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Pollution, environmental regulation and firm performance

Research Project
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01.07.2021
 - 30.06.2023

This project investigates the impact of the EU Emissions Trading Scheme (EU ETS) on firms using administrative data from German manufacturing for the years 2003-2019. We study the implications of climate policy on firms and, indirectly via changes in emissions intensities, on the environment. At the same time, there is mounting evidence that environmental quality also affects firms. The second part of our project focuses on this reverse causality and thus contributes to our knowledge about the interactions between the economy and the environment. Our work builds on our previous research funded by the SNSF involving the same data. The first work package examines the long-term effects of the EU ETS via its impact on regulated firms' product choices. The introduction of a price on greenhouse gas emissions changes the relative production costs, which will be reflected in product prices. This is the subject of our previous research, in which we show that manufacturing firms in Germany pass on their marginal costs fully to consumers. In that previous work, we took a short-term perspective and examined what happens to the output price if the production costs increase by one Euro. In this project, we focus on the long-term implications in the form of product choice. Over time, consumers can be expected to substitute away from emissions-intensive products, which have become costlier, towards greener products. In order to retain market share and profits in the face of this demand response, firms will need to adjust their product portfolio towards less emission-intensive products over time. In WP1, we investigate whether such a shift can be observed among German manufacturing firms, and whether this shift is stronger for the firms covered by the EU ETS. Our second work package builds on the recent literature about the effect of air quality and tem-perature on firm outcomes. There is an older literature that documents detrimental health effects as a consequence of air pollution and temperature variations. This is a first-order reason to establish clean air standards. Environmental policy is usually interpreted as a tradeoff between more environmental quality (and better health) on the one hand, and a reduction in GDP and growth on the other. However, if workers (and thus firms) become more productive if the air quality improves, as suggested by the recent literature, then this tradeoff may in fact be a win-win-situation, at least within certain pollution bounds. To investigate this question, we will link satellite-based data of ambient air pollution and temperature to the location of individual manufacturing plants in Germany and investigate whether changes in environ-mental quality causally affect firms' productivity. We address the potential endogeneity problem between industrial production/productivity and pollution by using an instrumental variable approach that relies on temperature inversions and prevailing wind directions. As the main measure for productivity, we propose to use the total factor productivity that we have computed for the firms in our sample in the context of our previous project. There is a high degree of synergy between the proposed and the previous research as both projects rely on the same administrative firm-level data. The data are very rich in terms of information content, but the prevailing confidentiality rules render them difficult to work with. Having incurred significant fixed costs in terms of our understanding the data and their limitations, we are now in a position where additional time invested will likely have a high benefit-cost ratio. We propose to use the same data to follow up on our previous project with a new set of research questions. Including both a Postdoc and a Ph.D. in the project will furthermore contribute to capacity building in research. We hope that the proposed work will deepen our understanding of the effects of air pollution and its regulation on firms and thus inform policy makers about the costs and benefits of environmental regulation.

Collaborations & Cooperations

2023 - Participation or Organization of Collaborations on an international level
Di Maria, Corrado, Associate Professor, University of East Anglia, Research cooperation

Members (2)

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Beat Hintermann

Principal Investigator
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Roman Eric Sieler

Project Member