Do environmental provisions in preferential trade agreements reduce emissions traded in global value chains?

Fairuz, Maisha; Foster-McGregor, Neil Working Paper Do environmental provisions in preferential trade agreements reduce emissions traded in global value chains? ADB Economics Working Paper Series, No. 755 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Fairuz, Maisha; Foster-McGregor, Neil (2024) : Do environmental provisions in preferential trade agreements reduce emissions traded in global value chains?, ADB Economics Working Paper Series, No. 755, Asian Development Bank (ADB), Manila, https://doi.org/10.22617/WPS240541-2 This Version is available at: https://hdl.handle.net/10419/310378 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/3.0/igo/ ASIAN DEVELOPMENT BANK ASIAN DEVELOPMENT BANK 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org DO ENVIRONMENTAL PROVISIONS IN PREFERENTIAL TRADE AGREEMENTS REDUCE EMISSIONS TRADED IN GLOBAL VALUE CHAINS? Maisha Fairuz and Neil Foster-McGregor ADB ECONOMICS WORKING PAPER SERIES NO. 755 December 2024 Do Environmental Provisions in Preferential Trade Agreements Reduce Emissions Traded in Global Value Chains? This paper examines whether preferential trade agreements (PTAs) increase emissions embodied in trade, further considering whether environmental provisions in PTAs affect this relationship. The results suggest PTAs are associated with increased emissions embodied in trade, with this effect mainly because of increased trade between PTA partners. The presence of an environmental provision in PTAs, however, mitigates this effect, with environmental provisions reducing both the scale of trade and the emissions intensity of that trade. About the Asian Development Bank ADB is committed to achieving a prosperous, inclusive, resilient, and sustainable Asia and the Pacific, while sustaining its efforts to eradicate extreme poverty. Established in 1966, it is owned by 69 members —49 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. ASIAN DEVELOPMENT BANK The ADB Economics Working Paper Series presents research in progress to elicit comments and encourage debate on development issues in Asia and the Pacific. The views expressed are those of the authors and do not necessarily reflect the views and policies of ADB or its Board of Governors or the governments they represent. ADB Economics Working Paper Series Do Environmental Provisions in Preferential Trade Agreements Reduce Emissions Traded in Global Value Chains? Maisha Fairuz and Neil Foster-McGregor No. 755 | December 2024 Maisha Fairuz ([email protected]) is a PhD fellow at Maastricht University. Neil Foster-McGregor ([email protected]) is a senior economist at the Economic Research and Development Impact Department, Asian Development Bank. Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) © 2024 Asian Development Bank 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines Tel +63 2 8632 4444; Fax +63 2 8636 2444 www.adb.org Some rights reserved. Published in 2024. 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Corrigenda to ADB publications may be found at http://www.adb.org/publications/corrigenda. Notes: In this publication, “$” refers to United States dollars. ADB recognizes “China” as the People’s Republic of China. ABSTRACT While global value chains (GVCs) are considered an important development escalator, concerns over their environmental consequences have been increasing. By providing opportunities to shift production to developing economies, GVCs risk carbon leakage. Preferential trade agreements (PTAs) have proved important drivers of GVC trade. In this paper we examine whether the presence and breadth of PTAs is associated with increased emissions embodied in GVC trade, and further ask whether the presence of environmental provisions in PTAs impacts upon emissions traded in GVCs. Our results suggest that the presence of a PTA between partners is associated with increased emissions embodied in GVC trade, with this effect largely the result of increased GVC trade between PTA partners. We also show, however, that the presence of an environmental provision in PTAs can mitigate this effect, with environmental provisions reducing both the scale of GVC trade and the emissions intensity of that trade. Keywords: global value chains, CO2 emissions, preferential trade agreements, gravity model JEL codes: F13, F18, Q56 ______________________ Early drafts of this paper were presented in the Asian Economic Integration Report (AEIR) Theme Chapter Workshop (October 2023), the Asian Development Bank’s Economist Forum (January 2024), and at the UK Trade Policy Observatory, University of Sussex (March 2024). 1. INTRODUCTION Global value chains (GVCs) have become a critical part of the global trade network, driving economic development and industrialization by enabling economies to specialize in specific stages of production rather than entire industries (Bank 2019; Taglioni and Winkler 2016). This fragmentation of production has provided developing economies in particular with a more accessible path to industrialization (Baldwin 2018). However, alongside economic benefits, GVCs have been linked to a growing share of global CO2 emissions. Carbon-intensive production stages, such as intermediate manufacturing, can be offshored to economies with weaker environmental protection, resulting in relocation rather than a reduction in global CO2 emissions (Peters et al. 2011). With this offshoring often taking place from developed to developing economies that have weaker environmental standards and are more emissions intensive in production, this carbon leakage can result in higher emissions overall. Whereas the evidence of carbon leakage remains weak, the possibility raises questions regarding trade liberalization policies and the resulting environmental footprint (Antweiler, Copeland, and Taylor 2001; Dean 2002; Lopez 2017). Over the past few decades, preferential trade agreements (PTAs) have facilitated trade liberalization, which has in turn promoted a deeper integration of economies into GVCs (Delera and Foster-McGregor 2020). Simultaneously, PTAs have evolved to encompass broader issues (Mattoo, Rocha, and Ruta 2020), including environmental provisions aimed at mitigating the environmental impacts of trade. The central question is whether PTAs, by promoting GVC trade, contribute to higher CO2 emissions, and if inclusion of environmental provisions within these agreements can effectively reduce emissions or emissions intensity. From a theoretical perspective, GVCs influence the CO2 emissions of an economy through three primary channels. First, a scale effect results from the expected positive impact of GVCs on productivity and production, resulting in higher emissions produced (Antweiler, Copeland, and Taylor; Wang, Wan, and Wang 2019). Second, GVCs may alter the composition of production, often shifting it toward more emissions-intensive manufacturing sectors, especially in developing economies. However, the relationship between GVC participation and emissions per capita may be nonlinear as a high enough participation rate may have a negative influence on emissions (Wang, Wan, and Wang 2019). This is the structure effect, whereby GVCs change the composition of productive activities within an economy, resulting in changes in the economy’s emissions profile. Third, the technology effect suggests that GVC participation can lead to the diffusion of cleaner technologies, potentially reducing the carbon intensity of production (Delera et al. 2022; Gries et al. 2018). PTAs, particularly those with strong environmental provisions, can impact all three of these channels. While PTAs promote GVC trade, they can also influence the structure of production and encourage technology sharing through regulatory harmonization and 2 cross-border investments. Nevertheless, the presence of environmental provisions within PTAs further confounds these expected effects. For instance, environmental provisions that are restrictive may have a negative effect on trade, ultimately leading to a negative scale effect through PTAs. Moreover, the role of legal enforceability of these provisions remains underexplored within a GVC context. Finally, such changes in PTA design also raise questions of how costs and benefits from such agreements are distributed among members of different income levels. Using GVC data from the EORA multiregional input-output tables (Lenzen et al. 2012, 2013) and PTA data from Hofmann, Osnago, and Ruta (2017), we study the effect of PTAs, particularly PTA breadth and the presence of environmental provisions, on CO2 emissions embodied in GVC trade. While PTAs are expected to increase emissions through the scale effect, the existence of environmental provisions may mitigate this. We find that PTAs do increase CO2 emissions in GVCs. However, the presence of environmental provisions offsets most of the increase in GVC-related emissions, most likely through trade restrictive clauses. Our results indicate that environmental provisions reduce GVC emissions through the structure and technology effect. In addition, we explore whether legal enforceability of these environmental provisions makes them more effective in reducing emissions in GVC trade. We find that both enforceable and nonenforceable environmental provisions have negative effects on emissions traded in GVCs, finding in some cases that non-enforceable provisions are more effective. Finally, we assess whether the effects of environmental provisions and PTAs in general for environmental consequences differ based on the income level of the economies. We find that the scale effect predominates in low, upper-middle and high-income economies, but the intensity effect (i.e., structure and technology effects) is more pronounced in lowermiddle income economies. The following section reviews the literature on the role of GVCs in global emissions and the effect of PTAs in driving trade. It also reviews literature on the consequences of increasing the breadth of PTAs, especially the environmental provisions. Section 3 outlines the econometric specification in relation to the scale, structure, and technology effects, and describes the construction of indicators of CO2 emissions embodied in GVC trade. Section 4 presents the results and section 5 provides a discussion and conclusion. 3 2. LITERATURE REVIEW Impact of GVC Trade on CO2 Emissions GVCs involve the fragmentation of production processes across multiple economies, a trend which has dramatically reshaped the global economy and trade dynamics. Their environmental implications, particularly regarding CO2 emissions, have been studied from both the production and consumption perspective, and tied to ecologically unequal exchange (Althouse et al. 2023; Meng et al. 2018; Moran et al. 2013; Wang, He, and Song 2021). GVCs account for an increasing share of CO2 emissions and present the risk of carbon leakage, with carbon intensive stages of production moving to economies with weak environmental protection and relatively emissions intensive production processes.1 High-income economies may outsource pollution-intensive production processes to lower-income economies, effectively transferring the emissions burden while reaping the benefits of clean final production (Kanemoto et al. 2012). This phenomenon, termed “carbon leakage,” potentially exacerbates the environmental impact of GVCs as reductions in emissions in one economy can be offset by increases in another (Babiker 2005) . Although the evidence in favor of carbon leakage is rather weak (Grubb et al. 2022), the potential for carbon leakage is one argument put forward to support the introduction of the European Union’s Carbon Border Adjustment Mechanism (CBAM) (Nordström 2023) and remains a concern as carbon prices being to rise and carbon pricing is introduced in more jurisdictions (Black, Parry, and Zhunussova 2022). As mentioned, GVCs can affect CO2 emissions through three main channels. The scale effect occurs when GVCs result in increased production, which in turn increases overall emissions (Al-Mulali and Sheau-Ting 2014; Weber et al. 2008). The structure effect involves GVCs shifting production toward dirty sectors, usually in manufacturing, which results in more carbon-intensive production (Guo, Zou, and Wei 2010; Kumbaroğlu 2011; Stöllinger 2016; Zhao et al. 2017). Finally, the technology effect considers GVCs as a source of technological change that can reduce CO2 emissions and emissions intensities (Morrison, Pietrobelli, and Rabellotti 2008; Okushima and Tamura 2010; Wang, He, and Song 2021; Zhang et al. 2021). Given these channels, there is an expectation that the scale and structure effect of GVCs works to increase CO2 emissions embodied in GVC trade, while the technology effect decreases emissions. The Role of PTAs in Driving GVC Trade and Increasing Breadth of PTAs The proliferation of PTAs has been a crucial driver of GVC expansion by promoting trade liberalization and reducing barriers to trade. PTAs facilitate the cross-border movement of goods and services, particularly intermediate goods, which are central to GVCs. This is achieved through tariff reductions, harmonization of standards, and investment protections that enhance trade flows between member economies (Baldwin 2013). Moreover, the design of PTAs can influence the extent to which they promote GVC integration. The horizontal depth or breadth of a PTA—measured by the 1 This alludes to the pollution haven hypothesis, which is explored later in the literature review. 4 comprehensiveness of its provisions, such as the inclusion of investment rules, intellectual property rights, and dispute settlement mechanisms—has been shown to correlate positively with GVC trade (Boffa, Jansen, and Solleder 2019; Delera and FosterMcGregor 2020; Laget et al. 2020). The expansion of PTAs beyond traditional trade liberalization reflects the growing recognition that trade agreements must also address the environmental challenges posed by increased global economic integration. While early PTAs primarily focused on tariff reductions and market access, more recent agreements have included environmental provisions to ensure that trade does not come at the cost of environmental degradation. These provisions are designed to harmonize environmental standards across signatory economies, promoting sustainable development and reducing the risk of negative externalities, such as pollution from GVCs (Morin, Dür, and Lechner 2018). The inclusion of environmental provisions is now seen as essential to ensuring that trade liberalization supports not only economic growth but also environmental protection, particularly in industries deeply integrated into GVCs. In theory, this shift in PTA design should have an impact on CO2 emissions in GVC trade, as environmental provisions impose commitments on member economies to uphold environmental standards, adopt cleaner technologies, and reduce emissions embodied in trade flows (Martínez-Zarzoso and Oueslati 2018). These trends further highlight the dual role of PTAs with environmental provisions. PTAs, by reducing trade barriers, are expected to increase trade among members which, in turn, increases emissions. This positive correlation between trade and emissions is well documented in empirical literature. At the same time, environmental provisions in PTAs can offset this increase in emissions through a change in structure of trade or technology transfer that allows cleaner production and trade. The Rise of Environmental Provisions in PTAs Brandi et al. (2020) argue that environmental provisions within PTAs affect trade through both trade restrictive and liberal mechanisms. Restrictive environmental provisions are designed to limit carbon-intensive trade flows either through stringent regulations on environmental standards or through restricting trade in ‘dirty’ goods. Liberal environmental provisions, on the other hand, are geared toward facilitating ‘green’ trade through reductions in trade barriers in environmental goods and facilitating the adoption of clean technologies or promoting eco-friendly trade practices, which may enhance competitiveness by driving innovation and efficiency—a premise consistent with the Porter Hypothesis (Porter 1991; Porter and van der Linde 1995). According to the Porter Hypothesis, well-designed environmental regulations can stimulate innovation, leading to “win-win” outcomes where both environmental quality and economic performance improve (Mealy and Teytelboym 2022). This is analogous to the technology effect outlined earlier. While environmental provisions garner public support, some studies argue that they can be used as a bargaining tool in trade agreement negotiations as well as a mechanism to restrict the competitiveness of those economies with the fewest environmental 11 Figure 2 shows the overall trend in GVC emissions split over economy pairs within PTAs and without PTAs. Emissions that result from non-PTA based GVC trade is much greater than PTA related emissions throughout the period. While both are steadily increasing, largely because of increased trade in GVCs, PTA related emissions are growing much faster. PTA related emissions were about 10% of total GVC emissions in 1990 and grew to about 35% by 2010 and remained around that share for the rest of the period. For purposes of comparison, Figure 3 shows the trends in the total value of GVC exports for 1990–2015, again decomposed into PTA and non-PTA trade. The growth trajectory of GVC exports show a similar pattern to emissions, although with a more dramatic increase in exports after 2000. In 1990, economy-pairs with a PTA represented about 22% of total GVC exports, but this had increased to 46% by 2015. These two figures highlight the growing relevance of PTA related GVC activities and the emissions embodied in them. Emissions that result from GVCs grew by 3.6% per year, on average, while exports in GVCs grew by 6.5%. The growth rates for pairs not in PTAs were 5.4% for exports and 2.4% for emissions, whereas for pairs in PTAs the numbers were 9.0% for exports and 8.6% for emissions. These differences highlight the growing importance of GVC trade within PTAs, further suggesting that while emissions intensity has been declining for both PTA and non-PTA related GVC trade, the decline has been faster for non-PTA GVC trade. Figure 2: Trend in GVC Emissions: PTA vs. Non-PTA, 1990–2016 GVC = global value chain. MT = metric tons, PTA = preferential trade agreement. Source: OECD TeCO2 database (https://www.oecd.org/en/data/datasets/greenhouse-gas-footprint-indicators.html) (accessed 15 November 2023). 0 1,000 2,000 3,000 4,000 5,000 6,000 Millions of MT GVC emimssions (No PTA) GVC emissions (PTA) 12 Figure 3: Trend in GVC Exports: PTA vs. Non-PTA, 1990–2016 GVC = global value chain, PTA = preferential trade agreement. Source: Author’s calculations using OECD Inter Country Input Output Tables (https://www.oecd.org/en/data/datasets/inter-country-input-output-tables.html) and OECD TeCO2 database (https://www.oecd.org/en/data/datasets/greenhouse-gas-footprint-indicators.html) (accessed 15 November 2023). Figure 4 shows the share of total GVC emissions by income level of the exporter, with about 90% of emissions being due to exports of upper-middle and high-income economies. While the combined share remains mostly stable throughout the period, there is a slight increase in the emissions share due to upper-middle income economies over time. The share of lower-middle income economies also showed signs of an increase, with the share rising from 6.2% in 1990 to 14.2% in 2016. At the same time, the share of high-income economies dropped from 51% to 41.5%. Several factors may explain these dynamics. First, middle income economies have increased their integration into GVCs, meaning that they account for a higher share of GVC exports (Figure 5). The share of GVC exports of high-income economies has fallen from 83% in 1990 to 65% in 2016. Second, technological change in more developed economies may have resulted in increased emissions efficiency that has reduced their contribution to emissions. Given imperfect diffusion of technologies, such developments would disproportionately benefit emissions efficiency in developed economies. Third, the changes may also be linked to the pollution haven hypothesis, with developed economies offshoring some of their dirtier activities to developing economies. This can also be considered, therefore, to represent a shift in the structure of GVCs between developed and developing economies. 0 2,000 4,000 6,000 8,000 10,000 12,000 $ billion GVC exports (no PTA) GVC exports (PTA) 13 Figure 4: Emissions in GVCs by Income Level GVC = global value chain. Source: Author’s calculations using OECD Inter Country Input Output Tables (https://www.oecd.org/en/data/datasets/inter-country-input-output-tables.html) and OECD TeCO2 database (https://www.oecd.org/en/data/datasets/greenhouse-gas-footprint-indicators.html) (accessed 15 November 2023). Figure 5: Exports in GVCs by Income Level GVC = global value chain. Source: Author’s calculations using OECD Inter Country Input Output Tables (https://www.oecd.org/en/data/datasets/inter-country-input-output-tables.html) (accessed 15 November 2023). 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Low Income Lower-Middle Income Upper-Middle Income High Income 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Low Income Lower-Middle Income Upper-Middle Income High Income 14 5. RESULTS Estimating the Impact of the Presence and Breadth of a PTA On Emissions in GVC Exports Table 1 reports the main regression results, including results on the impact of the presence and the breadth of PTAs on emissions embodied in GVC exports, and the impact of environmental provisions on GVC-related emissions. The table further reports results using a standard fixed-effects regression approach and using Poisson Pseudo Maximum Likelihood (PPML) methods. Following much of the recent literature using the gravity equation we estimate a structural gravity model that includes economy-pair and importer-time and exporter-time fixed effects. Results in Table 1 (Column 1) suggest that the existence of a PTA between economy-pairs is associated with an increase in emissions in GVC exports of around 5.2%.2 This suggests that even after accounting for exporter, importer and pair characteristics, PTAs are associated with higher emissions embodied in GVC trade. The reasons for this increase are likely related to the impact that PTAs have on GVC trade, with increases in GVC trade because of PTAs increasing emissions embodied in trade. The decomposition results that follow provide more insights. Results using the measure of PTA breadth—that is, the share of the 52 provisions included in the PTA agreement—instead of PTA presence give similar results (column 2 of Table 1). The statistically significant coefficient estimate of 0.0392 suggests that a move from no PTA to the broadest PTA is associated with an increase in emissions embodied in GVC exports of around 4%.These results suggest that even comprehensive PTAs may increase the emissions in GVC exports, though the effect is relatively small, and we have not accounted for any nonlinearities in the relationship between PTA breadth and GVCrelated emissions. To examine this potential nonlinearity, we next consider whether the presence of an environmental provision in PTAs offsets this observed positive impact of PTA presence on GVC-related emissions. 2 Calculated as 𝐺𝐺𝐺𝐺𝐺𝐺(𝛽𝛽)−1. 15 Table 1: Estimating the Impact of the Presence and Breadth of a PTA on Emissions in GVC Exports Fixed-Effects Estimator PPML (1) (2) (3) (4) (5) (6) (7) (8) PTA Dummy 0.0506*** 0.0960*** 0.0481*** 0.0491*** (0.00408) (0.00721) (0.0180) (0.0183) PTA Breadth 0.0392*** 0.0976*** 0.0433* 0.0433* (0.00465) (0.0110) (0.0256) (0.0258) Env. Provision -0.0749*** -0.0655*** -0.0544*** -0.0455** -0.0554*** -0.0456** (0.00783) (0.0100) (0.0181) (0.0210) (0.0183) (0.0212) Constant 7.324*** 7.326*** 7.324*** 7.326*** (0.000371) (0.000298) (0.000360) (0.000296) Economy Pair FE Yes Yes Yes Yes Yes Yes Yes Yes Importer-Time, Exporter-Time FE Yes Yes Yes Yes Yes Yes Yes Yes Observations 751,937 751,937 751,937 751,937 751,937 751,937 752,837 752,837 R-squared 0.995 0.995 0.995 0.995 0.995 0.995 0.995 0.995 Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1. GVC = global value chain, PTA = preferential trade agreement. Source: Author’s calculations. Estimating the Impact of the Presence of an Environmental Provision in PTAs on Emissions in GVC Exports To consider the role of the presence of an environmental provision, columns 3 and 4 of Table 1 introduce the dummy variable capturing the presence of an environmental provision. Qualitatively, the coefficients on the PTA variables remain positive and significant, though the size of the coefficients is somewhat larger than in columns 1 and 2. Focusing on the coefficient on the environmental provision dummy variable we see that coefficients are negative and significant. Coefficients on the environmental provision dummy are similar when included alongside the PTA dummy and PTA breadth variable. In the case of the PTA dummy, the coefficient on the environmental provision variable suggests that the presence of an environmental provision is associated with a reduction in GVC-related emissions of around 7.2%, while when including the PTA breadth variable an environmental provision is associated with a reduction in GVC-related emissions of 6.3%. While these estimated reductions are lower than the increase in emissions associated with the presence or breadth of a PTA, the effects are substantial. In the case of the PTA dummy, the estimated reduction in GVC-related emissions because of the presence of an environmental provision is around 72% of the increase in GVC-related emissions associated with the presence of a PTA. These findings suggest that while PTAs facilitate trade and increase emissions, environmental provisions within these agreements play a critical role in mitigating these effects. Estimating Effects of PTAs and Environmental Provisions Using PPML The results in the first four columns of Table 1 use fixed effects structural gravity models and provide support for the view that even as PTAs increase GVC-related emissions traded between PTA partners, the presence of an environmental provision in those 16 agreements can offset this increase. The use of PPML methods have become an increasingly popular way of dealing with the presence of zero trade flows and heteroscedasticity (Santos and Tenreyro 2006). For our purpose, there are good reasons for avoiding using PPML. The dependent variable in our analysis, the emissions embodied in GVC exports, is constructed using multiregional input-output tables and methods. In principle, there should be no zero observations when constructing these data, with any zero values being the result of missing observations rather than zero trade flows. Including the zero values, therefore, is not recommended. In addition, the approach that we adopt relies on a decomposition of GVC-related emissions into a scale and intensity effect, with the intention being to decompose the effect of PTAs and environmental provisions into an effect working on these two terms. This can be achieved using a linear model, such as OLS or fixed effects regression models, but the decomposition breaks down for the nonlinear PPML model. Despite these arguments, it is useful to examine whether results obtained using the standard fixed-effects model also hold when using the alternative PPML approach. The final four columns of Table 1, therefore, report results using the PPML estimator. The results when using PPML include both economy-pair and importer-time and exporter-time fixed effects. Columns 5 and 6 of Table 1 report results from models estimated on the same set of observations as used in the first four columns, thus avoiding including missing values in the regression model, while the final two columns include the full set of observations. The results are consistent and indicate a positive impact of PTA presence and PTA breadth on GVC-related emissions and a negative impact of an environmental provision. Focusing on columns 5 and 6, the results suggest that the presence of a PTA is associated with an increase in GVC-related emissions of about 4.9%, with the broadest PTA associated with an increase of 4.4%. Conversely, the presence of an environmental provision is associated with a reduction in GVC-related emissions of between 4.4% and 5.3% depending on the specification. These results are thus consistent with those reported using standard fixed effects models, although in the case of PPML the presence of an environmental provision tends to more than offset the increase in GVC-related emissions associated with the presence of a PTA. Given the challenges of the PPML for our approach, in the rest of the paper we focus on standard fixed-effects regression models. 17 Do Legally Enforceable Environmental Provisions Have Differential Effects on GVC Exports? While the above results show that the presence of environmental provisions has a consistent negative effect on emissions, we can further assess whether the enforceability of such provisions causes a differential impact. Table 2 extends the previous analysis using an interaction between the environmental provision variable and whether the provision is legally enforceable. For comparison the table includes the results from columns 3 and 4 of Table 1. Focusing on the results on the environmental provision variable, the first thing to note is that the coefficient on the combined environmental provision variable lies between the coefficients for enforceable and non-enforceable provisions as would be expected. When included alongside the PTA dummy, the results indicate that environmental provisions that are not legally enforceable are associated with a decrease in GVCrelated emissions of about 9%, while provisions that are legally enforceable are associated with a 6% reduction in GVC-related emissions. The two coefficients are significantly different. This is interesting because the non-enforceable provisions seem to be more effective in reducing emissions. This may be because non-enforceable provisions signal a commitment to environmental standards or because they are backed by international pressure or norms that encourage compliance even without legal enforcement. While legally enforceable provisions are still effective, the smaller magnitude might suggest that their impact is more dependent on how strictly they are enforced or on the specific legal and institutional frameworks of the economies involved. Including the two environmental provision variables alongside the PTA breadth variable gives results that are qualitatively similar. Non-legally enforceable PTAs are associated with a 7.1% decrease on GVC-related emissions, and legally enforceable ones with a 5.8% reduction. While the impact is slightly smaller than those in column 2, the results still suggest that both enforceable and non-enforceable provisions can be effective in reducing emissions. In this case, there are no significant differences in the size of the two coefficients. Given challenges in enforcing environmental provisions related to differences in environmental standards across various jurisdictions, as well as having effective legal mechanisms that allow enforcement, the result that non-enforceable provisions in PTAs are associated with reductions in GVC-related emissions provides some reassurance and support for the signaling role of environmental provisions. 18 Table 2: Regression Results Distinguishing between Legally Enforceable and Non-enforceable Environmental Provisions in PTAs (1) (2) (3) (4) PTA Dummy 0.0960*** 0.0963*** (0.00721) (0.00721) PTA Depth 0.0976*** 0.0957*** (0.0110) (0.0110) Env. Provision -0.0749*** -0.0655*** (0.00783) (0.0100) Env. Provision (Not Legally Enforceable) -0.0859*** -0.0686*** (0.00873) (0.0103) Env. Provision (Legally Enforceable) -0.0579*** -0.0568*** (0.00856) (0.0111) Constant 7.324*** 7.324*** 7.326*** 7.326*** (0.000360) (0.000362) (0.000296) (0.000296) Year FE No No No No Economy FE Yes Yes Yes Yes Importer-Time, Exporter-Time FE Yes Yes Yes Yes Observations 751,937 751,937 751,937 751,937 R-squared 0.995 0.995 0.995 0.995 Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1. PTAs = preferential trade agreements. Source: Author’s calculations. Decomposing the Effect of PTAs and Environmental Provisions into a Scale and Intensity Effect After identifying an effect of PTAs and environmental provisions in PTAs on GVC-related emissions, we move to assess the scale and intensity effect by decomposing GVC-related emissions. Results are reported in Table 3, and the analysis focuses on results using PTA breadth rather than the PTA dummy for reasons of brevity. In this table, models 1 and 4 shows the effect on GVC-related emissions and are replicated from Table 1 and Table 2 above, with models 2 and 5 reporting results with GVC-related exports as the variable (capturing the scale effect) and columns 3 and 6 results when GVC-related emissions intensity is the dependent variable (capturing the emissions intensity effect). In terms of the scale effect, results from model 2 suggests that a shift from no PTA to the broadest PTA is associated with a 6.7% increase in GVC exports, while the presence of an environmental provision is associated with 3.9% reduction in GVC exports. The corresponding results for the intensity effect in model 3 show that a shift to the broadest PTA is associated with a 3.29% increase in emission intensity of GVCs and the presence of environmental provisions in PTAs is associated with a 2.73% reduction. Using these results and those from model 1 it is possible to decompose the overall effect of PTAs and environmental provisions in PTAs into a scale and intensity effect. The results suggest that about 67% (i.e., 0.0652/0.0976) of the overall effect of PTA breadth on GVC-related emissions is due to an increase in the scale of GVC exports in response to a PTA, with the remaining share a result of an increase in emissions intensity, likely because of a change in the structure of GVC exports toward more emissions intensive sectors, such as manufacturing. The scale effect is also found to account for most of the overall effect of the environmental provision (-0.0387/-0.0655=0.59), with the intensity effect accounting for the remaining 41% of the overall effect. Environmental provisions thus 19 seem to work by reducing the level of GVC exports between trade partners, but also by reducing the emissions intensity of GVC-related exports. This latter result would be consistent with environmental provisions shifting the structure of GVC exports toward cleaner sectors. The results do not preclude the possibility of environmental provisions also resulting in increased technology diffusion that improves emissions intensity, but we cannot distinguish between the structural and technology effect in our results. Results when splitting between enforceable and non-enforceable environmental provisions are qualitatively similar to the results in models 1–3, with the presence of environmental provisions—legally enforceable or not—associated with lower GVC exports and the emissions intensity of those exports. The results suggest that the size of the coefficient for non-enforceable environmental provisions is larger (in absolute value) than that for enforceable provisions in the case of emissions intensity, a difference that is statistically significant. For GVC exports there is no significant difference in coefficients between non-enforceable and enforceable environmental provisions, though in this case the coefficient is larger (in absolute value) for enforceable provisions. There are differences in the importance of the scale and intensity effects between enforceable and non-enforceable provisions. For non-enforceable provisions, the scale and intensity effect account for a similar share of the overall effect. The scale effect accounts for 53% of the reduction in GVC-related emissions from an environmental provision, and the intensity effect accounts for 47%. In the case of enforceable provisions, however, the scale effects accounts for 79% of the overall reduction in GVC-related emissions, whereas the intensity effect accounts for 21%. The results suggest that enforceable environmental provisions have a much stronger impact on overall emissions by reducing GVC exports but are less successful in reducing emissions intensities. Table 3: Decomposing the Effect of PTAs and Environmental Provisions on GVCRelated Emissions (1) (2) (3) (4) (5) (6) Emissions Exports Emissions Intensity Emissions Exports Emissions Intensity PTA Depth 0.0976*** 0.0652*** 0.0324*** 0.0957*** 0.0666*** 0.0291*** (0.0110) (0.0104) (0.00486) (0.0110) (0.0104) (0.00482) Env. Provision -0.0655*** -0.0387*** -0.0269*** (0.0100) (0.00946) (0.00448) Env. Provision (Not Legally Enforceable) -0.0686*** -0.0364*** -0.0322*** (0.0103) (0.00971) (0.00462) Env. Provision (Legally Enforceable) -0.0568*** -0.0450*** -0.0118** (0.0111) (0.0103) (0.00488) Constant 7.326*** 14.30*** -6.977*** 7.326*** 14.30*** -6.977*** (0.000296) (0.000263) (0.000132) (0.000296) (0.000263) (0.000132) Year FE No No No No No No Economy FE Yes Yes Yes Yes Yes Yes Importer-Time, Exporter-Time FE Yes Yes Yes Yes Yes Yes Observations 751,937 751,937 751,937 751,937 751,937 751,937 R-squared 0.995 0.996 0.995 0.995 0.996 0.995 Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1. GVC = global value chain, PTA = preferential trade agreement. Source: Author’s calculations. 20 Impacts of PTAs and PTA Provisions on Emissions in GVC Exports by Exporter’s Income Level We extend the analysis by assessing whether the magnitude of the overall scale and intensity effect depends on the income level of the exporter. By examining the effects of PTAs and environmental provisions on emissions in GVC trade by income group, we are interested in understanding whether the burden and benefits of these show heterogeneous effects and whether they fall on specific economy groups. One argument that we consider relevant is the idea that since low-income countries tend to have lower bargaining power in negotiations over trade agreements, they may be required to accept more stringent environmental standards in trade agreements than they would prefer. In contrast, in high-income economies environmental stringency in trade agreements may not differ substantially from that already in existence. A further argument is that given comparative advantage low-income countries may tend to specialize in more emissionintensive activities in GVCs and, therefore, their exports may be disproportionately affected by the environmental provisions in PTAs. Conversely, such provisions may favor low-income countries by enabling the diffusion of green technologies that can reduce emissions traded in GVCs. While it is not straightforward to distinguish between these different hypotheses, combined they provide a strong motivation to consider the possibility of heterogeneous effects of environmental provisions in PTAs by income level. Results are reported in Table 4, with three sets for each income group, these being when the dependent variable is: (i) the logged level of GVC-related emissions; (ii) the log of GVC exports; and (iii) the log of the emissions intensity. The results for low-income countries indicate that a shift from no PTA to the broadest PTA is associated with an increase in GVC-related emissions of 58%, and two-thirds of this is due to the scale effect and the rest is due to the intensity effect. The effect of an environmental provision is to reduce the emissions embodied in PTAs by about 20%, substantially lower than the overall effect of the deepest PTA. This reduction works through both the scale and intensity effect, with the scale effect accounting for around 59% of the overall effect. The results thus suggest that environmental provisions seem to be effective in mitigating the effects of PTAs in low-income countries through regulations that limit the export of emission intensive goods (scale effect) and possibly encouraging cleaner technology that reduces emissions intensity (intensity effect). Results for lower-middle and upper-middle income economies present some differences from those for low-income countries and relative to each other. 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Journal of Cleaner Production 142, 3500–16. Zhou, L., X. Tian, and Z. Zhou. 2017. The Effects of Environmental Provisions in RTAs on PM2. 5 Air Pollution. Applied Economics 49(27): 2630–41. ASIAN DEVELOPMENT BANK ASIAN DEVELOPMENT BANK 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org DO ENVIRONMENTAL PROVISIONS IN PREFERENTIAL TRADE AGREEMENTS REDUCE EMISSIONS TRADED IN GLOBAL VALUE CHAINS? Maisha Fairuz and Neil Foster-McGregor ADB ECONOMICS WORKING PAPER SERIES NO. 755 November 2024 Do Environmental Provisions in Preferential Trade Agreements Reduce Emissions Traded in Global Value Chains? This paper examines whether preferential trade agreements (PTAs) increase emissions embodied in trade, further considering whether environmental provisions in PTAs affect this relationship. The results suggest PTAs are associated with increased emissions embodied in trade, with this effect mainly because of increased trade between PTA partners. The presence of an environmental provision in PTAs, however, mitigates this effect, with environmental provisions reducing both the scale of trade and the emissions intensity of that trade. About the Asian Development Bank ADB is committed to achieving a prosperous, inclusive, resilient, and sustainable Asia and the Pacific, while sustaining its efforts to eradicate extreme poverty. Established in 1966, it is owned by 69 members —49 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance.