Environmental Policy and Technological Innovation: Evidence from Taiwan Manufacturing Industries

Transcription

1 Envronmental Polcy and Technologcal Innovaton: Evdence from Tawan Manufacturng Industres Dana H. Tsa Professor, Graduate Insttute of Economcs, Natonal Sun Yat-Sen Unversty Correspondence: Dana H. Tsa Graduate Insttute of Economcs Natonal Sun Yat-Sen Unversty Kaohsung, Tawan (tel): ext.5619 (fax): Emal:

2 2 Envronmental Polcy and Technologcal Innovaton: Evdence from Tawan Manufacturng Industres Dana H. Tsa Natonal Sun Yat-Sen Unversty Abstract Mchael Porter suggested that the tradtonal trade-off between envronmental regulaton and compettveness may have overestmated envronmental complance costs, neglected nnovaton offsets, and dsregarded the affected ndustry's ntal compettveness. We examne the stylzed facts regardng envronmental abatement nvestments and nnovaton n varous ndustres. Ths paper examnes the role of market nnovaton and the ncurred necessary adjustments n explanng the apparent contradcton between markets and the envronment. It argues that market nnovaton can serve as a powerful tool of envronmental polcy operatng together wth a compettve market envronment. To capture the market nnovaton and the ncurred adjustments for enterprses n complyng wth the envronmental standard requres a model wth dynamc adjustment features. Ths paper apples an emprcal ndustry dynamc model to explctly ncorporate assocated adjustments n analyzng the effcency of the abatement nvestment by ndustry. By nvestgatng abatement nvestments n varous ndustres, we analyze the nnovaton and adjustment effects of envronmental polcy. We apply the emprcal ndustry dynamc model to Tawan manufacturng ndustres and nvestgate how well the double-focus of ndustry effcency and envronmental perpetual development has been developed n the process of ndustralzaton. The Tawan manufacturng ndustres were chosen snce t has been characterzed by ncreasng nnovaton and nvestment n R&D, especally the rapd nnovaton n electroncs, computers, materals, and processes whch had marked as the source of the substantal growth before Asa fnancal crss. The ndustres wth hgher nnovaton spllover effects and lower adjustment effects are dentfed to effectvely enhance optmal polcy n amng at both economc effcency and envronmental perpetual development for Tawan's balanced growth. JEL Classfcaton: C5; L5; L6; O3 Keywords: Envronmental polcy; Technologcal nnovaton and dffuson; Adjustment effects

3 3 Table of Contents I. Introducton II. Prevous Fndngs on the Trade-off between Envronmental Regulatons and Compettveness III. A Dynamc Model of Producton wth Abatement Captal IV. Emprcal Fndngs 4.1 Measure of Investment Incentves, Economes of Scale, and Adjustment Costs 4.2 The Decomposton of the Impacts of Envronmental Regulatons on TFP V. Concludng Remarks

4 4 I. Introducton The relatonshp between envronmental goals and ndustral compettveness has conventonally been thought of as nvolvng a tradeoff between socal benefts and prvate costs. The tradtonal vew s that frms pursue effcency at the expense of envronmental protecton because one frm's consumpton s rrevocably lnked to those of others. Ths leads to ll-defned prvate choces and to the falure of ndustry compettveness. Markets can therefore nduce over-consumpton of envronmental resources, such as clean ar. Recprocally, envronmental concerns are often blamed for undermnng market performance. Envronmental regulaton can lead to undue costs and prevent the unfettered behavor needed for achevng ndustry developments. (e.g. Denson 1979; Chrstansen and Haveman 1981; Gray 1987; Conrad and Wastl 1995; etc.). In the recent decade, the envronment-compettveness debate has been shfted to a new dynamc nternatonal compettveness paradgm. Mchael Porter suggested that the tradtonal trade-off between envronmental regulaton and compettveness may have overestmated envronmental complance costs, neglected nnovaton offsets, and dsregarded the affected ndustry's ntal compettveness. Markets may have evolved some of the most nnovatve and useful solutons for global envronment problems. (e.g. Barbera and McConnell 1990; Gray and Shadbegan 1993; Jaffe and Stavns 1994; Porter and Lnde, 1995; Jaffe, et. al. 1995; and Jaffe and Palmer 1996; etc.) Ths paper examnes the role of market nnovaton and the ncurred necessary adjustments n explanng the apparent contradcton between markets and the envronment. It argues that market nnovaton can serve as a powerful tool of envronmental polcy operatng together wth a compettve market envronment. Ths study s then to analyze the nter-connecton relatonshp among enterprse effcency, ndustral technologcal nnovaton, the measure of envronmental polcy tools, and the assocated adjustments. The focus s to examne the drect and ndrect effects of the envronmental regulaton on enterprse technologcal factors. Wll the mpacts of envronmental regulaton affect the technologcal changes and stmulate the technologcal nnovaton of the enterprse? Does there exst a connecton between economes of scale and the envronmental costs? The ndustry characterstcs, scale economes and the assocated adjustment costs wll be the focus of analyzng economc effcency and the envronmental nvestment n ths study. To capture the market nnovaton and the ncurred adjustments for enterprses n complyng wth the envronmental standard requres a model wth dynamc adjustment features. 1 We apply an 1 Recently there are sgnfcant advancements n modelng dynamc factor demand model. (See for a detaled survey n Nadr and Prucha 1999) And a vast lterature shows the wde spread use factor demand models for emprcal analyss. (See, e.g., Prucha and Nadr 1996; Galeott 1996; and Good, Nadr and Sckles 1997 for partal references.)

5 5 emprcal dynamc model to Tawan manufacturngs and nvestgate how well the double-focus of ndustry effcency and envronmental perpetual development has been developed n the process of ndustralzaton. The purposes are two folds. Frst, f ndeed there exsts the ndrect postve effects of envronmental regulaton that promote technologcal nnovaton, nventon, and dffuson, optmal regulatory polcy may requre mposng a lghter regulatory burden on hgh technology ndustres or beng desgned to be more nnovatve-orented. Second, we nvestgate how well the double-focus of ndustry effcency and envronmental perpetual development has been developed n the process of Tawan s ndustralzaton. Have the hgh-technology, hgh-growth, low-adjustment costs, and hgh nnovatve-orented envronmental mpacts ndustres been hgher prorty n Tawan s development? Ths study s then consdered to serve for two purposes: 1) to provde the economc evdence for mplcatons of busness strategy n pursung effcency and growth; and 2) to dentfy the rght ndustres for Tawan and to effectvely enhance optmal polcy n amng at both economc effcency and envronmental perpetual development for a balanced growth. The Tawan manufacturng ndustres were chosen snce t has been characterzed by ncreasng nnovaton and nvestment n R&D, especally the rapd nnovaton n electroncs, computers, materals, and processes whch had marked as the source of the substantal growth before Asa fnancal crss. The study s concerned wth the sustanable development of the Tawan economy and n partcular wth the future ndustry compettveness-envronment partnershp. Adoptng the values of sustanable development also mples an ncrease n the ndustry's envronmental and socal costs. For an ndustry already n poor stuaton ths s potentally a problem. To pursue sustanable development, the Executve Yuan (EY) of the Republc of Chna (ROC) on Tawan establshed the Natonal Councl for Sustanable Development (NCSD) n August In Tawan, the meanng of sustanable development s apparently more than just choppng down less trees than you plant or, n the sea, not fshng at a level greater than that of natural recrutment and cohort survval measured over an extended tme scale. As an sland country, Tawan s ndustral growth has to be adherng to the prncple of sustanable development. Ths paper nvolves emprcal research nto the workngs of a number of ndustres n Tawan. The study mproves our understandng of the ndustres nvolved, and, more broadly, to help assess the relevance of a number of economc theores of compettveness-envronment complexty. Ths paper examnes the role of market nnovaton and the ncurred necessary adjustments n explanng the apparent contradcton between markets and the envronment. It argues that market nnovaton can serve as a powerful tool of envronmental polcy operatng together wth a compettve market envronment. Ths paper apples an emprcal ndustry dynamc model to explctly ncorporate assocated adjustments n analyzng the effcency of the abatement nvestment by ndustry. We 2 Ever snce the 1992 Unted Natons Earth Summt, the pursut of sustanable development has been the common goal of natons around the world. The partnershp relatonshp of the ndustry-envronment has been

6 6 apply the emprcal ndustry dynamc model to Tawan manufacturng ndustres and nvestgate how well the double-focus of ndustry effcency and envronmental perpetual development has been developed n the process of ndustralzaton. The ndustres wth hgher nnovaton spllover effects and lower adjustment effects are dentfed to effectvely enhance optmal polcy n amng at both economc effcency and envronmental perpetual development for Tawan's balanced growth. In order to ntate the process of unravelng the productvty-envronmental-regulatons nexus, ths study nvestgates the drect and ndrect nnovaton effects of the envronmental regulaton on ndustry productvty by 15 Tawan manufacturng ndustres. A dynamc producton model s bult up to nclude the economc effects of technologcal characterstcs on frms and comples wth conventonal envronmental regulatons. Ths paper s organzed as follows. Secton 2 revews the lteratures survey the mpact of envronmental regulatons on enterprse effcency and/or ndustral productvty. Secton 3 specfes a dynamc model of producton ncorporatng abatement captal and nternal adjustment costs, and decomposes the mpact of envronmental regulatons on TFP to drect and ndrect effects. Secton 4 presents the emprcal model and results for 15 Tawan manufacturng ndustres. Secton 5 summarzes our results and develops ther mplcatons for envronmental regulaton and for future research. II. Prevous Fndngs on the Trade-off between Envronmental Regulatons and Compettveness In the earler lterature, the mpact of envronmental regulaton on ndustral productvty seems qute obvous. In order to comply wth the envronmental standards, some unproductve nputs have to be used for complyng wth the envronmental standards. The process dd not ncrease outputs but decrease measured TFP (total factor productvty) because more wll be subtracted from the growth rate of output. From ths perspectve the effect of envronmental regulaton on productvty s obvously negatve; open questons only are how to measure t and does the mpact matters. (Denson 1979; Chrstansen and Haveman 1981; Gray 1987; Lu and Chu 1992; Conrad and Wastl 1995; etc.). In measurng the mpacts of dfferent forms of envronmental regulatons on productvty change, Denson (1979) used a TFP approach to estmate the effect of envronmental regulatons on TFP for all manufacturng (0.35% less per year). Gray (1987) also used ths approach to examne the mpact of health, safety and envronmental regulaton on productvty growth lookng at data for 450 manufacturng ndustres. He attrbutes about 30% of the declne n TFP growth to such regulatons (0.44% less per year). Further parametrc TFP studes have been appled by Norsworthy, Harper and Kunze (1979) and Conrad and Morrson (1989). Norsworthy, Harper and Kunze (1979) found the decrease n aggregated labor productvty from abatement captal cost to be between 0.1% - 0.2%. In declared clearly to be the goal of the sustanable development supported by balancng growth n economc development wth envronmental protecton.

7 7 Conrad and Morrson (1989), cost shares were modfed by abatement captal, and the contrbuton of regulaton on productvty n the U.S., Canadan and German steel ndustres were compared. Gollop and Roberts (1983) nvestgate the mpact of envronmental regulaton on 56 electrc utltes usng a cost functon approach. They found ar polluton regulatons reduced frm-level productvty growth by 0.59%. Chrstansen and Haveman (1981) reveal reduced labor productvty growth by 0.27% usng an econometrc approach wth envronmental regulaton ntensty as an explanng varable. Barbera and McConnell (1986) estmate a system of factor demand equatons and fnd that abatement requrements have reduced captal and labor productvty n several ndustres. Recently an ncreasng number of economc lteratures have explored the possblty that envronmental regulatons may also gve some postve spllover effects on productvty. Whether these effects are large enough to cover the negatve effects s then an emprcal queston and cannot usually be determned a pror. Gray and Shadbegan (1993) state that: In some cases, regulatons may ncrease productvty. In response to pressures to reduce waste water dscharges, some plants adopted closed-loop producton processes and dscovered after dong so that the cost savngs from recyclng raw materals reduced total costs. Barbera and McConnell (1990) and Jaffe and Stavns (1994) all ndcate the possblty that for some ndustres envronmental regulatons can stmulate nnovatons that reduce costs by lowerng nput prces or by ncreasng the productvty of an ndustry s nputs. Jaffe (1995) further verfes f there do exst ndrect postve effects of envronmental regulaton on the technology changes and productvty growth, the analogy would not be so straghtforward. In ths framework, envronmental regulatons are seen as beng not only bengn n ther mpacts on nternatonal compettveness, but actually a net postve force drvng prvate frms and the economy as a whole to become more effcent and compettve n nternatonal markets. In the long run, the development and wdespread adopton of new technology can greatly amelorate what, n the short run, sometmes appear to be overwhelmng conflcts between economc well-beng and envronmental qualty. The lteratures measurng the spllover effects of the envronmental regulatons on ndustral productvty focus on the mproved rates of nventon, nnovaton and technology dffuson. Kemp and Soete (1990) suggest that the mpact of envronmental regulaton can be benefcal f regulatons desgned to protect or enhance envronmental qualty were desgned to foster rather than nhbt technologcal nventon, nnovaton, and dffuson. Barbera and McConnell (1990) nvestgate both the drect and ndrect mpacts of the envronmental regulatons usng a flexble functonal form cost functon. The drect mpact of envronmental regulaton on productvty growth s due to the dverson of resources toward requred abatement captal. The further ndrect effect s then as conventonal nputs and producton processes are changed n response to requrements to purchase abatement captal. They estmate total factor productvty and the drect and ndrect productvty effects of envronmental regulatons for fve pollutng ndustres (Paper; Chemcals; Stone, Clay, and Glass; Iron and Steel; and Non-ferrous metals) and fnd that net mpact of envronmental regulaton on total factor productvty growth s farly small even for only about

8 % of the productvty declne of the 1970s n these ndustres. Porter and van der Lnde (1995) comment that studes fndng hgh envronmental complance costs have tradtonally focused on statc cost mpacts, gnorng any offsettng productvty benefts from nnovaton. These studes typcally overestmated complance costs, neglected nnovaton offsets, and dsregarded the affected ndustry's ntal compettveness. Envronmental regulaton had a very uneven mpact on manufacturng ndustres, dependng on ther market structure, ndustry characterstcs, number and sze structure of plants and factor shares. Pashgan (1984) proves that small companes have been harmed relatvely more than large companes and shows how optmal plant sze and the sze dstrbuton of plants wll be changed under envronmental regulaton. Gray and Shadbegan (1993) analyze the mpact of polluton abatement expendture on productvty and fnd that the more regulated plants have sgnfcantly lower productvty growth than the less regulated plants. Jaffe and Stavns (1994, 1995) develop the framework for comparng emprcally the effects of alternatve envronmental polcy nstruments on the dffuson of new technology. Tsato and Porter (1996) present a graphcal analyss of how proft-maxmzng frms would respond when requred to control polluton. The graphcal presentatons n ths study attempts to ntegrate the two polluton reducton responses open to frms: output reducton and use of abatement technology. Hartman et al. (1997) apply a large US plant-level database, created from PACE and ASM, to estmate the costs of abatement for major ar pollutants (e.g. sulphur oxdes, carbon monoxde, hydrocarbons, lead, etc.) n all US manufacturng sectors. They conclude that command-and-control regulaton n the US has acheved emssons reducton at unnecessarly hgh cost and provde a consstent foundaton for prorty-settng. Gray and Shadbegan (1998) examne nvestment allocaton across exstng plants and test whether envronmental regulaton affects nvestment decsons. They conclude envronmental nvestment "crowdng out" productve nvestment wthn a plant, and frms shftng nvestment towards plants facng less strngent abatement requrements. As Porter and Lnde (1995) nterpreted the new paradgm of envronment-compettveness relatonshp, the paradgm defnng compettveness has been shftng, partcularly n the last 20 to 30 years, away from the statc model to a new dynamc paradgm of nternatonal compettveness, based on nnovaton. Recently an ncreasng number of economc lteratures have theoretcally and emprcally proved the mportance of nnovaton n envronment-compettveness relatonshp. Gray and Shadbegan (1993) state that: In some cases, regulatons may ncrease productvty. In response to pressures to reduce waste water dscharges, some plants adopted closed-loop producton processes and dscovered after dong so that the cost savngs from recyclng raw materals reduced total costs. Barbera and McConnell (1990) and Jaffe and Stavns (1994) all ndcate the possblty that for some ndustres envronmental regulatons can stmulate nnovatons that reduce costs by lowerng nput prces or by ncreasng the productvty of an ndustry s nputs. Jaffe (1995) further verfes f there do exst ndrect postve effects of envronmental regulaton on the technology changes and productvty

9 9 growth, the analogy would not be so straghtforward. In ths framework, envronmental regulatons are seen as beng not only bengn n ther mpacts on nternatonal compettveness, but actually a net postve force drvng prvate frms and the economy as a whole to become more effcent and compettve n nternatonal markets. In ths paper, we focus on the role of nnovaton n sustanable development. We examne the stylzed facts regardng envronmental abatement nvestments and nnovaton n a panel of manufacturng frms n varous ndustres and regons. And we re-examne the testable hypotheses rased from the exstng lteratures n the presence of adjustment process n the dynamc framework. III. A Dynamc Model of Producton wth Abatement Captal Theoretcal Model Suppose Y represents the homogeneous output of the frm net of polluton and U represents polluton, these two outputs produced usng I costlessly adjustable nputs x = (x 1,..., x,..., x ) and M I quas-fxed nputs k = (k 1,,..., k,..., k ) whose adjustment costs are sgnfcant and m M postve3. Then the transformaton functon for a two-output multple-nput technology s f ( Y, U, x, k, k&, t) = 0, where k s the level of quas-fxed nputs at the begnnng of the perod; k & s the adjustment vector of changes n the quas-fxed nputs durng the perod, the contnuous changes n quas-fxed nputs can be represented by dscrete changes kt - k t-1 ; and t s tme. If polluton were unregulated or untaxed, the frm would gnore t and use combnatons of the other nputs to produce the revenue generatng good, Y. Due to the envronmental regulaton, however, frms must also employ technques for reducng polluton caused by the producton of Y. We treat emssons as a functon of abatement captal n place, A, and the amounts of other nputs of producton, U = U ( A, x, k, k&, t). And the producton functon for Y as Y ( A, x, k, k&, t), where the nputs are used to produce Y or n conjuncton wth abatement captal to reduce polluton. We assume that the frm mnmzes net producton costs (Cs) subject to an exogenous level of producton, nput prces, abatement captal and technology. Thus, there exsts a restrcted cost functon, whch can be wrtten as C s ( Y, p, k, k&, A, t), where C s s short run producton cost; p s the vector of prces of the nputs x. 3 We use k t to denote the physcal captal stock at the end of perod t for whch the frm chooses how much of the begnnng-of-perod stocks wll be left over at the end of the perod, e.g. to choose approprate levels of mantenance. That s, the frm can choose endogenously the rate of deprecaton for those stocks. To formalze ths, we can wrte I k t = k& + δkt 1, where δ (the geometrc deprecaton rate for quas-fxed nput k) s endogenously defned, and the adjustments k & = k t kt 1 generate adjustment costs.

10 10 That s, the enterprse s assumed to determne the approprate level of producton and mnmze C = p x + φ( k& ) + p kk & = + φ( k& ) + p kk & s Cv, where C s ncludes the conventonal varable cost C v = h( p, k, Y, A), the adjustment costs borne by the enterprse φ(k & ), and the long run cost of the addton to the quas-fxed factors whch are valued at p k, the long run servce prces of the quas-fxed factors. Necessarly, φ( k & ) = 0 when k & = 0, whch s consstent wth and defnes long run equlbrum. Replacement nvestment -- that nvestment requred to mantan the current level of the stocks of quas-fxed factors -- s assumed to be costless n adjustment terms. An equaton for optmal short run gross nvestment n the presence of nternal adjustment costs s readly developed from the Euler equatons 5 when an explct form s mposed on φ. Thus we specfy nternal adjustment costs as 6 4 (1) φ(k & ) = p h ]. &, 1 y k t 1 & t & A t 1, [ ( Γ x + Γ y + Γ A +.5Γ ( k Δk ) )( k Δk ) x where Γ x s an M I matrx such that the varable nput x and quas-fxed factor k m ; γ k measures the adjustment cost assocated wth lagged of Γ y s an M J matrx such that γ ym measures the adjustment cost assocated wth output y j and quas-fxed factor k m ; Γ A s an M 1 vector such that γ Am measures the adjustment cost assocated wth abatement captal A and quas-fxed factor k m ; Γ k s an M M matrx such that γ mn measures the second order effect of dsequlbrum n quas-fxed factors k m and k n on adjustment cost. 7 The premultpled product of prces (whose exponents sum to 1) ensures that the functon s homogeneous n the frst degree n prces of varable nputs. 8,9 4 The concept of adjustment costs and mplcatons n producton modelng, see Morrson (1994) and Tsa (1999). 5 The Euler equatons state that the net change n expected dscounted costs from hrng one more unt of quas-fxed nputs at t s zero. That change s then the sum of the ncrease n varable costs (whch s negatve), the expected dscounted value of the extra expendtures whch the frm must ncur by holdng (at t only) one extra unt of quas-fxed nputs, and expected dscounted prce of the future quas-fxed nputs. 6 See for a more elaborated formulaton n Tsa (1999). The pattern of the adjustment cost functon can be roughly categorzed nto 4 types, see detals n Hamermesh & Pfann (1996). 7 Necessarly, φ( k & ) = 0 when k & = 0, whch are consstent wth long run equlbrum. Replacement nvestment -- that requred to mantan the current level of the stocks of quas-fxed factors -- s costless n adjustment terms. 8 We must mpose φ( k & ) 0 because negatve adjustment costs make no economc sense. 9 The parameterzaton of equaton (11) requre that γ x, γ y, γ A, γ k > 0 ; γ m = γ = m m 0 ; γ rm = γ = = m ym γ m Am 0 ; and γ = γ mn =. r m mn 0 n

11 Gven a specfcaton of the adjustment cost functon, the Euler equaton for physcal captal demand s k& m = 1 ( * h C p v + pkm + γ m x,. t 1 + γ rm y& r km r / γ mm ) + δ mkm, t 1. + γ Am A + γ mn ( k& n δ nkn, t 1 ) n m (2) Gven a twce-dfferentable functonal form for the varable cost functon and the assumpton of short run cost mnmzaton, dervatves of the short run cost functon by Shepard's Lemma yeld cost share equatons: ln Cv φ ln Cv (3) s = + = + γ m x, t 1( k& m δ mkm ). ln p ln p ln p m The nput demand equaton for varable nput s thus C (4) v Cv q = ln t m m m m m x k k + e p + γ, 1( & δ ) p ln. Ths model treats abatement captal as effectvely exogenous to the frm 11. The total cost functon (C s ) defnes the cost of producng the conventonal output, Y, n terms of the conventonal nputs, x and k, gven the requrement of purchase abatement captal. In ths framework, two effects are dstngushed -- drect and ndrect effects -- as the mpacts of requred abatement captal on total factor productvty growth of the manufactured output. Frst, the requrement to buy abatement captal mposes a drect cost on the ndustry causng total nput costs to be hgher for the same level of output. Second, the requrement to operate a stock of abatement captal s lkely to affect the amount or combnaton of conventonal nputs necessary to produce the manufactured output. Ths s a shft n the producton functon for manufactured output and t wll be referred to as the ndrect effect. The total costs of producng Y are these ndrect costs plus the drect costs of the abatement captal, C A (=P A A): 10 The short run cost s reduced by addng to the quantty of nput m only when v m > p km C / k ;.e., when the shadow value of captal exceeds ts servce prce. Thus the short run cost mnmzng condton for quas-fxed nput m s gven by ( k & φ ) / k m = C v / k m, m p km. 11 Ths approach dd not consder technology based requrements whch s complyng wth performance standard so far.

12 12 (5) C * = C( Y, p, k,k&, A, t) + CA, = Cv + φ( k & ) + p k k & + CA. To measure the effect of abatement requrements on TFP, we frst totally dfferentate (5) for consderng the mpact of envronmental regulaton on productvty measurement. Total costs may be decomposed nto factor prce change; output change; the effect of abatement on the cost functon; the changes n quas-fxed nputs; techncal change; adjustment costs n quas-fxed nputs; and the drect abatement costs. We begn ths exploraton of productvty mpacts wth the cost-sde defnton of productvty growth, lettng dots above varables denote the dervatve wth respect to tme: ε A (6) ( ), * C t = S C S p& + ε p CY Y& + ε Y CA A& + ε A CK k& h& dφ k k + εct + + p k k h d k Cv Cv + S A C& C A where S C = C v / C *, S A = C A / C *, S = x p / C v. TFP s defned as the growth n cost not accounted for by growth n prces and output and may be wrtten n terms of C * as (7) TFP = ε * C t S p& k& Y& p k Y = TC + IDAE + DAE + PSE + ACE. where h& TC = SCεCt h A& IDAE= SCε CA + SCε A C& DAE= S A A C A CK k& k p& PSE= S Cε p Y ( S 1) + ( S 1) Y CY & k k dφ k k ACE= SC + SC pk d k Cv Cv Equaton (7) shows that TFP may be decomposed nto fve major components: (a) the shft n C v due to

13 13 techncal change; (b) the shft n C v due to abatement captal purchases (or the ndrect abatement effect); (c) the growth n the drect cost of abatement requrements per unt of conventonal output (or the drect abatement effect); (d) prce and scale effects; and (e) adjustment costs effects when the frms are adjustng to comply wth new envronmental standards. Emprcal Implementaton To mplement emprcally, we approxmate C v wth the translog restrcted varable cost functon for a sngle output y and a sngle quasfxed nput k. (8) ln Cv = a0 + Σa ln p +.5ΣΣ j aj ln p ln p j + a ln ln ln.5 ln 2 y y + Σay p y + a yy y + a ln ln ln.5 ln 2 k k + Σck p k + bkk k + byk ln y ln k + ba ln A + ΣcA ln p ln A +.5b ln 2 AA A + bya ln y ln A + bak ln Aln k + bt t + Σct ln pt +.5b t 2 tt + byt ln yt + bkt ln kt + bat ln At. The usual restrctons for homogenety of degree one n prces and for short run cost mnmzng producton are mposed on the parameters of (8): a = 1; (9) aj = aj = ay = ck = ca = ct =0,, j ; and j by + bk = 0,. The adjustment cost for a sngle quasfxed nput s adapted as (10) (k & ) = h φ ]( γ m x t ( k& 1 m δ mk m, t 1 ) + p & & ) [, γ rm yr ( k m δ mk m, t 1 m m r + γ Ak ( k& - δ k )A + 5 γ ( k& δ k )( k& δ k )). t-1. mn m m m, t 1 n n n, t 1 m n

14 14 There are two dsadvantages of estmatng a demand model based on share equatons. 12 Frst, the ( ) calculated share s ncorporates both exogenous (p) and endogenous decson varables (q ) n the dependent varable. Consequently n a small sample, least squares-based estmaton (GLS, I3SLS, GMM) where demand quanttes are the targeted varables, the mnmzed quantty s less relevant than when the demand quanttes are specfed as the dependent varables. Second, n a system wth n demand varables, only n-1 of the share equatons are ndependent, whle all n demand equatons are ndependent. Thus the demand system ncorporates addtonal stochastc nformaton and s therefore more effcent. Accordngly, we specfy the estmable demand equatons as (11) C q = v (a + aj ln p j + ay ln y + ck ln k + ca ln A+ ct t) P j + ( γ + γ )( k - δ kt-1 ) + e The estmable equaton for k & s derved by (7) and expandng lnc v ln k k& m = ( / γ mm 1 h C v p + p k m ) + δ k + e. m m, t 1 m * km + γ m x,. t 1 + b Ak ln A + γ rm y& r + n m γ mn ( k& n δ k n (12) n, t 1 ) The complete estmable model then conssts of the varable cost functon (8), the varable nput demand equaton (11), and the quasfxed nput adjustment equaton (12). The endogenous varables are Cv, q, and k & as dependent varables n (8) (11) and (12). IV. Emprcal Fndngs The dynamc model of producton wth abatement captal s appled to analyze the drect as well as ndrect effects of envronmental regulatons on total factor productvty growth for 15 Tawan manufacturng ndustres, The measures presented n ths secton were generated usng output and nput prce and quantty data of these ndustres from Tawan Statstcs Bureau Offce of 12 Conventonal procedure s to estmate the cost functon jontly wth two of the three share equatons. McElroy (1987) proposed and demonstrated that the Addtve General Error Model (AGEM) proved to be more advantageous n that t ncorporates more nformaton, and the error terms have drect nterpretatons as nput

15 15 Productvty. The captal data s constructed usng the perpetual nventory method wth a 10% deprecaton rate. 13 The abatement captal expendtures have been obtaned from Industral Statstcal Surveys and Industral Census Report (provded by Statstcs Dvson, Tawan Mnstry of Economc Affars). The translog varable cost functon, augmented by adjustment costs and the full cost of new quasfxed nputs, s the bass for a short run cost functon that merges seamlessly nto a long run functon as adjustment costs declne. Estmaton of the adjustment cost model was carred out usng generalzed method of moments (GMM) 14, an nstrumental varables technque, to adjust for the endogenety of short run changes n the captal stock. The nstruments chosen are the relatve varable nputs prces 15, the lagged values of the exogenous cost arguments and output quantty, the begnnng of the year captal stocks for physcal captal stock and abatement captal stock, and lagged values of net nvestment n physcal captal and abatement captal endogenzed to accommodate non-statc expectatons. 16 The estmaton results for 15 Tawan manufacturng ndustry for the perod ndcate a hgh degree of precson n the model, gauged n terms ts explanatory power. All equatons exhbt R 2 s of.9 or better, except for the Euler equaton for physcal captal that explans 72% of the varaton n the captal nput. The estmated coeffcents are adjusted for seral correlaton and heteroskedastcty, and hence the quanttes nferred from them -- economes of scale, adjustment costs, total factor productvty, and the mpacts of envronmental regulaton on TFP, etc. -- are unbased. The usefulness of ths quanttes. See also Norsworthy and Jang (1992, chapter 3) for a dscusson of the advantages of the demand equaton over the share equaton. 13 A deprecaton rate of 10% has been used n many studes n dynamc producton modelng (see, for example, Bernsten and Nadr 1991; Nadr and Prucha 1994; Manuneas 1999). 14 As shown by Pndyck (1982) and Pndyck and Rotemberg (1983), f the error terms are condtonally homoskedastc, the GMM estmator proposed by Hansen (1982), Hansen and Sngleton (1982), s equvalent to the NL3SLS. 15 The varable nput prces are nstrumented because n the Euler equatons t s the expectatons of future prces for p L, p M that are relevant. 16 The nstrumental varables chosen ddn t nclude any current varables appearng n the estmated equatons snce measurement errors, optmzaton errors or technologcal shocks mght be correlated wth varables n the cost functon, nput demand equatons and the Euler equatons.

16 16 specfcaton was also suggested from the overall sgnfcance of the hgher-order terms. In the followng subsectons, the measure of nvestment ncentves, scale economes, and adjustment costs wll frst be analyzed, and then the mpacts of the envronmental regulatons on TFP wll be decomposed nto 5 categores of sources: pure techncal changes, drect abatement effects, ndrect abatement effects, prce and scale effects, and adjustment effects. 4.1 Measure of Investment Incentves, Economes of Scale, and Adjustment Costs Measures of economes of scale and adjustment costs are presented n Table I. The scale economes, defned as the nverse of the sum of output coeffcents mnus the quas-fxed nput coeffcents, 17 have mportant mplcatons on the nterpretaton of productvty-growth measures. Ths lnkage emerges because cost changes arsng from fxtes and output growth gven the exstng technology, as well as those from techncal change, wll be captured n standard productvty-growth measures. Ths wll affect measures of envronmental regulaton on both fnancal and productve performance. For all 15 Tawan manufacturng ndustres, there are sgnfcant economes of scale: e.g. Precson Machnery Manufacturng (1.67), Rubber Products (1.56), Leather Products (1.68), Mscellaneous Products Manufacturng (1.54), and Electrcty and Electroncs Manufacturng (1.52), etc.. We also found hgher prce and scale effects nduced by the envronmental regulaton (n Table IV) for the ndustres wth hgher measures of the economes of scale. So these measures also ndcate there may be strong nnovaton nduced effects for the ndustres wth strong economes of scale. The adjustment costs of quas-fxed factors net nvestment provdes the lnkage between current margnal costs and expected future benefts. It can be seen from Table I that all the adjustment costs are postve, as the theory requres. 18 Although adjustment costs for physcal stocks tend to be qute sgnfcant for most ndustres, t may not ndcate the speed of the adjustment process. Rapd adjustment may be due to a large margnal value of the captal stock, a declne n the relatve prce of hgh-tech captal, a lack of sgnfcant adjustment costs, or the low cost share of ths type of captal. 17 As t s defned n Denny, Fuss and Waverman (198l).

17 17 Although adjustment costs for physcal captal are sgnfcant for most ndustres, adjustment costs tended to be between 4% and 30% of per unt captal (rental) costs, whch, n turn, are a small share of total costs. Shadow values of physcal captal and ndexes of the shadow-value ratos are presented n Table II. The margnal shadow value Zk = Cv / xk shows the savngs on varable nputs allowed by a margnal ncrease n xk. The shadow value rato (ZKRAT = Zk/ p k ) wll fall short of 1 to the extent that the value to the frm of an addton to the asset stock s less than the market prce. These measures can be used to assess the economc motvaton underlyng dfferences and smlartes n nvestment decsons between ndustres. The ncreases n shadow-value ratos for physcal captal reveal that when nvestment ncentves ncrease n the sense that the margnal valuaton (product) ncreases relatve to the market prce. Ths suggests that there was less pressure to reduce the captal stock to accommodate utlzaton problems, even wth postve net nvestment stll not clearly economcal gven current costs. The shadow-value rato can be nterpreted as an overall measure of nvestment motvatons and short-term cost effects. These measures n Table Ⅱ show strong nvestment ncentves for the followng ndustres: Textle Industry, Petroleum & Coal Products, Non-Metal Industry, Basc Metals Industry, Metal Products Manufacturng, Machnery Equpment Manufacturng, and Electrcty and Electroncs Manufacturng. 4.2 The Decomposton of the Impacts of Envronmental Regulatons on TFP As a bass for our analyss, the mpacts of envronmental regulaton on ndustry TFP are decomposed nto fve major components: (a) the pure techncal change; (b) the drect abatement effect (growth n the drect cost of abatement requrements per unt of conventonal output); (c) the ndrect abatement effect (the shft n C v due to abatement captal purchases); (d) prce and scale effects; (e) adjustment costs effects due to changes n quas-fxed nputs. The emprcal results of estmatng total productvty and the drect and ndrect productvty effects of envronmental regulatons are shown n 18 The varable cost functon should be ncreasng and convex n net nvestment. Ths s satsfed at all ponts of

18 18 Table III - V. The drect effect of envronmental regulatons on productvty growth s due to the growth n the drect cost of abatement requrements per unt of conventonal output as conventonal nputs and producton processes are changed n response to requrements to purchase abatement captal. For the overall manufacturng ndustres, we have found negatve relatonshp between polluton abatement costs and total factor productvty level and growth rate, shown n Table III. These measures concde wth the conventonal wsdom that the effect of envronmental regulaton on productvty s negatve. The magntudes of the estmated coeffcents of drect effects n ths study are dfferent across manufacturng ndustres, wth Garments & Clothng, Textle Industry and Foods Industry are more sgnfcant than other manufacturng ndustres. There can be further ndrect abatement effects revealed by the dverson of resources toward requred abatement captal and the shft n C v due to abatement captal purchases. It ndcates the overall mpact on the reallocaton effects on the outputs and nputs. To acheve better envronmental qualty, the frm may have to reduce the use of polluton-ntensve nputs, reduces output quantty, or lowers short run profts. In recent work, Gray and Shadbegan (1998) also reflects ths effect by showng that envronmental nvestment "crowd out" productve nvestment wthn a plant, and frms shftng nvestment towards plants facng less strngent abatement requrements. The negatve ndrect abatement effects also show for all 15 Tawan manufacturng ndustres, wth more sgnfcant effects n Machnery Equpment Manufacturng, Non-Metal Industry, Basc Metals Industry, and Transportaton Tools Manufacturng than other manufacturng ndustres. Techncal changes are the pure Solow resdules of productvty growth, ndcatng what left over unexplaned of the technologcal changes. The techncal changes are most notable n the followng order: Electrcty and Electroncs Manufacturng, Metal products Manufacturng, Basc Metals Industry, Forest & Furntures, and Non-Metal Industry. (Table III) Prce and scale effects ndcate that to some extents the ndustres have some monopoly power to rase the prce or expand the scale n order to mantan the proft margn. These effects are sgnfcant especally for some olgopolstc the sample.

19 19 ndustres wth hghly concentraton and market power. Table IV shows for all 15 Tawan manufacturng ndustres there are postve prce and scale effects, wth the sgnfcance n the followng order: Petroleum & Coal Products, Non-Metal Industry, Basc Metal Industry, Metal Products Manufacturng, Machnery Equpment Manufacturng, Electrcty and Electroncs Manufacturng, and Transportaton Tools Manufacturng, etc.. Adjustment costs effects occur due to the dynamc adjustments of quas-fxed factors. The nternal adjustment costs ncorporated n ths dynamc settng represent the aggregate of the nternal purchased costs and nstallaton costs of the changes n quas-fxed nputs (physcal captal). The nvestment and then the resultng nternal adjustment costs are endogenous n the producton functon. The adjustment cost effects show that the changes n the quas-fxed nputs nduced by the envronmental regulaton n effect mprove the enterprse effcency for all 15 manufacturng ndustres. (Table IV) The postve adjustment effects for all manufacturng ndustres show the adjustment process has postve mpacts on enterprse effcency, and reflectng how enterprse strve for effcency gans. The role of physcal captal (and n ths case, human captal and R&D are not dvded from the captal category) and ts adjustments play mportant role for enterprse n complyng wth the new envronmental standard. The postve and statstcally sgnfcant nternal adjustment costs show mportant dmenson that should not be gnored n the ndustral transformaton process to the new envronmental standard. Of all 15 manufacturng ndustres, the total ndrect effects (the sum of the ndrect abatement effects, prce and scale effects, and the adjustment effects) are postve for all 15 Tawan manufacturng ndustres. It could explan by the followng scenaros: (1) Most Tawan manufacturng ndustres have nput allocaton flexbltes to some extent to accommodate the envronmental regulatons and stll keep the expanson of total costs n control. (2) Or alternatvely, some ndustres may have some monopoly power to rase the prce or expand the scale n order to keep the proft margn. (3) The extra abatement requrements push the frms to seek for more nnovatve actvtes n order to cut down the producton costs, and furthermore ncreases the productve technology effcency. And the mplcaton s clear that the regulatory authortes should provde more nsghts n desgnng ncentve regulaton mechansm, nstead of command and control mechansm for the hgh-tech

20 20 nnovaton-nduced ndustres. The overall mpacts of envronmental regulaton on enterprse effcency for most ndustres are the ncrease of the productve performance. Comparng the manufacturng ndustres, we fnd that Basc Metals, Metal Products Manufacturng, and Electrcty and Electroncs Manufacturng show the greatest ndrect spllover effects of envronmental regulatons. Due to the sgnfcant ndrect effects, the enterprses are wllng to nvest n R&D n order to exert more ndrect effects that generate benevolent cycles. And the overall effects of the envronmental regulaton on TFP are sgnfcantly postve for all 15 Tawan manufacturng ndustres. It reflects the fact that that the mplementaton of envronmental regulaton s not crowdng out the producton costs, but nstead t stmulates ndustry's nnovaton and dffuson, and furthermore ncreases the productve technology effcency. However, envronmental regulaton had a very uneven mpact on manufacturng ndustres, dependng on ther market structure, ndustry characterstcs, number and sze structure of plants and factor shares. V. Concludng Remarks Ths paper provdes an emprcal dynamc framework to explctly ncorporate assocated adjustments n analyzng the nter-connecton relatonshp among enterprse effcency, technologcal factors, adjustment costs, economc ncentves and the measure of envronmental regulatons. The model s convncng n that t accounts for more than 90 percent of the varaton n varable costs, and n the demands for labor and materals nputs, and captures 72 percent of the varaton n the captal nput. Overall, the model performs well n decomposng the drect and ndrect effects of envronmental regulaton abatements on ndustry productvty and n clarfyng the role of captal as quas-fxed nputs and the resultng nvestment behavor. The model exhbts postve adjustment costs for all tme perod. Whle the overall adjustment cost results are plausble, we consder that the partcular specfcaton reported here s only an example of what may be acheved n the future wth more ndustry-specfc detal ntroduced nto the adjustment cost functon. Because of the mportance of technologcal nnovaton and structural changes n Tawan manufacturng ndustry, we expect that adjustment cost model llumnates n the producton modelng analyss for Tawan manufacturng

21 21 ndustry. The dynamc producton modelng s appled to estmate total factor productvty and the drect and ndrect productvty effects of envronmental regulaton. The emprcal results for 15 Tawan manufacturng ndustres show a postve total effects of envronmental regulatons on overall ndustry productvty for all 15 Tawan manufacturng ndustres. For the overall manufacturng ndustres, we have found a sgnfcant negatve relatonshp between polluton abatement costs and total factor productvty level and growth rate. The magntudes of the estmated coeffcents of drect effects are dfferent across manufacturng ndustres, wth Petroleum & Coal Products and Basc Metals Industry are more sgnfcant than other manufacturng ndustres. Though there are negatve drect effects and ndrect abatement effects reveal the envronmental nvestment crowdng out productve nvestment, the nduced sgnfcant postve prce and scale effects and adjustment cost effects result n postve total ndrect effects for most of Tawan manufacturng ndustres. Comparng the 15 manufacturng ndustres, we fnd that Basc Metals, Metal Products Manufacturng, and Electrcty and Electroncs Manufacturng show the greatest ndrect spll-over effects of envronmental regulatons. And the postve adjustment effects for all manufacturng ndustres show the adjustment process has postve mpacts on enterprse effcency, and reflectng how enterprse strve for effcency gans. The role of physcal captal (and n ths case, human captal and R&D are not dvded from the captal category) and ts adjustments play mportant role for enterprse n complyng wth the new envronmental standard. The postve and statstcally sgnfcant nternal adjustment costs show mportant dmenson that should not be gnored n the ndustral transformaton process to the new envronmental standard. The emprcal evdence of ths study also shows envronmental regulaton had uneven mpacts on Tawan manufacturng ndustres, dependng on ther market structure, ndustry characterstcs, number and sze structure of plants and factor shares. For all 15 Tawan manufacturng ndustres, there are sgnfcant economes of scale: e.g. Precson Machnery Manufacturng, Rubber Products, Leather Products, Mscellaneous Products Manufacturng, and Electrcty and Electroncs Manufacturng, etc.. For the ndustres wth more sgnfcant economes of scale and lower adjustment costs (e.g. Basc Metals, Metal Products Manufacturng, and Electrcty and Electroncs

22 22 Manufacturng), we found greater ndrect spll-over effects of envronmental regulatons. So these measures also ndcate there may be strong nnovaton nduced effects for the ndustres wth strong economes of scale. And the mplcaton s clear that the rght ndustres should be dentfed wth hgher economes of scale, lower adjustment costs, and greater ndrect spll-over effects of envronmental regulatons to effectvely enhance optmal polcy n amng at both economc effcency and envronmental perpetual development for a balanced growth. Ths study also sheds lght on the regulatory authortes should provde more nsghts n desgnng ncentve regulaton mechansm, nstead of command and control mechansm for the hgh-tech nnovaton-nduced ndustres. To nform the regulatory process, t s mportant to nvestgate the decomposton of TFP growth nto components due to pure techncal changes, drect abatement effects, ndrect abatement effect (growth n the drect cost of abatement requrements per unt of conventonal output), prce and scale effects, and adjustment costs effects due to changes n quas-fxed nputs. The emprcal evdence shows that hgher prce and scale effects nduced by the envronmental regulaton assocate wth the ndustres wth hgher measures of the economes of scale and lower adjustment costs. And the measures of ndrect abatement effects, prce and scale effects and adjustment effects also ndcate there may be strong nnovaton nduced effects for the ndustres wth strong economes of scale. It ndeed provdes nsghts n desgnng ncentve regulaton mechansm, nstead of command and control mechansm for hgh-tech nnovaton-nduced ndustres. However, TFP dfferences sgnal dfferences n unt cost reducton. The economc logc of the Laffont-Trole framework suggests that dfferences n management practce and n regulatory oversght may account for part of the dfferng productvty performance records n dfferent ndustres. Further studes of the above dscusson ssues usng plant level data as comparatve case studes mght also mprove the nformaton base for regulatory authortes. The plant level dataset may also shed lght on the geographcal varaton and the dfferent polcy tools that mght generate more effectve level of technologcal nnovaton. Other future research and the ongong work are focused n the followng drectons. The adjustment costs should be occurred not only for productve quas-fxed nputs but also for abatement captal. The model s not yet ncorporatng all the ndrect effects nto consderaton, e.g., the spll-over effects nduced by protectng or enhancng envronmental

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