Investing in the environment

Investing
in the environment

Daniel Chudnovsky
says that foreign direct investment by multinational companies may improve the environment in developing countries and calls for vigilance to ensure that this takes place

The effects of foreign direct investment (FDI) on the environment in developing countries are now assessed quite differently from in the past. From being accused of investing in developing countries to take advantage of lax environmental regulations – and hence being responsible for many environmental problems – multinational companies (MNCs) are now increasingly considered as leaders in introducing good environmental management practices and in diffusing environmentally sound technologies. The evidence in support of both arguments is limited, but there is no doubt that many MNCs have the potential to be a more conducive agent for introducing environmentally sound technologies. Their actual environmental management, however, depends on the age of the facilities, the presence of sunk costs, host country environmental regulations and enforcement, the availability of pollution prevention technologies and their own global environmental policies.

The traditional position suggested that ‘pollution havens’ existed in developing countries to attract more FDI, since MNCs could be interested in escaping from countries with high environmental standards. Despite the popularity of this argument, however, there is little evidence of their existence. Most investment decisions are not made on the basis of environmental criteria. As environmental costs represent less than 2 per cent of the gross domestic product of industrialized countries, it is difficult to imagine that they have any significant weight in location decisions.

Environmentally friendly technology
However, the costs of complying with more stringent environmental regulations might be greater in particular sectors – such as chemicals, oil, steel, mining or cement – and therefore might play a more significant role in the decision-making process. There is a common fear that some developing countries may use lower environmental standards to attract new FDI in these sectors, and gain competitive advantages by lowering standards, or failing to raise them. The new position increasingly argues that FDI can facilitate access to environmentally sound technologies that might improve the host country’s environment. It may also lead to some standardization of technologies used across countries and promote the diffusion of environmentally friendly technologies through expanding environmental goods and services.

As some MNCs are pioneers in researching and applying pollution prevention technologies, their affiliates may play a positive role in diffusing them in developing countries. Pollution prevention measures have economic as well as environmental advantages over more conventional ‘end-of-pipe’ solutions. As many observers testify, pollution prevention technologies may not only be less costly than end-of-pipe treatment, but may in some cases generate additional monetary benefits. So it is no surprise that they have been warmly received in developing countries, where such social problems as poverty or unemployment can only be mitigated in a context of sustained and sustainable economic growth.

The idea is therefore to shift from a corrective to a preventative approach. Developing an innovatory capability to find preventive solutions for pollution problems should be a key element in making this fundamental change and an integral part of any policy framework aimed at developing a national system of innovation.

As MNCs move from end-of-pipe towards pollution prevention environmental management approaches, they may do more than merely use such technologies in their developing country affiliates. They may also influence the environmental management of their affiliates’ suppliers, competitors and customers both by setting an example and by introducing their own environmental standards. And they may provide local engineers and technical staff with training in pollution prevention technologies and practices and waste minimization.

Key questions
Key questions are whether MNCs follow the same environmental standards applied in their home country when operating abroad regardless of the host country’s own environmental regulations – and whether their developing country affiliates impose those standards on their suppliers and subcontractors. There are several examples of MNCs which do apply the same environmental standards in affiliates operating abroad as at home, but these tend to be corporations operating in several industrial and service branches, rather than those involved in exploiting natural resources. Indeed liberalizing FDI may encourage some MNCs to rely on exporting domestic natural resources without due regard to the limits of sustainability. Even when MNCs do impose codes of conduct on their affiliates abroad, they may not request that their suppliers or subcontractors follow suit. Many MNCs no longer own and operate the plants in which some components of their products are made, so they subcontract production and act as global distributors. This de-coupling has prompted MNCs to assert that they are not responsible for the environmental conditions or wage levels in factories that manufacture parts of their products. Nevertheless, some do impose codes of conduct on their subcontractors and this can have a positive spill-over on local conditions. Such codes of conduct may go beyond environmental issues, to cover also ethical, health and safety standards.

Positive spill-over
Environmental regulations in developing countries generally tend to be more lax than in developed ones, and this must be taken into account when studying the relationship between FDI and the environment in the developing world. If MNCs apply higher environmental standards in their operations than are required by local regulations – or even simply comply with such regulations – there may be a positive spill-over not only on the environment and social welfare of the host country, but also on the technological upgrading of national firms and competitors. But this is not always the case, and so special attention should be given to the way MNCs operate, taking into account working conditions and the way natural resources are harvested. MNCs may have a negative impact on social development through ‘resource degradation’.

Multinational companies are increasingly considered as leaders in introducing good environmental management practices

Other factors should also be taken into account when studying the impact of FDI on the environment in developing countries. As income rises, some environmental problems are likely to be attenuated while others increase. Among those likely to improve are problems associated with the lack of infrastructure, such as sewage systems and the supply of drinking water. Those likely to get worse are related to higher levels of development and industrialization, such as industrial emissions, toxic waste and urbanization.

Technology diffusion
In industrialized countries, diffusing pollution prevention technologies plays a crucial role in improving the environmental performance of the production sector without lowering its competitiveness. Special attention should thus be paid to this issue and to the role played by MNCs’ affiliates in this respect. There is also a crucial need to develop the knowledge and expertise to handle technological change among local firms so as to take advantage of environmental spill-overs from MNCs’ affiliates and to accomplish the organizational changes required if they are to move towards pollution prevention technologies

Daniel Chudnovsky is Professor of International Business and Development Economics at the University of San Andrés and Director of the Centro de Investigaciones para la Transformación (CENIT), Argentina.

PHOTOGRAPH: Stephen Dupont/UNEP/Topham

Complementary articles in other issues:
Issue on Chemicals and the environment, 2002
Issue on Poverty, Health and the Environment, 2001
Issue on Production and Consumption, 1996

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