmental standards

with access to advanced technology. In these circumstances, developing countries can use

Technology transfer

environmental regulations to force foreign producers to supply new technologies. We

Policy

support the theory with a quantitative analysis of new data on the relationship between

Air pollution

automobile FDI and developing countries’ adoption of emission standards. We find that automobile FDI has a strong positive effect on the probability of adoption. # 2013 Elsevier Ltd. All rights reserved.

1.

Introduction

The conventional wisdom holds that there is a California effect in international environmental policy: regulations diffuse from importing nations to exporting nations (Drezner, 2001; Neumayer, 2001; Prakash and Potoski, 2006; Vogel, 1995). If an importing nation enacts a regulatory policy, exporting firms in other nations must comply with the policy, unless they stop exporting. This reduces the exporting firms’ incentive to lobby against new domestic regulations. Domestic environmental constituencies gain the upper hand, and the government responds by enacting the regulatory policy that is no longer opposed by the exporting firms.1

Although empirical evidence generally supports the ‘‘trading up’’ hypothesis, some prominent cases are difficult to explain with reference to exporter–importer dynamics. For example, consider China’s experience with environmental regulations. In the year 2000, the Chinese government adopted the automobile emission standard, Euro 1, that the European Community had applied already in 1992 (Gan, 2003).2 While the environmental benefits were obvious, domestic exporters did not play a role. As we show below, the Chinese automobile industry was barely competitive at home (Gallagher, 2006a; Thun, 2006). Since China was not a major automobile exporter, the conventional California effect does not hold. Moreover, automobile emission standards did not play a role in China’s WTO accession.3

* Corresponding author. Tel.: +1 4047270487. E-mail address: [email protected] (E. Saikawa). 1

Regulations could also improve the competitiveness of a country (Lewis and Wiser, 2007; Porter and van der Linde, 1995). While this standard applies to air pollution emissions, it is not to be conflated with a fuel quality standard. 3 In a statistical analysis, we do find evidence that WTO accession negotiations generally induce developing countries to adopt standards. 1462-9011/$ – see front matter # 2013 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.envsci.2013.11.010 2

environmental science & policy 38 (2014) 192–206

China’s case raises important questions for scholars of international political economy. In addition to exporter– importer dynamics, which alternate mechanisms transmit environmental regulations from one country to the other? How can we explain the global diffusion of environmental regulations to developing countries that are not major exporters? What roles do different actors, such as governments and foreign and domestic companies, play in the diffusion of environmental regulations and clean technology? These questions are important now that a number of developing countries have sustained impressive growth rates for decades. Many of the economically most successful developing countries, especially in East Asia, have pursued aggressive ‘‘developmental’’ growth strategies based on rapid industrialization and export competitiveness (Johnson, 1982; Wade, 2000). Economic globalization may promote development at the expense of sustainability, but the international diffusion of regulations may also protect the environment. For scholars of comparative development and environmental policy, understanding the mechanisms of regulatory diffusion holds theoretical and empirical promise. The literature offers few insights into the international diffusion channels of environmental standards. Holzinger et al. (2008) demonstrate that international communication channels facilitate the spread of environmental regulation among industrialized countries, but they do not analyze developing countries. Perkins and Neumayer (2010) and Prakash and Potoski (2007) show that the spread of voluntary environmental standards is facilitated by foreign direct investment (FDI), but they do not study actual environmental regulations imposed by the state. A large body of literature examines economic policy diffusion (Brooks, 2005; Dobbin et al., 2007; Elkins et al., 2006), but these theories may not apply to environmental regulation. Cao and Prakash (2010) show that trade competition is associated with certain forms of pollution, but they do not provide any direct evidence that regulations per se are influenced by trade competition. Finally, Perkins and Neumayer (2012) examine the relationship between FDI and automobile emission standards. They do not find consistent evidence that FDI promotes environmental standards.4 We propose that FDI is a key mechanism by which environmental regulations diffuse, as developing country governments can use regulatory requirements to promote technology transfer by foreign companies. In a simple formal analysis, we establish that governments can benefit from using environmental standards to force (i) technological development on domestic companies while (ii) inducing foreign companies to transfer advanced environmental technologies that domestic companies then replicate, especially under joint ventures. Since such technology transfer enhances the country’s productivity and international competitiveness, it is in the government’s interest. Moreover, the strategy is necessary if domestic companies are not equipped to develop advanced environmental technologies without foreign transfers forced by the government. The imposition of an environmental standard forces foreign companies to choose 4

Their cross-sectional analysis provides some support for the argument, but their panel analysis does not support the argument.

193

between abandoning the market or providing new technologies that domestic companies can replicate. We hypothesize that the government’s strategy succeeds whenever (i) the domestic consumer markets are lucrative enough and (ii) the cost of forced technology transfer to the foreign companies is not prohibitive. We provide qualitative and quantitative evidence for the importance of FDI as a diffusion channel for environmental standards. In addition to investigating the details of the Chinese case based on interviews with industry and government representatives, as well as secondary sources (Gallagher, 2006a; Gan, 2003; Thun, 2006), we test the formal model against a new dataset on the global adoption of automobile emission standards in developing countries. Using original data on the importance of FDI from industrialized countries in domestic automobile production, we find strong support for the notion that both the lucrativeness of domestic consumer markets and the importance of FDI from the global North condition the probability that a developing country adopts automobile emission standards in a given year. Our contributions are the following. First, we demonstrate how environmental regulations may play an integral part in the ‘‘developmental state,’’ or centralized industrial policy in developing countries (Johnson, 1982; Kohli, 2004; Soete, 1985; Wade, 2000; Woo-Cumings, 1999). Second, we provide a new answer to the question why FDI may also facilitate the adoption of environmental regulations (Neumayer, 2001; Perkins and Neumayer, 2010; Prakash and Potoski, 2007). Our theory shows that FDI is, in addition to export markets, another mechanism through which the California effect operates. Third, the theory developed here sheds light on strategic interactions between governments, domestic companies, and foreign companies. These insights illuminate the role of different types of actors in the political economy of development and environmental sustainability. Finally, the core theoretical logic is of considerable policy importance. As developing countries struggle to find the balance between environmental protection and competitiveness, the notion that some of them may simultaneously improve environmental quality and facilitate technological development gives a good reason for optimism. Our argument offers a new political rationale for the ‘‘Porter hypothesis,’’ or the conjecture that environmental standards may enhance industry competitiveness (Huber, 2008; Lewis and Wiser, 2007; Porter and van der Linde, 1995). We show that even if environmental standards are economically costly to domestic producers, they may nonetheless enhance competitiveness by promoting inward technology transfer.

2.

Puzzle and argument

How do environmental regulations diffuse from one country to another? According to Vogel (1995), major economic powers can ‘‘internationalize’’ their environmental regulations simply by imposing product standards on imports. As Vogel (1995, 6) explains, ‘‘in the case of many environmental and consumer regulations, stricter standards represent a source of

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competitive advantage for domestic producers. . . when rich nations with large domestic markets. . . enact stricter product standards, their trading partners are forced to meet those standards in order to maintain their export markets.’’ For example, if this logic applied to automobile emission standards, many automobile exporters would adopt European or American standards. Since the exporting companies must comply with European and American standards in any case, the cost of adopting these standards decreases (Drezner, 2001; Heichel et al., 2005; Prakash and Potoski, 2006; Perkins and Neumayer, 2010). This argument cannot be applied to the Chinese case. Although China has undergone a dramatic economic transformation, Chinese automobile export capabilities were severely limited by outdated technology at the time the government first adopted the European emission standards (Gallagher, 2006a; Thun, 2006). Given this handicap, most of the Chinese automobile producers did not seek to develop export capabilities. Indeed, many domestic companies were against emission standards. This preference structure is incompatible with the existing ‘‘trading up’’ argument, as there were very few domestic firms without foreign joint venture partners that would have been supportive of emission standards.5 The puzzle of Chinese emission standards can thus be reformulated as one of explaining why the government chose to impose them despite a lack of support from purely domestic firms. To some degree, environmental benefits can explain why the Chinese government was interested in emission standards to begin with. However, China’s developmental strategy is also built on economic growth and rapid industrialization. If environmental benefits were all there is to these emission standards, the government might have chosen to reduce the burden of domestic companies by imposing less stringent requirements on them. Yet there is no systematic evidence that such discrimination was pursued by the government. While the diffusion literature also ascribes a role to international institutions (Dobbin et al., 2007; Frank et al., 2000), there is little evidence that they played an important role. By far the most plausible candidate is the WTO, as China was negotiating accession when standards were adopted. Indeed, it seems intuitive that the United States and the European Union would use WTO accession to influence China’s environmental policies. However, the negotiations tell a different story. First, the United States concluded the negotiations with China already before automobile emission standards were adopted; since the WTO accession agreement does not explicitly require automobile emission standards, this sequence goes against the idea that the United States required changes in policy before accepting accession. Second, neither the United States nor the European Union mention automobile emission standards in their bilateral accession 5

This is not to say that the Chinese government was not interested in enhancing the industry’s competitiveness. However, it is notable that the industry itself was not supportive of the emission standards.

agreements with China. The negotiations focused on China’s import tariffs, service liberalization, sanitary and phytosanitary standards, trade and investment discrimination, antidumping, and intellectual property rights.6 To explain the puzzle, we argue that the government benefited from automobile emission standards in two interrelated ways. First, by requiring that domestic companies comply with relatively stringent emission standards, the government implicitly forced them to develop technology. Given the high cost of research and development, the government decided to force the industry to provide the ‘‘public good’’ of technological development. Second, the automobile emission standards also allowed the government to pursue this strategy at a relatively low cost. By imposing the standards, the Chinese government also forced foreign companies to introduce more advanced production technologies in joint ventures. This allowed their Chinese counterparts to adopt these technologies at a lower cost than if they had to pay for research and development. By providing foreign producers with strong incentives to introduce advanced technology in China, the automobile emission standards were a useful ‘‘policy tool’’ (Schneider and Ingram, 1990; Salamon, 2002) for the Chinese government that allowed policymakers to change the behavior of foreign automakers when they could not directly command said automakers to introduce advanced technology. To construct a theory around this ‘‘double dividend’’ notion, we rely on three main assumptions. First, the idea that a government forces technological development on a reluctant industry is not logically tenable unless innovation is characterized by sizeable positive externalities. If research and development do not constitute a public good, the government need not promote technological development. Each domestic company simply selects the optimal investment in research and development, and the story ends there. Positive externalities are widely accepted as an integral element of technological development in the scholarly literature. Most importantly, Romer (1990) develops a dynamic model of innovation in general equilibrium. He finds that the trajectory of technological development can be improved through subsidies for research and development. In the field of environmental policy, Lewis and Wiser (2007) and Walz (2007) empirically demonstrate that the development of wind energy industry has been critically dependent on generous subsidies and adoption policies in domestic markets across the world. Similarly, Fischer and Newell (2008) demonstrate that technology subsidies can greatly improve the effectiveness of international climate policy. Some scholars have specifically applied this idea to developing countries and found evidence of improving technological innovation capabilities (Gallagher, 2006a; Gan, 2003; Walz, 2010).

6 For the European Union, see ‘‘The Sino-EU Agreement on China’s Accession to the WTO: Results of the Bilateral Negotiations.’’ European Commission (n.d), available at http://trade.ec.europa.eu/doclib/html/111851.htm. For the United States, see ‘‘Summary of U.S.–China Bilateral WTO Agreement.’’ White House Office of Public Liaison (November 17, 1999), available at https:// www.uschina.org/public/991115a.html (accessed 15.11.11).

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environmental science & policy 38 (2014) 192–206

Second, we emphasize the integral connection between FDI and technological development. Without FDI or other international inputs, the only pathway to new technology is indigenous innovation. FDI allows developing countries to benefit from advanced foreign technologies (Keller, 2004; Rodrı´guez-Clare, 1996; Ockwell et al., 2008). Finally, our theory should only be applied to regulations that could promote technology transfer. In the case of automobile emission standards, this is true because automobiles that pollute a lot are simply banned. For other regulations, this may not be true. For example, if a developing country subsidizes wind or solar energy, it need not follow that foreign clean technology manufacturers introduce advanced production technologies in that country. Instead, they may simply export outdated technologies to energy utilies.

3. Case study: China’s automobile emission standards The Chinese case illustrates the following features of our theory. First, even if domestic companies do not support environmental regulations, the government may nevertheless strategically exploit them as a de facto industrial policy. Second, major exporter status is not a necessary condition for the strategic imposition of environmental regulations. Finally, environmental regulations are most useful if foreign companies with advanced production technologies have formed joint ventures with certain domestic companies. To our understanding, previous research has not recognized the validity of these three claims. In addition to secondary literature, the case study is based on 78 interviews with managers in the automobile industry, government officials, and researchers. The interviews were conducted in person by one of the authors in July–August 2008, February 2009, and July 2009. The locations in China were Beijing, Tianjin, Shanghai, Guangzhou, Chongqing, Hong Kong, and Hangzhou. The locations in Japan were Chiba, Tokyo, Toyota, and Tsukuba. Phone interviews were also conducted with interviewees in Seoul, Washington DC, California, and Michigan.

3.1.

Background

The origins of automobile emission standards can be found in the rapid increase of automotive vehicles, especially in the United States, in the 1960s. As vehicle emissions became a substantial source of air pollution in industrialized countries, the United States adopted a stringent set of standards that would require a 90 percent reduction in tail-pipe emissions relative to previous regulations. Japan and many European countries rapidly followed suit. These three standards became the global standards, and after four decades, they remain the only three alternative standards in existence. Although the origins of automobile emission standards are in the industrialized world, they have also spread to developing countries. As Fig. 1 shows, by 2009, 67 countries had adopted standards with stringencies equivalent to the original standards in Europe, Japan, and the United States.7 Indeed,

80

70

60

Total 50

Data collected by one of the authors.

Developing Countries

40

30

20

10

0 70 9 72 9 74 9 76 9 78 9 80 9 82 9 84 9 86 9 88 9 90 9 92 9 94 9 96 9 98 0 00 0 02 0 04 0 06 0 08 19 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2

Year

Fig. 1 – Diffusion of automobile emission standards. (Saikawa, 2013)

while most industrialized countries have already adopted standards, diffusion among developing countries has continued at a rapid pace since the early 1990s. Similarly, many developing countries have adopted more stringent standards at a faster pace than many industrialized countries did in the past. One major country that adopted the European standard was China. In 2000, the Chinese government adopted the original common standard for the European Community (1992), labelled Euro 1 (Gan, 2003). For passenger cars, China adopted the nextgeneration Euro 2 standard in 2004, only to adopt the Euro 3 standard in 2007. Some cities, such as Beijing and Shanghai, have already adopted the Euro 4 standard, and national adoption took place in July 2010.8 Considering that the European Union only adopted the Euro 5 standard in 2009, 17 years after the original adoption of Euro 1, this progress is extraordinary.

3.2.

Chinese automobile industry

China adopted the Euro 1 standard at a time of rapid growth in the automobile industry. The Chinese government believed that by investing heavily in the automobile industry, the country could develop ‘‘basic manufacturing capabilities in a wide variety of industries’’ (Thun, 2006). Indeed, already in 1986, the central government had announced the idea of using the automobile industry as a ‘‘pillar industry’’ for economic development. Yet in 1990, China’s annual automobile production was only 42,000 units, whereas the United States was producing nine million (Gallagher, 2006a). In the 1990s, sales of new automobiles grew annually by 27 percent, and by 2002, China’s production had increased to one million. Thus, the number of automobiles in China doubled every 2.5 years (Gallagher, 2006a). In 1994, China had enacted a regulation mandating that in the production of automobiles, motorcycles, or engines, foreign companies were allowed to own at most 50 percent of a joint venture with a Chinese counterpart. In a similar 8

7

High Income

‘‘Beijing Tightens Vehicle Exhaust Controls.’’ China Daily July 30, 2009.

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regulation for the automobile industry, the Chinese government also placed some specific requirements to enhance technology transfer. For example, all joint ventures were required to use at least 40 percent of parts and components from the local companies (Gallagher, 2006a). Wang Zhigang, a research fellow at the State-owned Assets Supervision and Administration Commission of the State Council, asserts that China ‘‘used to worry foreign capital would manipulate China’s auto industry by controlling technologies, brands and markets.’’9 This joint-venture policy is favored by domestic companies, as it is believed to increase technology transfer to China in automobile industry. Dong Zhiyuan, the vice general manager of Beijing Automotive Holding, states that ‘‘foreign companies transfer profits through auto parts premium and technologies. If the policy is loosened, it will be more difficult for Chinese companies to get technologies and voices.’’10 Indeed, available empirical evidence shows that automobile FDI in China has generally resulted in technology transfer (Nam, 2011). Until late 1990s, the Chinese government also raised high tariff barriers to provide protection for local companies. Despite inferior quality, local companies maintained their market share under trade protection. However, over time, China experienced a ‘‘dramatic increase in the level of competition and the prospect of an increasing level of global integration’’ (Thun, 2006). More than 80 percent of the Chinese automobile manufacturers had joint venture partners, so it was not at all easy for the purely domestic Chinese manufacturers to compete. Especially after China’s entry into the WTO in 2001, the outlook for manufacturers without foreign partners appeared daunting in the absence of domestic protection (Gallagher, 2006a). Indeed, total foreign direct investment in the automobile and related industries reached US$60 billion during the 1990s (Gallagher, 2006a). In sum, at the time of standards adoption, the Chinese local automobile industry itself was hardly in a position to compete with foreign companies for domestic, let alone international, markets.

3.3.

Foreign company preferences

An interesting feature of China’s decision to adopt the Euro 1 standard is the fact that many foreign companies with joint ventures in China were concerned about intellectual property rights and, in particular, copyright violations by their Chinese partners. When China first turned to Japan for assistance in developing the automobile industry, the Japanese companies exported a large number of trucks to China and agreed to provide some advanced technologies, but they were careful not to distribute technologies that would generate potential competitors for international export markets (Gallagher, 2006a). Similarly, prior to the adoption of emission standards by the Chinese government, foreign companies did not introduce advanced environmental technologies in China. These problems are also not idiosyncratic, as intellectual property rights present a major challenge for foreign

9 ‘‘Looser Policy on Auto Joint Venture Expected.’’ Market Avenue May 15, 2008. 10 ‘‘Looser Policy on Auto Joint Venture Expected.’’ Market Avenue May 15, 2008.

companies seeking to exploit advanced technology in China (Guerin, 2001; Miesing et al., 2007; Ockwell et al., 2008). If anything, these problems have only become worse in recent years. In 2004, General Motors (GM) filed a lawsuit against a Chinese automobile company, Chey Automobile. According to GM, ‘‘the two vehicles share almost identical body structure, exterior design, interior design and key components’’ (Autoweb, 2006). Similarly, Honda Motors filed a lawsuit against another Chinese automobile company, Shuanghuan Automobile, accusing the company of illegally copying a Honda sports utility vehicle.11 In this setting, the need to introduce pollution-control technologies meant that they could be illegally replicated as well. And yet, the emission standards also had a silver lining for the foreign companies. To the degree that foreign companies found ways to protect their intellectual property rights, perhaps by strategically introducing the absolute minimal technologies needed to comply with the Chinese emission standards, they would gain an edge over those Chinese companies that would not be able to obtain access to similar technologies. Indeed, some foreign companies decided to lobby the central government for European standards.12 For them, it was particularly important to prevent China from developing indigenous standards that would require additional investments in research and development.

3.4.

Domestic company preferences

The domestic companies responded in variegated ways. A particularly important determinant was whether they had formed a joint venture with a foreign company. If a local company had a foreign partner, it could obtain advanced environmental technologies relatively easily.13 Indeed, to enhance technology transfer, Beijing required that foreign companies fill a form, providing a detailed description of the advanced technologies that they would provide.14 For Chinese companies without foreign counterparts, it was difficult to meet the new standards.15 Since they bought virtually all advanced technologies used in production, including engines, from foreign companies, these local companies saw the emission standards as a threat. They lobbied the central government, so the government was aware of the fact that adopting stringent standards would present major challenges to local companies.16 As Gallagher (2006b, 388) writes, ‘‘[s]ince Chinese firms do not have their own capability to design the cleaner technologies, they fall even 11 ‘‘GM Charges Chery for Alleged Mini Car Piracy.’’ China Daily December 18, 2004. 12 Anonymous interview with a manager in Chinese automobile industry in China, July 14, 2008. 13 Interviews with Mr. Yan Ding and Mr. Vance Wagner at the Vehicle Emissions Control Center in Beijing, July 14, 2008. 14 Anonymous interview with a Japanese government official in Tokyo, August 11, 2008. 15 The fact that the Euro 1 standard was not as stringent as more recent European standards does not mean that there were no costs. For the Chinese companies, the status quo ante was no regulation whatsoever. 16 Anonymous interview with a manager in Chinese automobile industry in China, July 29, 2008.

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further behind the foreigners.’’ Indeed, according to Thun (2006, 217–221), it is not unusual in the automobile industry that foreign competitors drive domestic companies out of business. In Mexico, for example, liberalization efforts culminating in the formation of NAFTA ‘‘fundamentally transformed the nature of Mexican supply networks... the local Mexican supply firms were replaced with large global suppliers (Thun, 2006, 218–219).’’ Thus, it is not surprising that the purely local companies opposed plans to introduce environmental regulations that favored the technologically more advanced foreign companies and joint ventures.

characteristics of the problem. We then find the equilibria of the game under the assumption that players behave rationally and strategically. The formal analysis is organized as follows. First, we present the model. Second, we conduct an equilibrium analysis. Finally, we summarize the empirical implications of the model and apply our propositions to the Chinese and other cases. To maximize accessibility, we present the simplest possible formal model and offer substantive examples throughout.

4.1. 3.5.

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Model

Discussion

The Chinese government was hardly supported by the domestic industry in the development of emission standards. Some foreign companies lobbied for the European standards, but others did not have a strong position for or against the regulation. Some domestic companies were rather indifferent to the standards because they had access to the advanced technologies if necessary, yet many domestic companies were against the standards. Thus, on balance, it appears that the coalition in support of regulation was weak. If the industry did not support emission standards, why was the Chinese government suddenly so anxious to adopt them? We argue that the adoption of vehicle emission standards increases technology transfer. Without government intervention, domestic firms had no interest in developing advanced technologies, because this would only increase production costs. Given the severity of price competition in China and other developing countries, emission standards were necessary to induce technological development in the Chinese automobile industry, so as to prepare it for exports to regulated markets in the future.17

In the game, the government of a developing country must decide on [i] the FDI entry mode and [ii] the imposition of environmental standards. These two public policies are separate, but the government’s decisions on them are strategically connected. The policies also influence both the decision of a foreign company to invest in a production plant and the technology choice of a domestic company. The government benefits from FDI and technology transfer because these increase the country’s productivity and international competitiveness, while the companies are only motivated by profits. Notation is summarized in the supporting information. The sequence of moves is the following:

To fully develop the strategic logic of international technology transfer through environmental regulation, we conduct a game-theoretic analysis. While our main theoretical premises are not complex, it is important to recognize that a government’s decision to impose environmental standards is strategic. Thus, it is essential to rigorously investigate the strategic interactions between governments, domestic producers, and foreign investors that ultimately determine whether the benefits of new environmental regulations exceed the costs. Game theory is a mathematical method that allows researchers to investigate strategic behavior systematically under transparent assumptions about interests and information available to the players. Our model is designed to capture the strategic setting of environmental standards and technology transfer, and we base our assumptions about the incentives of players on the fundamental

1 The government selects the FDI entry mode, open or joint. 2 The foreign company selects entry or no entry. 3 The government decides on an environmental standard, adoption or no adoption. 4 If the foreign company entered, it selects basic or advanced technology. If it exited, it does not move. 5 The domestic company selects basic or advanced technology. This sequence includes the assumption that the government cannot credibly commit to the choice of environmental standards prior to the entry decision by the foreign company.18 Since the game tree has 28 final nodes, and thus rather uninformative, we instead offer a simplified tabular representation of the payoffs in the supplementary appendix. Consider the domestic company’s payoffs. First, the cost of basic technology is zero because it is already available. The cost of advanced technology is denoted by c > 0, for in developing countries, advanced technology might not be automatically available. The exact cost c will depend on the FDI entry mode, as detailed below. Second, the domestic company obtains a profit, normalized to 1, if it can sell to the domestic market. This profit is available only if (i) it uses advanced technology or (ii) there is no environmental standard. Intuitively, only advanced technology enables compliance with the environmental standard. Other than that, advanced technology produces no benefits to the domestic company. If the foreign company does not enter, it obtains a zero payoff from retaining the status quo. If it enters, it obtains a

17 As Gallagher (2006a) notes, automobile emission standards did not allow China to immediately leapfrog to sustainable transportation. However, below we show that automobile innovation has increase dramatically in China since a national standard was adopted.

18 We exclude the possibility of a categorical ban on FDI. Adding it would complicate the mathematical analysis, without undermining the strategic argument for environmental regulations that we propose. For countries with sufficient interest in FDI, a categorical ban on FDI is irrelevant.

4.

Formal analysis

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profit, also normalized to 1, when it can sell to the domestic market. When the foreign company enters but cannot sell, the payoff to it is also zero.19 Without an environmental standard, the foreign company can sell regardless of technology choice. If there is an environmental standard, the foreign company can sell as long as it selects the advanced technology at a small cost e ! +0. However, it is afraid of potential technology transfer. If the domestic company applies the advanced technology under a joint venture, and the foreign company has chosen the advanced technology, the foreign company must pay an additional cost d > 0. This cost can be intuitively thought of as lost competitive advantage, as the joint venture enables the domestic company to copy advanced technologies from the foreign company. Importantly, we assume that the foreign company need not pay this cost if the domestic company researches without a joint venture. The domestic company pays the full price of developing the advanced technology, so it seems plausible to assume that the foreign company does not suffer a major loss of competitiveness when the domestic company develops the advanced technology.20 The government uses the environmental standards both to abate pollution and facilitate technological development. By imposing an environmental standard, it increases consumer prices by p > 0 and avoids negative environmental externalities worth q > 0. To ensure that the environmental standard is not a forgone conclusion, we assume p  q > 0. This assumption says that the cost exceeds the benefit in the absence of technological development. It clearly does not apply to all developing countries (Dasgupta et al., 2006), but if the environmental standard is unconditionally profitable, there is no need for a formal analysis (Bechtel and Tosun, 2009). We thus focus on those instances where the government faces a genuine tradeoff. The environmental standard only facilitates technological development indirectly, by potentially inducing the domestic company to adopt the advanced technology. Specifically, if the domestic company selects the advanced technology, the government benefits from ‘‘learning by doing’’ and other positive externalities worth l > 0. Some of the benefits of technological development are positive spillovers that engender economic growth far beyond the specific company that first adopts the advanced technology. The government may also value increased future exports and the trade surplus that results. The government also cares about the domestic company’s technology development cost. Specifically, if the domestic company adopts the advanced technology at cost c*, the government also incurs a cost R ! 0+. This cost is assumed to be very low to ensure that the government nonetheless prefers the advanced technology. If the domestic company adopts the advanced technology at cost c*, there is no extra political cost. We also assume the government is generally interested in FDI: the government obtains a payoff u > 0 from the foreign company’s entry even without advanced technology because 19

All results hold with an additional entry cost. A more general model would allow the foreign company to suffer some loss, but this extension does not generate additional theoretical insights. 20

FDI is economically valuable to it. If foreign technology is cleaner than domestic technology, u can also be thought of as containing an environmental component. This assumption provides a rationale for not requiring a joint venture in some circumstances. The effect of a joint venture on the marginal technology cost c is crucial. If the foreign company did not enter or there is no joint venture, the domestic company cannot copy technologies, so the cost is ‘‘high,’’ c = c*. Under a joint venture, this cost decreases to ‘‘low,’’ c = c*. We set c* > c*. For simplicity, we assume c* 2 [0, 1], so that the domestic company has an incentive to choose the advanced technology under a joint venture, as long as environmental standards have been enacted. This assumption is substantively plausible because the joint venture allows inexpensive technology transfer. Notably, the cost of technology transfer need not be exactly zero.

4.2.

Equilibrium

In a game of complete information, the appropriate solution concept is the subgame-perfect equilibrium. We characterize the FDI entry mode and adoption decisions for the government; the entry and technology decisions for the foreign company; and the technology decision for the domestic company. Each must be optimal given equilibrium behavior ‘‘down the game tree.’’ A complete mathematical solution is provided in the supporting information. We use backward induction to find the conditions under which the government selects a joint venture and imposes environmental standards. To reduce notation, we require that the government select the open mode if it is indifferent. While not necessary for our results, this assumption is substantively plausible because the government might suffer a small reputational cost if it requires a joint venture from international investors. Similarly, we require that the foreign company does not enter if it is indifferent. This is plausible if there is a small entry cost. The equilibrium analysis will reveal the following tradeoff. If the government selects the open FDI entry mode, it de facto commits to not burdening the foreign company with an environmental standard, even as the option is formally available at a later stage. However, the government can also select the joint FDI entry mode to retain the environmental standard as an option. If the foreign company nevertheless enters, the government can then facilitate technology transfer by imposing the environmental standard.

4.2.1.

Technology adoption

To begin with, consider the technology decision of the domestic company. If there is no environmental standard, the domestic company need not do anything to maintain market share. If there is an environmental standard but no joint venture or the foreign company has exited, the cost of research and development is c*. The domestic company researches if and only if c*  1. Under a joint venture, the domestic company researches if and only if c*  1 or the foreign company chose advanced technology, as c*  1. Intuitively, domestic company is guaranteed to select the advanced technology only if the foreign company has already selected it, so that technology transfer is possible.

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Should the foreign company choose the advanced technology? Without emission standards, clearly not, as the cost is e and the benefit is zero. With emission standards under the open mode, the cost is e and the gross payoff 1 because sales are thus possible. With emission standards under a joint venture, the domestic company will respond by also selecting the advanced technology, so the foreign company chooses the advanced technology if and only if d < 1, as e ! +0. Intuitively, the foreign company only selects the advanced technology if necessary and the cost of technology transfer is not prohibitive.

4.2.2.

Environmental standards

Given these incentives, should the government impose an environmental standard or not? First, the government understands that the domestic company will not research without an environmental standard. If there is no joint venture or the foreign company does not enter, environmental standards do not induce research unless c*  1, so the government does not impose because q  p < 0. But if c*  1 or there is a joint venture, an environmental standard induces research if and only if d < 1. When this condition holds, the government imposes if and only if l > p  q;

(1)

where the left side is the benefit and the right side is the net cost. Otherwise the government does not impose. Intuitively, the environmental standard must induce enough technological development to outweigh the cost.

4.2.3.

Entry

Should the foreign company enter or not? If the FDI mode is open, the foreign company will not pay the technology transfer cost d, so it enters. But under a joint venture, it invests if and only if (i) the government will not subsequently impose an environmental standard or (ii) the cost of technology transfer does not exceed the net profits from entry, d < 1. Most importantly, the open mode is a credible commitment by the government not to allow illegal technology appropriation.

4.2.4.

FDI mode

What about the FDI mode? The government can choose the open mode, so as to ensure that foreign direct investment is forthcoming. However, it cannot exploit the environmental standard to secure technology transfer. Alternatively, it can choose the joint venture and potentially benefit from technology transfer by forcing the domestic company to research through an environmental standard. In the next section, we characterize the government’s strategy in detail.

4.3.

Empirical implications

The previous analysis allows us to characterize equilibrium behavior for any admissible set of parameter values. The proofs can be found in the supporting information. To begin with, we demonstrate that the government never chooses the joint venture and then fail to impose the environmental standard.

199

Proposition 1. The government never selects the joint venture and then fails to impose an environmental standard. Why is there no joint venture without environmental standards? Empirically, governments have many reasons to require joint ventures, but in our model, joint venture only enables technology transfer. If the government selects the joint venture, it does not subsequently ‘‘forget’’ that the only benefit is to reduce the cost of advanced technology under environmental standards. Consequently, we can exclude one possible scenario. Another possibility is that the government neither requires a joint venture nor imposes an environmental standard.

Proposition 2. The government selects the open mode but does not impose an environmental standard if and only if p  q > l or d, c*  1. The foreign company enters and neither company selects the advanced technology. There are two reasons why the government might choose the open mode. First, if the consumer price of environmental standards is too high, the government will not impose environmental standards in any case. Second, if a joint venture requirement deters FDI, technology transfer is impossible in any case, so the government prefers not to forgo FDI. Given that the government does not select a joint venture, it subsequently does not impose an environmental standard either because (i) the benefits are too low or (ii) it is too costly for the domestic company to select the advanced technology. Many African countries meet these criteria. Consider, for example, the Kenyan case. Kenya allows open investment in the automobile sector, and foreign vehicle manufacturers thus dominate. For Kenya, FDI is essential because it ‘‘stimulates domestic investment, promotes economic growth, creates employment opportunities and promotes transfer of new technology’’ (Kinaro, 2006). Since Kenya is not generally an unusually lucrative investment target, it has applied liberal FDI policies to enhance inflows from other countries. Although there are some local manufacturers, such as Kenya Vehicle Manufacturers, they focus largely on assembling foreign models. Similarly, annual vehicle sales in Kenya are limited to approximately 10,000 units. Thus, the environmental benefits of automobile emissions in particular would be quite limited. Given this combination of (i) limited FDI without liberalization and (ii) few environmental benefits from emission standards, Proposition 2 applies. What about an environmental standard without joint venture?

Proposition 3. The government selects the open mode and imposes an environmental standard if and only if l > p  q while d  1 and c*  1. The foreign company enters and each company selects the advanced technology. The only reason why the government fails to exploit the cost reduction from a joint venture is that a joint venture prevents FDI. The foreign company correctly anticipates that

environmental science & policy 38 (2014) 192–206

Proposition 4. The government selects the joint venture and imposes an environmental standard if and only if d  1 and l > p  q. The foreign company enters and each company selects the advanced technology. This proposition says that if FDI is so profitable for the foreign company that it invests despite technology transfer, the government can safely allow technology transfer without jeopardizing FDI. If the benefits of environmental standards – pollution abatement and technological development – exceed the increase in consumer prices, the government subsequently imposes the environmental standard. This proposition is our analytical explanation for the case of China. Given the lucrative market opportunities that China, as a huge and rapidly growing economy, can offer to multinational corporations, the government was confident that FDI would continue to flow despite stringent joint venture regulations. Therefore, China required its foreign investors to ‘‘own no more than 50 percent in total shares and that they transfer technology to their domestic partners’’ (Long, 2005, 334). By adopting stringent vehicle emission standards, China also made sure that advanced environmental technologies – a critical asset for exports to regulated markets – would be transferred from developed countries. As Gallagher (2006b, 389) puts it, once the Chinese government imposed the Euro 1 automotive emission standard, ‘‘US firms immediately transferred the pollution-control technologies required to meet this standard to their joint-venture partners

100

200

300

China Auto Exports Real Trade Value in US Million Dollars

environmental standards induce technology transfer, and if the cost is too high, it refuses investment. Thus, the government must select the open mode to salvage the benefits from FDI. However, if the cost of advanced technology is not prohibitive, the benefits of environmental standards nevertheless outweigh the costs. South Korea is an illustrative example. As Kohli (2004) explains, already in the 1970s, the Park regime adopted, especially in heavy industries, a strategy of deep governmental intervention for economic development. One of the sectors that the government emphasized was the automobile industry. In addition to offering cheap credit, the government provided infrastructural support and generously removed administrative hurdles. According to Kohli (2004, 113), ‘‘the availability of state-of-the-art technology and management from its former colonial master, Japan,’’ was instrumental for the successful development of the Korean automobile industry. Thus, South Korea was able to develop advanced technologies capabilities without requiring joint ventures for FDI in the automobile sector. Why, then, did Korea adopt automobile emission standards as early as in 1987? Given the rapid economic growth and high population density in the Korean peninsula, and especially in the urban areas, the environmental benefits were substantial. Additionally, given that relatively advanced technologies were already available from the Japanese companies, the cost to domestic manufacturers was lower than, for instance, in the Chinese case. The final possibility is that the government selects the joint venture and imposes an environmental standard.

0

200

1970

1980 to all countries

1990 Year

2000

2010

to countries with standards

Fig. 2 – Automobile exports from China between the years 1970 and 2006. (United Nations Trade Statistics Database21)

in China.’’ Thus, Proposition 4 can be applied to the Chinese case. Interestingly, the growth of China’s automobile exports is also consistent with our theoretical argument. Fig. 2 shows how they have grown between the years 1970 and 2006. While demonstrating the existence of a causal relationship between the automobile emission standards and export competitiveness is difficult, the explosive growth in automobile exports provides additional indirect evidence in support of our theoretical model. If we are right to argue that environmental standards induce foreign producers to transfer advanced technologies to Chinese automobile producers, one would expect robust increases in automobile exports in the years following standards adoption. Some actual cases contain features of several propositions. In Latin America, for instance, the Brazilian experience exemplifies a hybrid of Propositions 3 and 4. In 1997, against a backdrop of rapidly growing automobile ownership and production, the government of Brazil adopted the Euro 1 standard, and since then the government has rapidly imposed ever more stringent standards. Indeed, according to the United Nations Environment Program, already by 2003, there were 170 automobiles for every 1000 people, a very large number for a developing country.22 What is more, Brazil, as a large agricultural producer, blends ethanol and gasoline to an unprecedented degree to keep the automobile fleet in motion. While pure ethanol produces little air pollution, an ethanol– gasoline mix actually generates more air pollution than pure gasoline. Thus, consistent with Propositions 3 and 4, Brazil had a particularly strong incentive to adopt automobile emission standards. In regard to FDI, in Brazil, ‘‘where the world’s largest automobile and auto parts manufacturers have production facilities... the automotive industry is an important FDI recipient’’ (UNCTAD, 2007, 58). And, although Brazil’s FDI 21

Available at http://comtrade.un.org/db/ (accessed 01.09.10). ‘‘Latin America and the Caribbean.’’ Partnership for Clean Fuels and Vehicles at http://www.unep.org/pcfv/regions/LAC.asp (accessed 07.04.10). 22

environmental science & policy 38 (2014) 192–206

regime has undergone substantial liberalization in recent years, being now relatively liberal, the government has imposed a 60 percent local-content requirement ‘‘for Brazilian customers in order to benefit from various government finance and investment programs’’ (Ivarsson and Alvstam, 2005, 1331). Thus, while the FDI mode is generally open, the Brazilian government has indirectly made foreign companies dependent on subsidiary production by local companies, thus facilitating technology transfer (Ivarsson and Alvstam, 2005). This strategy fits well to the broader technology policy of ethanol substitution which, according to Gallagher (2006b, 384), ‘‘provides evidence that strong government policies and good technological capabilities are both needed to achieve widespread deployment of cleaner energy technologies.’’

5.

Research design

We predict the adoption of automobile emission standards. Specifically, we explain adoption as a function of how lucrative the developing country is for (i) automobile FDI from advanced industrialized countries and (ii) as an automobile market. This is the key hypothesis from our model, as both Propositions 3 and 4 require the availability of foreign technology through FDI.23 We demonstrate that a higher FDI from industrialized countries increases the probability that a country adopts automobile emission standards. After analyzing the adoption of automobile emission standards, we also provide suggestive evidence for the positive association between standards and technology transfer. Our binary dependent variable captures whether country i adopts automobile emission standards at year t (Saikawa, 2013).24 By automobile emission standards, we refer to any set of standards that is at least as stringent as the Euro 1 standard initially applied by the European Community in 1992. The Euro 1 standard was the first ‘modern’ standard that necessitated the use of catalytic converters.25 For all years following adoption, a country is removed from the dataset.26 We focus on the initial adoption of standards because it is the most consequential decision. Subsequent increases in the standard are not comparable because domestic companies already had to adjust to environmental standards.27 Because we are interested in the automobile FDI to developing countries from advanced industrialized nations, we need detailed data on production by foreign manufacturer. Since such data are only available starting in 2000, our panel data includes the years 2000–2006 and 92 countries that have not adopted automobile emission standards by that time.

201

While the panels are short, note that only 10 developing countries had adopted automobile emission standards by the year 2000. Therefore, the fact that we begin in the year 2000 does not mean we cannot capture the diffusion phase of the global spread of automobile emission standards. Because the adoption of emission standards is a relatively rare event with a frequency of 2.6 percent in our dataset, a standard logistic regression could significantly underestimate the probability of adoption (King and Zeng, 2001a,b). We thus use a rare events logistic regression to predict the probability that a country adopts emission standards in a given year. We cannot conduct a non-parametric Cox model because some of our control variables only vary over time, and not across countries. To account for correlation and heteroskedasticity across observations, we estimate robust standard errors clustered by country. Although temporal dependence is a minor problem given that we have only seven years, we include a time trend to account for time dependence.28 The descriptive statistics and a correlation matrix for all the variables are found in the supporting information.

5.1.

Independent variables

To test our claim that countries use emission standards as a means for international technology transfer, we construct a variable FDI. The FDI variable measures the number of passenger cars produced by foreign manufacturers in a country. A larger number indicates that a country receives higher inflows of FDI to the automobile sector. According to our theory, automobile FDI should encourage governments to use automobile emission standards as a strategic policy that allows domestic companies to gain access to advanced technology. The data for this variable are from the International Organization of Motor Vehicle Manufacturers’ Production Statistics.29 To our understanding, this is the most complete dataset on foreign automobile production.30 An ancillary implication of our model is that the lucrativeness of the country as a market for automobiles sales should also influence the probability of adoption. Thus, we include GDP per capita to our models. The data are in constant 2000US$ as reported in the World Development Indicators. Countries may adopt emission standards when their per capita national income reaches a high value (Dasgupta et al., 2002). If this argument holds, the number of countries with emission standards increases as more countries develop economically. As the summary statistics indicate, the distributions of these two variables are somewhat skewed. Thus, we also estimate models with logarithmized values of FDI and GDP per capita.31

23

To distinguish between the two propositions, we would need data on FDI regulations for more than a hundred developing countries; this is beyond the scope of this article. 24 Specifically, yi,t = 1 at time of adoption and yi,t = 0 at other times. 25 In recent years, some countries have ‘leapfrogged’ to immediately adopt even more stringent standards. At this time, our data do not capture such variation. 26 No country has ever rescinded its automobile emission standards. 27 For an analysis exploiting multiple levels of standards, see Perkins and Neumayer (2012).

28

We omit year fixed effects to avoid losing temporal variation. The data can be found at http://www.oica.net (accessed 01.09.10). 30 Perkins and Neumayer (2012) provide panel data on automobile FDI from UNCTAD. Their data covers a longer period of time, but for any given year it is missing for a large number countries. Given that we are interested in analyzing global patterns, it is essential to have complete coverage for every year included in the empirical analysis. 31 We add +1 to logarithmized variables, so as to avoid losing zeros. 29

202

5.2.

environmental science & policy 38 (2014) 192–206

Control variables

Although our main interest is to identify the role of automobile FDI on the adoption of standards, we also include several theoretically informed control variables. These variables are chosen because there are strong theoretical reasons and empirical evidence that they could influence automobile emission standards while also being correlated with automobile FDI and GDP per capita. By including these control variables, we can properly account for confounding factors. The variables we include in the empirical analysis are Auto Exports, Environmental Ministry, Political Regime, PM10, WTO, Global number of standards, Distance-weighted adoption, and Bureaucracy Index. In addition to these variables, we also include two regional dummies: Asia and Europe, as well as the time trend.

5.2.1.

Auto exports

According to the extant diffusion literature, countries may adopt emission standards when their automobile exports to previously regulated markets are high, either because their exporters are obliged to comply with foreign automobile emission standards in any case or for competitiveness reasons (Porter and van der Linde, 1995; Saikawa, 2013; Vogel, 1995). This is the conventional wisdom on the California effect. In two models, we control for the total automobile exports value, All Auto Exports, for automobile emission standards’ adoption. Our empirical analysis begins in the year 2000. By that time, all high-income OECD countries had already adopted standards. To conduct a more rigorous test of the diffusion hypothesis proposed by the literature, in some models we control for the total number of automobile exports to high-income OECD countries, OECD Auto Exports, as reported in the United Nations Trade Statistics Database.21 According to the diffusion hypothesis, countries exporting to high-regulating countries have little to lose from domestic regulation because their exporters are already complying with more stringent standards.

5.2.2.

Environmental regulation

Countries may adopt emission standards when their overall environmental regulation levels are high. We control for the existence of environmental ministry (Env Ministry) to control for the possible difference in regulation levels. These data are from Aklin et al. (2012) and Busch and Jorgens (2005). While the existence of a ministry does not necessarily imply stringent policies, Aklin et al. (2012) show that it is highly, positively correlated with a wide variety of environmental policies.

5.2.3.

Pollution levels

Countries may adopt emission standards in order to remedy their air pollution problems due to vehicle emissions,. We control for such pollution by using the concentration of the fine particulate matters with a diameter of 10 mm or less, PM10.33 Vehicle emissions are one of the major sources of this pollutant, so this is a good measure for us. Had we instead used such pollutants as carbon dioxide or sulphur dioxide, we would have introduced bias in our estimations because these pollutants are mostly not caused by automobiles. Therefore, focusing on PM10 is ideal.

5.2.5.

WTO

Much of the extant literature on policy diffusion emphasizes the role of international institutions (Dobbin et al., 2007; Vogel, 1995). Given that automobile emission standards diffuse through trade channels, it does not seem implausible that WTO membership would change developing countries’ incentives to enact standards. Indeed, China’s adoption of automobile emission standards coincided with WTO membership. For this reason, we include a binary variable indicating whether a developing country i is a WTO member at time t.34

5.2.6.

Global number of standards

Another key argument in the diffusion literature is that policies diffuse through peer pressure (Simmons and Elkins, 2004). In the case of environmental policies, previous scholarship emphasizes the central importance of global norms (Frank et al., 2000). Therefore, we include a count of the global number of automobile emission standards in our regressions. If the conventional wisdom concerning global norms is valid, then the coefficient for this variable should be positive.

5.2.7.

Distance-weighted adoption

Countries may adopt emission standards when their neighbors have already adopted them (Simmons and Elkins, 2004). We therefore include this spatial lag variable to control for number of adoptions, each weighted by distance. The distance data are from Bennett and Stam (2000).35

5.2.8.

Bureaucratic quality

The cost of adopting emission standards depends on bureaucratic quality. In particular, high bureaucratic quality may encourage countries to adopt standards. Thus, we control for bureaucratic quality, as measured in the International Country Risk Guide.36

Political institutions

Democratic countries could more readily adopt emission standards compared to authoritarian countries, because democratic governments are often more responsive to public opinion (Binder and Neumayer, 2005; Li and Reuveny, 2006; Neumayer, 2002).32 It is easier for citizens in democratic countries to pressure governments to adopt emission standards by punishing politicians for not doing so. We control for the democracy levels in a country using the Polity IV score. The values range from 10 (most authoritarian) to +10 (most democratic). 32

5.2.4.

However, note that Ward (2006) finds only weak evidence for the effects of democracy on environmental performance.

33

Data are available from the World Development Indicators. As a robustness check, we also created a pre-accession variable to capture incentives to adopt standards during negotiations. See below for a detailed discussion. 35 Specifically, for each country i at time t, we sum over cumulative adoptions in other countries j by time t, multiplied by the difference between the maximum distance in the dataset and the distance between countries i, j. As a normalization the value of this variable is divided by the sum of this country’s distance to all countries. 36 See http://www.prsgroup.com/ICRG_Methodology.aspx for a description (accessed 15.04.12). 34

environmental science & policy 38 (2014) 192–206

5.2.9.

Regional dummies

Members of the European Union (EU) were required to adopt emission standards by 1999, and thus adopting the standards was one of the requisites for a country to join the EU. We therefore control for the European region, Europe, using a binary measure that is set equal to 0 if a country is not located in Europe and 1 otherwise. Following previous literature on normative emulation and learning as some of the possible mechanisms of policy diffusion (Dobbin et al., 2007; Simmons and Elkins, 2004), we also include the Asian regional dummy variable, Asia, to capture the increasing number of adoptions in the region. Since Asian countries have been both particularly active in adopting automobile emission standards and a major target of automobile FDI, this control variable allows us to identify more precisely the effect of automobile FDI. The regional variable for Asia (Europe) is also positively (negatively) correlated with automobile FDI.

6.

Empirical findings

Before estimating regression models, it is prudent to examine patterns in the raw data. A simple cross-tabulation of automobile FDI and adoption between the years 2000 and 2007 can be found in the supporting information. Most countries have no FDI in the automobile sector, and a clear majority of them had not adopted emission standards by 2006. On the other hand, countries that do receive some automobile FDI are much more likely to adopt emission standards at some point. Only 10 out of 69 countries without high automobile FDI adopted standards by 2006, while 9 out of 17 countries with high automobile FDI adopted them at some point. The relative frequencies are 14 and 53 percent, a 3.7fold difference. This is consistent with our theory, as we claim that the availability of FDI should enhance technology transfers under environmental standards. Countries that already draw a lot of automobile FDI are in a good position to use environmental standards to induce technological change through foreign transfers. The results from a multivariate regression are shown in Table 1. We start with a simple Model 1 and 2 without control variables. These includes only the two independent variables (FDI and GDP per capita) and the time trend. Model 1 use nonlogarithmized variables and Model 2 use logarithmized variables for the two independent variables. Next, we introduce all control variables in the model. Models 3 and 4 use total automobile exports, while Models 5 and 6 use total automobile exports to high-income OECD countries. Models 3 and 5 use non-logarithmized variables, whereas Models 4 and 6 use logarithmized independent variables for those that are skewed as mentioned above. As the table shows, automobile FDI has a positive effect on the probability of adoption at a given time in all of the models. This finding corroborates our theoretical expectations. We also simulated the substantive effects of FDI. In Model 4, a shift from no automobile FDI to a production of 1000 cars by foreign manufacturers in the previous year increases the likelihood of adoption from 4.1 to 7.7 per cent, holding the WTO variable and the regional dummy variables at the median, year as 2006, the global number of standards to be

203

61, and all the other control variables at the mean. By further increasing the production by foreign manufacturers to 10,000 cars, the likelihood of adoption becomes 9.6 per cent. As to our second hypothesis, GDP per capita has a positive coefficient in all models. However, the coefficient is only statistically significant in Model 4. This illustrates that the economic level has somewhat uncertain effects on adoption, even if positive in expectation. Moreover, the FDI level has more weight on regulating vehicle emissions. The control variables have weak and inconsistent effects on adoption. As soon as we account for FDI, neither automobile exports nor automobile exports to high-regulating OECD countries have a statistically significant, positive effect on the probability of enacting automobile emission standards. Environmental ministries, democratic political institutions, pollution levels, WTO, the global number of standards, distance-weighted adoption, and bureaucratic quality do not appear to have much influence on countries’ adoption of vehicle emission standards, as the coefficients are not statistically significant. These observations do not mean that these variables do not have any effects, but they do imply that the possible effects are subject to considerable uncertainty. On the other hand, the regional variables (Asia and Europe) have positive coefficients, and they are all statistically significant. Given these results, it would be interesting to examine whether developing countries’ adoption of automobile emission standards produces any technology transfer or not. Indeed Dechezlepreˆtre et al. (2012) find evidence that stringent automobile emission standards increase technology diffusion. While a full causal analysis would be the subject of another paper, the following illustration provides some suggestive evidence. We collected data on international patents filed under the Patent Cooperation Treaty (1971) in sectors that are directly related to automobile manufacturing.37 We then examined how the number of patents has varied over time, and especially before and after the adoption of automobile emission standards. The results for inventors from Brazil, China, India, and Mexico are shown in the supporting information. In each country, a dramatic change in the number of automobile patents is associated with the initial enactment of the automobile emission standard. While this does not establish causality, the strong association is suggestive nonetheless. When we calculated the mean number of patents for countries that never adopted automobile emission standards, no change was seen over the same time range, as shown in the supporting information; this suggests that there is a relationship between standards and patents.

7.

Robustness

As robustness checks, we tried several alternate specifications. Using the Model 4 as our baseline, we conducted a standard logistic regression without the correction for rare events and a probit model. In each case, the coefficient for the

37

See supporting information.

204

environmental science & policy 38 (2014) 192–206

Table 1 – Empirical analysis. Logistic regression with a rare events correction. Model 1 AUTO FDI (no log)

Model 3

Model 5 9.342 (2.775)

0.083* (0.049)

0.041 (0.026)

0.091 (0.069) 0.445*** (0.159)

0.117** (0.057) 0.080 (0.063) 0.693** (0.348)

0.581 (0.385)

ALL AUTO EXPORTS (no log)

0.034 (0.942)

ALL AUTO EXPORTS (log)

0.143 (0.106)

OECD AUTO EXPORTS (no log)

0.253 (1.004)

OECD AUTO EXPORTS (log) MINISTRY

0.099 (2.056) 0.034 (0.054) 0.002 (0.010) 0.152 (0.949) 0.397 (0.339) 2.728 (13.33) 0.110 (0.612) 1.671* (0.960) 1.688** (0.646) 1.047 (1.001) 2068.8 (1984.8) 406

POLITY PM10 WTO GLOBAL NUMBER OF STANDARDS DISTANCE-WEIGHTED ADOPTION BUREAUCRATIC QUALITY ASIA EUROPE YEAR Constant Observations

Model 6

***

8.448 (2.890) 0.148*** (0.049)

GDP PC (log)

Model 4

***

8.962 (2.472)

AUTO FDI (log) GDP PC (no log)

Model 2

***

0.023 (0.108) 43.448 (216.2) 470

0.137 (0.113) 20.76 (226.1) 470

0.692 (1.417) 0.006 (0.044) 0.003 (0.009) 0.362 (1.053) 0.519 (0.357) 3.10 (13.72) 0.149 (0.686) 1.611* (0.927) 1.766** (0.719) 1.172 (1.051) 2311.5 (2081.9) 406

0.292 (1.411) 0.042 (0.052) 0.003 (0.011) 0.215 (0.902) 0.389 (0.340) 3.388 (12.22) 0.141 (0.575) 1.668* (0.929) 1.663** (0.647) 1.037 (0.995) 2049.7 (1972.2) 406

0.051 (0.098) 0.732 (1.343) 0.024 (0.050) 0.002 (0.010) 0.173 (0.972) 0.498 (0.348) 3.27 (13.10) 0.104 (0.638) 1.673* (0.941) 1.633** (0.756) 1.122 (1.038) 2212.7 (2057.8) 406

Robust standard error in parentheses. * p < 0.1. ** p < 0.05. *** p < 0.01.

FDI variable is positive and significant, and this is also true for the coefficients of the regional variables. Considering the statistical significance of regional variables, we have also created a model where we remove all European countries. The objective of this was to test that the significance of the FDI variable was visible not only for European countries, which required the standards for EU members, but also for other countries as well. We indeed find that the FDI variable is positive and significant excluding European countries, and these results give us assurance that the FDI increases the probability of emission standards’ adoption, not just for Europe, but for all countries. The same holds when both Europe and Asia are excluded. While we did not find evidence for the effects of WTO membership, it seems equally plausible that countries adopt environmental regulations during accession negotiations. If we include a binary variable capturing a two-year or

three-year period before WTO accession, it has a positive and statistically significant coefficient: accession incentives may indeed promote the adoption of automobile emission standards. Equally important, the coefficient for automobile FDI remains positive and statistically significant. Finally, we also included all other regional dummies in our model to confirm that the FDI variable is still positive and significant. This result gives us confidence that the FDI increases are not solely due to the geographical reasons, but indeed are due to what we have hypothesized. Automotive FDI leads to more adoption of emission standards in developing countries.

8.

Conclusion

Why do developing countries adopt environmental standards? Using China as a motivating case study, we have argued

environmental science & policy 38 (2014) 192–206

that environmental standards can promote international technology transfer to developing countries with substantial FDI from advanced industrialized nations in the automobile sector. The argument has several implications for future research. First, if we are correct to argue that international technology transfer is an essential determinant of environmental regulations in the global South, similar hypotheses could be applied to data on other environmental regulations. While much recent scholarship has investigated developing countries’ ability to attract FDI, our analysis opens pathways for exploring their ability to strategically benefit from it (Rodrı´guez-Clare, 1996). Second, our contention regarding the possibility that environmental and other regulations can implicitly induce foreign producers to transfer technology may offer a new rationale for the notion that state intervention can enhance national competitiveness (Lewis and Wiser, 2007; Porter and van der Linde, 1995). Social scientists of all stripes acknowledge the importance of technological innovation. However, the ability of different developing nations to develop their technological capabilities remains uncertain. We have argued that an environmental regulation can also serve as a vehicle of technological development by facilitating international technology transfer. In an era of a global environmental crisis and continued extreme poverty, such win-win strategies are particularly welcome. At the same time, the strategy proposed here is only applicable in certain circumstances. Environmental standards as a strategy of international technology transfer depend on a foreign company’s sufficient interest in the developing country’s home market, so that the foreign company is willing to export advanced technologies despite the possibility of reverse engineering. For small developing countries with small home markets, alternative strategies are needed.

Appendix A. Supplementary data Supplementary data associated with this article can be found, in the online version, at http://dx.doi.org/10.1016/ j.envsci.2013.11.010.

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