"...a plant spending $1 million more on pollution abatement investment spends about $1 million less on productive investments."

Do environmental regulations affect corporate investment? In a paper recently published by the NBER, Wayne Gray and Ronald Shadbegian take a close look at the paper industry and find that both the choice of technology used in production and the level of investment are influenced by environmental regulation.

As they began their research on Environmental Regulation, Investment Timing, and Technology Change(NBER Working Paper No. 6036), Gray and Shadbegian visited 10 paper mills in the Northeast and talked to both plant managers and environmental directors. They also interviewed corporate executives and government regulators. "Our visits gave us a much greater appreciation of the differences across plants, especially in their production technology, and the importance of institutional aspects of regulation leading to differences across states in regulatory stringency," they say. These interviews greatly informed the direction of their research. Their visits and discussions provided the basis for statistical analyses, using investment data from the Census Bureau's Longitudinal Research Database and the Lacewood Directory, an industry publication.

The authors confirm that environmental regulations do matter. Plants in states with more stringent environmental rules are less likely to use the "dirtier" production technologies. For example, plants using mechanical pulping tend to generate more air pollution, and this technology is less common in states with stricter air quality regulations. By the same token, sulfite pulping, which is associated with more water pollution, is less likely in states with tougher water pollution rules.

State regulatory strictness doesn't significantly influence total investment spending. However, the timing of investment is affected, as plants bunch together pollution abatement and productive investment, probably reflecting the high cost of shutting down a plant for renovations. Also, it appears that plants with steep bills for pollution abatement have less money available for other investments. The results indicate nearly complete crowding out: a plant spending $1 million more on pollution abatement investment spends about $1 million less on productive investments, averaged over the time period studied.

The authors began their paper asking, "How much can economists learn from [directly observing] the 'real world'? Can plant visits and conversations with people in the industry suggest hypotheses to test, or modeling strategies? Is empirical research helped (or hindered) by understanding institutional details?" In light of their study, the answer is clearly yes -- economists learn a lot from engaging the real world.

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