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Environmental Policy and International Competitiveness

Environmental Economics Seminar Series
Department of the Environment, Sport and Territories, 1996
ISBN 0 642 24879 6

Environmental management and industry competitiveness

Terry A'Hearn
Economics Unit
Environment Protection Authority, Victoria

Introduction

There are obviously a large number of issues which I could talk about under the title of my presentation - 'environmental management and industry competitiveness'. However, probably the most useful contribution I can make is to describe a few observations that EPA has on this issue based on its more than twenty years of experience in running Victoria's environment protection system. Hence, the sub-title of my talk - 'an EPA perspective'. In particular, I want to talk about some of the innovative approaches pursued by EPA since the mid 1980s and how they relate to industry competitiveness.

A common perspective

The debate about the effect of environment protection on industry competitiveness is often framed within a common though misleading perspective. People who hold this perspective believe that two of society's major goals, economic prosperity and environment protection, are nearly always in direct conflict. This is the classic 'conservation versus development' divide with which we are all familiar.

If one holds this perspective, it probably also leads to the conclusion that efforts to improve environment protection will usually cause a reduction in industry competitiveness. Despite a growing recognition that the economy and the environment are interdependent, this is a view that many people still bring to these environmental debates.

How does EPA respond to this perspective?

Well, let me start with a simple fact: it is clear that the Victorian community expresses a strong desire for both economic prosperity and environment protection. Environmental issues have very much become mainstream issues over the past couple of decades and they are likely to continue to be. In making these observations, as I am sure you would agree, I am hardly stating anything controversial.

But what does this mean for environment protection efforts? Well, one obvious approach is to seek solutions which have both environmental and economic benefits. This is what has become known as seeking 'win-win' opportunities. This aim has driven much of the development of Victoria's environment protection system over the past decade. In developing new approaches to environment protection, EPA has sought to maximise the opportunities provided by the growing recognition that, as we approach the twenty-first century, economic prosperity and environment protection must be viewed as complementary goals, not conflicting ones.

This new perspective is also being pursued in many areas of the private sector where we are increasingly seeing that many firms now realise that environmental considerations are no longer an 'add-on'. Fewer and fewer firms are leaving environmental management to an off line department. Instead, there are many progressive firms which regard environmental management as a core part of doing business. These firms ensure that environmental considerations are incorporated into their key decision-making processes. Furthermore, they recognise that being a good environmental performer will increasingly be a key prerequisite for maximising potential future profits.

In the remainder of my talk, I would like to discuss some of EPA's practical experience in promoting the joint pursuit of economic prosperity and environment protection.

A practical example - cleaner production

In what ways has EPA tried to achieve environment improvements either while enhancing, or at the least, not adversely affecting industry competitiveness? One approach has been to promote the adoption of cleaner production and waste minimisation philosophies within industry.

When environmental management became a significant issue for industry in the 1970s, the approach that was pursued is what we now refer to as 'end-of-pipe' solutions. This involved focussing on the end of the production process and cleaning up or removing the wastes that had been produced during the process.

In Victoria, this end-of-pipe approach was very successful in helping to reduce gross pollution problems. However, in the early and mid-1980s, it became apparent that a new approach was needed. The new approach that was developed involved changing the management focus to reviewing the entire production process and looking for opportunities to reduce wastes before they are created. This contrasts with the end-of-pipe philosophy where the aim is to remove or reduce wastes after they have been created. As much as practicable, wastes are now reduced at source, rather than at the end.

The key advantage of a cleaner production approach is that it can reduce environmental impact and reduce costs at the same time. In other words, it can contribute to both reducing the environmental impact of a production process and to enhancing a firm's competitiveness.

I will now briefly discuss two examples to illustrate how this approach has been used by two Victorian firms.

Example one - Ford Australia Ltd

Ford requires each of its plants to develop and implement a Waste Minimisation Plan. Under these plans, Ford has put in place a number of cleaner production initiatives to reduce the generation of solid wastes, increase water re-use and recycling and promote energy conservation. I will describe one of these initiatives to demonstrate the benefits Ford has generated.

Ford decided to look at its process of the caustic cleaning of paint off skids and booth grates to see if there were any cleaner production opportunities. In the end, the actual solution was technically quite simple and involves blasting the paint off with a high pressure jet of water.

From an environmental perspective, chemicals (e.g. caustic soda) have been eliminated from the process and this has also led to avoiding the acid neutralisation of the prescribed wastes. In addition, environmental benefits have flowed from the reduction in energy use.

From a commercial perspective, the new approach is saving Ford approximately $300,000 per year in reduced heating costs and disposal of caustic residues. The capital outlay for the blast equipment was approximately $120,000 giving the project a direct payback period of less than five months. This is before allowing for other indirect financial benefits such as annual savings in excess of $100,000 arising from the fact that the new approach leads to a two to three per cent reduction in reprocessing of reject items.

Example two - Cadbury Schweppes

In 1992, Cadbury Schweppes began a Cleaner Production Project to build on its previous waste minimisation activities. Twelve areas were identified for immediate action and staff throughout the organisation were invited to contribute ideas.

At the end of the first year, the Project had delivered environmental benefits such as a reduction in solid and liquid wastes and dramatic reductions in water usage and energy consumption.

These initiatives have also generated significant financial benefits for Cadbury Schweppes. For an initial capital outlay of $1.25 million, the Project has produced estimated annual savings of $780,000. The company expects similar returns from future initiatives that flow from the Project.

In each case, adopting a cleaner production approach has generated both environmental gains and financial gains (and, therefore, an enhancement in industry competitiveness).

From projects such as these, EPA sees cleaner production as presenting significant opportunities for the future. I now want to touch on some of our observations about encouraging this approach.

Cleaner production - promoting the concept

When I joined EPA as an economist, my initial reaction to the concept of cleaner production was that, according to economic theory, the potential for untapped win-win opportunities is virtually impossible. From the perspective of a theoretical economist, cleaner production opportunities shouldn't really exist.

Why? Well, the line of theoretical logic is fairly simple. Our economic textbooks tell us that firms are profit-maximisers. If this is so, a firm will adopt any cleaner production opportunities that will reduce its costs of production irrespective of environmental considerations.

However, experience in industrialised countries indicates that cleaner production philosophies are being increasingly adopted, but are no means widespread throughout all industries. EPA certainly believes that there will be substantial potential in cleaner production in the future.

So, from an economic perspective, why is cleaner production not already practised more widely? Does it mean that some firms are 'irrational' in ignoring cleaner production and, hence, profit-maximising opportunities?

Well, as we might expect, the explanation is not that firms are irrational. Instead, the explanation is that reality is far more complex than economic theory would suggest. In practice, there are several reasons that account for the fact that some firms have not yet fully embraced a cleaner production approach.

According to economic theory, one barrier to implementing a cleaner production option involving significant capital expenditure (e.g. to install cleaner technology) is financing constraints. Clearly, this will sometimes be the case, particularly during periods of high interest rates.

However, there are often other more important reasons, especially when one considers that cleaner production sometimes involves changes in operational practice as much as requiring new capital equipment. I will now run through some of those reasons.

Firstly, it must be recognised that, for most firms, it was only during the 1970s that environmental management first became a significant issue. Managing the environmental impact of an industrial operation throws up a complex set of challenges. Many industries have achieved substantial improvements in environmental performance over this period. However, it is unrealistic to expect all firms to have completed a total change in approach in only twenty to twenty-five years from not really worrying about the environmental impact of their operations to having fully embraced a sophisticated cleaner production philosophy.

Secondly, as already noted, adopting cleaner production opportunities can often involve a significant shift in management philosophy. As we are repeatedly being told, our industries have been subject to substantial change over the past decade or so in areas such as financial deregulation, tariff reform, rapid changes in information technology and Australia's new focus on the Asia-Pacific region. Any organisation can only successfully manage change or innovation on a certain number of fronts. Up until now, introducing a cleaner production philosophy may, for some firms, have not been identified as a high priority compared to managing other reform issues.

Thirdly, a related point is that environmental management is not yet part of core business for some firms. For such firms, environmental issues are still dealt with by an off-line unit which does not exert a strong influence on core operating decisions. (Indeed, in some small and medium sized firms, environmental management issues may hardly be dealt with at all.) In contrast, in firms where environmental management is part of the key operational decision-making processes, it is more likely that cleaner production opportunities will be both identified and implemented.

Fourthly, some firms might recognise the potential positive financial returns from cleaner production, but simply have more pressing issues with which to deal. This may especially apply to small and medium sized firms. The manager of a small manufacturing firm may want to implement some cleaner production options, but simply never gets the time to do so (or even to identify those options in the first place). Instead, he or she must constantly give priority to day-to-day issues of finance, customer service and employee relations.

Obviously, there will be other reasons which explain why many firms have not embraced a cleaner production philosophy. However, all that I want to establish is that there are a number of practical explanations which would not really be predicted by economic theory.

The existence of these practical realities presents a challenge to EPA and others (e.g. business groups such as the Australian Chamber of Manufactures) who are trying to promote cleaner production to find ways of overcoming these obstacles.

In EPA's case, cleaner production facilitation is now built into a range of EPA programs. For example, EPA staff help firms to identify cleaner production opportunities during the statutory works approval process for proposed major new or expanded plant. In addition, EPA encourages cleaner production through an annual Cleaner Production Award, Cleaner Production grants to small and medium sized enterprises, assistance with technology transfer, sponsorship demonstration projects, industry sector training courses and workshops and the dissemination of information.

Cost of environmental compliance

Before moving on to one other example of an EPA initiative which tries to produce both environmental improvements and economic benefits, I wish to make a couple of comments on the issue of the cost of environmental compliance.

As I noted earlier, there's a fairly standard view that environmental compliance costs reduce industry competitiveness. In his paper, Mick Common mentioned some of the studies which look at the extent to which environmental compliance costs affect competitiveness. He reports studies which show that: 'environmental compliance costs have little effect on competitiveness [as] they are generally low. Esty cites estimates of 2.1 per cent of GNP for the USA in 1990 and 2.4 per cent of total sales for major corporations worldwide in 1991'.(see note 1 below) Results of a similar magnitude are reported in the Australian Bureau of Statistics' series on pollution control costs.

The results of some other studies show that environmental compliance actually enhances industry competitiveness. The Institute for Economic and Environmental Studies at California State University concluded that those Californian industries subjected to the tightest environmental control actually performed better than competitors based in states with weaker controls.(see note 2 below)

1 Common, Mick, 'Environmental Policy and International Competitiveness' , paper presented at the 27 April 1995 Australian National University seminar, p. 8

2 Cited in The Age, Melbourne, 17 April, 1995, p.11

I do not want to go into this debate in too much detail, but I would like to briefly note three points.

Firstly, I simply note that this is a difficult empirical question which requires very careful application of economic analytical techniques.

Secondly, I wish to return to my point about the continuing change in philosophy from end-of-pipe management to cleaner production approaches. If a firm is using old-style end-of-pipe technology, it is likely to be much easier to isolate the costs of environmental compliance. This is because the costs can usually be more readily identified and fairly clearly attributed to environmental compliance purposes.

However, the more that a firm adopts cleaner production approaches, the more difficult it becomes to identify its environmental compliance costs. If environmental management decisions are built into the whole production process and produce both environmental improvements and cost savings, how do you separate the environmental management costs from expenditure designed to return a profit?

To illustrate this point, let us return to Ford's paint cleaning process changes. The new method of paint cleaning reduces the environmental impact of the production process, but it also generates significant costs savings for Ford. In this case, is it really possible to estimate the cost of environmental management? After all, there are no discrete costs at the end of the process which can be ascribed solely to environmental management purposes. Instead, costs have been incurred to generate both environmental improvements and future cost savings.

In general, this difficulty of attributing costs will increase in importance as more and more firms embrace cleaner production approaches.

Thirdly, it must be remembered that the timing of compliance action is crucial in estimating environmental compliance costs.

For example, suppose that a target is set so that it is necessary for an industry to reduce emissions of a particular pollutant. If compliance with the target is required in the short-term (say six months), this might necessitate scrapping existing equipment and installing new equipment.

However, suppose that, from an environmental perspective, it is possible to allow a reasonable phase-in period in which the industry is given some time (say five years) to meet the lower emissions target. In this scenario, the firms in the industry may be able to make significant reductions in emissions when undergoing re -equipment exercises as part of their normal asset replacement cycles. In many cases, when firms come to replace assets, the only equipment available on the market will be more efficient in terms of both productive capacity and reduced emissions. Again, the environmental compliance costs will be much lower than if the target had to met in the short time-frame.

Naturally, the timing of environmental compliance will depend on a number of factors and, especially where pressing environmental problems exist, long phase-in periods will not be feasible. However, it is worth noting that the timing of compliance action can significantly affect environmental compliance costs.

Accredited Licensee System

Finally, I would like to describe EPA's innovative Accredited Licensee System which represents an attempt to encourage sound environmental performance by rewarding good environmental performers.

In 1994, the Environment Protection Act was amended to allow for the accreditation of licensees able to demonstrate an ability and commitment to effective environmental management.

This scheme represents a highly innovative approach to regulation that will provide Victorian businesses which are scheduled premises with the opportunity to move into a form of co-regulatory partnership with EPA and the community. Under the scheme, companies with demonstrated capabilities and a commitment to environment protection can apply for accredited status.

Accredited Licensees will have greater scope to manage their environmental performance for a site in the most cost-effective manner. This will generate savings for an Accredited Licensee from:

The reduced demand on EPA resources in servicing the new system will enable pressing problems such as diffuse pollution sources to be more effectively addressed within existing resource allocations. It will also free EPA resources to provide additional assistance to small companies experiencing environmental problems.

The community will have improved access to information about Accredited Licensees' operations, forward plans and performance as well as greater opportunities to discuss their concerns with companies through fora such as local community liaison committees. All these are essential if this co-regulatory approach is to receive sustained community support.

Because Accredited Licensees will be operating under a less prescriptive whole of site licence and will not require works approval for most plant improvements, they will be able to devote their efforts to more creative and cost-effective approaches. The importance of protecting their Accredited Licensee status and commitment to continuing improvement is expected to produce better environmental performance with fewer mishaps.

In particular, significant benefits will flow to an Accredited Licensee from having a sound Environmental Management System (EMS) in place (this is one of the requirements of accreditation). From an environmental perspective, it is expected that the discipline imposed by an EMS will lead to increased environmental awareness and, hence, to better environmental outcomes. In particular, the number of environmental incidents should be reduced and waste minimisation opportunities should be more readily identified.

From an economic perspective, an EMS should also generate other benefits for the Accredited Licensee. Operational efficiencies will be created as companies spend less time, especially senior management time, on crisis management because an EMS introduces a proactive approach. The cost of pollution incidents and, therefore, any resultant legal action will also be reduced. The increased likelihood of identifying waste management opportunities should also reduce costs involved in raw material purchases and waste treatment processes.

Companies using an EMS may also gain a competitive edge in terms of international trade and investment. This is because markets, especially European markets, are increasingly looking for proven environmental credentials before doing business. A certified EMS provides evidence of such credentials. It also places a company in a better position to take advantage of international developments.

Furthermore, the Accredited Licensee system builds on, and can be integrated with, quality management approaches already being adopted by business rather than adding new layers, costs or requirements. Checks and balances will be provided by the prerequisites for accreditation:

Should an Accredited Licensee fail to maintain the high standards of environmental responsibility and performance involved in the system, accreditation will be withdrawn and a more prescriptive licence and control system reimposed. The licensee would lose some of the cost advantages of greater flexibility and the market advantages derived by being formally recognised as a good environmental performer.

The Accredited Licensee Scheme represents a further step towards a partnership with industry and the community that will deliver both environmental improvements and more freedom from regulatory control. In short, the scheme should help deliver better environmental outcomes at lower cost to the Victorian community.

Again, the Accredited Licensee Scheme represents an attempt to make good environmental performance something which enhances a firm's competitiveness.

Conclusion

I've argued that, based on EPA's experience, future efforts will increasingly be focussed on ways of pursuing environment protection that actually enhance industry competitiveness or, at the very least, minimise any adverse effects. In other words, we should always seek opportunities which maximise this congruence of industry competitiveness and environment protection.

One final point that I would like to make is that while success in this endeavour relies on many factors, one key factor will be developing adequate levels of trust.

This is because to make innovative approaches such as the Accredited Licensee Scheme work, EPA needs to assure itself, the Parliament and the community that the environmental results will be delivered.

In order to capitalise on the greater flexibility offered by some of these approaches, industry needs to demonstrate that it can act responsibly and that it can continue to improve its environmental performance.

If an adequate level of trust is not developed, these innovative approaches are less likely to succeed. If this happens, one of the main alternatives will be to return to a heavier reliance on prescriptive regulation. Such a development would be a backward step. It is likely to prove costly for both the EPA and industry, as well as being inflexible and not very effective in delivering the continued environmental improvements that the Victorian community expects. The consequences would be adverse from the viewpoint of both the environment and industry competitiveness.


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