Plant Location, Wind Direction and Pollution Policy Under Offshoring

• Published date: 01 August 2017
• Date: 01 August 2017
• DOI: http://doi.org/10.1111/twec.12274

Plant Location, Wind Direction and

Pollution Policy Under Offshoring

Laixun Zhao

1

and Tetsugen Haruyama

2

1

Research Institute of Economics & Business, Kobe University, Kobe, Japan and

2

Faculty of Economics, Kobe University, Kobe, Japan

1. INTRODUCTION

IN ancient Greek mythology, Aeolus is the ruler of wind, controlling its direction and

strength, thereby commanding the worship of sailors and fishermen. In our modern days,

wind direction is an important factor in determining pollution across regions and countries.

1

For instance, sand and dust are blown from west Mongolia and north-west China, carried over

across the Yellow Sea and the Japan Sea and fall as yellow rain in Japan almost every spring;

meanwhile, Japanese firms are moving production facilities to China to take advantage of

lower costs and then importing goods back home; the notorious PM2.5 made news headlines

around the globe, because it is so tiny and light that not only hangs in the air and can be car-

ried far away and to many countries by wind but also can penetrate the filtering organs in a

human body; there are concerns that some countries in Europe build power plants and heavy

industries along their borders so that a part of the pollution emitted can be taken away by

wind; pollution in Hong Kong has substantially increased in recent decades even though many

manufacturing firms have left, to the Pearl River Delta across the border in China, and wind

then carries emissions from these firms back to Hong Kong (BBC News, 2007).

The theoretical literature often treats trans-boundary pollution as symmetric, which in the

real world is rarely the case. Think of water pollution that always flows downstream, or air

pollution which often blows eastwards due to the way the globe spins. It is safe to say that

pollution is more often one way than symmetric, albeit symmetry is technically easier to han-

dle in modelling. This asymmetry makes the polluter even more reluctant to control emission.

The real world can only be more complicated, because many polluters are also victims of

other polluters.

In the present paper, we incorporate explicitly wind direction, by constructing a model of

how wind direction and country/plant location affect pollution and incentives to curb pollu-

tion. We have in mind neighbouring countries such as China and Japan, or Germany and

Poland, etc. Japanese and German firms may undertake foreign direct investment (FDI) in

China and Poland, perhaps due to lower abatement or production costs (e.g. lower wages)

there. But pollution emitted from foreign production may be blown back home. In addition,

We wish to thank an anonymous referee, professor Eden Yu, and participants of SAET (Ischia), WEAI

(Kyoto), ETSG and of workshops at Bari, Colorado, Kobe, Kwansei, TNU and YNU for very useful

comments and suggestions. The usual disclaimer applies.

1

Anecdote has it that in 1991, the then chief economist for the World Bank, Lawrence Summers, wrote

in an internal memo that the World Bank should encourage moving dirty industries to less-developed

countries like Africa, because income and therefore the cost of pollution are low in such countries.

As will be shown in the present paper, with wind direction considered, his logic becomes largely

groundless.

The World Economy (2017)

doi: 10.1111/twec.12274

©2015 John Wiley & Sons Ltd

1646

The World Economy

countries differ in their attitudes towards pollution. Stronger environmentalism may force the

government to take tougher pollution policies, which may impact the three countries

differently.

To examine related issues in a unified framework, we suppose there exist three countries

East (E), West (W) and Home (H), lying on a horizontal line from east to west, with H lying

in the middle and sharing separate borders with the other countries. Production emits pollution

which is carried across country borders by eastbound wind. This problem is identical to one

in which the three countries lie along a river, with W in the upstream, H in the middle and E

in the downstream.

More specifically, one could assume that H is a developed country, while E and W are

developing countries (possibly with much lower wages and other costs). A multinational

enterprise (MNE) in H is considering producing at home as well as undertaking foreign direct

investment (FDI) in both E and W. The relationship between E and H is like that between

Poland and Germany (the less-developed country is downwind), and the one between W and

H is like that between China and Japan (the less-developed country is upwind), or between

the Pearl River Delta and Hong Kong.

Certainly, with the externality generated by wind direction, country/plant location is crit-

ical in determining whether governments choose tough or lax environmental policies. With-

out other distortions, when countries cooperate, they will choose pollution taxes in a

ranking of t

E

<t

H

<t

W

. However, if countries do not cooperate, this ranking can be easily

deviated from, such as when country H cares about firm profits or consumer surplus, or

when its environmentalism is strong. Deviation leads at least one of the upwind countries

to emit more effective pollution, aggravating its own environment as well as that in other

downwind countries. Thus, it is wise for countries to take into account environmentalism

and governments’ preference on profits and consumer welfare, when designing pollution

policies.

One might think that with asymmetric pollution, upwind countries have lower incentives to

impose tougher policies. However, we find that to the contrary, it is the most downwind coun-

try that has the least incentive, because the effectiveness of its policy is diluted by upwind

pollution and its output (pollution) reduction is substituted by other countries. This finding

reiterates the importance of strengthening pollution control in the upwind countries.

When the model is generalised to oligopoly with one firm in each country, we find that

several additional undesirable scenarios may arise. First, each government loosens pollution

control if the domestic firm’s abatement cost rises, in order for the domestic firm to compete

with foreign rivals, thereby generating more pollution; second, the upwind country W may

lower its pollution tax if pollution becomes more trans-boundary (such as in the case of tiny

and light pollutant PM2.5), and the downwind foreign country E may do the same if environ-

mentalism is strong in country H, which generates more pollution for the whole world and

causes worse consequences for global welfare maximisation.

Third, under free trade, an increase in H’s environmentalism may even loosen home pollu-

tion control but tighten those in foreign countries, a result that is completely counter-intuitive.

These stem from each government’s incentives to capture more oligopolistic rents, driving

them to lower domestic pollution taxes and increase domestic outputs, even though it would

increase pollution. In other words, under oligopoly with three firms, the rent capturing incen-

tive dominates the pollution-reducing incentive. And this holds true with more firms, because

the total rents to be shifted from rival firms increase. These results point to the importanc e of

international cooperation in designing relevant pollution-control policies.

©2015 John Wiley & Sons Ltd

WIND DIRECTION AND POLLUTION CONTROL 1647